by From Peter Radford This is just for fun. It’s nearly the holiday season after all. Let’s tell a story: a friend of ours here in southern Vermont was looking for a job. She saw an advertisement posted by a local business. Or, perhaps, she heard something about a job from a friend. In any case she applied and got the job. Well done. Her wage is, naturally, determined by her marginal productivity. We all know that. All wages are determined by individual worker marginal productivity. Right? Our friends’ new employer has an education in economics and remembers what Mankiw says: “Economic theory says that the wage a worker earns, measured in units of output, equals the amount of output the worker can produce. Otherwise, competitive firms would have an incentive to alter the number of
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from Peter Radford
This is just for fun. It’s nearly the holiday season after all.
Let’s tell a story: a friend of ours here in southern Vermont was looking for a job. She saw an advertisement posted by a local business. Or, perhaps, she heard something about a job from a friend. In any case she applied and got the job.
Well done.
Her wage is, naturally, determined by her marginal productivity. We all know that. All wages are determined by individual worker marginal productivity.
Right?
Our friends’ new employer has an education in economics and remembers what Mankiw says:
“Economic theory says that the wage a worker earns, measured in units of output, equals the amount of output the worker can produce. Otherwise, competitive firms would have an incentive to alter the number of workers they hire, and these adjustments would bring wages and productivity in line. If the wage were below productivity, firms would find it profitable to hire more workers. This would put upward pressure on wages and, because of diminishing returns, downward pressure on productivity. Conversely, if the wage were above productivity, firms would find it profitable to shed labor, putting downward pressure on wages and upward pressure on productivity. The equilibrium requires the wage of a worker equaling what that worker can produce.”
That’s pretty clear. Open and shut.
Our friend’s wage is determined by her output. Measured in units.
That’s interesting. Our friend is an accountant. Her output is reports and so on.
Nevertheless her wage matches her output in numbers of reports. Or so the story goes. And, naturally, her new employer has that information close to hand. As they do for every single one of the several hundred positions they have to fill. All employers have all that data to hand when they hire people. Employers are, as we all know, all knowing.
Aren’t they?
Of course they are!
Back to the story: our friend —Jane — is happily producing marginally. Meanwhile her employer — Anne — hears that a local factory has just been re-organized and its accounting function has been moved to the headquarters in another state. There are a few accountants looking for work. One of whom is well known to Anne — they play tennis together. During a conversation after a game Anne learns that this other accountant, who has more experience than Jane, is willing to work for less. Anne has a predicament. Jane’s wage matches her output perfectly, but that output could be produced for less.
Now what?
The local labor market has been flooded with unemployed accountants. The supply curve has moved. The market is telling Anne that she should be paying less.
Now Anne has a quandary. What to do?
Did she misunderstand Jane’s marginal productivity? Surely not. She has perfect information. Not understanding is not possible. She breathes a sigh of relief. It would not do not to have perfect information. Just the other day she was discussing interest rates in 2054 and found the conversation totally boring — everyone knows the same thing! There was no discussion to be had. But this marginal productivity thing vexes her.
What to do indeed!
Anne feels ignorant. She is overpaying. The market says so. But her perfect information of marginal productivity also says she is paying the correct wage. She needs to square this circle.
She gets annoyed. How could the market and her perfect information of Jane’s marginal productivity not align? How can Anne combat the laws of economics?
She rummages around her attic to find her copy of Mankiw’s textbook to refresh her memory. The resolution to her dilemma will surely be there. After all this cannot be a unique circumstance. Economists have thought of everything.
No?
Phew.
She discovers that Mankiw goes on:
“Why don’t real wages and productivity always line up in the data? There are a several reasons”…
She reads on to explanation number three:
“3. There is heterogeneity among workers. Productivity is most easily calculated for the average worker in the economy: total output divided by total hours worked. Not every type of worker, however, will experience the same productivity change as the average. Average productivity is best compared with average real wages. If you see average productivity compared with median wages or with the wages of only production workers, you should be concerned that the comparison is, from the standpoint of economic theory, the wrong one.”
Oh my! Workers may differ in various ways. Anne is stunned. This had never occurred to her. She should have paid more attention in her economics classes. She would have known more about business.
Perhaps she can resolve her dilemma by calculating average productivity. The average of what, she wonders. The average of her accountants? But she only has two. The average of all her workers, including Bill the office janitor? His output is the number of mop strokes per hour. How does that average with Jane’s reports per hour? Mopping and accounting seem so different. But not in economics. They are “units”. They are the same thing when you think about it long enough.
Then Anne begins to get confused.
Mankiw says that “productivity is most easily calculated for the average worker in the economy”. Anne wonders just who this average worker is. Does she employ this person? Is it Jane? Is it Bill? She hopes that it isn’t that Susan in marketing whose output is perfectly known but seems never quite to achieve the sales goals Anne sets.
Then Anne recalls why her economics textbook is in the attic and not at the office. It has no relevance. She pours herself a congratulatory drink.
The telltale is in the way Mankiw words his explanation.
He leads off by saying that “economic theory tells us…”. Anne should have stopped there. Its economic theory! It isn’t the reality she lives in. Mankiw drives the message home when he says “… the equilibrium requires he wage of a worker equaling what that worker can produce.”.
The equilibrium requires. How can an equilibrium require something? Who, or what, is it that is actually doing the requiring? Perhaps economists trying to fit things together? Surely not!
Anne wonders where this equilibrium is. Possibly near the average worker? Does Bill have something to do with it? Anne notes to herself that she will ask Bill if he has seen an equilibrium in the hallway next time she sees him.
After a second drink Anne realizes that Mankiw has not helped her at all. But she still feels upset that she’s paying Jane more than she might pay her tennis partner. Where in economic theory can she find help?
All this talk of averages and an equilibrium don’t have much relevance to Jane. Or Anne. How can it be that the average has so little to say about an individual experience? How can economics be so blind to those individual experiences? After all, Anne vaguely recalls, Mankiw and the others were always running on about individuals in their lectures. The individual was everything. Wasn’t it? Or did she forget? So why does Mankiw retreat to “averages”?
What, exactly, is an average in this context? Who is it? And is this why, Anne wonders, why so many people today feel rotten despite all those upbeat numbers on the economy she reads about? Are they averages too? Are the people average, or is it the data?
Even more confused, Anne listens to the economic news. The labor market is running hot apparently. The Fed might have to raise interest rates to cool it off. Oh dear, Anne thinks. Is that another average? Who is running hot? Does that mean the local supply of accountants is part of that average? Maybe. Maybe not. Did the Fed forget about the local accountants? Should she tell someone?
In frustration Anne gives up. She switches channels to get the latest weather report. At least those people give more accurate forecasts. But she is haunted by the idea of averages. When she steps out tomorrow morning will the weather be the average? Or will it be what she actually experiences?
Who knows?
Meanwhile Jane goes to sleep happy with the knowledge that she beat the market. Not that that’s possible.
_________________________________
Addendum:
I took some liberty with my Mankiw quotes. They are not from a textbook. They are from a blog post he wrote a few years back. Nonetheless, learning, as I always try to do, I decided to abstract to get at the essence of the problem. Call it poetic license.
And yes. Economists can square this circle. They have a lot of square circles in their inventory.