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    Professor Herbener,

    My understanding is that wage rates are determined by supply and demand, and also by marginal productivity. And that excessively high real wages lead to unemployment.

    Is there a way to determine what the market real wage rate for a specific specialization is?

    We know that government intervention in the labor markets drives up the price artificially, but how can we know what the real wage rate should be? How do we measure marginal utility, and how do we analyze the interaction between that and supply and demand to arrive at a market based figure of legitimate labor prices?


    The wage for each type of labor service is determined by demand and supply.

    The choice the worker makes to supply his labor to a particular entrepreneur is based on his assessment of the value of the alternative compared to the value of the employment opportunity with this entrepreneur.

    The choice the entrepreneur makes to demand the labor services of a particular worker depend upon the entrepreneur’s assessment of the marginal revenue product generated by the labor service discounted by the rate of interest if the entrepreneur pays the worker in advance of selling the output he helps produce.

    Because both supply of labor services and demand for labor services depend upon the workers’ anticipations and the entrepreneurs’ anticipations there is no way for an economist to accurately estimate what the wage would be under different conditions. The economists can determine whether the wage would be higher of lower under different conditions, but the quantitative magnitude of the difference cannot be objectively calculated.

    Market wages will always reflect the DMRP and opportunity cost of the labor services given the circumstances, including government interventions, under which the trade of labor is conducted. But what the exact wage of a labor service would be in the absence of government intervention can only be estimated imprecisely.


    Professor Herbener,

    What should we make of the idea that wages are stagnating?

    What should we make of this graph, which seems to show that the relationship between worker productivity and wage growth has ceased to be as connected as it used to be?


    Is it true that wage growth is always tied to capital investment?

    Thank you


    First, I agree with the basic point of the story posted on ZeroHedge. Freeing the Fed from the final gold fetter on its monetary inflation with Nixon’s repudiation of Bretton-Woods was a watershed event. The American economy has been worse since 1971.

    Second, in order to see whether or not a particular worker’s wage correlated with his DMRP you would have to look at data specific to that person and the production process he works within. The data in the graph are highly aggregated and deeply controversial. Productivity data are especially problematic.


    Most of the respectable data sets at least limit aggregation as much as possible.


    Wages are not a reliable guide to whether or not a person’s standard of living is rising, falling, or stagnant. At a minimum, one must know what’s happening to the prices of goods also.

    The most reliable way to tell whether or not a person’s standard of living has risen is to look at how the set of consumer goods the person has changes over time. If he accumulates more and better consumer goods in the set that he owns, then his standard of living is rising. By this measure, I think it’s safe to say that standards of living have risen significantly over the last 50 years.

    Rising standards of living result from rising productivity which is caused by a combination of 1) acquiring more and better producer goods: labor, land, and capital goods; 2) improving technology; 3) lowering time preferences to have more saving-investing [including in 1 and 2] which results in building up the capital structure of production; 4) enacting pro-market reforms; 5) fostering a culture of entrepreneurial initiative.

    Which of these causes are most important may vary across person, place, and time. But, in general, capital accumulation seems to be the most important.




    I’m wondering if you can explain the fundamentals of how increased productivity leads to higher wages.

    Thank you


    A wage is the market price for a unit of a particular labor service. All market prices are determined by demand for and supply of the item. It is a law of economics a greater demand for an item, ceteris paribus, results in a higher market-clearing price. The demanders of labor services are entrepreneurs. The factors that determine the demand entrepreneurs have for a particular labor service are its contribution to the production of output (marginal physical product), the price of output it helps to produce (which combined with MPP gives marginal revenue product), and the rate of interest (which combined with MRP gives DMRP). Entrepreneurs are willing to pay more for a labor service of greater productivity because it generates more output and therefore, more revenue for the entreprise. Because labor is relatively non-specific, the competitive bidding of other entrepreneurs prevents any one of them from paying less than its DMRP.

    An elite NFL quarterback commands a higher wage than an average NFL quarterback because he helps produce more wins, more division titles, more championships all of which generate more revenue for the team owners. A team’s entrepreneurs cannot pay less than his quarterback’s DMRP as long as there is a market economy in which bidding for his services can occur.


    Thank you for explaining these things to me.

    As a follow up question, are you aware of any studies which have tracked the change in the typical household’s expenditures on necessaries like housing, food, utilities, etc? It would seem to me like that would also be a factor in assessing living standard changes, not just consumer good price changes.


    You can track such data from the Bureau of Labor Statistics, Consumer Expenditure Survey:


    Here is a BLS study using such data:


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