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Testing theory: marginal product and wages

Economic theory tells us that, in a perfectly competitive labor market, labor should be paid according to its “marginal product.” Now, without the jargon: The last workers to be hired by a business should receive pay that is equal to their contribution to the output of that business. So, let’s compare the data with the theory…

Unfortunately, we have no data on the marginal product. But fortunately, we have data on average product. Although it’s not a certainty, these two products should be correlated. So, the graph above shows real growth rates for average product and the average wage. But again, there’s a limitation to the data: We must use the wage of production workers only if we want a series that’s long enough to compare with average product.

Ultimately, it doesn’t look like these series are closely related. The two data limitations we have here could be undermining the relationship. Or the labor market could be less than perfectly competitive. Or the theory could be wrong. It’s difficult to say. But such is the life of an economist… For some more-rigorous research on this topic, take a look at this recent Economic Synopses essay.

How this graph was created: Search for “real output per hour” and select the series shown here. In the “Edit Graph” panel, add the next series by searching for “average hourly earnings” and taking the series with the longer duration. Then modify this series by adding the CPI data series and applying the formula a/b. Select “Percent Change from Year Ago” as the units.

Suggested by Christian Zimmermann.

View on FRED, series used in this post: AHETPI, CPIAUCSL, PRS84006091

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