Lately, I’ve been thinking about the inadequacy of the notion of marginal product for economic analysis.

Consider a shop with only one employee which would be unprofitable if the selling process were automatized. What is the marginal product of the employee? Or, more exactly, what will be the product of the shop without that employee? Zero. This example demonstrates that it’s impossible in this case to mathematically strictly separate the contribution of various factors of production the way it is usually done.

But suppose the question is about the productivity of the addition of another employee to an enterprise that can function without her. Can we say that her marginal product will be reflected in the change in revenue which will happen after her hiring absent other changes? No, because the change in the revenue will be not just because of the net impact of the worker but because of the changed productivity of capital or even other workers.

In other words, productivity isn’t a mathematical function of several variables like, say, the height of a mountain (even if you consider everything in strictly monetary terms). It is with regard to the latter that you can strictly mathematically separate the impact of movement in a particular direction on the height. But you can’t calculate even in principle the marginal contribution of small factor units.

If this is correct then a big question arises about how factor prices are determined in the market. The current theory has it that they tend to be paid the monetary equivalent of their discounted marginal product. What can we say if we abandon the notion of marginal product?

I think we can build a market process theory of factor price determination. We can say that factor prices reflect the extent to which the opportunities of using the relevant factors profitably are discovered by entrepreneurs.

To illustrate what I’m saying consider an employee in a certain business who gets, say $1000 per month. From this fact we can say that entrepreneurs have not yet discovered the opportunity to employ her in a way which would be profitable enough to allow to pay her a higher salary.

This approach has the big advantage that it doesn’t require the postulation of the superhuman ability of entrepreneurs to somehow calculate the exact contribution of each factor to the product of their enterprises but at the same time leaves completely intact the logic of economic calculation.

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