AP_Krugman_Textbook

marginal productivity theory can explain the distribution of income among different
types of land, labor, and capital as well as the distribution of income among the factors
of production. In Module 73 we look more closely at the distribution of income be-
tween different types of labor and the extent to which the marginal productivity theory
of income distribution explains differences in workers’ wages.

module 70 The Markets for Land and Capital 693

Help Wanted!

Hamill Manufacturing of Pennsylvania makes

precision components for military helicopters

and nuclear submarines. Their highly skilled

senior machinists are well paid compared to

other workers in manufacturing, earning nearly

$70,000 in 2006, excluding benefits. Like most

skilled machinists in the United States, Hamill’s

machinists are very productive: according to the

National Mechanists Association, in 2006 each

skilled American machinist generated approxi-

mately $120,000 in yearly revenue.

But there is a $50,000 difference between the

salary paid to Hamill machinists and the revenue

they generate. Does this mean that the marginal

productivity theory of income distribution doesn’t

hold? Doesn’t the theory imply that machinists

should be paid $120,000, the average revenue

that each one generates? The answer is no, for

two reasons. First, the $120,000 figure is aver-

aged over all machinists currently employed.The

theory says that machinists will be paid the value

of the marginal product of the last machinist

hired,and due to diminishing returns to labor,

that value will be lower than the average over all

machinists currently employed. Second, a

worker’s equilibrium wage rate includes other

costs, such as employee benefits, that have to be

added to the $70,000 salary. The marginal pro-

ductivity theory of income distribution says that

workers are paid a wage rate, including all bene-

fits,equal to the value of the marginal product. At

Hamill, the machinists have job security and good

benefits, which add to their salary. Including

these benefits, machinists’ total compensation

will be equal to the value of the marginal product

of the last machinist employed.

In Hamill’s case, there is yet another factor

that explains the $50,000 gap: there are not

enough machinists at the current wage rate. Al-

though the company increased the number of

employees from 85 in 2004 to 110 in 2006,

they would like to hire more. Why doesn’t Hamill

fyi

raise its wages in order to attract more skilled

machinists? The problem is that the work they

do is so specialized that it is hard to hire from

the outside, even when the company raises

wages as an inducement. To address this prob-

lem, Hamill is now spending a significant

amount of money training each new hire. In the

end, it does appear that the marginal productiv-

ity theory of income distribution holds.

Source:

Courtesy U.S. Air Force

Module 70 AP Review

Check Your Understanding

1. Explain how each of the following events would affect the
   equilibrium rental rate and the equilibrium quantity in the
   land market.
   a. Developers improve the process of filling in coastal waters
   with rocks and soil to form large new areas of land.
   b. New fertilizers improve the productivity of each acre of
   farmland.
   2. Explain the following statement: “When firms in different
   industries all compete for the same land, the value of the
   marginal product of the last unit of land rented will be equal
   across all firms, regardless of whether they are in different
   industries.”

Solutions appear at the back of the book.