Question

Why did J. B Clark maintain that perfectly competitive markets would yield a just and fair distribution of income? What were the errors that would result from competitive markets?. Discuss your answer around 3000 word and above

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It is the purpose of this work to show that the distribution of the income of society is controlled by a natural law, and that this law, if it worked without friction, would give to every agent of production the amount of wealth which that agent creates. However wages may be adjusted by bargains freely made between individual men, the rates of pay that result from such transactions tend, it is here claimed, to equal that part of the product of industry which is traceable to the labor itself; and however interest may be adjusted by similarly free bargaining, it naturally tends to equal the fractional product that is separately traceable to capital. At the point in the economic system where titles to property originate,—where labor and capital come into possession of the amounts that the state afterwards treats as their own,—the social procedure is true to the principle on which the right of property rests. So far as it is not obstructed, it assigns to every one what he has specifically produced.

In a series of articles and monographs, published at intervals since 1881, I have endeavored to formulate the parts of this theory relating severally to value, capital, wages, interest, rent and profits. These papers appeared in the New Englander, the Quarterly Journal of Economics, the Yale Review, the Political Science Quarterly, the Annals of the Academy of Political and Social Science, the Revue d'Economie Politique, the Dictionary of Political Economy, and the series of monographs and studies published by the American Economic Association. These partial statements are now brought into an orderly arrangement and extensively supplemented.

J.B Clark’s Marginal Productivity Theory of Distribution:

MP theory of distribution is used to determine the price of an input. For simplicity’s sake, we want to determine the price of labour i.e., wage rate. Anyway, this theory can be applied in the determination of any input.

The origin of the MP theory is rather obscure. However, J. B. Clark, an American economist, is greatly responsible for the popularisation of this theory in the late 1890s and early twentieth century. Jevons, Walras, Wicksteed, Marshall, Hicks, etc., have also given their own marginal productivity theories of distribution.

In certain respects, each version is somewhat different. Seeing different versions of the MP theory of distribution, Joseph Schumpeter, also an American economist remarked that there are as many marginal productivity theories as there are economists. Anyway, here we are concerned with the Clarkian presentation of the theory.

Clark’s Version:

J. B. Clark’s MP theory of distribution states that price of any input is determined according to the marginal product of that input. Thus, the price of labour—the wage rate—is determined by the volume of marginal product, or, to be more specific, the value of marginal physical product (VMP). Assuming a perfectly elastic supply of labour, wage of labour is determined in accordance with the VMP_L.

Since product market is characterised by perfect competition, VMP_L becomes equal to MRP_L. Thus, wage of labour tends to become equal to VMP_L =MRP_L. A competitive profit-maximising firm will go on employing labour until wage equals VMP_L = MRP_L i.e., W = VMP_L = MRP_L. This is the essence of the Clarkian version of the MP theory of distribution.

Assumptions:

Before presenting his theory, Clark made some simplifying assumptions abstracting from the real world. He assumed a completely static society where population, stock of capital, and techniques of production are constant.

Following are the important assump­tions of this theory:

i. Perfect competition exists both in product market and in input market. As a result, price of the product and price of the input are given.

ii. Every unit of input is homogeneous and easily substitutable.

iii. Inputs are perfectly mobile.

iv. There exists full employment of resources.

v. Employer can measure the marginal product of an input in advance.

vi. Law of variable proportions operates.

vii. Firm hires input with the objective of profit-maximisation.

viii. If all inputs are paid according to their marginal products total product would be exhausted—there would be neither surplus nor deficit.

Perfect competition in input market implies that neither input seller nor input buyer can influence the price of an input. At a given price, any amount of the input may be supplied. As a result, price of any input becomes equal to its average cost and marginal cost i.e., P = AC = MC. This means that the input supply curve must be perfectly elastic.

For the sake of analysis, we assume labour as the variable input. So, VMP_L=MRP_L curve is the labour demand curve. S_L = AC_L = MC₁ curve is the supply curve of labour.

Diagrammatic Representation of the Theory:

In Fig. 10.3 units of labour are measured on the horizontal axis and the price of labour i.e., wage rate or marginal product is measured on the vertical axis. Negative sloping labour demand curve (VMP_L=MRP_L = D_L) intersects the perfectly elastic labour supply curve (AC_L = MC_L = S_L) at point E. Point E is the equilibrium point because, at the going wage rate OW, the firm employs labour till wage rate equals VMP_L =MRP_L. In other words, the firm maximises profit by employing OL amount of labour at the wage rate OW. In fact, OW (=LE) is the marginal product of labour. Thus, wage of labour is determined by VMP_L= MRP_L.

OL is the profit-maximising level of employment because, at the ruling wage rate OW, the firm will not be able to maximise profit if it employs more than OL or it stops employment short of OL. If the firm hires less than OL units of labour at the wage rate OW, it means VMP_L = MRP_L > OW. So, it will be wise on the part of the firm to go on employing more labour until VMP_L=MRP_L = AC_L = MC_L.

Further, if the firm employs more than OL units of labour at the wage rate OW, VMP_L = MRP_L falls short of OW. This means that the marginal cost of labour is higher. So the firm will cut short of employment until VMP_L = MRP_L = AC_L = MC_L is reached. So, the profit-maximising firm should employ OL units of labour at the wage rate OW.

Labour, in this case, is the variable input while other cooperating inputs—say, land, capital and organisation, are the fixed inputs. Total output is, thus, the area under the VMP_L =MRP_L curve. Thus, the total production is the area OAFL. Out of this total output, the firm pays OWEL as wages and the rest (i.e., WAE) is being paid as the rewards of the other inputs in the form of rent, interest and profit. Thus, payment made in accordance with the marginal product exhausts the total product—there is neither surplus nor deficit.

However, this interpretation of the MP theory fails to determine the price of an input because input price is given or pre-determined. At a given wage rate OW, for an individual firm or industry, how many units of labour are employed can be known from this MP theory. In fact, what we have determined is the level of employment, given the wage rate. Thus, from the micro point of view, Clark’s theory is a theory of employment, rather than a theory of input price determination.

From a society’s point of view, what is pre­determined is the level of employment rather than the reward of an input. This is shown in Fig. 10.4 where we have drawn a perfectly inelastic supply curve of labour. This means that in the economy OL amount of labour is available. The supply of labour intersects the VMP_L = MRP_L = D_L curve at point E. Thus, E is the equilibrium point.