Question

Chief Executive Officers (CEOs) are paid more than $100 million per year. Leading entertainers and sports figures make more than $10 million per year. The average physician earns about $200,000 per year. Most professors earn $50,000-100,000 per year. Sanitation workers earn $40,000-50,000 per year.

How do you account for the relative compensation of these different professions?  Does it reflect their marginal revenue productivity?  Explain based on the theory of demand and supply in the finished goods and services markets or the product market and the marginal productivity theory of labor demand that you have studied this past week.

Answer 1

The relative compensation of different profession is different primarily because of the differences in the labour demand and labour supply for particular professions. This difference in wages arise out of the difference in qualifications, desirability of the occupation, work nature etc. Therefore across different jobs, there will be wage differentials which depends on the type of the job market, i.e. the demand and supply of labour in that particular job market.

However this wage differential can be explained by the marginal productivity theory of labour demand which states that labors ultimately receive wages which is equal to the value of the marginal product of labour under the conditions of perfect competition. Thus till the point where the value of the marginal product of labour is equal to the wage rate, the employer keeps on hiring. Thus the wage rates vary according to the marginal product of labour which is different in different job markets.

However, in the real world, wage rates might vary even within homogenous labour market because of the discrimination between different identities and therefore certain assumptions like the perfect mobility and perfect competition might not hold in the dynamic world.