Pricing of the Factors of Production and the Labor Market

0:00Okay, well, good morning, everyone. I hope you're excited as I am to have reached the midpoint or the middle day of our seminar. So far, everyone's hanging in there. I don't think we've lost very many. I hope everyone is sleeping well. We ran into a group of you at a bar in town last night, and while certainly the social interaction is a good way to exchange ideas and to broaden your knowledge and causal realist economics, I hope you didn't broaden it too late into the night. Personally, I went to bed last night thinking about today's lectures, and I slept like a baby. I woke up every two hours and started crying uncontrollably. This morning's lecture is on the pricing of the factors of production, with some particular application to and examples from the labor market.

0:52And just as a reminder, the kind of analysis that we've been doing this week, So-called Causal Realist Economic Analysis has the objective of deriving universal laws of social interaction, what Carl Menger called exact laws, that are very general and applicable to a wide variety of situations. Nonetheless, from the most basic economic principles, we can derive many additional applications and examples that take the general rule and apply it to particular cases, particular sets of circumstances. And so what we want to do this morning is start with the general principles of pricing that we discussed yesterday and extend them to talk about a specific case of economic goods and services that are priced in markets, Namely not consumer goods or final goods that are enjoyed or consumed by the end user, but rather intermediate goods or what we call factors of production, economic goods that are used in the production of other goods.

1:59So let me just kind of remind you of the basic setup here. What are economic goods? Joe discussed this on Monday. Economic goods, we can think of them most generally as scarce means that are employed or used to achieve the ends of individual human actors. So, you know, this bottle of water is an economic good which I use, if I drink it, I'm using it to achieve my end of quenching my thirst. Okay, or I could put it to some alternative use, like splashing somebody in the audience with water to wake them up. That would be my end, of which this is a mean. But we call this a means. We call this a consumer's good because its services are consumed directly. What we call producer goods, or factors of production, are goods that are used in the process of making other economic goods.

2:54Okay, so for example, land. And when the economist speaks of land, He means not just sort of land in the common everyday sense, but the part of land or nature that is nature-given or God-given, not the part that is improved through human activity, and we'll talk about that distinction a little bit more later. So really, by land we mean natural resources, unimproved land and so on, factors of production that we simply find around us and we don't have to go to any effort to create or discover. Labor, the services of human effort is a producer good. Why? Because we don't consume labor directly. We employ labor to produce bottles of water and other goods and services that we do consume.

3:39Okay, and finally, producer goods are capital goods, what we can think of as the produced means of production. I'm sure that's a typo. That should say capital goods and not producer goods on the bottom bullet there. So we mean things like tools, machines, buildings, et cetera, which are themselves made out of land or natural resources and labor. Joe made the point the other day that when we create capital goods, we can use the word create, but really what we're doing is rearranging or transforming the primary factors of production, natural resources and labor to make some intermediate good that is then used in the process of production. Okay, so land, labor and capital goods as three different categories of producer goods.

4:30Now, what are some examples of consumer goods and producer goods or what makes something a consumer good or a producer good? Notice that it isn't anything sort of intrinsic in the physical characteristics of the good that make it a producer good or a consumer good. It's purely subjective, meaning how a good is used in an individual's plans, economic activities or plans. So consider bread, for example. If we put this in the terminology employed by Carl Menger, the notion that goods have different orders, why do you think about what goes into the production of bread? If I consume bread, then the bread itself that I eat is the final consumer good.

5:17And you can think of a series of intermediate goods. We start with soil and seed and water and fertilizer at the first stage. Those are then made into wheat by application of human labor and some capital goods. The wheat is transformed into flour. The flour is transformed into bread. So in Menger's terminology, as we move up the scale towards the original inputs, we call those higher order factors or higher order goods. And then as we move down the scale towards the end consumer good, Mayer calls these lower order goods and services. So the higher order goods are employed to create the lower order goods. And while certainly there is a physical or objective manifestation of the relationship among these goods, we don't just wish into our minds that flour can be made into bread.

6:04It is objectively true that flour can be made into bread. Right, but it's the fact that I consume the bread that makes it the lowest-order good in the scheme. For example, I like to buy fresh-baked bread from the bakery at home rather than, you know, sort of sliced bread that you get in a Wonder bread or whatever. But, you know, the drawback of buying fresh-baked bread is that because it doesn't have as many preservatives in it, It goes stale more quickly, right? If you don't consume it in a day or two, it gets kind of hard and crusty. Well, I mean, you can throw away your hard crusty bread, or if you're clever, you can make it into croutons. Or, you know, dressing or stuffing to put in your Thanksgiving turkey. Okay, so I like to make homemade croutons out of my stale, crusty bread, right?

6:54So, we can imagine a production process where I start with the same higher order goods. I use them to produce, they're used to produce wheat, flour, bread, then the bread is transformed through the passage of time and not much human labor, it's really neglect, into stale bread, and then the stale bread is transformed into croutons by cutting it up and toasting it and adding some garlic and some herbs, it's really delicious. So the point is that the bread in this example is exactly the same physically as the bread on the previous slide, but now it's become a higher order good, it's become an intermediate good The Bread is an intermediate good. It's a producer good. It's not something that the restaurant owner consumes. What the restaurant owner consumes is the income received from the bread.

7:39In a restaurant, right? So the final good that's consumed in the restaurant is the meal, right, of which the bread is a component, right? So from the restaurant's point of view, the bread is an intermediate good. It's a producer good. It's not something that the restaurant owner consumes. What the restaurant owner consumes is the income received from the patrons of the restaurant. Okay, the patrons consume the meal itself. Okay, so again, exactly the same bread, the bread is the same in all these three cases, but where it fits in the production scheme depends on the purposes of the individuals involved. Okay. Overview, sort of the basic principles of the pricing of factors. I'll start with the overview and then we'll go through some of these points one by one in greater detail.

8:32So the most general statement, which I'll just give it to you now, and then we'll explain in more detail where it comes from, is that the rental prices of factor services that are rented, so the price that you pay for the use of a factor service that belongs to someone else, rental prices and the purchase prices of factors that you can buy outright are determined by demand and supply in factor markets. Right? Just like the price of the car radios in my example yesterday is determined by demand and supply in the market for car radios, the same applies to the prices of producer goods. And notice we need to make this distinction because many producer goods can be either purchased or rented.

9:20Okay, so if you think about, you know, yard tools, if you need some kind of a digger and you don't own the digger, you can go to Sears or you can go to the rental center and you can rent it for a day. You pay $20 or $30 to rent its services. Well, you're still consuming, you're using the services of a producer good, but you're renting it on a per hour or per day basis. Right, or you can go to the hardware store and purchase the digging machine yourself. Okay, and we'll explain a little bit later how the purchase price of the machine is related to the rental price of its services. There are some intermediate goods for which purchase is not possible, such as labor services. Right, you rent the services of your employees, you don't purchase them outright.

10:08Right, now one can imagine, hypothetically, and of course historically, a society with slavery, with legal slavery, right, then the purchase of a slave would be analogous to the purchase of a machine in the factor markets, right, but in the absence of slavery, labor cannot be purchased in that fashion, only the service, laborers cannot be purchased, only labor services can be rented per unit of time or per activity performed or so on, okay. Now, we understand how demand and supply work, right? We discussed them the last couple of days, and we understood, we learned that the demand for consumer goods is determined by the ability of those consumer goods to satisfy human ends, human wants.

10:56Okay, so the reason I'm willing to pay for this bottle of water is because it gives me utility, if you like that term. Okay, I get satisfaction out of consuming the water. Now, why do I hire services of intermediate goods? Okay, if I employ Joseph Salerno to work, you know, let's say I employ him to be my personal assistant. It would be a good job for him to do my typing and my filing and so on. Well, I mean, I don't do it because I get intrinsic satisfaction or because I get a lot of utility out of having him around because he's such a charming, witty fellow, okay? No, I employ his services because I value the things that he can produce, typed letters and, you know, filed papers and so on, okay?

11:45When McDonald's employs a hamburger worker, it's not that the McDonald's corporation gets subjective utility out of having that worker around, it's rather that McDonald's would like to get more money, okay? And by employing that laborer, that laborer produces hamburgers and french fries, which McDonald's can sell for money, okay? The point is, the demand, we cannot explain the demand for factors of production in exactly the same way as we explain the demand for consumer goods. It's not based directly on the utility, the subjectively perceived utility that they provide. Rather, one of the great, we rely on one of the great contributions of the Austrian economists, starting with Menger and Boehm-Bawerk and Bezer and others whom we've talked about, The theory of imputation tells us that the rental prices of particular factors of production, non-specific isolable factors used in variable proportions, I'll explain in just a minute what nonspecific, isolable and variable proportions mean.

13:01So read that as the rental prices of... certain factors tend to equal what we call their discounted marginal revenue products. They're discounted marginal revenue products. The rental prices of other factors of production are determined by bargaining between resource owners and entrepreneurs. So factors of production that do not meet those particular criteria, that are not nonspecific, isolable and used in variable proportions, are determined by bargaining among resource owners and entrepreneurs. Now let me explain what all that means. We'll start with some basic principles of production economics or production theory and define some of these terms that we've been using.

13:48What economists call the law of returns, you may have heard it described as the law of diminishing marginal returns, law of diminishing returns, which is about the same, is not quite correct technically, but means more or less the same thing. The Law of Return says that if we hold constant the quantities of complementary factors, there always exists an optimum amount of any variable factor. By variable factor, we mean a factor of which we can use a little bit more or a little bit less in production. So imagine hamburger workers at McDonald's. The McDonald's corporation can employ additional units of labor or employ fewer units of labor and that affects the amount of output that's produced.

14:37Okay, so the law of return says, if we think only about varying the number, the amount of hamburger worker labor that we use, holding constant the equipment that's used, the tools, the size of the building, the amount of energy, the amount of land and so on, the other factors of production. There's some optimal amount of labor, some amount of labor that produces the maximum amount of output for those other combinations of complementary factors. In other words, it isn't the case that we can keep adding units of labor without adding more of the additional factors, the complementary factors, and always get the same amount of additional hamburgers.

15:26Okay. Let me give you a little bit more terminology. What we call the marginal physical product, or just marginal product for short, or the factor of production, is the addition to total product or output from employing one more unit of that factor, holding other factors fixed. Okay, so the question is if we add one more unit of hamburger worker labor, one more worker hour, or we employ one more hamburger worker, how many more hamburgers do we get? Three hamburgers, five hamburgers per unit of time. Okay, so that's the marginal physical product of the additional unit of labor, okay? Now the principle of diminishing marginal returns tells us that as we add additional units of a factor, its marginal product, marginal physical product, meaning the amount of additional output holding the other factors fixed, eventually begins to decline, eventually declines.

16:26How do we know that? Well, we can understand that quite simply by thinking of the counterfactual. What would it be like if the law of diminishing returns did not hold? Imagine that you have a pot, a flower pot about this big, and you have a corn stalk in it. So you're producing corn that you'll then consume. What are the inputs? Inputs, well, you need some seed, you need some soil, you need water, fertilizer, sunlight, I guess that's it, TLC, maybe you have to talk to the plant. Those are the inputs into production. So you have certain amounts of those things, you get a certain amount of corn. Suppose you say, well, I'd like to get a little bit more corn, so I'm going to add a little bit of Miracle Grow, or a little bit of additional fertilizer.

17:17By adding this additional fertilizer, I get a slightly bigger plant. Maybe I get two years of corn instead of one. Okay, I add a little bit more fertilizer, I get even a bigger corn plant. Right, but it isn't the case that I can simply keep adding fertilizer, but never get a bigger pot, add more soil, seed, water, sunlight, and continue to get ever increasing amounts of corn. Okay, I mean, if I could, I could grow the entire world's food supply in one flower pot. I could produce all the corn in the U.S. and get all the ethanol subsidies, sorry, and feed all the hungry people simply from one flower pot. And we know that that doesn't make logical sense. It's logically incoherent.

18:04And the reason is because you need some combinations of factors to produce the final goods. You need some additional soil at some point. You need some additional water. You need a bigger pot. Given diminishing marginal returns, the only way you can get continual increases in output is by increasing quantities, not just of one factor, but of all the factors in some combinations, in some combination. More terminology, what we call the marginal revenue product of a factor of production. It's like the marginal physical product, but expressed in monetary terms, rather than in units of physical goods, okay? So go back to the McDonald's case. As McDonald's adds additional workers, it can produce additional hamburgers.

18:53It then sells those hamburgers on the market for hamburgers in the consumer goods market and receives money, right? So the marginal revenue product of the factor is how many more dollars of revenue do I get from employing one more unit of this factor, okay? Now finally, before we can analyze things from the entrepreneur's point of view, we have to add to our concept of marginal revenue product some notion of time discounting, okay? And I think Joe will talk a little bit more about discounting and time preference in his first lecture tomorrow. But the idea, the basic idea is that because production takes time and because the value of goods and services produced in the present is greater than the value of those same goods and services coming in the future.

19:44I think you used the example, what was it of the guy asking the girl out on a date? Yeah, typical Salernian example. Because people have positive time preference, the value of the factors of production that the entrepreneur employs today is greater than the value of these future goods and services that will be produced. In other words, because production takes time, as an entrepreneur I have to purchase the factors of production today and then I receive the receipts from selling the output only at some point in the future. Right, so to compare my outlays today with my receipts tomorrow, I need to discount my future receipts by some discount factor.

20:30And for convenience, we'll simply describe that as the interest rate. Okay, imagine there's a uniform rate of interest. So the discounted marginal revenue product is just the marginal revenue product discounted by the rate of interest. Okay, let me give you just a few numerical examples that I think sort of help to illustrate the concept of some of these different cases. different cases, what do we mean by isolable, not isolable, specific, nonspecific and so on, the term isolable simply means that we can isolate the marginal product of that, of a particular factor, independent of the other factors, okay, as we'll see some factors do not have marginal products that can be isolated for reasons that we'll see, so what in the textbooks they describe One of those variable proportions means a production process where there is some substitutability among the inputs.

21:27So imagine that we have a production process that employs three inputs, A, B, and C. And if you use four units of A, ten units of B, and two units of C, you can produce $100 worth of output. So for the sake of these examples, let's ignore the discount and just think in terms of the marginal revenue product. So I can use 4A, 10B, and 2C and get $100 worth of output. If I reduce my use of factor A by one unit, so I only use three units of A, 10 units of B, and two units of C, I can produce $80 worth of output. So I can still produce some output. It isn't the case that I need four units of A to produce anything. If I cut back my use of A a little bit, I get a little bit less output measured in revenue terms.

22:15So the marginal revenue product of factor A in that example Supposed you have a production process in which the factors can only be combined in certain proportions. Imagine that every hamburger worker has a spatula and they can't share spatulas for some reason. So if you add another hamburger worker, but don't give him a spatula, he's useless. He can't produce a hamburger without a spatula. So that's a case where to get any additional output, you can't just add a unit of one factor. You have to add all of the factors in a particular fixed proportion. So again, start with the same case. If it takes 4A, 10B and 2C to produce $100 worth of stuff, If you go down to three units of A, well then you might as well only have 75% of B, seven and a half units and 1.5 units of C, because the additional 25% of B and C is useless without the additional 25% of A.

23:25So we can imagine that by combining reduced amounts of A, B and C in the same proportion, you can produce 75 units, $75 worth of output. Right, then the marginal revenue product of factor A is $25 rather than $20. Right, again, it's simply the difference between the value of production with four units of A and the value of production with three units of A. Right, and notice the value of A is higher here, because if you take away some A, you've got to take away some B and C too. So this is a case where the marginal product of A is not strictly isolable because you can't really separate the marginal product of A from the marginal products of B and C because you need them all working together in concert.

24:12You can imagine a more extreme case where factor A is what we call an indispensable factor. Meaning, unless you have factor A, you can't produce anything at all. So you can have one unit of A, two units of B, and three units of C, for example, and get $200 worth of output. You get rid of factor A, you still have your two units of B and three units of C, but now you can't produce anything. Now the value of output is zero. So think about, for example, a steering wheel on an automobile. It isn't the case that if you don't have the steering wheel, well, the car is still pretty much just as good, but not quite as good. You know, it's not so good at all without a steering wheel.

24:58So what's the marginal revenue product of this indispensable factor? Well, it's equivalent to the value of the entire output, meaning that if you take away unit A, the whole thing's worth nothing. So the marginal product of factor A is 200 bucks. One of the things you notice in this example is that it isn't the case that the sum of the marginal revenue products has to equal the value of the final output. In a case with indispensable factors, you could easily have the case that maybe lots of factors of production have a marginal revenue product equal to the value of the entire car, of the entire final product.

25:43There's no, so it doesn't violate any assumptions about factor pricing, okay, so it's not a case that we're trying to sort of add up the marginal revenue products to get the value of the total product, okay, whether, whether we can do that or not depends on the technical aspects of production as described here, okay, now let's go back to the same kind of analysis that we did yesterday, where we think about factor pricing using Boehm-Bawerk's concept of the marginal pairs, okay, so this is a diagram very similar to what we used yesterday to Discuss Consumer Goods. Okay, so imagine we have a particular factor of production and assume that its marginal revenue product is isolable. Okay, so assume that entrepreneurs, right, have made forecasts of the marginal revenue product of various units of this factor and assume that they've discounted these by the appropriate rate of interest.

26:36Okay, so if I employ one factor, one unit of this variable factor, of this isolable factor, I get an additional revenue of $30 in discounted terms. Okay, so by employing one, the first hamburger worker produces me $30 worth of discounted marginal revenue. If I add a second hamburger worker, I get $27 per hour of additional discounted marginal revenue. Not quite as much as the first unit. Okay, when I add a third unit, I get discounted marginal revenue product of $25 and so on. Why do you suppose the marginal revenue product, or the discounted marginal revenue product, of these additional units of the factor are worth less than the discounted marginal revenue product of the previous unit of the same factor?

27:32Principle of Diminishing Returns Right, so the marginal physical product of these units of production is decreasing as their use increases. But another way to think of it is this. It's just like when we did the example with sacks of wheat from Boehm-Bawerk, from Menger, that, I mean, suppose that you had these different units of a factor with different marginal revenue products. If you were only going to employ one unit of the factor, you wouldn't use it in a way that generates only $20 of additional revenue. You would employ the most valuable service unit of the factor first, and then only employ the next most valuable service unit of the factor second, and so on.

28:21So the point is that the discounted marginal revenue product is decreasing in the use of the factor as we use additional units of the factor. Now suppose that there are owners of these factors of production, if it's labor. There are the individuals who own their own labor services. They have some reservation prices or reservation demands for their factors as well, for their factor services. So there's factor owner one, two, three, four, and so on. Right, and imagine that each one has a minimum price below which he would not offer his factor services for exchange. Okay, so Factor Owner 1, Worker 1 says, if I can't get at least $9 per hour, I'm staying home.

29:06Okay, and Factor Owner 2 says, if I can't get at least $11 per hour, I'm not willing to work, and so on. So again, we have the same kind of analysis that we did yesterday where we want to find an equilibrium or market clearing price by thinking about the marginal pairs, doing the analysis of the marginal pairs. We can do this one on a graph. It's very similar to one of the graphs we used yesterday. In fact, it's quite similar because I used the copy and paste function in PowerPoint and changed the labeling and so on. and so on. Okay, so what we have in the downward sloping line, right, is the discounted marginal revenue product of the first, second, third, fourth factor and so on. Right, and for simplicity, to make our story a little bit easier, I've assumed that the reservation price of the least capable factor owner, in other words, the person least willing to sell, is above the discounted marginal revenue product of the last unit of the factor that's available.

30:07So there's five units of the factor service out there, right? Meaning that we can ignore these reservation demands and thinking about the determination of equilibrium price. Right, so just as we did yesterday, we have the case that the equilibrium price of the factor is determined by where this demand curve given by the discounted marginal revenue product and the New Product of the Factor intersects the vertical line representing the available stock of that factor of production. Okay, so again, this is just demand and supply analysis. Again, what makes it a little bit different from the analysis we did yesterday, the twist, is that you have to keep in mind that the demand for the factor of production, It's not simply marginal utility, right? It's the degree to which that factor can be used to produce goods and services that will then generate marginal utility to consumers who will pay for them, funds that will come back to the entrepreneur and so on.

31:07Okay? We can get that cleaned up. Okay, let's look at a couple more, whoops.

31:17Chad, what happened? Oh, okay. Okay. Now we get back to this notion of imputation, this funny word imputation. Right, the term, what does it mean to impute something? Right, it means to sort of take it back a step. Right, so the idea, the analysis that we've been performing here tells us that the value of these units of labor or units of the factor depends on the value of the Consumer Goods that they eventually produce. Right, so consumers assign utility or value to units of goods they consume, and those utilities or values are imputed backwards or up in Menger's diagram to the higher order goods and services that are used to produce them.

32:06Okay, this is a very fundamental point that is at odds with the main tradition of factor pricing in the classical approach, in classical economics. The classical view was the view that the prices of goods and services that are exchanged in the market, the prices of consumer goods, are explained by the cost of the factors that went into producing them. Okay, so if it's very costly to produce a Mercedes, a Mercedes will have a very high price. If it's much less costly to produce a Chevrolet, then a Chevrolet will sell for a low price. Well, one of the great insights of the Austrian economist was that this explanation has the causal relationship exactly reversed.

32:52It isn't the cost of production that determine the value of the final product. Rather, it's the value of the final product that determines how costly it is to produce in terms of how much money is needed to purchase the factors. A great example that Mises gives in Human Action is the value of land, land used to produce particular goods. Anybody have any idea what this is a picture of? Maybe the picture is too small for you to see. A vineyard. Yes, a vineyard. This is actually a vineyard in the Champagne region of France. The classical economists would say something like this. They would say, well, if you go and buy a bottle of champagne at the store or in a restaurant, it's very expensive.

33:40The reason champagne is so expensive is because this land on which the champagne grapes are grown is very valuable land. If I want to become a champagne producer, it's going to cost me a lot of money to buy land to set up a vineyard in the Champagne region of France. Mises points out, no, the truth is exactly the reverse. The reason land in the Champagne region of France commands such a high price is because the drink that it's used to produce is something that is extremely valuable to consumers. Because people are willing to pay very high prices to drink a glass of champagne, the value of the inputs used to produce champagne, the prices of those factors are bid up where they reflect, in an important sense, the value of the final goods they're used to produce.

34:33If there were some change in people's tastes and preferences, for example, suppose that the food police succeed in convincing people that champagne is evil, that champagne will give you a heart attack, or champagne will do this bad thing or that bad thing, and for some reason, people decide they no longer like to drink champagne. What's going to happen to these land prices? Yeah, they're going to plummet. So it's not that the value of the land is intrinsically given somehow. depends exclusively on the value of the grapes, the value of the wine, the drink that's made from these grapes, okay? To put it another way, in the Austrian view, all costs are, in the subjective sense, opportunity costs.

35:19Right when we speak of the businessman's costs of production, or the entrepreneur's costs of production, that refers to the prices that he pays for factors of production, What determines the prices of those factors of production? Well, it's determined by the value of various goods and services that can be used, that can be produced from those factors. Right? So, imagine that this land can also be used for tourism. Let's say that you could build very fancy hotels on this land, and you could rent out the rooms at a very, very high price. Well then the cost of using this land to grow grapes for champagne is the utility or value foregone by not having these luxury hotels.

36:04So the cost of deploying any particular factor in one line of production or another is the utility or value foregone from not having that factor available in some other line of production. All costs are opportunity costs. What has been called the marginal productivity theory, developed primarily by the Austrians and also by some of their fellow travelers, J.B. Clark in the U.S. for example, is this idea that the prices of factors tend to equal their discounted marginal revenue products, okay? By the same token, the incomes that factor owners receive, we'll get to this point in a moment, is determined by the discounted marginal revenue product of the factors that they own, okay?

36:52So if the question is how does value or income as expressed by consumers and their purchases get distributed among different factor owners, well, it's distributed by, in terms of the marginal revenue products, the discounted marginal revenue products of the factors, and the factor services that those owners possess, okay? Factors through the process of competitive bidding by entrepreneurs, factors will tend to be allocated to their highest valued uses in production, okay? If consumer demand for champagne falls and demand for luxury hotels in this region increases, then we'll tend to see land sold, vineyard owners will sell the land to hotel operators, okay?

37:39Assuring that the resources will tend to be allocated to their highest-valued uses in production, okay? Now, in terms of a good or service that you can purchase, a capital good or land that can be purchased like this, for example, we can calculate the purchase price of the producer good, of the intermediate good, by taking the future stream of rental payments and summing them up and discounting back to the future. Okay, so the sum of the discounted values of the future revenue stream, income stream, will be capitalized into the value of the purchase price of the asset. Okay, land that has very high value used in production will be expensive if you can purchase the land outright.

38:26Similarly, the digging machine that you can get from rent-a-center. If the value of being able to dig in your yard goes up, then the rental payments would have a tendency to rise, and then the capitalized value of the asset itself will similarly rise. There are a number of common fallacies, many of which you're surely familiar with, that arise from the failure to understand the fundamentally subjective and consumer-driven, demand-driven theory of imputation. Probably the most famous is, of course, the labor theory of value associated with Marx and his followers. Marx argued that the value of goods and services to consumers is a function of the quantity of labor that went into their production.

39:13So to Marx, labor is the only source of value, of value creation, and goods and services that we consume embody certain amounts of labor in them. Well, I mean, it doesn't take much thinking. It's not very hard to come up with counter examples that are hard to explain within the Marxian system. Again, you know, if it's very difficult to make grapes requires a lot of, it's a very labor-intensive process, it's very expensive, but consumers don't like champagne, right? They're not going to pay a high price for champagne just because a lot of workers had to sweat and toil to make it. You can employ all the labor you want to try to produce fur coats or down jackets that you sell in Auburn in June and you're probably not going to get a lot of money selling them. It doesn't matter how much labor went into them.

40:12The Austrian approach says the value of that labor depends on the value that consumers attach to the final good. With this basic setup, a demand and supply analysis, we can do just what we did yesterday and say, well, what explains changes in prices of factors of production? Sometimes wages rise, sometimes they fall, sometimes land prices rise and fall. Why? How can we explain that? Well, we can explain it by shifting the supply and demand curves, just as we did yesterday. We can imagine that the available supply or stock of a factor of production increases or decreases. We can shift that vertical supply curve to the left or the right. We can imagine that the demand for a factor of production given by its discounted marginal revenue product, sorry, that should be MRP instead of MVP.

41:05Just as an aside, Rothbard uses a sort of idiosyncratic term. He uses her marginal value product instead of marginal revenue product. and I copied this from some old notes and forgot to change it to MRP. So Chad, if you could digitally alter that at post-production, I would appreciate it. While you're changing my face and making me look slimmer and all that. Okay. We can imagine that the marginal revenue products of the factor changes because of a change in people's time preferences affecting the rate of interest or because changes in the physical productivity of the Factor, depending on the availabilities of complementary factors and so on. Let's look at a few examples, right?

41:51We can imagine that there's an increase in the supply of the factor, right? So we go from the original stock S to this new stock S prime. If we assume that the marginal revenue product schedule remains the same, then the equilibrium rental price of that factor is going to fall from P1 to P2, okay? This could be, you can think of the labor market, for example. Imagine that there is a change in cultural norms, for example, about women in the workforce. And so women who previously would not have entered the workforce because it wasn't considered socially acceptable, now decide to enter the workforce and so the supply of labor that's available for sale increases, it's gonna tend to bid wages down.

42:38But if we think about labor in a particular geographically isolated labor market, the market for home construction in Southern California, right, if there's an if there's an increase in the immigration of unskilled or skilled labor for Mexico, that's useful in the construction industry, right, that increase in supply, the supply of available workers will tend to drive down market wages in the construction industry. You could also think about the role of education here. High school, college-age men and women can choose either to be in the labor force or they can choose to be in school full-time. If the price of college education were to rise, if tuition rates were to rise, then on the margin some college students would drop out of school and enter the labor force instead, which would lead to, again, a rightward shift in the supply curve here and would tend to put downward pressure on wages.

43:36Let's look at a couple of different examples of changes in demand. First example, suppose that there's a change in the interest rate. Suppose that interest rates rise because of contractionary policy by the Fed, contractionary monetary policy. So what I've done here is besides the discounted marginal revenue product schedule, I've put the undiscounted MRP schedule in there as well. The discounted marginal revenue product is going to be less than the undiscounted marginal revenue product. So imagine the MRP schedule as shown there and the DMRP schedule as the one shown in black.

44:22So imagine that the interest rate rises. Even though the marginal revenue product in nominal terms hasn't changed at all, Applying a higher discount rate means the discounted marginal revenue product will be lower than it was before. So the DMRP schedule shifts down to the blue one, D prime, given by DMRP prime. And so that puts downward pressure on the price of the factor. So the equilibrium price of the factor falls from P1 to P2. You can also imagine that the interest rate stays the same. The discount factor stays the same, but the marginal revenue product itself changes. Suppose the marginal physical product goes up, and correspondingly the marginal revenue product goes up.

45:13From MRP, the one in black, to MRP prime, the one in blue. Well then that brings up the DMRP schedule with it. So the equilibrium price would rise from P1 to P2. You get the idea. Let's talk about a few specifics that apply to the labor market. Why do this? Well, I mean, right, there's a sense in which we can analyze the labor market using exactly the same tools we use to explain markets for labor and for capital goods and so on. But, I mean, the labor market, number one, has some peculiarities associated with the fact that you can't buy labor. You can only rent it. And because we ourselves are human beings and many of us are employed in the labor market, we tend to find it interesting.

46:02Policy makers tend to intervene in the labor market more than they intervene in other markets. So it's worth taking a little bit of time to go through some of the specifics associated with labor. Let's go back and think some more about the demand for labor. Remember our basic story is that the value of labor and thus entrepreneurs' willingness to pay for labor services depends on the market prices given by subjective utility of the final goods and services that labor is used to produce. Okay. People sort of wonder and they puzzle over why some professions earn higher wages than others and it just doesn't seem right or it doesn't seem fair that a school teacher, even in a private market for education, A school teacher can earn $30,000 or $40,000 a year, and a professional athlete can earn millions of dollars a year.

47:01Well, that just seems wrong, right? Because a school teacher is, or let's use a different example, let's say a nurse. A nurse is really taking care of people's fundamental health needs, whereas a star athlete is just entertaining us. It seems like a nurse is intrinsically worth more than a professional athlete. Shouldn't a nurse earn more? Well, economic analysis tells us that in free markets for labor services, wages are going to be determined by the valuations consumers attach to marginal units of the factor. And our willingness to pay for one more labor hour of a nurse, nurses services is much, much lower than people are willing to pay to see LeBron James for one more hour, even though he had a pretty lousy game last night.

47:52So, if you think it's wrong that pro athletes earn such high salaries, the flaw is not in the institutions of the labor market, but in all of us. Be angry at your fellow man and woman for being willing to pay so much through ticket prices and higher advertising rates for televised games and merchandise and so on, paying so much to see LeBron James do his thing.

48:22One of the most important determinants of the marginal physical product of a unit of labor is the quality and quantity of complementary capital goods. Okay, it's available. I mean, look, it's quite obvious if you think of a farmer trying to grow wheat with a scythe and a pick and a shovel. One farmer can't grow a whole lot of wheat per day using those kind of tools. But now imagine the same farmer with a combine harvester. The farmer can now produce vastly more wheat per hour or per day from having this very sophisticated fancy equipment.

49:09So if you think, well, why is it that workers tend to earn much more today than they earned in years past, even in inflation-adjusted terms? Why is it that a street sweeper today earns much more than a street sweeper earned 100 years ago? Well, it isn't because the government has intervened to raise the wages of street sweepers. And it isn't because labor unions have exercised their collective bargaining power to increase wages for street sweepers. In fact, wages have tended to rise the fastest in industries that are the least unionized. No, the reason that street sweepers earn so much more today is because the value of a marginal unit of their labor is vastly greater than it was a hundred years ago.

49:59Because a hundred years ago all they had was a broom, a broom and a dustpan. Now they have those little machines, those little vehicles that they drive around with the little brushes. Okay. I would love to drive one of those. It looks like a lot of fun. Basically, it increases in capital per worker that explains the secular increase in wages through time. Just as a side note, one topic in economics It's got a lot of attention in the last years, what they call microfinance or microcapital, microenterprise development. You might be familiar with this fellow, Mohammed Yunus, who won the Nobel Peace Prize this last time around.

50:44He's a Bangladeshi economist, a Ph.D. in economics from Vanderbilt University, who operates a bank, or a sort of bank-like entity called the Grameen Bank in Bangladesh, where where he makes very small loans to individuals, mostly women, so they can engage in so-called entrepreneurial activities, so they can start their own businesses. And sort of the model, the Grameen Bank development model, is that the surest way to get a very poor country like Bangladesh out of poverty is to facilitate a lot of entrepreneurship, to make individuals in Bangladesh into entrepreneurs who own their own businesses, to make them and Business People, in a sense. Well, I mean, there's a lot that one can say about the specifics of the Grameen Bank model, and there's some issues associated with Mr. Yunus himself and his strategies and the extent to which his bank has relied mainly on government handouts.

51:41It's not really a bank, a private enterprise bank. But the point that's relevant here, and a point that hasn't been raised so much in the discussion in the last year about the Grameen Bank, is that if we look historically at economic development, If we look at countries that started out very poor, all of the Western countries in the late medieval period, through the Industrial Revolution, to the present, even countries, the Asian Tigers and so on, that grew very rapidly after World War II, in all of those cases, the way in which those countries were able to increase GDP per capita standards of living rapidly in a relatively short amount of time was through large Large increases in the amount of capital invested per worker, in other words, increases in labor productivity, higher wages, almost all of that is explained by wage growth, which suggests that the best way to increase standards of living in Bangladesh is to have Nike build a lot of big factories there and employ lots of people as wage earners, okay?

52:55It's hypothetically possible, it's conceivable, that a country could come out of poverty through small-scale mom-and-pop businesses. But that hasn't ever happened in history. We don't know any examples of that. In every other case, it's been increases in labor productivity reflected in wage growth that has led to increases in standards of living in poor countries. It's a very unfashionable thing to say, because then it sounds like you're endorsing sweatshops and all sorts of horrible things, rather than autonomy and individual self-respect and so on from owning your own business. So that's why nobody says it, but I'm saying it. Oh, okay, something else that affects the demand for labor could be employer tastes for discrimination.

53:46Remember I said before that if I employ Joseph Salerno as my personal assistant, but I'm not doing it because I like him personally. I would only do it because his services are valuable to me. If I'm an executive, hiring him makes my services that I sell on the market for executive services more valuable. Well, I mean, it might be the case that in addition to his value to me as an input, maybe I do consume a little bit of having him around. Okay, maybe I just like him. Or a more realistic case, maybe I just don't like him. Okay, and I'm not willing to pay as much as his labor services would command because I just don't want to have him around.

54:34Or the example that Joe gave yesterday, the employer who doesn't like redheads, Murray Rothbard's favorite example, refuses to hire any redheads. That lowers the overall demand for redheads, for the labor services of redheads, and can push down the wages of redheads. Now it turns out that it would tend to be very costly for an employer to engage in such behavior. We would not expect empirically to see a lot of firms that refuse to hire redheads, because by doing so, they're increasing their own labor costs, because they've cut themselves off from one particular segment of the market. There may be very competent redheads out there who will not be hired by this firm, who can be hired away by competitors.

55:20Other firms will end up likely out-compete the discriminatory firm. Nonetheless, this taste for discrimination can put downward pressure on the wages of redheads. A little bit more on labor supply. Something that affects labor supply is workers' taste for being in different occupations. It is true that the primary reason that many people engage, offer their services in the labor market is to make money, to earn income. But people also may get intrinsic satisfaction or dissatisfaction from being employed in particular lines of work.

56:05There's some consumption value in being in one occupation or another. I, for example, entered the profession. I chose to be an economics professor, not because of the vast sums of money that I make as an economics professor. Naturally, I could go into some other line of work and make bazillions of dollars if I wanted to. I just choose not to. I don't know if you can detect the sarcasm on a streaming webcast, but I get a lot of intrinsic satisfaction about what I do. So my decision to enter the labor market for economics professors is driven not exclusively by the wages that are available in that profession, although on the margin that does have an impact. At some price the wage would be so low that I would go and enter some alternative line of work that I enjoy less because I value having the income more.

56:58What labor economists refer to as compensating differentials refers to additional wages that are required in particular industries to attract workers to those industries because the occupation is inherently distasteful. So there's lots of empirical evidence on this, for example, You know, garbage collectors earn more than guys who, you know, deliver furniture, even though it's very similar, the jobs are very similar in terms of their physical characteristics, you bend down and pick stuff up and put it in a truck. Okay, but because garbage collectors have to work with smelly, stinky garbage and nobody wants to do that, the wages in that industry must be higher to attract workers into that occupation.

57:50We can explain that very simply with this graph, if I can just go back for a moment here. Right? You can imagine that in the market for garbage collectors, these reservation demands are much higher than they are in the market for furniture truck loaders. Okay? So at a market wage of $20, for example, that would be lower than a lot of potential workers' reservation demands. So if you think back to our graphs from yesterday in which the reservation demand from possessors of the good or service is higher, right, if this curve were way up here, then the market wage would be determined at a higher level, right, depending on the relationship between that reservation demand curve and this original demand curve.

58:38Okay. I should have put that in there. The graph in there. Okay. And by the way, we'll come back to it in just a moment. This point about workers' tastes reminds us that there is a lot of heterogeneity in the labor market. Right? All jobs are not the same and all workers are not the same. Right? And there's a sorting process that takes place in the labor market where workers with particular characteristics or attributes or preferences are matched with jobs that have particular characteristics. We'll come back to that point in just a moment. The wages and alternative occupations affect the supply of labor, like my professor wage example, right?

59:23If the way, if my next best opportunity is to be, gosh, what would it be? An opera singer, right? And the wages of opera, what's that? Security guard. Security Guard, thank you. Custodian. If the wages for security guards were to increase substantially, I might substitute out of the labor market for professors. Right. There can also be both private and governmental restrictions on entry into labor markets that affect equilibrium wages. There's a whole literature on occupational licensing that explains how licensing boards with government assistance are able to restrict the supply of labor into particular occupations, a kind of cartelization effect to increase the price.

1:00:12For example, take the market for lawyers' services. You could imagine a world in which anybody who wants to can be a lawyer. Don't have to go to law school, don't have to pass a bar exam, don't have to be state certified. You might think, well, who would employ such a lawyer? Well, it could be the case that for particular legal services, someone who's been employing someone who's had three years of training in a law school isn't necessary. In fact, de facto, there are a lot of services that can easily be performed by non-lawyers, even though they're often performed by lawyers at real estate, for example.

1:00:57In some states, you need an attorney to handle the documents purchasing a house. In other states, you just need an assessor or a title processor who isn't a lawyer but does exactly the same work, handles exactly the same documents. Think of the medical profession, the rise of so-called nurse practitioners who are not MDs, have not passed the state medical licensing exam, but yet do a lot of the same services that doctors perform, a lot of routine medical care. So imagine that even without bar exams and this kind of official certification, some people could specialize in performing legal services, and there would be a demand for their services, And there will be a supply of people available to perform those services.

1:01:43Then some clever lawyers get together and say, Hey, we shouldn't allow just anybody to be a lawyer. I mean, that would not be in the public interest. Then you can have all kinds of people out there offering legal services who aren't properly trained and they're misleading the uninformed consumer. We need to have restrictions on who can be a lawyer. We need to make everybody go to law school and have a degree. We need to make everybody pass a really hard exam and everybody to get a license from the state, from the government that says you are hereby qualified to practice law. Okay, so imagine that all these restrictions are put in place, for example, make everybody take the bar exam. Well, the available stock of attorney services in a world where you have to pass the bar exam and go to law school and so on, to be a lawyer is less than the stock of people who could perform legal services in the absence of the licensing restriction.

1:02:43So the effect of having restrictions on entry is obviously to raise wages. So the equilibrium price of legal services in a world with all these restrictions is higher than it otherwise would. Right now, if you talk to attorneys, they will not say, well, of course, we must have these strict licensing requirements so we can make more money. They'll say, oh, my goodness, we have to protect the public from unscrupulous attorneys. I mean, there's a lot that can be said about that argument and how fallacious it is, right? Right? Well, I mean, she assumes that people are, it's very extremely patronizing, assumes that consumers would not be able to tell who's performing decent services or not, they couldn't rely on third-party independent certifiers and so on, but I mean, I always think, well, if protecting the public welfare is the rationale for occupational licensing for lawyers or doctors, you know, what explains requirements for occupational licensing for barbers?

1:03:51Why do you have to pass a test and get a government certificate to be able to cut hair? You know, is it to protect the public from the menace of bad hair? It's really hard to come up with a sort of a public interest rationale for those kinds of restrictions. Okay, let me tell you a little bit, let's talk a little bit more about some of the details or peculiarities of compensation. The first thing to realize is that employers bid for labor services according to the discounted marginal revenue product of units of labor, but how the units of labor are paid can be In other words, I may generate, say, $100 an hour worth of labor services for my employer in terms of discounted marginal revenue product, but I don't have to get that $100 in cash, right?

1:04:54I could receive it in all cash. I could receive some of it now and some of it in deferred compensation. I could receive some of it in cash and some of it in services like fringe benefits, health insurance, medical care, retirement planning and so on. I could receive some of it in terms of enjoyment or satisfaction. In other words, my employer might say, look, you can get $100 an hour and work in an unattractive cubicle, Or you can get $75 an hour and work in this luxurious office. And some workers would be happy to receive part of their compensation in terms of a pleasant work environment.

1:05:39Whereas there's nothing in our theory that says that wages have to be paid purely in cash up front. It turns out that empirically, the ratio of salary or cash compensation to fringe benefits is not the one that would presumably emerge in a free market for labor. A lot of it is affected by tax policy. So the fact that wages are taxed but the cash value of fringe benefits is untaxed means that many of us prefer to receive some of our compensation in terms of health insurance and contributions to our retirement accounts and so on because that lowers our overall tax burden.

1:06:27Right, so there's a distortion in how labor market, one example of a labor market distortion, effective tax policy on the ratio between salaries and benefits. Interesting point on minimum wages is some economists have observed that there are cases in which minimum wages have been increased or established, where they weren't established before. And if you remember in the diagram that we had yesterday, in fact we saw it twice, Joe had one version, I had one version, right, where the government sets a legal minimum wage that is above the market clearing or equilibrium wage, right, that leads to an excess supply of labor, the quantity of labor supplied exceeds the quantity of labor demanded, there's a surplus of labor or unemployment, and a reduction in the quantity of labor that is employed.

1:07:23Fewer laborers, there are fewer labor transactions than there would be in the absence of the minimum wage. However, some people have observed, as I said, there are particular markets where minimum wages have been imposed or increased, and the quantity of labor employed does not seem to go down, or it doesn't go down as much as our analysis would predict. How can we explain that? Does that mean there's not a downward sloping demand for labor? Well, one explanation in some markets is that even in low-wage industries, fast food, for example, workers receive some of their compensation in non-monetary benefits, such as break times, discounted meals, having an employer supply uniform, and so on.

1:08:17Well, what some firms have done in fast food, for example, is responded to an increase in the government's minimum wage, not by laying off workers, but by reducing their actual wage rates, while continuing to pay the legally mandated minimum wage, by giving the workers shorter breaks, making them buy their own uniforms instead of providing the uniforms for them, making them buy meals instead of giving them reduced price meals, and in cases in industries where there are additional fringe benefits like health insurance and so on, reducing the amount of coverage of those, the provision of those fringe benefits. So that the real value of the wage has gone down even though the amount of cash you're paying per hour stays the same or goes up.

1:09:09So employers have ways of adjusting the actual compensation in a way to try to get around artificial restrictions on money wages, okay? Something else that we observe in some labor markets is that employees often have a long-term relationship with particular employers. But it isn't the case that every labor market transaction is kind of a spot market transaction where you hire a unit of labor for an hour or for a day and then at the end of the trading period the employer and employee go their separate ways and never see each other again. Okay? I mean, most of us are employed in long-term relationships with particular employers, right?

1:09:54And so the amount of pay may vary considerably over the period of this relationship, right? And what our theory explains is that the total amount of compensation received over this period will reflect the total value of the discounted marginal revenue product over this period. but they may not be equal on a day-to-day basis, right, in other words there are some occupations where individual employees, new employees who are just starting out may actually be paid less than their discounted marginal revenue product and more senior or tenured employees are paid more than their discounted marginal revenue product and firms may use this as an incentive device, right, as a means of trying to encourage younger workers to invest in and firm-specific training and so on, and to do the things that are necessary to get promoted to become more senior workers at some point.

1:10:54And so this doesn't indicate a defect or an imperfection in the labor market. It simply implies that if these trading partners have long-term relationships, it isn't the case that the wage equals the DMRP at every exact moment. It just, they're just equal on average over time through the life of the relationship, okay? The additional point about wages is that individuals who are self-employed, who own their own businesses, receive some of their compensation in the form of an implicit wage, right? Meaning that the owner of a small business may not write himself a check and call it a wage payment and fill out a W-2 form for himself and so on, right?

1:11:48The business owner, the compensation that he receives is in the form of the profits that his business earns. However, in a functional sense, sense of economic theory, at least part of that compensation reflects what we call an implicit wage, meaning the amount that he could earn in his next best opportunity if he were not a business owner. In other words, if I own my own business and I earn $100,000 in profit, which I pay to myself, but yet if I quit and went to work as a software engineer, I could earn $60,000, right? Then 60,000 of the $100,000 that constitute my profit reflects sort of the wages, the opportunity cost of my labor, The wages I have foregone by not being a computer programmer, software engineer.

1:12:47So that $100,000 is not all profit, only a part of it is profit and part of it reflects my implicit wage. The point is one cannot simply look at government generated statistics on wage payments, profit levels, profit amounts and so on and go from that directly to the economic categories of labor income or wage, profit, which we'll talk about in the afternoon session and so on, right? So what the business man or the accountant records as wage income or profit income does not necessarily correspond to the economic categories of wages and profits, okay? A couple of applications and extensions before we stop for questions.

1:13:35One interesting point is that there's no distinction in our analysis between production and distribution. A distinction that you sometimes see made in the economics literature. That well, production takes place and then subsequently, in a separate step, incomes are distributed among land, labor and capital, workers of different classes and so on. and so on. No, in fact, incomes are earned by factor owners as resources are employed in the production process. Okay, so incomes are generated as production takes place. There isn't production and then a separate stage in which all the income is divided up among different categories of factors. Okay. Distribution takes place in production. Okay.

1:14:24A couple of other sort of more technical points. Imagine a world in which there is no uncertainty about what future prices will be, what future market conditions will be. Okay, so entrepreneurs know with certainty that if they pay certain prices for factors of production in the present, use them to produce goods and services that they can sell in the future. They know exactly what those prices will be. They know exactly what their revenues will be in the future from selling the output they produce with the goods and services, with the factors that they purchase in the present. In a world like that, what incomes will be earned?

1:15:11Well, if I have to pay the full discounted marginal revenue product for every factor that I employ in production, well, there's not going to be any money left over for me after receipts are generated. Okay, so if the prices of all factors of production are bid up to their discounted marginal revenue products, there's nothing left over for the entrepreneur once production takes place. So, what factors will earn an income in a world like that? Well, only what we call, might call sort of the original factors of production will earn incomes in a world in the absence of uncertainty. So land will still earn an income, a rent from the use of land.

1:15:57Labor will earn an income because labor services must be compensated, right? But owners of capital goods will not receive any income. Why? Because the income that those capital goods generate will be imputed back to the land and labor, the original factors of production that were used to produce it, okay? So owners of capital goods may receive an interest return or to put it a different way, the time factor, the fact that the entrepreneur is willing to forego present consumption in anticipation of the earnings that he will receive in the future. His time preference will be rewarded in terms of an interest return.

1:16:43Okay, but the productivity of his capital goods themselves will not earn an income, will not earn a net income, the gross income to those capital goods will be paid out to the factors of production used to produce them and so on all the way up to the original or Highest Order Goods and Services, okay? A comment about land, I mentioned this before, of what economists, economists separate land into two distinct components, okay? Land in the economic sense is the part of the land that is truly nature-given or inexhaustible, okay? So the existence of the land in a specific, defined geographic area in a specific time and space. The part that can't be exhausted, can't run out, okay?

1:17:31What they sometimes call original land or basic land or ground land, right? In a world absent uncertainty will earn its discounted marginal value product, okay? What economists call geographic land or land that embodies capital improvements, for example, a field that's used in agriculture, right? Incorporates not only the actual land itself, but the way in which that land has been transformed through the application of labor and capital goods into something that can be used to grow corn or whatever. Okay, so the improved part of the land is a capital good, the return to which will be imputed back to the labor and the basic land or economic land that went into its production.

1:18:20Okay, another, let's see, How many more applications do I have? As many as you want. Okay, I'll actually just do, since it's 11, 20, I'll just do one more and then I'll stop. An important terminological point that we use in our analysis as to the term rent, concept of rent. Okay, the way economists use the term rent, the way rent is used in causal realist analysis is a little bit different from the common sense notion of rent and different from the way as some other economists use the term rent. We follow the terminology that was most clearly developed by the American economist Frank Fetter in the early 20th century, that rent simply means the payment per unit of time for the services of a good, okay?

1:19:14And this is in which this is the common sense definition, right, you rent an apartment, you pay rent on an apartment so many dollars per month, the right to live in the apartment. When I came here for the week, I flew into Atlanta and I rented a car. Okay, and so I'm paying so many dollars per day for the right to use that rental car. Okay, so a rent is simply the payment to any factor of production. It isn't just, some people think well, rents only apply to real estate. No, but if I go to, I don't know what they call it here, but where I live, they call it rent-a-center. You know, you can rent furniture, You can rent yard tools and so on, you rent them and the payment that I use, the payment that I give the store for the use of the digging machine is a rent. I'm renting the services of that good. Now some economists have used the term rent in specific ways that I think

1:20:08can be misleading. David Ricardo used the term rent to refer to only a certain part of the payments that go to factors. So not all of what I pay to rent the digging machine is a rent, only the part that goes to that factor beyond the amount needed to bring the factor into production. Alfred Marshall introduced the even more confusing notion of a quasi-rent, the payment to a factor beyond the amount necessary to retain the use of that factor in production. For our purposes you can ignore those usages completely and focus on the more straightforward sense that all of the payment to a factor is the rent to that factor.

1:20:54So rents are simply factor payments, all of the payments to factors. The price of a durable good, a refrigerator that you can buy, a digging machine that you can buy, a piece of land that you can buy, something that lasts, the capital value of of a Durable Good, is determined by capitalizing the extreme of expected future rents. So forecasting the rental prices that would be paid for the use of that factor through time and discounting it by the appropriate rate of time preference. Okay, by the way, you know, Joe gave some examples of, Joe explained how we know that time preference is positive, right, if there were no positive time preference, then the guy would take the girl's brush off of call me next year, you know, as a great thing.

1:21:45Yay, I got a date, okay. You can also think about this in terms of prices of durable goods, right. If there were no, if there were no such thing as positive time preference, then the value of the rental stream accruing to a particular piece of land or a durable capital good would be

1:22:07infinite. The fact that there are finite prices attached to land indicates there must be positive time preference because if the land never goes away, it always earns some rent, some ground rent. If we didn't have discounting, Well, we would add up an infinite stream of rents, okay? But we don't have an infinite capitalized value because at some point, those future payments are so heavily discounted that they're effectively zero, okay? Well, I'll stop now because I'm getting hungry and you guys probably are too, but we have a few minutes for additional questions and comments, please. You said that wages have characterized fastest in non-unionized sectors.

1:22:54Could you specify some of those sectors or perhaps point to studies that point to that conclusion? Could you attempt, in just a few words anyway, to explain why that would be so?

1:23:20Barely by increases in capital investments per worker, not by things like unionization, can I cite more specific examples or provide a reference? I'll have to think about a good reference. I don't have one at my fingertips just now. And I could give you some anecdotal examples, but rather than doing so, let me look it up and give you some hard numbers. I mean, a lot of examples come to mind, right? Wages in heavy manufacturing have lagged quite a bit in recent decades, and we think of industries Not all of them, but butlers and maids, for example, use them very, very rapidly.

1:24:12You pay your butler, you pay your butler quite a lot. Other questions, comments, please. Please. Back at your charts where you did the demand for labor and the supply for labor factors affecting it. Just this one, like this? No, you had a list of things affected. One of them was wages and alternative occupations. Oh yeah, okay, sure. I was wondering if you would also, based on your example, as far as a person who sleeps in a room, you said their productivity went up because they're using more capital, but even if they didn't have more capital, their wage is probably still higher, and I'm thinking one of those would probably be productivity in alternative occupations or demand for labor, so the fact that other industries are more productive, the price for it, even if you're not working in it, So what you mean is if the wages that I could earn in my next best alternative rise for some reasons unrelated to my productivity in my current occupation, my employer will have to pay me more to retain me?

1:25:35Yeah, that is essentially what you're saying. The person who speaks of Broome, you know, they could be doing the same exact thing a hundred years ago, they're making more today. Sure. Do you even know that I don't have more capital? No, it's a very good point. I didn't repeat the question. One could conceive of a situation in which productivity in alternative occupations rises more so than productivity in one's current occupation. and that would increase the reservation wage in the occupation at present. For example, in the sense in which this is a little bit unrealistic, but imagine that there has been no technological improvement in street sweeping. So all people have is brooms, right? Yet there has been tremendous technological improvement in agriculture. We've gone from hand tools to combine harvesters, right?

1:26:22Well, if the guy who's sweeping with the broom could be employed as a farmer, as a farm worker, instead of as a street sweeper, right? Even though he doesn't have a street sweeping machine, he only has a broom. I mean, no one in his right mind would continue to be employed in that occupation earning a dollar or two an hour if I could go earn $40 an hour driving a combine harvester, right? I mean, what makes the, just empirically, maybe we would expect that the kinds of technological improvements that we're describing would, to some degree, have an effect in lots of different industries. So if we have the technology to build combine harvesters, we'd probably have the technology to build better street sweeping tools. But as a theoretical matter, you're exactly correct. Dan.

1:27:10You mentioned occupations being rewarded with compensating differentials as a form of payment. Since compensating differentials or like approbation or something, they're not as discreetly defined as our monetary units. Do you think it might be difficult, more difficult to extract quality standards in industries that could pay their marginal product through compensating for personal debt as a monetary wage? I'm not sure I understand the question. Before I repeat it, what do you mean by quality standards? It seems like if you have, the bulk of your marginal product The question is, is it more difficult to design an appropriate compensation scheme when at at least part of an employee's compensation is received in non-monetary form.

1:28:29The answer is, I mean, yeah, sure. If you think of it in a diagram like this, right, suppose, you know, exactly what these reservation demands are is not something that the employer can sort of observe, right, this would have to be determined through trial and error, right? So I offer a particular combination of monetary and non-monetary benefits and see if I can attract The workers that I want, if I can't, well then I know I need to increase either the monetary part or try to improve the quality of the non-monetary part. You know, exactly how I do that is maybe challenging. There's some subtlety there, but this is something that in a market employers discover through experimenting with different kinds of compensation. Okay, well, let's break for lunch and we'll reassemble it too.