Tuesday, November 29, 2011

Krugman Doesn't Understand Micro

...or pretends not to.

"Yet textbook economics says that in a competitive economy, the contribution any individual (or for that matter any factor of production) makes to the economy at the margin is what that individual earns — period. What a worker contributes to GDP with an additional hour of work is that worker’s hourly wage, whether that hourly wage is $6 or $60,000 an hour. This in turn means that the effect on everyone else’s income if a worker chooses to work one hour less is precisely zero. If a hedge fund manager gets $60,000 an hour, and he works one hour less, he reduces GDP by $60,000 — but he also reduces his pay by $60,000, so the net effect on other peoples’ incomes is zip."

Further down he implies that this idea (that wage=value of marginal product) is some sort of bedrock principle of free-market economics.

Two problems with this:
1)Even if we were to use the perfect competition model that he's referring to (which I'm not sure any economists actually regard as an accurate description of reality), there is such a thing as consumer surplus. So, a producer does not capture all of the value that he creates.

2)There's no remotely good reason for free-market types to be wedded to the perfect competition model. It's easy to come up with sensible reasons why wage might not equal the value of marginal product. There could be transaction costs (e.g. maybe the worker will not search around until he finds someone who will pay him his marginal product. Maybe he ends the job search earlier and accepts a reasonably good wage that is lower than his marginal product.) One could also discuss the idea that some firms have market power (this can have some relation to the transaction cost idea mentioned above.) Lastly, whether we talk about perfect competition or not, there can be externalities. Does anyone really think Isaac Newton captured all the value he created? His wage was not billions or trillions of dollars.