Last update: 16th Sept 2018

Lecture 4
Objectives of lecture
 The lecture seeks to explain the functioning of the so-called factor markets from
the perspective of Neoclassical economics.
 Factor inputs for Neoclassicals typically include labour, capital, land, and (on
occasion) entrepreneurship.
 Factor inputs are not to be confused with commodity inputs. The former are
seen as services provided by individuals to producers of commodities in return for
which the owners receive an income. The factors themselves do not change hands,
only the services they provide. Commodity inputs are basically produced goods
which are bought and sold for a price. It is argued that capital services constitute
the services provided by the goods comprising capital.
 In their factor market analyses Neoclassicals seek to explain the determination of
the price and quantity of factors (labour, capital, etc.) utilised in production.
 As with the product market analysis, the Neoclassical factor market analysis
makes use of the notions of demand and supply. The interaction of the demand
for and supply of factor inputs are seen as determining their price and the quantity
of them used in production.
 As with their product market analyses Neoclassicals pay considerable attention to
the notion of equilibrium in these markets and why and how these markets tend
towards this equilibrium.
 In their analyses of factor markets, Neoclassicals seek to show that factor incomes
(or factor prices) reflect the contribution of factors to production and preferences
of individuals supplying the factor services. This contribution is determined by
productivity of the factors, and the magnitude of the contribution by the choices
of the owners of the factor services.
 Typically Neoclassicals use the factor market analyses to argue that the shortage
of capital in developing countries is caused by an excessively low real interest
rate, state banks and limited development of private financial markets, and high
unemployment in these countries is caused by an excessively high real wage
level and low labour productivity.
 The analysis is also used to argue that if wages are to rise then labour productivity
must rise.
 Neoclassicals are typically at pains to argue that wages have nothing to do with
profits and vice versa.

Criticisms
 Critics argue that it is difficult to conceive of entrepreneurship and define capital
in an unambiguous manner.
o Some Neoclassicals define capital as long-lasting inputs, without being
specific as to what long-lasting means, others define capital as any non-labour
produced input into production.
 Critics deny that it is meaningful to talk of “factor markets”, certainly in the case
of capital and entrepreneurship. Rather, what is more meaningful is a discussion
of the determinants of aggregate income shares in an economy.
o It is of note that many Neoclassicals deny or ignore entrepreneurship as a
factor input, and many textbooks avoid discussing capital as a factor input.
o One problem is that few, if any Neoclassical textbooks, provide an explanation
of the determination of profits/interest.
 Critics argue that while it is certainly true that aggregate income levels will move
with productivity, they also argue that income shares will move inversely to one
another.

Contents of lecture 4
General
 Factor markets are explained by the demand for and supply of factors.
Interaction of demand and supply will determine the quantity of factors used
in production and their price.
 The price of the factor is seen as the return to the factor for the use of its
services over a certain period of time. Typically Neoclassicals conceptualise
these returns as real returns – i.e., money returns allowing for inflation.

Criticisms
 Most textbooks provide limited treatments of factors markets, paying most
attention to labour markets.
 It is assumed that all factors are SUBSTITUTABLE for one another and that
factor proportions are variable. However, even allowing for the fact that
Neoclassicals find it difficult to unambiguously define capital, it can be argued
that there is a limited substitutability of produced and non-produced inputs for
labour and vice versa.
 When it is accepted that factor inputs are no longer fixed (i.e., over the long run)
Neoclassicals simply assume that there is a tendency for productivity of factors to
fall.

Labour market

Definitions
 The price of labour is given by the REAL WAGE.
 What is assumed to be bought and sold in the labour market is LABOUR
SERVICES and not the workers themselves. The workers are paid a wage to
provide their services to businesses for the purposes of producing goods and
services.

Criticisms
 Critics question whether what is sold and bought in the labour market is
particular labour services (e.g., carpenter, plumber, electrician, etc) or labour
 power in general – the ability to produce saleable commodities and a surplus of
saleable commodities. A surplus of saleable commodities refers to an excess of
these in terms of their money value which is over and above the cost of producing
them.
 Critics (Post Keynesians) argue that the price of labour is the money and not
real wage, since workers cannot bargain over the price.

Demand
 The analyses of the demand for labour typically begins with an analysis of the
demand by individual firms for labour in a given industry or sector, and then these
individual demands are aggregated to give the industry or sectoral demand for
labour.
o It is of note that the economy-wide demand would pertain to the
macroeconomic dimension.
 The demand for labour by the individual firm is seen as a function of a number of
variables including the price of labour (the real wage), the relative prices of other
factor inputs, the productivity of labour, income taxes, and those factors
influencing the demand for commodities produced by labour (so called derived
demand).
 The first factor typically considered is the real wage (W/P). The relation between
the real wage and the demand for labour is referred to as THE LABOUR
DEMAND CURVE. It is assumed that there is an inverse relationship between
the real wage and the demand for labour such that the labour demand curve is
downward sloping.
 The downward sloping labour demand curve linking the real wage and the
individual firm’s demand for labour is explained by the DIMINISHING
MARGINAL PRODUCTIVITY OF LABOUR. It is of note that the price of
the products of labour is now assumed fixed (whereas in lecture 2 it was the price
of the factor inputs that was assumed fixed). Hence, a fall in the productivity of
labour must translate into a lower real wage if there is to be an expansion in the
demand for labour.
 As noted above, the other factors of relevance for the explanation of demand,
apart from the real wage, are the productivity of labour and a number of derived
demand factors including income, tastes, prices of related goods, etc. Particular
emphasis is placed on the productivity of labour.
o Neoclassicals typically see productivity of labour as linked to skills,
and these in turn to education (private vs state). Some Neoclassicals see
productivity as linked to taxation, with high and low taxes explaining rising and
falling productivity.
o Derived demand refers to the relative demand for products or using
more labour intensive techniques (viz., services).
 A change in any of these other factors is shown as a shift in the labour demand
curve outwards away from, or inwards towards the, verticle axis.

Criticisms
 The short-run downward sloping demand curve for labour as explained by the
diminishing marginal revenue product of labour pre-supposes that labour can be
varied while capital and other inputs remain fixed, at least over the short-run. This
 suggests that firms are operating at full capacity – which is empirically
untenable. Most studies show that firms typically operate with excess capacity.
 Neoclassicals do not see that the demand for labour can rise along with rising real
wages if profits rise, and that the latter may even allow a rise in real wages. In
fact the argument is that the major explanation for changes in the demand for
labour in a capitalist economy is changes in the demand for the products of labour
(and the profits of the firm selling these products) and not either a fall in the real
wage (which would actually dampen such demand) or a rise in productivity. It
needs noting in this context that a rise in productivity does not necessarily imply a
rise in profitability. Much will depend on what is being produced and the
environment in which it is being produced.
 One can question the validity of assuming a diminishing marginal productivity
when for the most part factor inputs have a fixed ratio to one another – machines
typically require a certain number of workers. That is, one can question the
assumption of substitutability of labour for capital (and other factor inputs).
 To argue that relative factor prices influence the relative demand for labour also
suggests that factor inputs are substitutable. This does not happen in modern
economic systems.
 It is argued that as labour becomes more productive less labour is demanded and
not more.
 It can be argued that a fall in real wages would cause the demand for the products
of labour to fall (as a result of wages being lower than the prices of the goods
being bought by workers) leading to a fall, rather than a rise in demand for labour.

Supply
 The labour market supply is seen as the aggregate of labour supply by individuals
(i.e., hours of labour individuals seek to supply).
 Hence, labour market analysis begins with a study of the factors determining the
supply of labour by an individual.
 The factors affecting labour supply are the real wage, preferences for work and
leisure, institutional factors affecting these preference (e.g., labour laws, break-up
of unions, social security, unemployment benefits, breaking of taboos regarding
the employment of different gender, ethnic and other groupings, and taxes),
population growth, and immigration.
 The individual labour supply curve linking the supply of labour and the real wage
is referred to as THE LABOUR SUPPLY curve. It is argued to be upward sloping,
meaning that a higher real wage is required for an increasing supply of labour.
 The upward slope of the labour supply curve is explained by a DIMINISHING
MARGINAL RATE OF SUBSTITUTION between work and leisure. As
workers supply more labour time they place an increasing value on their leisure
time. Technically, this means that the labour supply curve is flat at low levels of
working hours offered but becomes steeper as labour offers more working hours -
a proportionately higher wage is required to compensate for progressively greater
sacrifices of leisure time.
 Changes in the other factors influencing the supply of labour apart from the real
wage (viz., preferences of workers between work and leisure, institutional factors,
taxes, etc) are shown by a shift in the labour supply curve inwards towards, or
outwards from, the verticle axis.
Criticisms
 Labour cannot bargain for a real wage, since they cannot control future
prices. It is argued that businesses typically arrive at wage bargains with labour
before they set prices.
 Most workers are not able to choose the number of hours they work.
 Seeing the supply of labour as a choice between working and leisure is a
misrepresentation of the nature of labour supply. For most labour there is not
a choice of how many hours in a day, or days in a week, they work. For many the
choice is between working or living an impoverished life.
 The relationship between the supply of labour and the real wage is not as
depicted by the upward sloping labour supply curve of Neoclassical theory. For
example, at higher levels of real wages increases in real wage may cause less
labour to be supplied, and, at low wage levels reductions in real wages may cause
more labour to be supplied – since real wages may be near the subsistence level.

Equilibrium
 Changes in the real wage rate are seen as important in explaining equilibrium in
the labour market.
 It is argued that if the labour market is allowed to work there should be no
unemployment, at least no structural unemployment, since everyone who wants
to work can work. It is for this reason that the definition of unemployment was
changed in the 1990s to exclude those who have been unemployed for more than a
certain period of time (e.g., 9 months), on the basis of the argument that those
unemployed for longer than this period can be presumed to prefer leisure!
 Neoclassicals argue that if there is unemployment it is because the price of
labour is too high, say due to institutional factors such as trades unions, minimum
wages, pensions, health insurance, etc., or the demand for labour is too low –
usually because the productivity of labour is seen to be too low.
 In the context of economic development, Neoclassicals use the real wage and
productivity of labour to explain unemployment.
 It is also assumed by Neoclassicals (usually in the context of economic growth
theory) that if wages are too high then there will tend to be a substitution of
capital (machines) for labour.
 Neoclassicals argue that for real wages to rise the demand for labour curve needs
to shift outwards in relation to labour supply (i.e., the other factors influencing
demand need to change). Neoclassicals typically suggest the most important way
this can happen is if the productivity of labour were to rise. The latter could be
due to either workers working harder and/or becoming more skilful.

Criticisms
 The Neoclassical notion of full employment is dependent on the contention
that there is always work available for those who want it. This is rarely the case
in capitalist countries where unemployment is functional (especially in
recessionary periods) and is a norm in many developing countries.
 Reducing wages in a situation of unemployment would worsen the problem
of unemployment since lower wages would cause the demand for goods and
services by workers to also fall leading to a fall in the demand for the workers
producing these goods.
 Wages are not, and cannot be, flexible in the manner supposed by
Neoclassical economics. This is because wages are of necessity fixed for
significant periods of time (see Heterodox analysis in lecture 4).

Capital market

Definitions
 Capital markets are not often discussed in the mainstream textbooks. This is at
least in part because there are considerable problems defining capital and the
return to capital in an unambiguous manner.
 From a Neoclassical perspective, capital is in fact best defined as a stock of (long-
lasting) physical inputs (or the money required to command these inputs). It
is argued that capital goods are bought by businesses for the productive services
they provide.
 The price of capital refers to the price paid for the services provided by the
capital goods. This is given by the real return. This is the return to the owner of
the capital goods over and above her/his cost. It is the opportunity cost of the use
of the capital goods. Some economists define the real return as the real interest
rate – the nominal rate minus the rate of inflation.
 The real rate of return is defined as the physical surplus produced by machines
in proportion to the machines. It is seen as falling over the short-run due to the
diminishing marginal physical productivity of capital.
 The source of the real return to capital is seen as the physical productivity of
this capital – the physical productivity of the machines.
 The magnitude of this real return (or magnitude of profit) is seen as rising along
with the productivity of the machines and the expansion of output, but at a
diminishing rate.
 Most Neoclassicals do not distinguish between interest and profit and see
interest as profit. These Neoclassicals typically ignore the role of the
entrepreneur in capitalism.
 The demand for capital is seen as the demand for the non-labour long-lasting
material inputs into production by firms, or investment demand. It is taken as the
sum of money that is used to pay for these non-labour inputs.
 The supply of capital is seen as the supply of money to buy these inputs, and is
seen as coming from the savings of individuals.

Criticisms
 Typically most economics textbooks ignore the discussion of capital markets as
factor markets. Examples are Krugman and Wells (2006) where there is no
discussion of capital in the chapter on the distribution of income.
 The notion of capital goods as goods providing capital services is difficult to
understand since for one thing it is difficult to understand what capital services
means. If it means being able to produce other goods, this could be said to apply
to ordinary tools purchased by individuals who do not use them to produce a
financial profit in the same way that firms do. If it means the service of producing
a profit, this begs the question what such goods might be, i.e., what are goods
which produce a profit and where could one buy them.
 The notion of a market for capital is also difficult to understand since it suggests
that there is a market for income generating means of production. While there are
certainly markets for borrowing and lending money as well as buying and selling
inputs (long lasting and other) these cannot be argued to constitute markets for
income generating assets. Indeed, whether loans obtained from banks or inputs
purchased in shops constitute capital depend on the purpose to which these are
given/obtained. Money can be loaned as capital (i.e., requiring the borrower to pay
interest on the loan) without it being also borrowed as capital (i.e., used to
generate an income). Similarly, a computer can be sold as capital (i.e., produced
as a good by a capital firm the sale of which will yield a profit to the firm) and
bought as a capital input but it may also be bought as a final consumption good
yielding no financial reward for its purchaser.
o One way in which Neoclassicals get around this is to argue that the
return to the owner of capital is not necessarily financial but needs to be
understood in terms of expanded the satisfaction it gives rise to.
 Neoclassicals exclude the money advanced to pay wages (and pay for inputs
which have a life span of one production period) when defining capital, without
any real rationale for doing so. This is especially problematic since businesses
typically compute their rates of return on capital advanced taking into account the
money they advance to pay for all inputs into production.
 Neoclassicals assume that the source of interest is the productivity of long-
lasting inputs but fail to explain how more physical outputs are produced by given
amounts of physical inputs, or why non-long lasting physical inputs do not
produce a physical surplus.
 It is unclear how one can conceptualise the real interest rate (the return on
physical inputs). In theory it is the physical commodity return in relation to the
commodities advanced as capital. The problem is that for these two magnitudes to
be comparable one has to assume they are the same commodities. Hence, the
absurd notions of capital and returns to capital which abound in Neoclassical
theory including capital as corn or putty and the return to capital in terms of corn
and putty. The Walrasian general equilibrium version of the theory assumes
capital is any commodity (not necessarily one which is an input into production)
whose rate of return in terms of itself is positive!
 Those who distinguish between capital and entrepreneurship admit that it is
difficult to talk about the demand and supply of entrepreneurship. For one thing,
there is no way to quantity entrepreneurship. Capital markets are deemed to
allocate capital to their most productive uses through the real interest rate
mechanism (seen as the price of capital services). Even granting there are capital
markets, the question is what profits are supposed to do in terms of allocating
resources. Are they supposed to allocate entrepreneurial skills? If so how are
these defined and measured? What is the rate of profit on entrepreneurial skills?
 Where Neoclassicals make a distinction between interest and profit (one being
the pure return to capital for parting with liquidity and the other being the risk
premium) it is unclear what profit constitutes a return to? Many Neoclassicals
argue it is a return to the entrepreneur (the owner of the enterprise), but this causes
trouble when discussing the marginal product of entrepreneurship.
Demand
 The demand for capital is associated with investment demand; the demand
for long-lasting inputs to expand production. Although this is seen as a demand for
the real physical resources to undertake investment and the real rate of interest is
the expected real or physical rate of return resulting from the investment, there is a
tacit assumption that this investment demand is the demand for real money
balances to buy the required non-labour inputs and the rate of interest is the real
rate paid to the suppliers of this money.
 The market demand for capital is given by the sum of the demand for capital
by individual firms.
 The demand for capital by an individual firm is argued to be a function of a
number of variables, including the price of capital (the real rate of interest on the
borrowed sum of money), the price of other factor inputs, the productivity of
capital, and those factors influencing the demand for the product (including the
relative price of the product, income, tastes, etc).
 The first factor influencing demand which is analysed is the real rate of
interest (approximated by the nominal rate of interest given in financial markets
minus the rate of inflation).
 The curve depicting the relation between the demand for capital and the real
interest rate is referred to as the demand for capital curve.
 The demand for capital linking the price of capital with the quantity of capital
demanded by the individual firm is argued to be downward sloping on the
assumption of diminishing marginal revenue productivity of capital.
o As more capital is employed the marginal productivity is assumed to
diminish. With given prices for the products produced with the extra capital the
additional revenue obtained is also assumed to fall. But the tacit assumption is
that all other inputs except for capital are fixed.
 The influence of factors other than the real rate of interest on the demand for
capital is shown by a movement of the demand for capital inwards or outwards
from the verticle axis. The other factors were noted above and include the prices of
other factor inputs, the productivity of capital, and derived demand factors such as
income, tastes, etc..
o The productivity of capital is linked to technological change and
typically seen as introduced into the individual production process via
borrowings.
o The derived demand factor refers in principle to products produced
using capital intensive processes.

Criticisms
 Following from the definition of capital, there is no reason to suppose that a firm
considers its investment demand (demand for capital) as only the purchase of
long-lasting material inputs into production (i.e., fixed capital), or even just
material inputs into production. Specifically, there is no reason to exclude non-
lasting material inputs or, and most importantly, the outlays on hiring labour.
 If the demand for capital is seen as the demand for money to buy long lasting
non-labour inputs then the rate of interest should be seen as the real rate of interest
that needs to be paid to the lenders of this money. However, this would suggest
that the firm’s demand for borrowed funds will depend on the extent to which its
 returns are able to cover these costs and compensate it for the risk of undertaking
the investment – i.e., an entrepreneurial profit. Otherwise one is assuming that
production is only for the purpose of paying an interest to the lenders of the
money. But if indeed there is need to generate a profit over and above the interest
paid to the lenders of the money, there is no reason to suppose the demand for
capital is inversely related to the real rate of interest that needs to be paid for the
borrowed funds. It is perfectly possible for the real rate to rise along with the
demand for the funds provided that the rate of profit is rising. Indeed, the rise in
the rate of interest would be made possible by the rise in the rate of profit.
 Many Neoclassicals typically avoid explaining why and how the demand curve
for capital is downward sloping, except for saying that it is the consequence of
diminishing returns. However, diminishing returns over the short run can only be
explained by diminishing marginal revenue productivity over the short-run, and
this necessitates the assumption that other factors cannot be varied. Aside from the
fact that this suggests the existence of excess capacity over the short-run, it
contradicts the fundamental premise of Neoclassical economics justifying rising
costs of production over the short-run, i.e., the only factor that can be varied over
the short-run is labour. And, over the long-run, when all factors are variable, it is
difficult to understand what might explain diminishing returns to capital – as
separate from diminishing returns to other factors.
 To argue that the demand for capital is related to the relative price of capital
suggests that capital is substitutable with other factors of production.
 It is implicit in the Neoclassical explanation of the demand for capital that an
increase in the productivity of capital translates into an increase in profitability.
But in fact an increase in productivity may be accompanied by a fall in
profitability.

Supply
 The supply of capital is technically the supply of the resources or “services”
needed for investment. The more savings there are the more of a country’s
resources are deemed to be devoted to activities other than consumption, i.e.,
investment.
 The supply of capital is associated with savings by individuals (real resource
savings) because it is understood in terms of consumption foregone by
individuals. That is to say, the capital borrowed by firms is the result of savings
or non-consumption by individuals.
 The supply of these capital services is not the supply of the machines by
individuals but rather the supply of money to buy the machines.
 The market supply of capital is seen as the aggregation of the individual
supply of capital by individuals – the market supply of capital services. Hence,
the analysis of the supply of capital should begin with the determinants of the
supply of capital by an individual.
 The supply of capital by an individual is seen as determined by; the price or
real rate of interest, the level of income, natural preferences of individuals
between consumption and savings, the institutional factors affecting these
preferences, and inflation.
 The focus in the first instance is on the link between the supply of capital by
the individual and the price of capital or the real interest rate. This relationship is
 typically depicted by THE CAPITAL SUPPLY CURVE. This curve is seen as
upward sloping (getting more verticle as capital supply rises) because of a
diminishing marginal rate of substitution between present and future
consumption. As individuals supply more capital (i.e., the more they postpone
present consumption) they place an increasing value on present consumption.
Technically, this means that the capital supply curve becomes steeper as capital
supply increases, since a proportionately higher real interest rate is required to
compensate for progressively greater sacrifices of present consumption.
 Aggregating individual capital supply curves gives the market supply curve.
Other factors influencing the supply of capital, aside from the real interest rate, is
depicted by the movement inwards and outwards of the market supply of capital
curve. The other factors which are responsible for this movement of the market
capital supply curve have been noted above and include the level of income,
preferences of individuals (their natural preferences to save) and institutional
and economic factors. Examples of institutional factors include the development
of the financial system, and tax policies, and examples of economic factors
include inflation and inflationary expectations.

Criticisms
 The supply of capital should not be thought of as individual consumption
forgone but rather investment finance.
 Savings, in the sense of investment finance, do (does) not come from
individual savings with financial institutions (as implied by Neoclassical
analyses) but retained earnings (profits) of companies.
 It is unclear that the more you save the progressively higher the interest rate
has to rise to encourage you to save more. Typically, rich individuals will save
(to finance investment) most if not nearly all their incremental income even
without any increase in real interest/profit rates. Other critics argue that high real
interest/profit rates might even encourage dissaving for certain income groups.
 If the rate of interest rises then profits will fall and so will savings. Hence, the
Neoclassical analysis only makes sense if we assume the rate of interest is profit.
But this contradicts the demand for capital analysis.

Equilibrium
 Changes in the real interest rate are seen as giving rise to equilibrium in the
capital market – a balance between demand and supply of capital.
 If there is an excess of demand for capital for Neoclassicals it is because the
real interest rate is too low, say due to financial repression and government
controls.
 It is argued (usually in the context of growth theory) that if the equilibrium
real interest rate is too high then labour will be substituted for capital.

Criticisms
 The rate of interest balances the demand for and supply of loans and not capital
invested in productive activities. If the rate of interest is taken as the rate of profit
 then there can be no equilibrium in the analysis since both curves would be
upward sloping (see below).
 A rise in the real rate of interest in the context of an excess demand for capital
may not eliminate the excess demand but merely cause profits to fall such that
both the supply and demand for capital fall (further).
 A high real rate of interest will not cause labour to be substituted for capital.
Rather it may simply depress the demand for loan capital.

The distribution of income

 The message of the Neoclassical approach is that the distribution of income is
determined by the productivity and choice of individuals.
 Wage differences between individuals in a given industry are due to choice
(choosing to work more) and/or productivity (working longer and harder to
produce more).
 Wage differences between industries are due to productivity differences of
workers in the different industries, which in the end could be explained by
skill differences. It could also be explained by workers working longer in
some industries – choosing work over leisure.
 Profit differences within a given industry must be because of cost (and
therefore productivity) differences.
 Profit differences between industries are denied in the context of perfect
competition, but if they exist are said to be because of monopoly practices in
some industries.
 If profits rise in relation to wages it is due to relative productivities of the
two. It is denied that increases in profits could be due to decreases in wages.
 It is denied that the source of profit is the excess labour performed by
workers (those who sell their labour services for a living) – excess over and
above what is needed to pay for their wages.
 Wealth accumulation by individuals in the form of greater quantities of
capital at their disposal is argued to be due to choice – the choice of future
over present consumption.
 It is denied that wage differences could be due to institutional factors such as
background, school, family, profession (certain professions are more highly
rewarded due to the role they play in ensuring the class system and profits
generation and accrual), etc. If institutional factors are admitted they tend to
be trade unions or government (wage legislation, paying government workers
more than private sector can afford, etc).

Criticisms
 Critics deny that the distribution of income can be understood as determined in
the markets for factors and reflecting the productivity of factors and choices
of their owners. Rather, the distribution depends on the institutional setting.
o Profits, interest and wages are not determined in markets for
entrepreneurs, capital and labour.
 Critics deny that the demand for labour and capital depend fundamentally on
their respective physical productivities. They argue this demand depends
more on the profitability of the enterprise as a whole.
  Critics deny it is possible to talk of a demand for labour independently of a
demand for non-labour inputs contra the Neoclassicals.
 Critics question the possibility of computing the contribution of capital to
the total product when one cannot even define capital (and even more so
entrepreneurship) unambiguously.
 Critics deny that labour receives a real wage equal to its contribution to
production.
 Critics deny that the supply of labour is fundamentally based on choices
between work and leisure and that the less people are paid the more they will
substitute leisure for work, especially those on low wages. It is argued that in
fact most individuals have little choice about how much labour time they
supply.
 Critics deny that wealth accumulation is the result of choices between
present and future consumption. They question the conclusion that rich people
became rich because they save more, i.e. sacrifice present for greater future
consumption. Rather, they see rich people become rich because they benefit
from the exploitation of labour.

Key elements for an alternative

 There is no such thing as factor markets and factor prices bringing the
demand for and supply of the factors into equality with one another. There are
factors of production and incomes accruing to these factors, but they are not to be
explained by the demand for and supply of the factors.
o Profits are not determined in the market for entrepreneurs.
o Interest is not determined in the market for money – the central bank
sets the rate of interest and supplies unlimited sums of money at this rate of
interest.
o Wages are set by firms for existing employees on the basis of the
profits they are seen as generating – allowing for certain socio-economic
structures.
 There is no market for entrepreneurs, and entrepreneurship cannot be seen as
a factor of production separate from capital.
 Entrepreneurs or productive capitalists are to be seen as distinct from money
lending capitalists.
 Capital cannot be seen as either the sum of material inputs required to
produce all commodities, or even the money to buy these material inputs. Rather,
it should be seen as the money advanced to buy all inputs into production with a
view to appropriating a certain rate of profit in relation to the value of the money
outlaid.
 The return on capital should be seen as profit and not interest. Interest is
paid out of profits to money lending capitalists.
 The demand for capital needs to be understood as investment demand by
firms. This demand does not depend on the money market rate of interest but on
the rate of profit (and/or magnitude of profit) accruing to the producers.
 The supply of capital should be understood as the money outlaid to finance
investment, with the primary source of this seen as coming from profit.
 The return on capital cannot be seen as determined by the physical
productivity of physical inputs into production. Rather, it is determined by labour
productivity and measured by labour time.
 What the entrepreneur buys is a certain amount of labour time (to produce
goods of a value that exceed the costs of producing them) and not particular
skills. What the entrepreneur pays is a certain money wage.
 The demand for labour does not depend on the productivity of labour, but on
the profitability of what is produced.
 The supply of labour does not depend on either the real or money wage but
on the institutional setting – labour having only their labour power to sell. In
modern times consumerism and debt replace poverty as the spur for labour to
obtain jobs at the going wage rate.
 The wage rate (wage per unit of labour time) is agreed (even if not paid)
before production takes place. Hence, it cannot be argued to be determined by the
productivity of labour. In fact, the wage rate is determined by the profitability of
production and the general institutional setting.
 The distribution of income is not determined in the market, but rather by the
institutional setting which is designed to make workers less able to bargain over
wages, viz., consumerism, debt, the legal system (limits on workers rights), low
pensions, no public healthcare, etc.