“We’ve had it wrong for a long time,” my friend, Francis Franks, told me at lunch in his school’s cafeteria.
“For generations,” he continued, “economists tried to explain how the pie is sliced … how much goes to labor and how much to capital, the resources used to produce the goods and services exchanged in the marketplace.”
“Good tuna salad,” I managed to say.
“They do a decent job here,” he acknowledged. “But how much will workers get of the price you paid for that sandwich? How much will go to the school that built this building, put in the kitchen equipment, and bought the bread and tuna?”
“Good questions,” I muttered.
“Good?” he exclaimed. “Those are essential questions economists must answer. Particularly now, with debates about income distribution in our society, as top executives get bigger pay checks, bigger slices of a slowly expanding pie.”
“I thought we settled that over a century ago,” I said.
“So did I,” he responded. “Yet the debate is intensifying. We were taught a simplified model of the economy where all labor was the same. Then, the pay for each worker was determined by the value of the product the last worker added to the total revenue of the firm.”
“Yes,” I agreed, “undifferentiated labor and the value of the marginal product. I remember it well.”
“Too well,” Francis sneered. “We all know workers have different skills, different work habits, and different experiences. Therefore, they differ in their contributions to the company. That’s why there are differences in pay checks.
“It was easy to teach about a simplified world. However, our students are out there now, using our over-simplified representation of the world as a model for how the world should be. And the government produces statistics that are based on our elegant, but misleading ideas.”