The marginal productivity theory of income distribution is based on the assumption that factor markets are perfectly competitive. In such markets we can expect workers to be paid the equilibrium value of their marginal product, regardless of who they are. But how valid is this assumption?

We studied markets that are not perfectly competitive in Chapters 13, 14, and 15; now let’s touch briefly on the ways in which labor markets may deviate from the competitive assumption.

One undoubted source of differences in wages between otherwise similar workers is the role of unions—organizations that try to raise wages and improve working conditions for their members. Labor unions, when they are successful, replace one-on-one wage deals between workers and employers with collective bargaining, in which the employer must negotiate wages with union representatives. Without question, this leads to higher wages for those workers who are represented by unions. In 2013 the median weekly earnings of union members in the United States were $966, compared with $797 for workers not represented by unions—more than a 20% difference.

How much does collective action, either by workers or by employers, affect wages in the modern United States? Several decades ago, when around 30% of American workers were union members, unions probably had a significant upward effect on wages. Today, however, most economists think unions exert a fairly minor influence.

In 2013, less than 7% of the employees of private businesses were represented by unions. Just as workers can sometimes organize to extract higher wages than they would otherwise receive, employers can sometimes organize to pay lower wages than would result from competition. For example, health care workers—doctors, nurses, and so on—sometimes argue that health maintenance organizations (HMOs) are engaged in a collective effort to hold down their wages. Yet the sheer size of the U.S. labor market is enormous and the ease with which most workers can move in search of higher-paying jobs probably means that concerted efforts to hold wages below the unrestrained market equilibrium level rarely occur and even more rarely succeed.