McDonald’s Kiosks and the Labor-Capital Tradeoff

Earlier this week, there were several stories about McDonald’s adding self-order kiosks. CNBC’s Sarah Whitten did a rare “just the facts” story that says McDonald’s is adding the kiosks to 1000 stores each quarter for the next two years. Sadly, most other stories read like editorials in favor of or against the new technology and blaming or exonerating minimum wage laws. For example, Christian Britschgi at insists the kiosks are not a reaction to the minimum wage,  ignoring former McDonald’s CEO, Ed Rensi, crediting “Fight for $15” as the reason for the kiosks two year ago. Let’s look the economics of the issue to avoid getting overtly political.

Consider the simplest model of a firm that wants to maximize profit (p ), using two generic inputs, labor (L) and capital (K). We’ll use perfectly competitive input markets, so the firm can use as much of each input as it wants at the prevailing markets’ costs, wage (w) for labor and rental rate of capital (r) for capital. The firm also faces a competitive output market, so it can sell all the output it wants at the market price (p). The firm’s production is a function of both labor and capital, q(L, K), which gives the maximum amount of output for a given level of inputs. The firm’s optimization problem is summarized here:

Labor-Capital Eqn1

Solving this problem is straight forward. Take partial derivatives with respect to both decision variables and set them equal to zero:

Labor-Capital Eqn2

Both of these can be solved for p:

Labor-Capital Eqn3

Where MPL and MPK are the marginal products of labor and capital, respectively. So the ratio of price and productivity for both labor and capital are equal. What does that mean? If any of the four parts of this equation change, the firm will take actions to restore the equality. For example, if the wage doubles, the productivity of the workers would also have to double. Otherwise, the firm will substitute away from labor and employ more capital (until the equality is restored).

In the case of McDonald’s kiosks, the switch to more automation could be the result of better productivity from automation (i.e., higher MPK), but is more likely a “perfect storm” of both artificially increasing wages and increasing productivity from capital. That’s bad news for low-skilled and entry-level workers.

If you want to ensure your employability, focus on improving your productivity (i.e., raise your MPL). You do that by investing in your human capital through better education or job training. Focus on being more productive for your employer rather than simply demanding higher wages.

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