2. Introduction
The pricing of factor services is only an extension of
the pricing of commodities with slight differences.
American economists treat pricing of factor services as
simply an extension of pricing of commodities.
4. Classical theory of distribution
Also known as Marginal Productivity theory of distribution.
Theory says that, “In equilibrium each factor of production
will be rewarded in accordance with its marginal
productivity, as measured by the effect of the addition or
withdrawal of a unit of that agent on the total product, the
quantity of other factors of production being constant.”
5. Marginal Productivity Theory Of Distribution
The classical economists had laid down a general theory of distribution
which was not accepted by later economist who evolved marginal
productivity concept.
The theory was first propounded by Ricardo and later explained and
developed by Wickstead and Clark.
The theory tells us that as the price of a commodity is determined by its
marginal utility as also the reward of a factor of production is
determined by its marginal productivity.
By marginal productivity of a factor of production, we mean the
addition made to the total production by the employment of marginal
unit i.e. the unit which the employer thinks worth while employing.
In the short period the reward of a factor may be more or less than the
marginal productivity but in the long-run the reward will become
equal to the marginal productivity.
6. Assumptions of the Theory
Perfect competition both in the commodity market
and the factor market.
All units of a factor of production are homogeneous or
uniform i.e., equal in efficiency and interchangeable.
All units of a factor will therefore, be getting the same
remuneration.
The theory assumes that the employer is interested in
getting the maximum amount of profits. In order to
maximize profits in using factor units every employer
uses only that number factor units of which the cost of
that last unit (marginal cost) will be equal to the
product of the last unit (Marginal Product).
7. Contd….
Production can be increased or decreased by changing
the factor units by small quantities.
Every unit of a factor of production is perfectly mobile
as between different regions and employments.
Assumes a long period to prove that the remuneration
of a factor will be equal to both average and marginal
productivity.
The production should be achieved under the
conditions of diminishing returns.
8. Contd…..
Explanation:
According the Marginal productivity theory of distribution
the reward of each factor of production in the long run is
determined by its marginal productivity.
If the reward is paid at a rate lower then the marginal
productivity, then it will not be advantageous for the factor
to continue in that industry and it will move to an other
industry.
On the other hand if the reward is more than the marginal
productivity, it will not pay the produce to the
entrepreneur and he will not keep the factor in the
industry. He will replace this factor by another, whose
marginal productivity is higher or whose cost is relatively
lower.
9. Average and Marginal Product of a Factor:
Physical productivity refers to the amount of a commodity
in terms of a physical unit which a factor helps to produce.
We convert physical productivity into money through the
system of price and this is known revenue productivity.
Suppose there arc 20 workers in a workshop' producing 100
pens a day. The total physical product is 100 pens and
average physical product per worker is 100/20=5 pens.
Suppose the price of a pen is Rs. 4/- the total revenue
product is 100 x 4= Rs. 400 and the average revenue
product is 400 / 20=.Rs. 20.
10. Criticism
Units of factors are homogenous
Different factors are substitutable
Amount of particular factor used can be varied
Factors are mobile between various uses
Assumes supply of factors to be fixed
Theory valid under perfect competition
11. Modern theory of distribution
The modern theory of distribution says that the price of a
productive service is determined by the demand and
supply for that particular factor.
12. Demand for a factor
Demand for factor is a derived demand.
Its demand depends on the commodity manufactured.
If the demand for goods are elastic or inelastic, the
demand for factors is also elastic or in elastic.
Demand for a factor of production depends on the quantity
of other factors required in the process.
Demand also depends on the value of the finished product.
More productive the factor, higher will be its demand.
The sum total of the demand of all the firms in the
industry, determines the price of a factor.
13. Supply for a factor
It refers to the number of units of the factor available for
sale in the market at a given price.
The law of supply does not cater to the supply of factors
of production under all conditions.
It depends on various other elements.
14. Supply of land
Economy point of view: Perfectly Inelastic.
Industry point of view: Perfectly Elastic.
Depends on the opportunity cost.
Y
x
y
x
P
r
i
c
e
supply supply
Perfectly Elastic
Perfectly
Inelastic
15. Supply of Labor
The number of hours for
which a laborer is willing
to sell his services at a
given rate.
To a limit supply increases
with increase in wages.
After certain wage rate
increase the labor prefers
leisure to work.
Hours
W
a
g
e
s
x
y
E
16. Supply of capital
Depends on amount of savings
Rise in interest will increase the saving, thus increasing
the capital and vice versa.
y
x
Supply
i
n
t
e
r
e
s
t
17. Supply of enterprise
No definite relation is laid down.
Supply of an entrepreneur depends upon other economic
factors.
18. Interaction of demand and supply
The demand and supply curve are required for
determination of price.
The price that will tend to prevail in the factor market at
which the demand and supply curve are in equilibrium.
The equilibrium is at the point of intersection of these 2
curves.
20. Cont’d…
Price of a factor of production will be determined at that
level when
Demand = Supply
21. Conclusion
Marginal productivity
theory states that, reward
for each factor is
determined by its marginal
productivity.
Modern theory states that
reward or remuneration is
determined on the basis of
demand and supply of
factors.
