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Theories Of Distribution.pptx

The document discusses theories of factor price determination. It begins by introducing the classical theory of distribution known as the marginal productivity theory. This theory states that in equilibrium, each factor of production will be rewarded according to its marginal productivity. The document then explains the marginal productivity theory in more detail and lists its assumptions. Finally, it introduces the modern theory of distribution, which says that factor prices are determined by the demand and supply of each factor, with the equilibrium price occurring at the intersection of the demand and supply curves.

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Unit - V
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.
Theories of distribution Theories of distribution are:-  Marginal Productivity Theory  Modern Theory of Distribution
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.”
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.
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).
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.
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.
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.
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
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.
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.
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.
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
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
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
Supply of enterprise  No definite relation is laid down.  Supply of an entrepreneur depends upon other economic factors.
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.
Supply curve Demand curve E y x P Q
Cont’d…  Price of a factor of production will be determined at that level when Demand = Supply
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.
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