Question

Explain the Marginal Productivity Theory of Distribution.

Answer 1

The marginal productivity theory of distribution was developed by Clark, Wickseed, and Walras. This theory explains how the prices of various factors of production are determined. This theory is also known as the “General theory of distribution” or “National dividend theory of distribution”.
Assumptions:

1. All the factors of production are homogenous and can be substituted for each other.
2. There is perfect competition in both factor and product market.
3. There is perfect mobility and full employment of factors of production.
4. This theory is applicable only in the long run.
5. The entrepreneurs aim at profit maximization.
6. There is no government intervention and no technological change.

Explanation of the theory:
Each factor is rewarded according to its marginal productivity.

1. Marginal product:
   The marginal product of a factor of production means the addition made to the total product by the employment of an additional unit of that factor.
2. Marginal physical product (MPP):
   The MPP of a factor is the increment in the total product obtained by the employment of an additional unit of that factor.
3. Value of marginal product (VMP):
   VMP = MPP x price

4. Statement of the theory:

1. The price of a factor of production depends upon its productivity.
2. The price of a factor is determined by and will be equal to the marginal revenue product of that factor.
3. Under certain conditions, the price of a factor will be equal to both the average and marginal products of that factor.

Marginal productivity under perfect competition:

X-axis represents factor units and Y-axis represents the factor price and revenue product.
MRP – Marginal Revenue Product Curve
ARP – Average Revenue Product Curve
AFC – Average Factor Cost Curve
MFC – Marginal Factor cost Curve
AFC – is horizontal under perfect competition and MFC coincides with it.
When there is perfect competition in the factor market, the firm is in equilibrium only when MFC = MRP
At the point Q by employing ON units of factors and paying OP price (NQ) where MFC = MRP
At Q, MRP = ARP
Price of the factor (NQ) = Marginal revenue
Product (NQ) = Average revenue product (NQ)
There is no exploitation of factors under perfect competition.
Beyond point Q the price paid to the factor is more than marginal revenue product and average revenue product, so employers do not employ the factors.