Marginal Productivity Theory of Distribution
MARGINAL PRODUCTIVITY THEORY OF DISTRIBUTION
This concept of
marginal productivity was taken from Ricardo and West. But both Ricardo and
West applied the marginal productivity concept only to land. The references for
the marginal productivity theory were taken from Thunen’s Der Isolierte
Staat [1826], Longfield’s lectures on political economy, and in
Henry George’s progress and poverty [1879]. This theory was rediscovered
by economists like J.B. Clark, Jevons, Wicksteed, Walaras and later Marshall
and J.R. Hicks popularised the doctrine of marginal productivity.
Marginal
productivity theory tries to explain how the price of the factor is determined.
As we know that a
firm motives to get profits that’s why it will not pay any factor more than its
marginal
productivity.
Similarly, each factor will charge his price at least equal to his marginal
productivity. That is how marginal productivity [not total productivity]
determines the price of a factor of production.
Since long as the marginal
cost of a factor is less than the marginal productivity, the entrepreneur will keep
on employing more and more units of the factors. When the marginal productivity
of the factor is equal to the marginal cost of the factor, he will stop giving
further employment.
What is marginal productivity: Marginal product may be physical marginal product. It means that it is the increase in output secured by an increase in the use of a factor. If we multiply increase in output by the prevailing price, we get the value of the marginal product. This is called marginal revenue product. Or we can say that the addition to the total revenue resulting from the use of one more unit of a factor is called marginal revenue product. This marginal revenue productivity is briefly called marginal productivity. Thus, marginal productivity of a factor is the addition made to total production by the employment of the marginal unit [ the unit which the employer thinks worthwhile to employ].
According to J.B. Clark, “The distribution of income of society is controlled by a natural law, if it worked without friction, would give to every agent of production the amount of wealth which that agent creates.”
Liebhafasky states, “The marginal productivity theory of income distribution states that in the long run under perfect competition, factors of production would tend to receive a real rate of return which was exactly equal to their marginal productivity.”
An entrepreneur will substitute one factor for another till the marginal productivities of all factors are equalized. At the margin of employment, the payment made to the factor concerned is just equal to the value of the addition made to the total production due to the addition of an extra employment of a unit of a factor. If the prevailing price is less the marginal productivity, then more labour will be employed. As we know the marginal productivity of a factor keep on diminishing with each increase of a unit of a factor, so an entrepreneur will keep on employing labour until marginal productivity of an extra unit equals to its prevailing price. On the contrary, when marginal productivity is less than the price of a factor, the firms will reduce the demand for labour. As a result, price of a factor will fall to the level of marginal productivity. Thus, due to competition, price of a factor of production tends to equal the marginal productivity.
Assumptions of the
theory:
1-Homogeneous Factors and Interchangeability: it assumes that all the units of a factor are homogenous so the productivity of different units of factor of production is the same. They can be employed inter-changeable due to having same efficiency.
2-Perfect Competition: it assumes that there is a perfect
competition both in factor and commodity market.
3-Perfect Substitutability: They can be substituted for each
other. Perfect
substitution is possible not only between the different units of the same
factor but also between the different units of various factors of production.
4-Perfect Mobility: factors are perfectly movable between different
places and industries.
5-Rational Behaviour: This theory assumes that each entrepreneur shows
rational behaviour to get maximum profits. He combines the different factors of
production in such a way that marginal productivity from a unit of money is the
same in the case of every factor of production.
6- Full Employment: It assumes that there is full employment of factors
and resources.
7-Law of Variable Proportions: It is based on the law of variable
proportions in the economy.
8- Long- run analysis: This theory is applicable in long-run.
Here
we try to explain how the wages tend to equal the marginal productivity of a labour. This is
applicable to other factors of production too.
Marginal Product
The addition made to the total product by employment of an additional unit of that factor is called marginal product of a factor of the production. The Marginal Product may be expressed as Marginal Physical Product (MPP), Value of Marginal Product (VMP) and Marginal Revenue Product (MRP).
1.
Marginal Physical Product (MPP)
The Marginal Physical Product of a factor is the increment in the total product obtained by the employment of an additional unit of that factor.
2.
Value of Marginal Product (VMP)
The Value of Marginal Product is obtained by multiplying the Marginal Physical Product of the factor by the price of product.
3. Marginal Revenue Product (MRP)
The Marginal Revenue Product of a factor is the increment in the total revenue obtained by the employment of an additional unit of that factor. We use briefly marginal productivity in place of marginal revenue productivity which is the addition to the total revenue resulting from the use of one more unit of a factor of production.
Explanation of the Theory:
We can explain this theory from the perspective of the industry
and an individual firm both.
From an industry’s perspective: under perfect competition, price of each
factor of production is determined at that point where demand of the factor is
equal to its supply. As the theory assumes that there is full employment in the
economy under perfect competition, therefore, supply of the factor is assumed
to be constant. So, price of the factor is determined by its demand which
itself is determined by the marginal productivity. Hence, marginal productivity curve [MRP] is
the demand curve for a factor of production.
In the above diagram, supply and demand of the labour is OX axis
and factor price/MRP is on OY axis. Supply curve SL is parallel to oy axis
which shows that under full employment conditions, supply OQ is fixed.
DL curve is moving down from left to right which is the marginal
productivity curve as well.
Factor price determines at that point where demand curve DL and
supply curve SL intersects each other. E is the equilibrium point where both
demand and supply of labour are equal and at this point price of the factor is
determined P for an industry.
From the firm’s perspective in perfect
condition, this price will be accepted by the firms and at this price, firm
will employ that number of labours at which factor cost [price of a factor
determined by an industry] is equal to its marginal productivity.
MRP=MFC
|
No of labours |
Total product [TP] |
Marginal product [MP] |
Price [MFC] |
Total revenue |
Marginal revenue product [MRP] |
|
1 |
10 |
10 |
10 |
100 |
100 |
|
2 |
18 |
8 |
10 |
180 |
80 |
|
3 |
24 |
6 |
10 |
240 |
60 |
|
4 |
28 |
4 |
10 |
280 |
40 |
|
5 |
30 |
2 |
10 |
300 |
20 |
|
6 |
31 |
1 |
10 |
310 |
10 |
|
7 |
31.5 |
.5 |
10 |
315 |
.5 |
In
this diagram, MRP is the marginal productivity curve. It is the demand curve
for a factor of production. The quantity of the factor employed OQ at the price
OP. At equilibrium point, marginal productivity equals price. If entrepreneour
emplys more qunatity of factor i.e., OQ1’ marginal productivity [Q1E1] will be less
than the price he has to pay. He will thus be a loser and if he employs less i.e.,
OQ2’ the marginal productivity [Q2E2] will be more than the price, he will add
to his profits by employing more till at QE where marginal productivity equals
price.
Thus, the price of a factor of production is determined by its marginal productivity.
Criticism of Marginal Productivity Theory: It has often been argued that marginal productivity theory is based on too many assumptions which are quite unrealistic. This theory is criticised on the following points:
1-No
two factor-units are homogeneous: It assumes that all the units of a factor are homogeneous. This
is not actually the case. The efficiency of labour differs from worker to
worker. Similarly, one piece of land differs from the other in fertility. The
capital equipment is also of different types. Since no two factor-units are homogeneous,
they are non-substitutable for each other.
2-Different
factors of production are non-substitutable for each other: It is assumed that different factors of
production can be substituted for one another, so that, it is possible for the
entrepreneur to use a little more land or a little more labour or capital, etc.
In real, it is not always possible to substitute labour for capital or land and
vice versa. Different factors of production are not close substitutes for one
another so marginal productivity of the various factors may remain unequal.
3-Factors are not perfectly movable: It is assumed that the factors of
production are mobile as between various uses. In real, land lacks mobility;
nor are labour and capital perfectly mobile. If a factor cannot be moved from
one use to another, its marginal productivity in the various employments may
remain unequal.
4-The
amount of a particular factor cannot be continuously varied: It is also assumed that the amount of a
particular factor, that is used in production, can be continuously varied, that’s
why, it is possible to apply a little more or a little less of the same factor.
If this is not possible, the use of the factor cannot be pushed to the point at
which its marginal productivity becomes equal to its cost.
5-The
theory is based on the law of diminishing returns: It means that, other
things remaining same, a disproportionate increase in the supply of any one
factor increases total production at a diminishing rate. We know, however, that
in manufacturing industries, the operation of the law of diminishing returns can
be stifled due to technical progress and innovations.
6-The
marginal productivity theory has been criticised by Keynes: One implication of this theory is that
if employment is to be increased, wages should be lowered, so that more labour
will be employed to make marginal productivity equal to the wage. It can be
true in the case of an individual industry or a firm but not applicable to the
economy as a whole. The total employment in an economy depends on effective or
aggregate demand, and not on the level of wages.
7-The
supply of a factor is not fixed: This theory assumes that the supply of a factor is fixed. In
actual practice, the reward enjoyed by a factor affects its supply. It is thus
a one-sided explanation as it approaches the problem from the demand side only.
8-Marginal
productivity and the reward of a factor are dependent on each other: According to this theory, marginal
productivity determines the reward of a factor of production. This is not
really the case. One affects the other. The marginal productivity or efficiency
of a factor also depends on the reward he gets. For example, the wages of the
labours determine their standard of living, which in turn determines their
efficiency or productivity.
9-Production is not the result of one factor alone: production of
a commodity is always a result of all the factors i.e. land, labour and capital
and their units working together. It is, therefore, not possible to calculate
the marginal productivity of each factor unit separately.
10-It is applicable only in the perfect competition: In reality, there is no perfect competition rather imperfect competition or monopolistic competition is the rule which leads to the exploitation of the factors by paying them less to their marginal productivity.
We may conclude in the words of
Professor Samuelson that, “It (marginal productivity theory) is not a theory
that explains wages, rents, or interest; on the contrary, it simply explains
how factors of production are hired by the firm, once their prices are known.”
it explains how many workers will be employed at a given wage level. It does
not explain how that wage level itself is determined.
Though Marginal productivity theory of distribution does not explain fully the determination of all factor prices but it plays an important role on the fixation of factor rewards.
Dr. Swati Gupta
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