Marginal Productivity Theory of Distribution -Explanation

Marginal productivity theory of distribution in economics has its own importance.in fact, the theory of distribution is very important for the entrepreneurs.in order to understand the marginal productivity theory of distribution, let us first understand some important terms.

Average Physical Product:

The Physical Product per unit of the factor of production is called Average Physical Product. One can calculate the Average Physical Product as;

APP= Total Output/Total No. of Factors of Production

Marginal Physical Product:

The Marginal Physical Product is an addition to the Total Physical Product when additional units of variable factors are employed by it.

MPP= Change in Total Physical Product/Change in units of Variable Factor

Marginal Revenue Product:

An addition to the Total Revenue due to the sale of additional output because of using one more unit of the variable factor.

MRP=MPP*MR

Value of Marginal Product:

Value of the Marginal Product is the Marginal Physical Product multiplied by its price.

VMP=MPP*P

Marginal Productivity Theory of Distribution Assumptions:

Marginal productivity theory of distribution is based on the following assumptions;

There is Perfect Competition in the Market

The theory assumes to be applicable to the perfect competition. This theory doesn’t consider the unequal bargaining power which may take place between buyers and the sellers.

Unit of Each Factor of Production are Homogenous

We assume that units of the factor of production are all the same in terms of their efficiency. Hence, all the workers have the same type of labor to offer.

The Theory is based on the Law of Diminishing Returns

The theory of distribution assumes that as additional units of the variable factor are added. The marginal productivity of the factor goes on diminishing.

Firms are Rational and try to maximize their Profits

We assume that every entrepreneur tries to maximize their profits. Hence, every organizer is rational and combines the factors in such a way that marginal productivity from every additional unit of money is same in case of every factor of production.

 Long Run

Marginal productivity theory of distribution explains the determination of rewards only in the long run.

Perfect Mobility

According to the theory, both labor and capital are perfectly mobile in the product and factor market. Without this assumption, the factor rewards can never be equal between different regions.

Full Employment

The theory assumes that all factors of production are fully employed. Hence, the economy is in operation at full employment level.

Marginal Productivity Theory of Distribution Definition:

Marginal productivity theory of distribution by Clark explains as to how the price of the factor of production is determined. It is done on the basis of distribution according to contribution.

According to Mark Blaug “The marginal productivity theory states that in equilibrium every productive factor will get its reward according to its marginal productivity”

So, the marginal productivity theory of distribution states that in the perfect competition, the price of each factor will be equal to its marginal productivity. It is because keeping other factors constant when we increase the variable factor.Then, according to the law of diminishing returns its marginal product will fall. Hence its marginal productivity will be equal to its reward under the perfect competition.

Value of Marginal Product, Marginal Revenue Product (MRP) under perfect competition:

marginal productivity theory of dstribution

In this table, we find that wage rate under perfect competition is Rs.60 and a firm is not able to change this wage rate. By employing the first unit of labor, you can see that firm gets Rs.140 as marginal revenue product. Hence, it is worth employing more units of variable factor i.e. labor. Since its yields revenue greater than the wage rate. Similarly, when the entrepreneur employs the 2nd unit of labor, the firm gets Rs. 120 as marginal revenue product and the wage rate is still lesser than that. The process of hiring a variable factor continues till it yields revenue greater than the wage rate (wage rate is the cost for the firm). At the 5th unit of the variable factor, the marginal revenue product is Rs. 60 and the wage rate is also Rs. 60.

The entrepreneur is earning revenue exactly equal to what he is giving to the labor in the form of wage. Thus, at this point, the firm determines the wage rate. After this, it does not employ any more labor. If it does so, it will be uneconomical for the firm. This is what law of marginal productivity explains. That wage rate under perfect competition is determined when the marginal productivity of the laborer become equal to its price.

Marginal Productivity Theory of Distribution Diagram:

 Marginal Productivity Theory of Distribution

Marginal Productivity Theory of Distribution Criticisms:

The economists have criticized the marginal productivity theory of distribution on the following grounds;

Unrealistic Assumptions

The theory is based on the assumption of perfect competition. In real life, the market is always imperfect. So, the assumption of perfect competition is unrealistic.

Identical Units of Factor of Production

We assume that all units of a factor are identical, in reality, however, the units can never be the same. Mostly, when it comes to a laborer. Each and every laborer differs in terms of their efficiency and skills. Likewise, if we talk about land. The land also differs in terms of its fertility.

One can’t measure Marginal Productivity separately

According to some economists, we can’t separate the marginal productivity of the factors of the production. As production is not the result of only a particular factor of production. Critics say that one can’t consider the marginal productivity of a factor in isolation. So, the change in total product is not the outcome of only one factor of production.

Perfect Mobility of Factors

The theory has assumed the perfect mobility of labor and capital. In real life, factors are imperfectly mobile. There is no rapid movement of factors between regions.

Full Employment Level

The theory is based on the assumption of full employment level. But in reality, there are more chances of underemployment than full employment.

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