MARGINAL

PRODUCTIVITY
THEORY
OF
DISTRIBUTION
SUBMITTED TO: SUBMITTED BY:
Ms Rupinder Kaur Prenita Ranjan
(A3211117130)
Anushka Sharma
(A3211117141)
Ananaya Khare
(A3211117075)
BA.LLB(H)
 2017-2022

ACKNOWLEDGMENT

We would like to thank our faculty incharge-

“Ms Rupinder Kaur”
for providing us the chance to research and make a project on the
topic-“Marginal Productivity Theory of Distribution”
which would be very helpful to us in our future career , it would not have been
possible for us to complete this project without her guidance and help

Lastly we would also like to thank our parents for their constant support , We
would also like to thank each other for our various contributions in the project

- PRENITA
RANJAN
-ANUSHKA
SHARMA
- ANANAYA
KHARE
Marginal Productivity Theory of Distribution

Subject Matter:

The marginal productivity theory of distribution, as developed by J. B. Clark, at the end of

the nineteenth century, provides a general explanation of how the value (of the earnings) of a
factor of production is decided.

In different words, it suggests some broad principles concerning the distribution of the
national income among the four factors of production.

According to this theory, the value (or the earnings) of a factor tends to equal the worth of its
marginal product. Thus, rent is up to the worth of the marginal product (VMP) of land; wages
are equal to the VMP of labour and so on. The neo-classical economists have applied
identical principle of profit maximization (MC = MR) to work out the factor price. just as an
businessperson maximizes his total profits by equalization Mc and Mr., he conjointly
maximizes profits by equalization the marginal product of every issue with its monetary
value.

The oldest and most vital theory of factor evaluation is that the marginal productivity theory.
it's additionally referred to as small Theory of factor pricing.

It was propounded by the German economist T.H. Von Thunen. however soon several
economists like Karl Mcnger, Walras, Wickstcad, Edgeworth and Clark etc. contributed for
the event of this theory.

According to this theory, remuneration of cache issue of production tends to be capable its
marginal productivity.Marginal productivity is that the addition that the utilization of 1
further unit of the issue makes to the overall production. goodbye because the monetary value
of an element is a smaller amount than the marginal productivity, the businessperson can
proceed using additional and additional units of the factors. He can stop giving any
employment as shortly because the marginal productivity of the issue is capable the monetary
value of the factors.
Definitions:
“The distribution of financial gain of society is controlled by a construct, if it worked while
not friction, would offer to each agent of production the quantity of wealth that that agent
creates.” -J.B. Clark

“The marginal productivity theory contends that in equilibrium every productive agent are
rewarded in accordance with its marginal productivity.” -Mark Blaug
The marginal productivity theory of financial gain distribution states that within the end of
the day below excellent competition, factors of production would tend to receive a true rate of
come that was specifically capable their marginal productivity.” -Liebhafasky
Assumptions of the Theory:
The marginal productivity theory of distribution relies on the subsequent seven assumptions:

1. excellent competition in each product and issue markets:

The speculation assumes the right competition in each product and issue markets. It implies
that each value of the merchandise and therefore the price of the issue (say, labour) remains
unchanged.

2. Operation of the law of decreasing returns:

The speculation assumes that the marginal product of a factor would diminish as further units
of the factor area unit used whereas keeping alternative factors constant.

3. Homogeneity and quality of the factor:

All the units of an element area unit assumed to be severable and uniform. It implies that an
element is often divided into tiny units and every unit of it'll be of identical kind and of
identical quality.
4. Operation of the law of substitution:
The the speculation assumes the chance of the substitution of various factors. It implies that
the factors like labour, capital et al are often freely and simply substituted for each other. for
instance, land are often substituted by labour and labour by capital.

5. Profit maximisation:
The leader is assumed to use the various factors in such how and in such a proportion that he
gets the utmost profits. this could be achieved by using every issue up to it level at that the
value of every is capable the worth of its marginal product.

6. economic condition of factors:

The theory assumes economic condition for factors. Otherwise every issue can not be paid in
accordance with its marginal product. If some units of a specific issue stay out of work, they
might be then willing to just accept the use at a value but the worth of their marginal product.

7. Exhaustion of the overall product:

The the speculation assumes that the payment to every issue consistent with its marginal
productivity utterly exhausts the overall product, exploit neither a surplus nor a deficit at the
tip.

8.Rational Behaviour:
The theory assumes that each producer needs to reap most profits. this is often as a result of
the organizer may be a rational person and he therefore combines the various issues of
production in such how that marginal productivity from a unit of cash is that the same within
the case of each factor of production.

9. excellent Mobility:
The theory assumes that each labour and capital area unit absolutely mobile between
industries and localities. within the absence of this assumption the issue rewards may ne'er
tend to be equal as between completely different regions or employments.
10.Interchangeability:
It implies that every one units of an element area unit equally economical and
interchangeable. this is often as a result of completely different units of an element of
production area unit uniform, since they're of identical potency, they'll use inter-changeable,
and e.g., whether or not we tend to use the fourth man or the fifth man, his productivity shall
be identical.

11. excellent Adaptability:

The theory takes as a right that varied factors of production area unit absolutely pliant as
between completely different occupations.

12. data regarding Marginal Productivity:

Both producers and homeowners of things of production have suggests that of knowing the
worth of factor’s marginal product.

13.Law of Variable Proportions:

The law of variable proportions is applicable within the economy.

14.The Amount of things of Production ought to be Capable of being Varied:

It is assumed that the number of things of production are often varied i.e. their units will
either be inflated or diminished. Then the remuneration of an element becomes capable its
marginal productivity.

15.The Law of decreasing Marginal Returns:

It implies that as units of an element of production area unit inflated the marginal productivity
goes on decreasing.

16.Long-Run Analysis:
Marginal productivity theory of distribution seeks to clarify determination of a factor’s
remuneration solely within the long amount.
Explanation of the Theory:
The marginal productivity theory states that below excellent competition, value of every issue
of production are capable its marginal productivity. the value of the issue is set by the trade.
The firm can use that range of a given issue at that value is capable its marginal productivity.
Thus, for trade, it's a theory of issue evaluation whereas for a firm it's an element demand
theory.

Analysis of Marginal Productivity Theory from the purpose of read of an

Industry:
Under the conditions of excellent competition, value of every issue of production is set by the
equality of demand and provide. because the theory assumes that there exists economic
condition within the economy, therefore, provide of the issue is assumed to be constant. So,
issue value is set by its demand that itself is set by the marginal productivity. Thus, below
such conditions, it becomes essential to throw light-weight on the demand curve or marginal
productivity curve of associate trade.
As the trade consists of a gaggle of the many companies, consequently, its demand curve are
often drawn with the demand curves of all the companies within the trade. Moreover,
marginal revenue productivity of an element constitutes its demand curve. it's solely because
of this reason that a firm’s demand or labour depends on its marginal revenue productivity. A
firm can use that range of labourers at that their marginal revenue productivity is capable the
prevailing wage rate.
Fig. 2 shows that at wage rate OP1, the demand for labour is ON1 and marginal revenue
productivity curve is MRP1. If wage rate falls to OP, companies can increase production by
exacting additional labour. In such a scenario the value of the artefact can fall and marginal
revenue productivity curve will shift to MRP2.
At OP wages, the demand for labour can increase to ON. DD1 is the firm’s demand curve for
labour. The summation of demand of all the companies shows demand curve of associate
trade. Since the quantity of companies isn't constant below absolutely competitive market, it's
unimaginable to estimate the summation of demand curves of all companies. However, one
issue is definite that's the demand curve of trade additionally slopes downward from left to
right. the purpose wherever demand for and provide of a factor area unit equal can verify the
factor value for the trade. This theory assumes the availability of an element to be fastened.

Thus factor pricing is set by the demand for factor I.e. issue value are capable the marginal
revenue productivity. it's been shown by Fig. 3. In the Fig. 3, range of labour has been taken
on OX axis whereas wages and MRP are taken on OY axis. DD1 is the industry’s demand
curve for labour. this is often additionally the Marginal Revenue Productivity curve.
Factor price (OW) = Marginal Revenue Productivity MRP.
Thus under excellent competition, issue value is set by the trade and firm demands units of an
element at this price.
Analysis of Marginal Productivity Theory from the point of view of a Firm:
Under excellent competition, range of companies is incredibly giant. No single firm will
influence the value of an element of production. each firm acts as a value taker and not a
value maker. Therefore, it's to just accept the prevailing value. No leader would really like to
pay over what others area unit paying. In alternative words, a firm can use that range of an
element at that its value is capable the worth of marginal productivity. Therefore, from the
purpose of read of a firm, the speculation indicates what percentage units of an element it
ought to demand.

It is because of this reason that it's additionally known as Theory of issue Demand. alternative
things remaining identical, as additional and additional labourers area unit used by a firm, its
marginal physical productivity goes or- decreasing. As value below excellent competition
remains constant, therefore once marginal physical productivity of labour goes on decreasing,
marginal revenue productivity will proceed decreasing. Therefore, so as to urge the
equilibrium position, a firm can use labourers up to a degree wherever their several marginal
revenue productivity is capable their wage rate.

Table 2 indicates that wage rate of labour is Rs. fifty five per labourers. value of the
merchandise made by the manual laborer is Rs. 5 per unit. Now, once a firm employs one
manual laborer, his marginal physical productivity is twenty units. By multiplying the MPP
with value of the merchandise we tend to get marginal revenue productivity. Here, it is Rs. a
hundred for the primary labour. The marginal revenue productivity of second manual laborer
is Rs. eighty five and of third manual laborer it's Rs. 70.

The marginal revenue productivity of fourth manual laborer is Rs. fifty five that is capable
wage rate. The firm can earn most profits if it employs up to the fourth manual laborer. If the
firm employs fifth manual laborer, it'll need to suffer losses of Rs. 15. Therefore, to urge most
profits, a firm can use an element upto a degree wherever MRP is equal to price.

In Fig. 4 range of labourers has been measured on OX-axis and wage rate on coordinate axis.
MRP is marginal revenue productivity curve and WW is that the wage rate prevailing within
the market. Since, below excellent competition wage rate can stay constant that's why WW
wage line is parallel to OX-axis.
MRP curve is sloping down-ward. It cuts WW at purpose E that is that the equilibrium wage
rate of Rs. 55. At point E, firm can demand solely four labourers. Thus, from the higher than,
we are able to conclude that an element is demanded up to the limit wherever its marginal
productivity is capable prevailing price.
Under excellent competition, in long amount within the equilibrium position, not solely the
marginal wages of a firm area unit capable marginal revenue productivity, even the common
wages of the firm area unit capable average internet revenue productivity as has been shown
in Fig. 5. The fig. five shows that at purpose ‘E’ marginal wages of labour area unit capable
marginal revenue productivity and therefore the firm employs OM range of staff. At this time,
even the common internet revenue productivity is capable average wages. therefore firm
earns solely traditional profit. If wage line shifts from NN to N[N] then the demand for
labour will increase from OM to OM1.

Some Key Concepts:

The theory is additionally supported key sure ideas.

These area unit the following:

1. MPP:
The first is marginal physical product of an element. The marginal physical product (MPP) of
an element, say, of labour, is that the increase within the total product of the firm as further
staff area unit used by it.

2. VMP:
The second idea is worth of marginal product. If we tend to multiply the MPP of an element
by the value of the merchandise, we might get the worth of the marginal product (VMP) of
that issue.

3. MRP:

The third concept is marginal revenue product (MRP). Under perfect competition, the VMP
of the factor is equal to its marginal revenue product (MRP), which is the addition to the total
revenue when more and more units of a factor are added to the fixed amount of other factors,
or MRP = MPP x MR under perfect competition. It is simply MPP multiplied by constant
price, as P = MR. [VMP of a factor = MPP of the factor x price of the product per unit, and
MRP of a factor=MPP of the factor x MR under perfect competition. So under perfect
competition VMP of a factor = MRP of that factor.]
The Essence of the Theory:
The theory states that the firm employs every issue up to it range wherever its value is
capable its VMP. Thus, wages tend to be capable the VMP of labour; interest is capable VMP
of capital then on. By equalization VMP of every issue with its price a profit- seeking firm
maximises its total profits. allow us to illustrate the speculation with respect to the
determination of the value of labour, i.e., wages.

Let us suppose that the value of the merchandise is Rs. five (constant) and therefore the
wages per unit of labour area unit Rs. two hundred (constant). because the range of things
apart from labour stay unchanged, wages represent the monetary value (MC).
Table 12.1: Calculation of MPP, VMP and MRP of a Variable issue (Labour)

Table 12.1 shows that at two or three labourers, the VMP or MRP of labour is bigger than
wages; that the firm will earn additional profits by using an extra labour. however at five or vi
labourers, the VMP or MRP of labour is a smaller amount than wages, therefore it might cut
back the quantity of labourers. however once it employs four labourers, the wage rate (Rs.
20) becomes capable the VMP or MRP of labour (also Rs. 20). Here the firm gets the utmost
profits as a result of its monetary value of labour (or marginal wage Rs. 12) is capable its
marginal revenue (VMP or MRP, Rs. 20).

Thus, below the belief of excellent competition a firm employs {a issue|an element} up to it
range at that the value of the factor is simply capable the worth of the marginal product
(=MRP of the factor). within the same approach it are often shown that rent is capable the
VMP of land, interest is capable the VMP of capital, then forth.
The theory could currently be illustrated graphically. See Fig. 12.2. Here WW is that the
wage line indicating the constant rate of wages at every level of employment (AW = MW.
Here AW is average wage and MW is marginal wage). The VMP line shows the worth of
marginal product curve of labour, and it goes down from left to right indicating decreasing
MPP of labour. Fig. 12.2 shows that the firm employs OL range of labourers, as a result of by
doing therefore it equates the MRP of labour with the wage magnitude relation, and makes
optimum purchase of labour.

Determination of issue evaluation below Imperfect Competition:

Marginal productivity theory applies to the condition of excellent competition. however in
reality we tend to face imperfect competition. Therefore, economists like Robinson,
Chamberlin have analyzed issue evaluation below imperfect competition. There area unit
varied companies below imperfect competition. however here we tend to shall analyze solely
market. below market, there's excellent competition in product market. Consequently MRP is
capable VMP. there's imperfect competition in issue market.
It indicates that there's only 1 client of the factors. Therefore, market refers to a scenario of
market wherever solely one firm provides employment to the factors. If the firm demands
additional factors, issue value can go up and vice-versa. However, the determination of issue
value below market are often explained with the assistance of Fig. 6.
In Fig. 6 range of labourers has been shown on coordinate axis and wages on coordinate axis.
MW is marginal wage curve and Hans Arp is that the average wage curve. MRP is that the
marginal revenue productivity curve and AW is that the average revenue productivity curve.
In the fig. vi a market can use that range of labourers at that their marginal wage is capable
MRP. In the fig. vi firm is in equilibrium at purpose E. Here, firm can use ON labourers and
that they are paid wages capable NF. during this approach, ON labourers can get less wages
than their MRP i.e. EN. market firm can have EF profit per manual laborer that arises because
of exploitation of labourers. Total profit SFWW’ is because of exploitation of labour.

Criticisms of the Theory:

The marginal productivity theory of distribution has been subjected to variety of
criticisms:
1. In determination of marginal product:
Firstly, main product may be a joint product— made by all the factors together. therefore the
marginal product of any specific issue (say, land or labour) can not be severally determined.
As William Petty found out as early in 1662: Labour is that the father and active principle of
wealth, as lands area unit the mother.

2. Unrealistic:
It is additionally shown that the use of 1 further unit of an element could cause associate
improvement within the whole of organisation within which case the MPP of the variable
factors could increase. In such circumstances, if the issue is paid in accordance with the VMP,
the overall product can get exhausted before the distribution is completed. this is often
absurd. we tend to cannot consider such a scenario in point of fact.

3. Market imperfection:
The theory assumes the existence of excellent competition, that isn't found within the globe.
But E. Chamberlin has shown that the speculation may be applied within the case of
monopoly and imperfect competition, wherever the marginal value of an element would be
capable its MRP (not to its VMP).

4. Full employment:
Again, the belief of economic condition is additionally chimerical. economic condition is
additionally a story, not a mirrored image of reality.

5. Difficulties of issue substitution:

W. W. Leontief, the Alfred Bernhard Nobel social scientist, denies the chance of free
substitution of the factors continually attributable to the technical conditions of production. In
some merchandise method, one issue can not be substituted by another. furthermore
organisation or entrepreneurship may be a specific issue that can not be substituted by the
other issue.

6. stress on the demand facet only:

The theory is one-sided because it ignores the availability facet of a factor; it's stressed solely
the demand facet i.e., the employer’s facet, hi the opinion of Samuelson, the marginal
productivity theory is just a theory of 1 facet of the demand for productive services by the
firm.

7. Inhuman theory:
Finally, the speculation is usually delineated as ‘inhuman’ because it treats human and non-
human issues within the same approach for the determination of factor costs.
 BIBLIOGRAPHY
1. Manoj Kumar
Marginal Productivity Of Distribution
www.economicsdiscussion.net
26th September 2018

2. Smriti Gupta
Explain the marginal productivity theory of distribution
www.owlgen.com
26th September 2018