Explain the Marginal Productivity Theory of Distribution.
Marginal Productivity theory:
Marginal Productivity theory is a bold attempt to explain the determination of rewards of various factors of production. It is the work of many writers each improving, amending and modifying the ideas of the others. David Record was the first to use the theory for the determination of “Rent of Land”.
Statement of the theory: According to J. B. Clark, “Under static conditions, every factor including the entrepreneur would get a remuneration equal to its marginal product. According to Prof. Mark Blaug, “The Marginal productive theory contends that in equilibrium each productive agent will be rewarded in accordance with its marginal productivity.
Meaning of Marginal Productivity In order to explain the theory, the various concepts of marginal productivity should be discussed at first.
Marginal Physical Product (MPP): It is defined as addition to the total product when one more unit of the variable factor is employed, the amount of all other factors remaining unchanged. For example, if two workers produce 5 pencils and three workers produce 7 pencils then MP will be 2 pencils.
Marginal Revenue Product (MRP): It is defined as the addition to the total revenue resulting from the employment of one more unit of the variable factor and the sale of the additional product. In mathematical notation, MRP is calculated as:
MRP = MP x MR
Value of Marginal Product (VMP): It is defined as the proceeds from the sale of the marginal product. In mathematical notation, VMP is calculated as: VMP = MP x P
Average Revenue Productivity (ARP) : It is the average revenue per unit of a factor of production.
Under Perfect Competition
since P (Price) = MR
∴ VMP = MRP
Under Imperfect Competition,
Since P > MR
∴ VMP > MRP
Explanation of the theory:
Marginal Productivity theory explains the following main facts.
Reward of each Factor unit is equal to its marginal productivity: We know that a rational producer aims either at maximizing his profit or minimizing his loss. Producer is in equilibrium only when the marginal cost is equal to marginal revenue. In other words, a producer will employ the factors only upto the point where the Cost of an additional factor unit equals its marginal revenue.
Hence Factor Price = Marginal Revenue Productivity (Or VMP).
Determination of factor Employment and firms Equilibrium in a factor market: The theory states that a firm should employ that many units of a factor (labor in our example) where marginal revenue productivity (or VMP) becomes equal to the factor -price (i.e. wage -rate in our example). VMP of a factor = Factor Price. It is here that a firm will be in equilibrium and will get the maximum possible profit in a given situation. This is explained in the following example and diagram:
It is clear from the above table and Figure that when MRP (or VMP) is greater than wage -rate (MW = AW), firm can increase its profit by employing more laborers. With the employment of more laborers, MRP will decline and it will eventually become equal to wage rate. Similarly, if wage rate is greater than MRP, firm will be in loss. Then it will go on reducing the number of laborers till wages and MRP become equal. Hence firm will employ 5 (Example) or ON (Figure) units of labor.
Thus, under perfect competition in the labor market a firm is in equilibrium when two conditions are fulfilled:
- (i) MRP (or VMP) = AW = MW (wage rate).
- (ii) MRP curve should cut MW (= AW) curve form above.
These two conditions are fulfilled in at point E (above figure). According to it, this firm will employ ON laborers at OW rate of wages.
Assumptions of the Theory:
- All the factor units are identical.
- Perfect competition in the factor market.
- Variable input coefficients it means that the proportion in which different factors are combined to produce a commodity can be changed.
- Given stock of each factor and their full employment (called stationary condition).
- Given state of technology (called stationary condition).
- This theory hold good in the long run.
- It is difficult to calculate the MP of a factor because production is a joint efforts of all factors.
- The theory ignores the role of supply curve of factors in determination of price of a factor.
- The theory is based on the assumption of perfect competition. It is an unrealistic assumption which rarely exist in the real world.
- The theory assumes full employment. Full employment rarely exist in the real world.
- Short period is ignored.
- It only explains the demand side of factors.
Thus, Marginal Productivity Theory is an incomplete and inadequate theory.