UNIT THEORY OF DISTRIBUTION

Structure
*
17.0 Objectives
17.1 Introduction
17.2 Alternative Approaches to Distribution of Income
#
17.2.1 Personal Distribution
17.2.2 Functional Distribution
17.3 The Classical Theory of Distribution
17.3.1 Rent
17.3.2 Wages
17.3.3 Interest
17.3.4 Profit
17.4 The Marginal Productivity Theory
17.4.1 Concepts of Productivity
17.4.2 Statement of the Marg~nalProdbctlvity Theory
17.4.3 Assumptions of the Marglnal Productivity Theory
17.4.4 Reward to a Factor and Factor Employment In a Firm
17.4.5 Cntical Analys~sof Marg~nalProductivity Theory
17.5 Let Us Sum Up
17.6 Key Words
17.7 Answers to Check Your Progress
17.8 Terminal Questions

1 7 . 0 OBJECTIVES

After studying this unit, you should be able to:

describe various approaches to distribution of income
discuss the classical theory of distribution
a explain the marginal productivity theory.

1 7 . 1 INTRODUCTION

Production is carried out by the collective efforts of land. labour, capital and enterpiise.
These factors of production are combined in different productive activities in different
proportions. Therefork, their relative shares in the joint income are not the same in all areas + .

of production. For example, land has a predominant role in agriculture. The other factor
which contributes no less than land to agricultural output is labour. Therefore, remunerations
to these factors of production are larger than those of other factors of production in
aghculture. In industries, on the contrary, much capital has to be employed and the
entrepreneur performs a very useful function. In fact, his contribution to output of an
industrial firm is generally quite substantial. While the role of land in industries is relatively
secondary, labour's contribution to industrial output is always large. These facts explain why
the shares of labour, capital and enterprise in the incomes of industrial units are large,
whereas land's share is small. These differences in the relative shares of the various factors of
production in different productive activities, however, do not affect the criteria on the basis of
which they are rewarded. The principles according to which land, labour, capital and
enterprise are remunerated are the same for all productive activities. In this Unit you will
' learn various approaches to distribution of income. Yod will also learn classical theory of
distribution and marginal productivity theory.
 -
-
Distribution of Income
17.2 ALTERNATIVE KPPROACHES TO
DISTRIBUTION OF INCOME
I

There are two main approaches to the problem of income distribution. One way to examine
the income distribution is to study as to how the national income is distributed among the
various members of the society. In this case the sources from which people derive their I

incomes are not relevant; what is important is as to how much income different people have
received. This is called 'personal' income distribution. The other way to examine the income
distribution is to study as to how are different persons rewarded for their services, or the
factors which they provide for the purpose of production rewarded. In this case attention is
given to the reward for the functions each factor performs in the processes of production.

17.2.1 Personal Distribution

\
Personal dishbution of income means the distribution of national income among the
various membeis of the society. These persons perform various kinds of activities and are
paid for their services. For example, workers, teachers, clerks and other officers get salaries,
and professionals like advocates, chartered accountants and physicians doing private practice
charge fees for their services. Since these services do not require the same skill and are not
uniformly productive, earnings of different persons engaged in these activities differ. But all
persons do not work. Some persons own either land or capital or in some cases both. In the
agricultural sector, a section of population owns land. These persons can either cultivate land
or give it to others who pay rent. In the first case, that is, if land is tilled by the owner, the
person's income is partly a reward for his labour and partly a reward for the services of land.
The owner of capital earns interest. A person can lend his capital to others and earn interest,
or he may invest it in his business where part of the income of the firm will be due to the
services of the capital. Entrepreneurs bear risk and perform some organisational f h i o n s for
P which they are rewarded in the form of profit. I

Incomes of a large number of people are not from one source only. Some people get salary
for the work which they do in offices and also earn interest on their bank deposits and
dividend on their investments in shares. Others earn income from agriculture and by working
in informal sector when there is no work to be done on farms. These are some of the
examples to underline the fact that a person can receive income in more than one form. In
examining personal distribution we are not concerned with the source or with the form of
income. Our interest is confined only to the size distribution of income. Thus in this case
we analyse as to why income inequalities exist and is there something which can be done to
make rich a little less rich and poor a little less poor.

17.2.2 Functional Distribution

Functional distribution refers to the mechanism whereby different factors are rewarded for the
services they render to the productive process. We have stated earlier that wages are paid to
labour,.rent to owners of land, interest to owners of capital and profit to entrepreneurs. In
functional distribution an attempt is made to examine how are wages,
rent, interest and profit determined. In this'hspect it is necessary to state that there
is no theory which could explain determination of the rewards of all the factors of production
in an equally satisfactory manner. According td modem economists, rent, wages, interest and
profit are the prices for the services rendered by land, labour, capital and enterprises
respectively in the production process. They assert the problem of functional distribution in
essence of the problem of factor pricing. The dichotomy between 'commodity pricing' and
'factor pricing' is, therefore, no longer recognised. It is now contended that the same
principles which determine commodity prices go to determine prices of various factors of
production. Having taken this position they consider pricing of factors of production as part
of the price theory.

Check Your ~ r o ~ r e sAs

1 ..Distinguishbetween the.pmonal distribution and the- fbctkml distribution.
 Theory of Distribution

1 7 . 3 THE CLASSICAL THEORY OF DISTRIBUTION

I
'"I

The earliest systematic discussion on distribution of income is found in the writings of the
classical economists. Adam Smith and Ricardo were the most prominent economists of the
classical school. These economists attempted to explain the prices of products in terms of
so-called "natural rates" of reward for labour, land and capital. These natural rates of reward
were explained by special theories. Interestingly, even the leading classical economists did
not wholly agree among themselves in explaining rent, wages, interest and profit and in
some cases their differences were on substantial points. We shall confine here only to what
are considered the representative theories of the classical school. For explaining rent
Ricardo's theory is considered most authentic. There are two theories to explain wages.
Adam Smith and David Ricardo developed the subsistence wige theory. Some other classical
economists, including J.S.Mill advocated the wages-fund theory for explaining wage rates.
Interest has been explained in terms of demand for and the supply of savings. Although the
classical economists used the concept of profit in their writings, they failed to develop a
consistent theory of profit.

17.3.1 Rent
As stated above on rent, the most authentic theory in the classical framework has been
provided by David Ricardo who is considered one of the foremost economists of the classical
school. According to Ricardo, rent i i that portion of the produce of earth which
is paid to the landlord for the original and indestructible powers o f ' t h e
soil. In his opinion, rent is not earned by the landlord by makingcertain improvements on
land. It is a surplus left after the costs of cultivation as represented.by payments to labour
and capital have been met.
In developing his theory of rent, Ricardo relied on deductive reasoning. In his opinion, man
must have cultivated the superiormost quality land first, and until such a land was available
rent could not arise. But in any buntry the best qualityiand cannot be available in unlimited
quantity. Its supply exhausts with the increase In population. As population grows and the
demand for foodgrains increases, people are compelled to bring the second best quality land
under cultivation. Obviously, the production on this land which is now marginal land will
not be as much as on the best quality land. According to Ricardo, on the marginal land there
cannot be any rent. Since the supply of this land is still abundant, the question of paying
rent on this land does not arise. However, rent emerges due to the excess production on the
best quality of land as compared to the marginal land. It will be equal to the surplus
production on superior lands over and above the production on marginal land. In this sense
Ricardo viewed, rent as a differential surplus that some plots of land earn
over and above the least fertile land under cultivation. You will learn more
about this theory of rent in Unit 19.

17.3.2 Wages
As mentioned earlier, the classical economists had developed two different theories of wage
determination. Adam Smith and David Ricardo are considered the chief exponents of the
subsistence wage theory. T.R. Malthus and J.S. Mill propounded the wages f e d theory. Let
us discuss them briefly.
The subsistence theory of wage determination assumes that labour is purchased-and sold
in the market like any other commodity and its value is determined like the values of other
commodities. Since the classical economists argue that in the long run the value of any
commodity is equal to its production cost, therefore the value of labour should also be equal
to the cost of producing it, which in essence is the amount required for maintaining the
worker and his dependents at the subsistence level. The subsistence wage theory asserts
that workers in the long run earn only the subsistence wage irrespective of their productivity
levels. In the short run, however, actual wage rate can be at variance from the subsistence
wage, but in the long nm through adjustments in the supply of labour the actual wage rate
will tend to be equal to the subsistence wage. Ricardo was of the view that the subsistence
level of wages will be rigidly fixed for all times.
J.S.Milt had pqmmdedUle wages fund theory in most cogent form. According to him,
wage rate depends on ratio of workforce to the amount of working capital
which is meant t o be spent directly on the purchase of labour. The wages
fund, that is, the amount of working capital provided for obtaining the services of labour is
not in practice any fund set aside for paying the wages. The producers only have an estimate
of it in their minds. The aggregate of these individualproducers' estimates make the national
estimate of wages fund which ordinarily remains fixed over times.Therefore, any change in
the wage rate that may occur will be due to a change in the number of workers willing to
work for wages. The wages fund theory does not suggest that in the long run wage rate
should remain stable at a certain level. It admits that over time wage rate may rise either due
to an increase in the wages fund resulting from higher savings or the decrease in the
workforce. The possibility of both the factors operating simultaneously also exists.

17.3.3 Interest
J.S. Mill is the chief exponent of the classical theory of interest. In his opinion, the rate
of interest is determined by the interaction of demand for and the supply
of cap&&He marked that "the rate of interest ... depends essentially and permanently on
the comparative amount of real capital offered amj demanded in the way of loan", and thus
''fluctuations in the rate of interest arise from variations either in the demand for loans or in
the supply"
The d6sical theory of interest suggests that the .source of supply of capital is that part of
income which is withheld from consumption. This is called saving. In the classical theory
,'
saving is functionally related to interest and varies d k t l y with it. The demand for capital is
made for investment purposes only and is interest-elastic. It implies that the demapd for
capital rises as the rate of interest deceases and it diminishes with the rise in the rate of
interest. To be brief, the demand for capital varies inversely with rite of interest. The demand
for and supply of capital are equal at a rate of interest which'is obtained by the iritersection of
the demand and supply schedules.

17.3.4 Profit
The classical economists did not provide any coherent theory of profit. It was difficult for
them because they had relied on labour theory of value for explaining the values of
commodities. According to this theory, the value of a commodity depends on the
amount of labour embodied in it. This might have been true in the earli~rsocieties
 --.-
when labour was the sol6 producer of commodities. Even in his times, Adam Smith 'mted Theory of Distribution
that employers used their own capital along with the hired labour for producing
, kmodities. He therefore G e d that when goods are sold they must fetch not only enough
ta cover the wages of workers but they must also bring in something by way of profit for
their employers, Smith did not believe that profits may be a special type of wages, the
reward for labour of inspection or supervision. In his opinion, profits bear relation to only
the size of the capital stock of the employers. Ricardo, who also relied on labow theory of
.lalue, failed to explain adequately the originof capitalist's profit. He argued that the value of
commodities depend on both present and past url In this way he incorporated capital ima
his-system and found an explanation for profit.
To sum up, the classical theories which explain rent, wages, interest, and profit provide
some insight into the distribution process but they are not entirely correct and, therefore,
have been abandoned. Modern economists now assert that land alone does not earn rent, It
-.
can accrue to any factor of -tion. This approach you will l m later in Unit 19. Wages
are determined neither by the subsistence level of workers nor by the wages fund. It is the
margindpoductivity of workers that decisively determines the wage rate. Since neither the
saving, nor investment are interest elastic, the basic pkmise of the classical theory of
interest is.incorrect. Finally, the classical theory fails to explain why profits arise.
Check Yaur Progress B
1 IlefrrpckaLMSmx~

2 Distinguish between rent.and interest.

*
- r r . n ~ ~ - . l - . ~ + ~ ~ m ~ ~ ~ ~ ~ ~ . . ~ c . c . c . ~ ~ ~ b ~ ~ ~ ~ ~ ~ ~ - ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ t ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ - ~

*...*. u .....................
..-......*.*..... r.s..t~.i*iii.i....**ii..i.intntnt..m..i..~~...~~~...~.~.... .
3 &nrbdekrdr% .-aa-ktr.
. fertility of the land. ...-+.Us .YI.b.*i...
iil m s * l l G b r r . a i d . r ~ r b * =r.r*r*.m-+c.r*-*rr*.~.~

i) ......................and .....,................ were the most pmtnZmt ecanornists of the

classical school:
ii) R i c d u ' s theory of rent is h s d on ...'................... ~eaming.
iii) The cluaiul Unary crpllim )n- tams of ...................... f a nd
...................... of savings.
iv) In the ...................... run the actual wage me can be-at variance fnwn the .

subsistence wage . .
v) wagcs fund thaory does not suggest that in tht ...:........, ........ma, wage rate
should l'knala &Me a$ a cumin lwei.
vi) The c l m i k l amnomists did pot any wk&t ttraory af ..-..,................
Distribution of Income
17.4 THE MARGINAL PRODUCTIVITY THEORY

Karl Marx and some other socialist thinkers were of the view that in a capitalist system,
labour was not paid all that it produced. The surplus was retained by the capitalist and it
constituted his profit. This was such an indictment of capitalism that the system looked
unethical. Some economists did not agree with M a n and attempted to prove that in a
capitalistic system of production there was no exploitation of workers. In doing so they
developed the marginal productivity theory of distribution in the particular context of wage
labour. Later on, this theory was used to explain the determination of rewards to other factors
of production also. Among the exponents of the marginal productivity theory J.B. Clark was
the foremost. In The Distribution of Wealth, he attempted to identify the objective
basis of distribution and in the process he developed the marginal productivity theory of
distribution. Later on Jevons, Wicksteed, Walras and Marshall also made their contributions
by way of making certain refinements in this theory. It is, however, to be noted that whereas
for J.B. Clark the marginal productivity theory is essentially a theory of distribution, for
Marshall it is a theory of demand for the factors of production.

17.4.1 Concepts of Productivity

It is necessary for you to learn certain concepts of productivity before the marginal
productivity theory is explained to you. These concepts are as follows :
1 Average physical productivity (APP): The output in any productive activity is
always in the form of physical units. For example, in agriculture the output of wheat
may be measured in quintals, in a readymade garments factory in shirts and trousers and
so on. You know that production is canied out jointly by land, labour, capital and
enterprise. Let us suppose that it is possible for us to separate the contribution of all the
units of a factor from joint output. In this case, average physical productivity of this
factor i.e. labour will be found by dividing the total output due to labour by total
number of units of labour. This may be written as follows :
t
Total output due to labour
APP of labour =
Total no. of units of labour
You have learnt the concept of average physical productivity in Unit 8 also. There it,has
been explained that the shape of APP curve is like inverted 'U'.
2 Marginal physical productivity XMPP) : You have learnt the concept of
marginal physical productivity in Unit 8. Here it will suffice to'say that keeping
quantities of other factors of production as constant, if a variable factor, which is labour
in this case, is increased by one unit, the addition to total production that takes place is
its marginal physical productivity. We can express the marginal physical productivity of
the nth unit of labour as follows :

In the equation MPP, is the marginal physical productivity of the nth unit of labour.
TPP, is the total productivity of n units and TPP(,l) is the total productivity of (n-1)
units. In Unit 8, it has been explained that the shape of MPP curve is like inverted 'U'.
Further, it intersects APP curve at its highest point. This has been shown in
Figure 17.1.
Y

4 %

rt 3
$E
an.
\ APP .
MPP

Units of Labour
Figure 17.1: Average and Marginal Physical Productivity Curves
3 Average revenue productivity (ARP): Since ficto; of production are paid in the Theory of Distribution
form of money, it is far more useful to know the money value of the productivity of a
factor. Average revenue productivityof a factor refers to the money value of the average
physical productivity. For knowing average revenue productivity of a factor, its average
physical productivity has to be multiplied by the price of the product. We can'txpress
this as follows :
-
ARP .= APP x P
where ARP is average revenue productivity, APP is average physical p e c t i v i t y and P
is price of the product. Average revenue groductivity curve is an exact replica of average
physical productivity curve.
4 Marginal revenue productivity (MRP): From the point of view of the
determination of the price of a particular factor, the concept of marginal revenue
productivity is far more useful than the concept of the marginal physical productivity. In
order to find the marginal revenue productivity of a factor, say 'labour, one has to
multiply the marginal physical productivity by the marginal revenue of the product.
This may be expressed as follows :
MRP, = MPP, x MR
where MRP, is marginal revenue productivity of the nth unit of labour, MPPn is the
marginal physical productivity of the nth unit of labour and MR is the marginal revenue
of the product.
Under perfect competition since marginal revenue is always equal to the price, in order
to find MRP one can multiply MPP by the price also. The marginal revenue
productivity curve under perfect competition is exact replica of marginal physical
productivity curve. Under monopoly it has the same shape, but is far more steeper than
MPP curve. This is so because under monopoly not only'marginal revenue remains ' .
lower than price, but it also shows a tendency to decline as the sales of the
increase. . .

Perfect Competition

.-
I MRP \

I
. Units of Labour, 0 U n b of Labour X .

Figure 17.2: Marginal Revenue Productivity Curve under Perfett

Competition and Monopoly

5 Value of marginal physical product (VMPP): Value of marginal physical

product refers to the value one gets by multiplying the marginal physical productivity
by the price of the product. This may be expressed as follows : .r .

VMPP = MPP x P
where V W P is value of marginal physical product, MPP is marginal physical
productivity and P is the price of the product. Under perfect competition since marginal
revenue is equal to price, MRP and VMPP are equal. However, under monopoly because
marginal revenue is lower than price, MRP is lower than VMPP.

17.4.2 Statement of the Marginal Productivity Theory

There are two versions of the marginal productivity theory. According to the J.B. Clark's
version of 'the theory, reward to a factor of production for its services is determined by the
marginal revenue productivity of that factor. Alfred Marshall takes a somewhat different
view. He states that the marginal revenue productivity of a factor reveals the demand for that
factor. This demand together with the supply of the factor determine the factor price which in
Distribution of Income a perfectly competitive market is naturally equal to the marginal revenue productivity of the
factor.
You have learnt earlier that buyers make a demand for commodities because they have
utility. They db not mind paying for these commodities as they possess want satisfying
power in the form of utility. Factors of production are not directly useful in the sense that
they do not have want satisfying power. However, their importance lies in their usefulness
in production. Hence the demand for a factor of productibn depends on its productivity. It is
thus clear that in contrast to the demand for consum&goods which is direct, demand for a
factor of production is derived and depends on the demand for those goods in the production
of which it will be used.
It is clear that productivity is relevant for determining the reward to a factor of production.
Another aspect that has to be explained is as to why the producer attempts to equalise the
factor price with the marginal revenue productivity only. Since now almost all economies i
are totally monetized implying that factors of production are remunerated in money only, the
concepts of average physical productivity and margingl physical productivity are not directlx
relevant. Now, we are left with threeconcepts, viz., average revenue productivity, marginal
revenue productivity and value of marginal physical product. Out of these three measures of
prohctivity the producer attaches importance to marginal revenue productivity only.
The principal objective of all producers is to maximise their profits. In order to realise this
objective, the producer must equalise the reward to a factor with the marginal revenue
productivity. This condition is valid for all market conditions. However, in case of a
perfectly competitive product market, the value of marginal physical product will be the
same as the marginal revenue productivity. Further in a perfectly competitive factor market,
the reward to a factor will be equal to marginal revenue productivity as well as average
revenue productivity. This has been shown in Figure 17.3.
Y
A

W (AW = M y

m
MRP ARP

0 L
>
X
Units of Labwr
Figure 17.3: Factor Price, that is, wage rate equals MRP and also ARP
I

It can be seen in Figure 17.3 that if the factor in question is labour, then the wage rate OW,
determined by the interaction of demand forand supply of labour equals both marginal
revenue productivity and average revenue nroductivity. In case the producer does not follow
the rule of equalising marginal revenue prqductivity of a factor with its price, he cannot
maximise his profits.
Broadly marginal productivity theory is correct as a factor's reward normally cannot be
greater or less than its marginal revenue productivity. However, the marginal productivity
theory is based on a number of assumptions which need to be stated to understand the
implications of the theory.

17.4.3 Assumptions of the Marginal Productivity Theory

The marginal productivity theory is based on the following assumptions:
1 Perfect competition is assumed to be prevalent in the factor markets. Suppose the factor
of production that we are considering is labour. It is assumed that in the market for
labour, the number of buyers and sellers is so much that the wage rate cannot be
influenced by any one of them single handed. Moreover, labour is assumed to be both
homogeneous and mobile.
2 The commodity produced by the concerned factor of production is assumed to be selling
in a perfectly competitive market.
3 The theory assumes that the various factors of production can be combined in different Theory. of Distribution
proportions in the process of production. This means @at it is possible to carry out
production by varying the quantity of one factor of production whereas the quantities of
other factors of production remain constant.
4 The production takes place inyccorpance with the law of variable proportions, implying
that in the final stage it is the law of diminishing returns which operates.
5
b
The theory assumes full employmen in the economy which implies that all factor units
are employed. Thus, it connotes that factor units will be willing to work at any
pricelreward which is less than the prevqiling market price.

17.4.4 Reward to a Factor and Factor Employment in a Firm

We have stated earlier in this Unit that a factor of production is useful to a producer on
account of its productivity. Therefore,the firm carrying out production makes a demand for a
factor of production keeping in view the marginal revenue productivity of that factor. Look
at Figure 17.3 where the curve MRP represents the marginal revenue productivity of labour
in a particular firm. The downward sloping portion of this curve essentially indicates the
fum's demand for labour. From the firm's point of view the supply of labour is perfectly
elastic and it can employ labour in whatever quantity it likes at the prevailing wage rate
which is OW. This wage rate as earlier pointed out is determined by the forces of demand and
supply in the labour market. In a perfectly competitive labour market, neither the firm
employing labour nor any worker offering his services can influence this wage rate by
exercising any influence either on the demand for or supply of labour. In this situation, every
firm employing labour is a wage-taker and faces the supply curve of labour as shown by
WW in Figure 17.3. Since the supply curve of labour is perfectly elastic, not only the
average wage and the marginal wage are equal but they are also constant throughout.
/
Since a fm canies out production in order ta earn maximum possible profit, it expands its
production upto a point where marginal revenue productivity of a factor becomes equal to the
marginal factor price. In our illustration, labour is the variable factor. Hence the firm decides
to employ labour upto such a point that the marginal revenue productivity of labour
becomes equal to marginal wage. In Figure 17.3 the fimreaches this stage when it employs
labour in OL quantity. By employing less of labour than OL and carrying out production
will mean loss of some profit that the firm could earn. Similarly, employing labour in
quantity larger than OL will result in some unavoidable loss because beyond OL marginal
revenue productivity is less than the marginal wage. Thus we generalise that the firm would
be in equilibrium only if it employs the labour (variable factor) in such a quantity that its
marginal revenue productivity becomes equal to marginal wage which in a perfectly
competitive labour market is the same as average wage.
In Figure 17.3 you will observe that not only marginal revenue productivity of labour is
equal to a marginal wage but the two are also equal to average revenue productivity and
average wage. In this situation, the firm neither appropriates any surplus nor suffers any
loss. Hence neither new firms feel induced to join the industry, nor any of the old firms feel
any compulsion to leave it. The industry is thus in equilibrium.

17.4.5 Critical Analysis of Marginal Productivity Theory

The marginal productivity theory does not offer an entirely satisfactory explanation of
distribution. It has been criticised on the following grounds :
1 Factors of production are not always divisible: Marginal productivity of a
factor of production can be estimated only when a factor of production should be
divisible or variable in small quantity. In practice, however, $is is not always possible.
Bow do we measure the marginal productivity of large steel plants which are neither
variable in small quantity nor divisible.
Therefore, measurement of marginal.productivity of capital equipment in most cases is
extremely difficult.
2 Factor proportions in most modern industries are not variable: In modem
industries now sophisticated technology been introduced, and as a fesult labour and
capital are employed in some fixed ratios. Roducers think that these factor proportions
Distribution of Income cannot be changed. This is a situation in which marginal productivity of a factor cannot
be measured.
3 Marginal productivity of capital and enterprise is not measurable: In the
production pmess capital acquires the form of capital equipment and in capital
equipment, technology on which productivity of labour greatly depends is embodied.
This is such a complex situation in which the available methods of estimated marginal
productivity of capital cannot be measured. Further interest is earned by the lender of the
funds. Does it imply that money lending is a productive activity, and in case this is
m e , then how is money lending related to the productive activity of machinery, plant
and other capital equipment is a riddle which the marginal productivity theory has failed
to resolve. The problem with respect to enterprise is still more difficult to overcome
because its units cannot be identified clearly. Further like land, labour, capital and
enterprise is not a variable factor which completely rules out the measurement of the,
marginal productivity of enterprise.
-A Unrealistic assumption: The assumption of perfect competition is highly
unrealistic, because it is not met either in factor markets or commodity markets. In the
real world imperfect competition prevails and it is possible for the employer to hire
factors of production,for a remuneration which is lower than the marginal productivity.
This is the basis of exploitation in a capitalist society operating at a level of less than
full employment.
5 The marginal productivity theory does not explain distribution: The
marginal productivity theory does not explain how rewards to different factors of
production are determined. It merely explains the demand for a factor of production and
then acknowledges the fact that reward to a particular factor of production is determined
by its demand and supply. Having known the factor price, the firm employs a factor
upto qpoint where its reward is equal to its marginal reyenue productivity. Hence the
marginal productivity theory cannot be accepted since it is based on highly questionable
assumptions.

C k k Your Progress C
1 Differen* between average physical productivity and marginal physical productivity.

.3: ' m a t you mean by margiii revenue productivity.

3 *ie wb&r fie fo!lowfng s&kkilts are TMM F d b

$3 Reward to a factor is equal to its rnargibal revenue productivi~~
Et..*,*r...n" ...I 'O.--.*

i MaqimI pradwdsivity curve reflects the supply of the factar cmceme4

V) The marginal productivity theory b u m e p fixed factor ppxtions in ptoduction.

 . Theory 'of Distribution

17.5 LET US SUM UP

The income distribution is examined in two ways. One way to examine it is to study as to
how the national income has been shared by the people. This is called personal distribution.
The other wpy to examine it is to study as to how different factors of production have been
rewarded. This is called functional distribution.
The earliest systematic discussion on distribution of income is found in the writings of the
classical economists. They, however, did not provide a general theory which could explain
rewards to all factors. They developed specific theories for different factors of production. The
thbiy. of rent was developed by Ricardo who stated that it is paid to the landlord for the
original and indestructible powers of the soil. There are two theories of wages. The
subsistence theory of wages states that wages are fixed at the subsistence level of workers.
The wages fund theory states that wages are determined by the amount of wages fund and the
supply of labour. Interest, according to the classical economists, is determined by the demand
for and supply of capital. profit is also earned by the capitalists. These theories now do not
., find any supporters.
The marginal productivity theory developed by J.B. Clark and,otherssuggests that reward to
each of the four factors of production is determined by its marginal revenue productivity.
When remuneration to a factor is equal to both marginal and average revenue productivity and
also marginal factor price then both the firm which employs the factor of production and the
industry to which the firm belongs are considered to be in equilibrium.
The marginal productivity theory is based on highly questionable assumptions which
undermine its validity. Further marginal productivity theory explains the demand for a factor
rather than its price. The reward to a factor is determined by the demand for and the supply of
the factor of production in question.

17.6 KEY WORDS

Average Physical Productivity: Per unit productivity of a factor of production

measured in physical units of the product.
Average Revenue Productivity: Per unlt productivity of a factor of producth
measured in money value of the product. .
Factor Price: Reward to a unit of a factor of production expressed in money terms.
Functional Distribution: Distribution of income among the various factors in
accordance with the services rendered by them.
Interest Elasticity: Responsiveness to changes in interest rate.
Marginal Land: Inferior most land whose value of output can just recover the cost of
cultivation.
Dletrlbution of Income Marginal Physical Productivity: Addition to total output due to an additional unit of
a variable factor.
Marginal Revenue ~roductivit~: Value obtained by multiplying marginal phyiical
productivity by the marginal revenue.
Personal Distribution: -Distributionof the national income among the people.
Rent; Reward to landlord for the services of land.
Subsistence Wage: Wage rate which is sufficient only for subsistence living.
Value of Marginal Physical .Product: value' obtained by multiplying marginal
physical productivity by the price.
Variable Factor Proportions: Proportions in which various ractors of production are
employed having scope for changes.

17.7 ANSWERS TO CHECK YOUR PROGRESS

A 2 (i) False (ii) True (iii) True (iv) False (v) False (vi) True (vii) True
3 (i) Land (ii) Interest (iii) Entrepreneur (iv) Wages (v) Personal distribution
(vi) Functional distribution
B 3 '(i) False (ii) True (iii) False (iv) True (v) False (vi) True (vii) True
4 (i) Adam Smith, Ricardo (ii) Deductive (iiiiDemand, Supply (iv) Short (v) Long
(vi) Profit (vii) Capital,
C 3 (i) True (ii) False (iii) True (iv) False (v) False
4 (i) Physical (ii) Price (iii) Value of marginal physical product (iv) Marginal revenue
productiviiy (v) Perfect competition.

17.8 TERMINAL QUESTIONS

1 Define functional distribution and distinguish it from personal distribution.

2 How did classical economists explain distribution of income among various factors of
production ?
\

3 Distinguish between interest and profit.. Is it not correct to say that both are earned by
the capitalists for the capital they invest in the production process ?
4 How did classical econdmists explain determination of wages ?
5 Explain the marginal productivity theory of distribution. Also state its assumptions.
6 Why is the marginal productivity theory not cksidered a satisfactory theory of
distribution ?

Note: These questions will help you to understand the unit better. Try to write answers
for them. But do not send answers to the University. These are for your p ~ c t i c only.
e