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Marginal Productivity Theory of Distribution

Updated on June 1, 2014


Distribution is an important division of economics. The theory of distribution deals with the division of the national income of the country among the various factors of production. The total volume of commodities and services produced in a country during a given period, say a year, may be roughly called its national income. National income is the result of the cooperation of the factors of production namely land, labor, capital and organization. Since the factors of production are scarce, we have to pay a price for them. Rent is the reward for land; wages are the reward for labor; interest is the price we pay for capital and profits are the reward for organization. In other words, we study in distribution how the national income is distributed among the various factors of production. It should be noted that the theory of distribution does not deal here with the problem of personal distribution, i.e., how the income of each individual is determined. It deals with functional distribution, i.e., how the income of each factor is determined. In the past, economists regarded the problem of production of wealth as the main business of economies. Now the problem of distribution occupies an important place in economic discussions.

Marginal Productivity Theory of Distribution

The Marginal Productivity Theory is the general theory of distribution. The theory explains how the prices of the various factors of production would be determined under conditions of perfect competition and full employment.

According to the Marginal Productivity Theory, the price of any factor will be equal to the value of its marginal product. For example, we know that a consumer will demand a commodity up to the point at which its marginal utility is proportional to the price he pays for it. Similarly, a firm will go on employing more and more units of a factor until the price of the factor is equal to the value of the marginal product. In other words, each factor is rewarded according to its marginal productivity. The marginal productivity is equal to the value of the additional product, which an employer gets when he employs an additional unit of that factor, the supply of all other factors remaining constant.

In theory at least, all units of a factor are uniform and are interchangeable. So the productivity of the marginal unit of a factor determines the rate that is to be paid to all units of the factor. The employer adopts what is known as the principle of substitution and combines land, labor and capital in such a way that the cost of production is minimum. Then the reward for each factor is determined by its marginal productivity. The Marginal Productivity theory of distribution has been used to explain the determination of rent, wages, interest and profits. That is why, it is called the general theory of distribution.

Assumptions of the Theory

The theory is based on the following assumptions:

  1. There is perfect competition.
  2. All units of a factor are homogeneous. It means that one unit is the same as the other unit in all respects.
  3. One factor of production can be substituted for another. In other words, all factors are interchangeable.
  4. The theory is based on the Law of Diminishing Returns as applied to a business organization. In consumption, the Law of Diminishing Utility tells us that marginal utility diminishes for every increase in the stock of a good. Similarly, the Law of Diminishing Marginal Returns tells that if you go on employing more and more units of a factor, say labor, its marginal productivity will diminish. So an employer, when once he comes to know that the increase of a certain factor is resulting in diminishing returns, he will substitute it by some other factor. Thereby, he will try to reduce the cost of production.
  5. There is full employment.

Criticism of the Theory

The Marginal productivity Theory has been criticized on many grounds. The following are some of the points or criticism.

  1. Every product is a joint product and its value cannot be separately attributed to either capital, or labor or land. It is almost impossible to measure the specific product of each of the factors. The problem becomes more complex when we have to measure the ‘productivity’ of certain categories of labor that render services (Example: doctors, teachers and actors). If, for instance, some labor is engaged in the production of some commodity, then there is some scope for quantitative measurement. But with regard to those who render services, the problem of determination of their reward becomes rather a difficult one.
  2. The theory takes into account only the factors operating on the side of demand and ignores the influences acting on the side of supply. It tells that a factor is demanded because it is productive and it is paid according to its marginal productivity. But this cannot be the case always. There are many instances where a factor of production has to be paid much more than its normal price on account of the scarcity of the factor in relation to the demand for it.
  3. The theory assumes perfect competition and full employment. But in the real world, “imperfect competition is the rule”. There is no perfect competition.
  4. In practice, it is not easy to vary the use of the factors of production.
  5. Lastly, the theory does not carry with it any ethical justification. If the theory is accepted, it means that factors get the value of what they produce. Suppose wages are low in a firm. The employer may say wages are low because productivity is low. But the real cause of low wages might be the exploitation of labor by the employer. Hence the theory should not be applied to justify the present system of distribution.

In spite of the above points of criticism against the theory, it should not be forgotten that it explains the role of productivity in the determination of reward for any factor. There is no doubt that the Marginal Productivity Theory is an incomplete explanation of the problem of distribution. But as Marshall puts it, “the doctrine throws into clear light one of the causes that govern wages.”

© 2013 Sundaram Ponnusamy


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