Condition of equilibrium:

The condition of equilibrium in the labor market is:

MC_L = VMP_L

Here,
MC_L = Marginal cost of labor
VMP_L = Value of marginal product of labor

Or

W = VMP_L

Here,
W = wages of labor

Note:  It is supposed that a firm can use any quantity of labor beneath a given wage rate as the supply of labor is supposed to be unlimited in a competitive market.

Diagrammatic example of wage determination in a competitive market

Figure above explains,

MPP_L = Marginal physical product (of labor) curve
VMP_L = Value of marginal product curve
VMP_L = MPP_L.PX (VMP_L = Marginal physical product of labor multiplied by price of the commodity)

In figure above, the equilibrium of the firm is illustrated by E. This is so as to the left of L, each unit of labor costs less than the value of its product (i.e., VMP_L > W). Therefore the firm will make much profit by hiring more workers. In the right of VMP_L < W. Hence, the profits of the firm will be decreased. Therefore profits will be maximum whenever VMP_L = W.

It follows from the above conversation that the demand curve of a firm for a single variable factor (example, labor) is its value of marginal product curve.

Therefore the productivity of the marginal unit of a factor finds out the rate which is to be paid to all units of the factor. The employer accepts the principle of replacement and combines land, labor and capital in such a manner that the cost of production is minimum. Then the reward for each factor is found out by its marginal productivity. The marginal productivity theory of distribution has been employed to elucidate the determination of wages, rent, interest and profits. That is why; it is termed as general theory of distribution.

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