Marginal Productivity Theory of Distribution:The marginal productivity hypothesis of distribution is the common theory of distribution. The theory elucidates how prices of different factors of production are determined under situation of perfect competition. This emphasizes that any variable factor should acquire a reward equivalent to its marginal product.
There is no basic difference between the mechanisms of determination of prices of commodities and that of factor prices. The factor prices are determined in markets beneath the forces of supply and demand. However there is one difference. As the demand for commodities is direct demand, the demand for factors of production is derived demand. For illustration, there will be demand for workers busy in construction industry (example, masons) only whenever there is demand for housing.
According to the marginal productivity hypothesis of distribution, in a perfectly competitive market (i.e., for products and inputs), each and every factor will be paid a price equivalent to the value of its physical product. However the theory is applicable to each factors of production, we might illustrate it with reference to labor.
A firm will go on using more and more units of a factor until the price of that factor is equivalent to the value of the marginal product. In another words, all factor will be rewarded according to its marginal productivity. The marginal productivity is equivalent to the value of the additional product that an employer acquires whenever he employs an additional unit of that factor. We suppose that the supply of all other factors stay constant.
We shall provide a simple example of the marginal productivity theory of distribution by making utilization of labor.
The main aim of a firm is maximization of gain. It will hire a factor as long as it adds more to net revenue than to total cost. Therefore a firm will hire a factor up to the point at which the marginal unit contributes as much to net cost as to total revenue since total profit can’t be further raised.
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