Marginal Productivity Theory of

Distribution
• The marginal productivity theory of distri-
bution, as developed by J. B. Clark, at the end
of the 19th century, provides a general
explanation of how the price (of the earnings)
of a factor of production is determined.
• In other words, it suggests some broad
principles regarding the distribution of the
national income among the four factors of
production.
• The oldest and most significant theory of
factor pricing is the marginal productivity
theory. It is also known as Micro Theory of
Factor Pricing.
• The marginal productivity theory of
distribution determines the prices of factors of
production. This theory states that a factor of
production is paid price equal to its marginal
product. For example a laborer gets his wage
according its marginal product. He is rewarded
on the basis of contribution he makes the
total output.
• Factors of production are demanded because
they have productivity. Higher the productivity
of a factor, greater will be its price. Marginal
product or otherwise called marginal physical
product (MPP) refers to addition to the total
physical product by employing one more unit
of a factor.
• When MPP is multiplied by price it is called
value of marginal product (VMP). Marginal
revenue product (MRP) is the addition made
to total revenue by employing an additional
unit of a factor. Average revenue product
(ARP) is the average revenue per unit of a
factor of production.
 Explanation of the Theory:
(a) Reward of each factor is equal to its marginal
productivity:
(b) Reward for each factor is same in every use.
 Assumptions of the theory,
1. Prevalence of perfect competition in factor as
well as product market.
2. All factors are identical.
3. Factors are perfect substitute for each other.
4. Factors are perfectly mobile.
5. Perfect divisibility of factors.
6. The theory operates in the long-run.
7. The theory is based on full employment.
 Criticism:
(1) Unrealistic assumptions
(2) Difficulty in the measurement of MRP
(3) Factors are not perfectly identical
(4) Reward determines productivity
 Rent
• In the ordinary language , the term Rent
means a periodical payment made to its
owner for the use of any particular thing such
as the rent of a building , rent of a machine,
rent of furniture etc.
 Contractual Rent
• As the periodical payment (monthly, quarterly
or yearly) is made according to the contract
agreed upon by the two parties ( owner and
tenant) , such a rent is known as the
contractual rent or the gross rent.
 Economic Rent
• In economics, the term rent is used in a
special sense here we speak of economic rent
rather than contractual rent.
 Difference between Contractual Rent
and Economic Rent
Contractual Rent Economic Rent
• Contractual Rent or • It refers only to the
contractual payment as payments made for the
it is often called is a use of land.
periodical payment • It does not include
made by a tenant to the interest on capital
owner of a thing investment made by the
(building, furniture etc.) landlord.
for its use and includes
interest on capital
investments.
 Economic Rent
• The term economic Rent has been used in two
different senses:
a) Differential Rent
b) Scarcity Rent
 Differential Rent
• David Ricardo and other classical economists had used
the term rent in the sense of differential rent or
differential payment.
• According to them, all lands are not equally fertile or
equally well situated.
• Different types of land have different fertility and
different situations, with the result that the more
fertile and more favorably situated land, gereneally
called as superior land enjoys and advantage over the
less fertile and less favourably situated land, gerenrally
called as the inferior land.
• With same amount of labor and capital, the
superior plot of land will give greater production
than the inferior land.
• This difference in the yield between the superior
land and the inferior land , according to Ricardo ,
is rent which accrues to the landlord.
• Such a rent arises because of the differences in
fertility, climate and situation of different lands.
 Scarcity Rent
• Modern theory of rent
• According to modern economists, economic
rent is not only a peculiarity of land alone,
other factors of production like labour and
capital also derive such rent.
• Economic Rent arise because of the scarcity of
factors of production.
 Cont..
• If the supply of a factor of production is perfectly
elastic, any number of unit of that factor can be
obtained at the prevalent market price and
therefore there is no question of existence of
rent.
• But in real life, the supply of a factor is not
perfectly elastic, it is less than perfectly elastic.
• The excess of income obtained by a factor is rent.
 Quasi- Rent
• The concept of Quasi – Rent was first
introduced in economic theory by Marshall.
• He referred the term to the short period
returns earned by factors of production other
than land.
• The concept of Quasi Rent is the extension of
the Ricardian concept of rent to the short run
earnings of capital euipments like machinery,
building etc.
 Cont..
• Rent arises because the supply of land is
permanently fixed and cannot be increased even
in the long period.
• Even in the short run the supply of other factors
of production say capital , equipments ,
machinery , buidings etc is also fixed and their
earnings also depend mainly upon the demand
conditions.
• Marshall prefers to call these short run earnings
as quasi rent rather than rent.
 Difference between Pure Rent and
Quasi Rent
Pure Rent Quasi Rent

• It is the surplus income • It is the surplus income

accruing to landowners. accruing to the factors
other than land.
• It is permanent as scarcity • It is a short term
of land is permanent. phenomenon, because
the scarcity of other
factors of production can
be removed in the long
run.
Similarity: Both arises because of scarcity.
 Concept of Rent Extended to other
factors
• Rent is not peculiar to land alone, it accrues to
all the factors of production the supply of
which is less than perfectly elastic.
 (i) Rent of Land
• We know that the supply of land is not only
less than perfectly elastic but it is rather
perfectly inelastic.
• The transfer earnings of land are zero, hence
the entire income accruing to it is rent.
 (ii) Rent of labour
• According to the modern theory, rent arises in
the case of labour also because the supply of
labour is less the perfectly elastic.
 (iii) Rent of Capital
• Rent arises in case of capital as well.
• The difference between the rate at which
people are willing to lend and the rate at
which they actually lend, is Rent.
 (iv) Rent of Enterprise
• The modern theory of rent applies to enterprises
also and is generally known as Rent of ability.
• Just as in the case of land, rent arises due to
differences in fertility of different lands, similarly
different entrepreneurs get different rates of
profit because of differences in their ability,
organizing capacity, experiences etc ; likewise
superior land enjoys a surplus over the inferior
land.