MARGINAL PRODUCTIVITY THEORY OF DISTRIBUTION LABOR ECONOMICS CIA 1

MARGINAL PRODUCTIVITY THEORY OF DISTRIBUTION

LABOR ECONOMICS CIA 1

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BY HARSHIT DANIEL JOSEPH, 1637008, 4MAECO

Marginal Productivity Theory of Distribution
as introduced by Von Thunen is a macroeconomic model of factor pricing. “The
Marginal Productivity Theory contends that in equilibrium each productive agent
will be rewarded in accordance with its Marginal Productivity.”- Mark Blaug.

There are two important prepositions to the
theory-

·      
Each factor produces goods according to its productivity.

·      
Each factor gets a share from the produce generated by
it.

The theory has the following assumptions:

·      
Labor is homogeneous in nature that is different units of
labor has the same efficiency and hence every unit is perfectly substitutable.

·      
Economic agents are rational that is firm intend to maximize
profits through minimizing costs.

·      
Labor is perfectly mobile

·      
The laws of variable proportion and diminishing marginal
returns is active

·      
Full employment exists in a perfectly competitive market.

Factors of Production are demanded because of
their productivity. Thus if productivity is high prices will be high too.
Marginal product also known as Marginal Physical product is the change in the
total product due to an increase in factor by one unit. Given perfect
competition a firm may employ various units of any factor up to a point where
the price of the factor equals its marginal productivity.  Each producer equates the price and
productivity of the factor. The price becomes the income of the factor while it
is a cost accruing to the producer. The point of equality is where   MPP=price. Suppose the producer employs fewer
units of factors then the productivity of the factor will be more and the cost of
production will be less. Thus in such this case the producer will maximize his
profit by employing enough quantity of factors so as to reach the equilibrium
point. Contrary to which if the number of factors employed is more than the
equilibrium level; the cost of production will be more than the productivity.
The producer will reduce his demand of factors in order to attain equilibrium.
Hence, his profit will be maximized at the point of equilibrium (MRP=MW). In
other words a producer finds it feasible only to heir labor to a point where
his cost of employing an additional labor unit equals the marginal revenue
product of the labor.

The theory also assumes that the productivity
of a factor is equal in its uses. If the factor cost are different in two different
uses i.e. of the factor cost in one use is not equal to cost in other use,
factors will move to that use with a higher factor cost. The process continues
until the productivity of a factor becomes equal in all its uses. In one
particular use the Marginal productivity of all factors is same and hence they
are the perfectly substitutable. The producer substitutes the dearer factor for
the cheaper ones until the marginal productivity of the factors becomes
proportional to their prices. This process of equilibrium determination is stated
as follows:

Assuming diminishing Marginal returns we
propound that when a more and more of a factor is employed, the marginal
physical productivity of additional factor start diminishing. This is the reason
that the Marginal Productivity Curve is downward sloping after a particular
point of employment of a factor. Since firms are motivated by profit maximization,
they will always compare their cost of employing (MR) an additional laborer with
the marginal productivity (MP) of the additional laborer.

They will
continue employing additional factor till a point where Marginal factor cost is
equal to Marginal Productivity. As soon as the productivity of an additional
factor equals the marginal factor cost, they will stop employing more factors
and thereby maximize their profit.

Now if we assume that there is a single industry operating in the
economy which comprises of firms. Then we can say that the prices of factors
are determined through interplay between the market forces of demand and supply.
Since we assume full employment to be the condition there is no excess capacity
in the economy and hence supply curve is perfectly inelastic thus the demand
curve alone represents the marginal revenue product. The demand curve basically
represents a summed up curve of demand curves of all the firms operating within
the economy. Given the above it will be evident that the price of labor will be
equal to its marginal productivity at any given time or a process as mentioned above
will be functional so as to equalize the two under perfect competition. The
situation of an industry is quite clear but the important part is the firm
which employs labor at the given price in a way to maximize profits and hence
we shall see how the labor employed at any given price is determined. This is
the reason that this theory is also known as the Theory of factor demand. As
from above we can conclude that the MRP curve is diminishing and hence a
downward sloping curve is inevitable. Each firm faces a downward slopin MRP
curve and at the given price tries to equalize the two by employing more and
more labor which finally tends to point beyond which any increase in labor employed
will only reduce profits.

.

The figure 1, 2 and 3 represent the price determination process in the
industry.

At OP price, the labor
demanded will be ON. DD1 is the firm’s
demand curve for labor. The summation of demand curves of all the firms shows
demand curve of an industry. Since the number of firms is not determined under
perfectly competitive market, it will not be possible to estimate the summation
of demand curves of all firms. However, it is certain that the demand curve of
industry also slopes downward from left to right. The point where demand for
and supply of a factor are equal determines the factor price for the industry.
The theory assumes that the supply of factors to be fixed. Thus factor price is
determined by the demand for factor i.e. factor price will be equal to the
marginal revenue productivity. It can be seen in Fig. 3. In the Fig. 3,
quantity of labor is taken on the X axis whereas prices and MRP have been taken
on Y axis. DD1 is
the industry’s demand curve for labor. This is also the Marginal Revenue
Productivity curve.

Factor Price (OW) = Marginal Revenue Productivity MRP.

Thus under perfect competition, factor price is determined by the
industry and firm demands units of a factor at this price.

Similarly, in fig 4 and 5 we see the quantity demanded by each firm is
determined

In Fig. 4 number of laborer is shown on the X-axis and
prices on Y-axis. MRP is marginal revenue productivity curve and WW is the wage
rate or prices. Under perfect competition wage rate remains constant since it
is determined by the industry, hence the WW line will be parallel to X-axis.

MRP curve cuts WW at
point E which give the equilibrium price to be 55 units where 4 units of labor
is employed.  We can now conclude that factors
are demanded only to the point where marginal productivity is equal to the
price.

From Fig. 5 we can see that the long run equilibrium
under perfect competition will be a point where not only Marginal wages are
equal to MRP but also Average wages are equal to ARP. At point ‘E’ in Fig. 5
the marginal wages of the laborers is equal to marginal revenue productivity
wherein each firm employs OM number of workers. Even the average net revenue
productivity is equal to average wages at point ‘E’. Thus each firm will earn only
normal profit.

The
condition of equilibrium in the perfectly competitive labor market can be
expressed mathematically as follows

 

 

MC =
VMP

Here,
MC= Marginal cost of labor and VMP= Value of marginal product of labor.

 

Firms
can employ as many labor as they desires at a given wage rate to maximize its
profits.

Further,

MPP = Marginal physical
product and VMP= Value of marginal product

 

VMP =
MPP x P

 (VMP =
Marginal physical product of labor into price of the commodity) P is the price
of commodity determined under the industry

 

Here
the marginal productivity of a factor determines the wage that is to be paid to
all units of the factor. The producer adopts the principle of substitution in
such as way so as to minimize his cost of production. The wages are then
determined by the marginal productivity of labor. This theory can be used to
explain the determination of rent, wages, interest and profits. Hence, it is
also called general theory of distribution.

CONCLUSION

  Every product is produced by
employing not only labor but other factors too hence it is a joint product and
its value cannot be separately attributed to either labor alone. It might not
be feasible to measure the ‘productivity’ of certain labor services like that
of doctors, lawyers and teachers etc. Similarly, different units of a
factor are not homogeneous. In fact they are heterogeneous and therefore they
are non substitutable. Land, capital and labor cannot be used in place of each other.
Labor in itself can vary in health and efficiency. Hence every unit of labor might
not equally productive. It might also not be feasible to measure
marginal revenue productivity of a factor. MRP reflects an add on to the total
revenue through employment of an additional unit of a factor. But actually it
is difficult to get it. In a large-scale industry, unit changes in factor
employed will not have significant effect on the total produce. The
theory is based on the unrealistic assumptions of perfect competition,
perfectly mobile factors and full employment. In reality there exists only
imperfect competition and factors might not be mobile as well as
underemployment or an excess capacity is a general phenomenon rather than full
employment.  The supply side is completely ignored by assuming that
supply of factors are fixed whereas importance is given only to the demand side
factors making the theory biased and hence it is a one sided theory. For
example, in a crisis like scarcity of a factor, it receives a much higher pay than
the normal one. Also it might not be easy to find alternatives uses of
factors. In the case of the theory the relationship between the cause and the
effect is not very clear. For instance when we determine the wages using MRP,
wages become the effect and MRP becomes the cause. But a labor with high wages
might just have higher productivity due to his efficiency and access to health
and education thereby making productivity the effect and wages the cause. Finally,
there is no ethical justification to the theory.  General acceptance of the theory would imply
that factors get all the value of what they produce. For example, workers in a
firm might get low wages due exploitation but that will not be reflected in the
theory. Hence, inequality in distribution is certainly not a phenomenon that
can be explained using this theory. To conclude, I would like to say that the
theory fails to take into consideration a few factors that might be prevailing
in the dynamic world. The existing imperfect competition in the market has not
been reflected. Such markets show the tendency of exploitation and at times
show different tendencies of different forms of markets. Labor unions and
bilateral monopoly are two such aspects. Finally the production process is both
extensive and intensive if we consider labor as a factor. We believe that the
entire produce is distributed among the labor. Extensive process implies use of
labor along with other factors whereas intensive process is where labor is used
quite in a larger amount. Labor is believed to create the entire produce. The
intensive process can be of two kinds, first being the use of labor more
intensively and second where capital is changed according to the labor
employed. In general, in both the processes it appears that, two or more agents
are involved in the production activity and it is not possible for one of the
factors to generate the produce by itself.

REFERENCES:

·      
Parker, U.S. (Apr., 1907). The Marginal
Productivity Theory of Distribution. Journal of Political Economy, 15(4)
231-237.

·      
Reder, M.W. (Oct., 1947). A Reconsideration of the Marginal Productivity Theory. Journal of Political Economy, 55(5),
450-458.

·      
 Ostroy, J.M. (May, 1984). A
Reformulation of the Marginal Productivity Theory of Distribution. Econometrica, 52(3), 599-630

· Clark, J.B. (May, 1958). The Distribution of Wealth (Review). Economica, New Series, 25(98), 181.

·      
Marginal Productivity Theory. Retrieved from :http://www.economicsdiscussion.net/theory-of-distribution/marginal-productivity-theory-of-distribution-2/7406