The Marginal Productivity Theory explains the basis of awarding the factors of production their rewards. Many economists worked in development of this theory like David Ricardo, Alfred Marshall, Barone, J.B. Clark and Walras. Now the final work on this theory is attributed to the Neo-Classical School of thoughts. The Marginal Productivity Theory states that reward of each factor of production tends to be equal to its marginal productivity in other words “Distribution according to “Contribution”. Marginal Productivity refers to the addition that the use of one extra unit of the factor makes to the total production.
Marginal Productivity Theory
According to the Marginal Productivity Theory an entrepreneur will keep employing additional units of a factor of production till the marginal productivity of the factor equals its marginal cost. The marginal cost of the entrepreneur in this case will be the payment he makes to the last unit of the factor.
Assumptions of the Theory
The Marginal Productivity Theory is based on certain assumptions which are as follows:
- There is perfect competition both in the factor market as well as in the product market.
- The different units of the same factor of production are homogeneous in the sense that all of them are equally efficient.
- The working hours for factors of production are given and fixed and there is no provision for overtime.
- All factors of production are assumed to be perfectly mobile.
- It is assumed that the various factors production must be perfect substitutes of each other, that one can be replaced for the other.
- The economy is working at or near full employment of factors.
- The theory is based on the assumption that production operates under the Law of Diminishing Returns. This means when other things are constant, an increase in the supply of the factor would increase the total production at a diminishing rate.
Tabular & Graphical Representation of Classical Theory of Distribution
So far a firm is concerned; it will employ that number of labourers, the last labourer of which gives it productivity equal to the prevailing wage rate. When an entrepreneur during production keeps the quantity of land and capital constant and keeps op increasing the number of labourers then according to the Law of Diminishing Marginal Returns after a particular stage the marginal productivity of the additional labourer will diminish. Thus an entrepreneur employs that number of labourers the last labourer of which gives him productivity equal to the prevailing wage rate.
Units of Labor |
Wage Rate (Rs) |
Marginal Revenue Product |
10 |
40 |
55 |
11 |
40 |
50 |
12 |
40 |
45 |
13 |
40 |
40 |
14 |
40 |
35 |
In the given table an entrepreneur has employed 10 labours and he has been observing the marginal productivity of every additional labourer, which is being diminished with every increase in the number of labourers. According to the table the entrepreneur has to employ a total of 13 labourers because the marginal productivity of 13^{th} labourer is equal to the prevailing wage rate i.e. Rs. 40. Thus he would not employ any additional labourer because his marginal productivity will be less than the prevailing wage rate. It clarifies that a firm shall employ such number of labourers the marginal productivity value 9f which equals the prevailing wage rate. In case the value of marginal productivity is greater than the prevailing wage rate then the firm needs to increase the number of labourers resulting decline in marginal productivity. Contrary to it if the marginal productivity of labourers is less than the prevailing wage rate than the firm needs to reduce the number of labourers, so that it becomes equal to the prevailing wage rate. This principle is not only applicable in the case of labour but it is applicable in the case of other factors of production also.
In the diagram given below MRP is the marginal productivity curve which shows that with increase in the number of labourers their marginal productivity declines, as shown by decline in the MRP curve from left to the right. If the pre ailing wage rate is OP then the entrepreneur will employ OQ quantity of factor of production, because at this stage the value of marginal productivity is EQ which is equivalent to prevailing factor’s price i.e. OP. If the price of the factor of production is reduced to OD then the value of marginal productivity will be KH. Contrary to it if the price of the factor of production is increased to OA then the entrepreneur will employ OC units of the factor of production which will give him CB marginal productivity value which is equal to the prevailing price of the factor of production. Thus according to the theory an entrepreneur shall always try to employ that quantity, number of a factor of production which gives him equal marginal productivity value to the prevailing factor’s price.