ECONOMIC

S
Distribution theory
• Distribution in economics refers to the
way total output, income, or wealth is
distributed among individuals or among the
factors of production (such as labor, land,
and capital)
• Distribution theory, in economics, the
systematic attempt guiding the sharing of
the national income among the owners of
the factors of production—land, labor, and
capital.
Distribution of income among the
factors of production
Factors of production Income received
Land Rent

Labor Wages/Salaries

Capital Interest

Entrepreneurship Profit
 The marginal productivity
theory of
distribution
• Introduced by: J.B Clerk , professor of Columbia
University ,USA.
• Moderated by: Jevons, Edgwarth , Walras
,Hicks, Marshal and few other renowned
economists .
Abstract: Price of a factor of production is equal
to the marginal productivity of that factor.
According to this theory, the price (or the
earnings) of a factor tends to equal the value of
its marginal product. Thus, rent is equal to the
value of the marginal product (VMP) of land;
wages are equal to the VMP of labour and so on
Key terms:
1.Marginal physical product , MPP: The quantitative
change in output of a firm or industry resulting
from a one unit increase in one input , where
other inputs are fixed.

Number of labour Daily working Production

hour (unit)
10 8 20
11 8 25

Here , Marginal physical product is 25-20= 5 units

• 2. VMP:
• The second concept is value of marginal product. If we
multiply the MPP of a factor by the price of the product,
we would get the value of the marginal product (VMP) of
that factor.
• 3. MRP:
• The third concept is marginal revenue product (MRP).
Under perfect competition, the VMP of the factor is equal
to its marginal revenue product (MRP), which is the
addition to the total revenue when more and more units of
a factor are added to the fixed amount of other factors
Assumptions of the
Theory
1.Perfect competition in both product and factor
markets: It means that both the price of the product and
the price of the factor (say, labor) remains unchanged.
2. Operation of the law of diminishing returns:
Secondly, the theory assumes that the marginal product of
a factor would diminish as additional units of the factor are
employed while keeping other factors constant.
3. Homogeneity and divisibility of the factor:
. It means that a factor can be divided into small units and
each unit of it will be of the same kind and of the same
quality.
4. Operation of the law of substitution:
It means that the factors like labour, capital and others can
be freely and easily substituted for one another. For
example, land can be substituted by labour and labour by
capital.
5. Profit maximization:
Fifthly, the employer is assumed to employ the different
factors in such a way and in such a proportion that he
gets the maximum profits.
6. Full employment of factors:
Sixthly, the theory assumes full employment for factors
Explanation
According to this theory, the producer will keep employing
labourers till the value of marginal product(VMP) is higher
than the wages paid to labourers.
But the law of diminishing marginal return applies in case
of production.
So the producer will shut employing labourers when the
value of marginal product(VMP) is equal to the wages
paid to labourers . Here the firm is in equilibrium position.
If a firm keeps employing labourers after attaining
equilibrium, then the value of marginal product(VMP) will
be lower than the wages. So a firm will incur losses.
A firm will keep employing labourers upto a point where
the VMP and the wages are equal.
Unit of Total Marginal Price(P) VMP=(MPP Wage(w)
labour production product x P)
(TP) (MPP)
1 8 unit 8 unit Tk.3 Tk.24 Tk.12

2 14 unit 6 unit Tk.3 Tk.18 Tk.12

3 18 unit 4 unit Tk.3 Tk.12 Tk.12

4 20 unit 2 unit Tk.3 Tk.6 Tk.12

 In above schedule price per unit of product is tk.3 and
wage per labourer tk.12. in perfect competition product
price and wage are constant. In case of 1st and second
unit of labour vmp is higher than wage. In this situation
employment of labour is profitable. In case of 3rd unit of
labour VMP=W=Tk.12.at this stage profit is maximum. In
case of 4th unit of labour vmp is tk 6, which is lower than
wage.
REN

TEconomic rent is a payment exclusively for
the use of land.
Gross rent: gross rent is the payment to
land lord paid after a certain period of time
 Gross rent= net rent +wage +interest+ profit
Net rent: Net rent is the payment to land
lord paid only for the use of land.
Net rent= gross rent –(wage +interest+
profit)
RICARDIAN THEORY OF
•RENT
Introduction: - the explanation that how rent arises, is
called the theory of rent. The classical theory of rent is
associated with the name of well known British economists
“David Ricardo”.

• Statement of Ricardian Theory of Rent

• According to David Ricardo: –
• “Rent is that portion of the produce of the earth which is paid
to the land lord for the use of original and indestructible
power of the soil”.
• Ricardo in his theory of rent has emphasized that rent is a
reward for the services of land which is fixed in supply.
Secondly, it arises due to original qualities of land which
are indestructible". (The original indestructible powers of
the soil include natural soil, fertility, mineral deposits,
climatic conditions etc., etc.).
Explanation and Example of RicardianTheory of Rent:
According to Ricardo:
"All the units of land are not of the same grade. They differ
in fertility and location. The application of the same
amount of labor, capital and other cooperating resources
give rise to difference in productivity. This difference in
productivity or the surplus which arises on the superior
units of land over the inferior units is an economic rent".
• The Ricardian theory of rent is explained by taking an
example:

Grades Yield in Price per Total

of Quintals Quintal Return
Land per ($)
Acre
A 50 50 2500
B 35 60 2100
C 20 70 1400
D 15 80 1200
• In the above schedule, we assume that there are
four grades of land A, B, C and D in a country. A
grade land is more fertile than B grade land. B
grade land is superior to C grade and so is C
grade to D grade land.

• Following Ricardo let us assume, a

settlers migrate batch of to this island.
cultivating A grade They begin yield 50 quintals of
land which
wheat per acre. Let us suppose now that the
population of that country increases and A grade
land is not sufficient to meet the food
requirements of the growing population.
• The inhabitants of that country shall then have to
bring under cultivation B grade land. With the
identical amounts of labor and capital. B grade
land yields 35 quintals of wheat per acre. A
surplus of 15 quintal of wheat {50 - 35 = 15)
which arises with the same outlay on A grade
land is an economic rent. B grade land being a
marginal land gives no rent.
• When owing to the pressure of growing
population and a rise in demand for food, C grade
land is brought under cultivation, it yields only 20
quintals of wheat with the identical amount of
labor and capital. With the cultivation of C grade
land, the economic rent of A grade land is now
raised to 30 quintals per acre: (50 - 20 = 30) and
that of B grade land 15 quintals of wheat per
acre. C grade land is a no rent land as it is
cultivated at the margin.
Diagram
:
• In the figure (19.1), the various grades of land in the
descending order of fertility are plotted on OX axis and
yield per acre is shown on OY axis. The cultivated area
due to pressure of population and the rising demand for
food is pushed to D grade of land which is a marginal
land. The owner of A grade of land gets a surplus, or
economic rent of 35 quintals of wheat, of B, 20 quintals
and on C grade, the rent is 5 quintals of wheat.
wage
• A wage is monetary compensation (or remuneration) paid
by an employer to an employee in exchange for work
done.
 Methods of wage payment:
1.Time based wages : Time based wage payment method
is a method where by the worker is paid by the hour, day,
week, or month.
2.Piece based wages: Piece rate system is a method of
wage payment to workers based on the quantity of output
they have produced.
Money wages and real
wages
• Money Wage is wage expressed in monetary terms (that is, in
units of a currency).
• Real wage is the wage expressed in terms of commodities.
• Difference : Money wages or nominal wages are wages that
are paid to a person regardless of the inflation rate in the
market. Money wages do not take into consideration the
purchasing power and the employee receives the amount that
is promised to him when he/she is hired. Real wages are
wages that provided taken into consideration the inflation
amount. Real wages are wages that determine the purchasing
power of the individual or how much goods the salary can buy.
Real wages can also be defined as the amount of goods and
services that can be bought from the individual’s wages after
taking inflation into account.
 Wage
Differentials
• Compensating wage differentials - higher pay can often be
reward for risk-taking in certain jobs, working in poor conditions
and having to work unsocial hours.
• Different skill levels - the gap between poorly skilled and highly
skilled workers gets wider each year. Market demand for skilled
labour grows more quickly than for semi-skilled workers..
 Wage
•Differentials
Differences in labour productivity and revenue
creation - workers whose efficiency is highest and ability
to generate revenue for a firm should be rewarded with
higher pay.
• Trade unions and their collective bargaining power -
unions might exercise their bargaining power to offset the
power of an employer in a particular occupation and in
doing so achieve a mark-up on wages compared to those
on offer to non-union members
• Employer discrimination is a factor that cannot be
ignored despite equal pay legislation