4501 Session 2
4501 Session 2
These notes are made by Dr. P. J. Desai for her students and sh 1
ould not be used or reproduced by anybody
The Marginal Productivity Theory of
Distribution
• This theory explains how the national income is distributed among the
different factors of production and therefore is also known as the
theory of factor pricing.
• The theory states that, “the reward which each factor of production
gets tends to be equal to its marginal productivity.” In other words, for a
just distribution of national income, a factor must get a reward which is
equal to its marginal productivity.
• (students must note that when we say a factor, it does not mean one
unit of capital or land or one labourer or entrepreneur. It means the
entire set of a factor. E.g. all labourers constitute the set ‘labour’ and so
on.)
These notes are made by Dr. P. J. Desai for her students and sh 2
ould not be used or reproduced by anybody
Marginal Productivity
• Marginal productivity of a factor means the addition made to the total
production by the employment of an extra/additional/marginal unit of a factor
in a given production process. (the quantity of all other factors used in the
same process will be assumed to be constant.)
• Marginal Productivity could be explained as,
1) Marginal Physical Product (MPP): the addition made to the total production
in (physical units) by the employment of an extra/additional/marginal unit of
a factor in a given production process.
e.g., if the employment of an additional unit of labour in a given
production process adds 5 units to the total production (when employment of all
other factors in this process is held constant) then 5 units is the MPP of labour.
These notes are made by Dr. P. J. Desai for her students and sh 3
ould not be used or reproduced by anybody
2) Marginal Revenue Productivity (MRP): It is the marginal physical product x marginal
revenue.
In other words, it is the addition made to the total revenue productivity by the
employment of an additional unit of a factor in the process when all other factor
employments are held constant.
MRPn=TRn-TRn-1 units.
3) Value of the marginal Product: Value of the marginal product means MPP x market
price per unit of the said product.
For a process operating under a perfectly competitive market, MRP = VMP because,
price (or AR) = MR
Under imperfect competition, price (AR) and so MRP VMP (MRP<VMP because MR
stands lower than AR under imperfect competition.)
These notes are made by Dr. P. J. Desai for her students and sh 4
ould not be used or reproduced by anybody
Marginal Productivity theory for a product produced under perfect
competition
Factor Units Total Output MPP Price per unit VMP(MPP x Total MRP
Price) Rev(total (TRn-TRn-1)
outputxprice)
1 25 25 2 50 50 50
2 70 45 2 90 140 90
3 110 40 2 80 220 80
4 145 35 2 70 290 70
5 172 27 2 54 344 54
6 191 19 2 38 382 38
7 199 8 2 16 398 16
8 199 0 2 0 398 0
9 195 -4 2 -8 390 -8
These notes are made by Dr. P. J. Desai for her students and sh 5
ould not be used or reproduced by anybody
• The above table shows that other factor employments remaining constant, when the
units of labour employed are increased, the MPP initially increases and then diminishes,
depicting the law of variable proportions.
• The market is perfectly competitive and so all units are sold at the same price i.e. ₹ 2.
Thus, VMP and MRP are equal.
• Now, if wage rate in the market is ₹ 70 then each labourer must be paid this wage rate.
• Now, the employer will employ labourers till a point where MRP (VMP) = the wage rate.
• This equilibrium occurs at the fourth unit of labour.
• If the employer employs less than 4 labourers then productivity is more than wage rate
and hence the employer lets go the opportunity of producing more total production.
• If the employer employs more than 4 units then she/he incurs losses as wage rate is
higher than productivity after the 4th unit of labour.
These notes are made by Dr. P. J. Desai for her students and sh 6
ould not be used or reproduced by anybody
• Now, what if the employer wants to expand production? Does the above
mentioned equilibrium determine final production level of the firm?
• The answer is that, this is not the final level of production. The employer
can now hold the employment of labour constant at 4 units and vary any
other factor of production to expand production. E.g. now the employer
can vary the amount of capital.
• The productivity of capital will also diminish after a few units are employed
and equilibrium will be determined at a point where MRP(VMP) = interest
given to capital.
• This way the proportion of all the factors of production will be determined
in a given production process.
These notes are made by Dr. P. J. Desai for her students and sh 7
ould not be used or reproduced by anybody
• =
• =
• =
These notes are made by Dr. P. J. Desai for her students and sh 8
ould not be used or reproduced by anybody
• In the figure, MRP is a
downward sloping curve
indicating diminishing
productivity as additional units
are employed. Wage rate = ₹ 70.
• MRP = wage rate at point E
determining OQ of employment.
• The MR/Price/AR curve coincide
and are horizontal in a perfectly
competitive market.
These notes are made by Dr. P. J. Desai for her students and sh 9
ould not be used or reproduced by anybody
Example of Marginal Productivity Theory
under an imperfect market.
• We know that under an imperfect market, MR ≠ AR. The seller must
reduce price in order to sell more. So price declines along the
downward sloping demand curve if Q must be increased.
• So check the example in the ensuing slide.
These notes are made by Dr. P. J. Desai for her students and sh 10
ould not be used or reproduced by anybody
Factor Units Total Output MPP Price per unit VMP(MPP x Total MRP
Price) Rev(total (TRn-TRn-1)
outputxprice)
1 25 25 2.00 50 50 50
2 70 45 1.80 81 126 76
3 110 40 1.50 60 165 39
4 145 35 1.30 45.50 188.5 23.50
5 172 27 1.20 32.40 206.4 17.90
6 191 19 1.15 21.85 219.65 13.25
7 199 8 1.13 9.04 224.87 5.22
8 199 0 1.13 0.00 224.87 0.00
9 195 -4 1.12 -4.48 218.4 --6.47
These notes are made by Dr. P. J. Desai for her students and sh 11
ould not be used or reproduced by anybody
• Now we see that MRP and VMP are not equal under imperfect
competition.
• So how will the equilibrium point be determined>
• It will be determined where Wage rate = MRP (VMP is higher than
MRP at every level)
• If the wage rate in the market is ₹ 23.50 then the producer will
employ 4 units of labour.
These notes are made by Dr. P. J. Desai for her students and sh 12
ould not be used or reproduced by anybody