Distribution Theory

Distribution Theory

Distribution, the theory concerned with the forces underlying the rates of reward (i.e. the prices) of factors of production (resources). In classical economics distribution theory was primarily concerned not only with rates of reward but also with the forces determining the relative shares of the broad categories of productive resources land, labour, capita' and enterprise in the total wealth arising from productive activity. Modern economic theory has never been able satisfactorily to solve this problem of the determination of relative shares. Although interest in it continues, the term distribution without qualification usually refers to the theory dealing with the more limited problem of the determination of factor prices.

Like other prices, those of productive factors are determined by demand and supply. The demand for a factor by a business enter-prise is a derived demand. It is derived from, first, the change in output (product) attributable to the employment (or non-employment) of a unit of it and, secondly, from the resulting change in sales revenue. The variation in product depends on the amount of cooperating factors with which the factor is combined: if they are held constant the law of variable proportions (diminishing returns) comes into play, that is, as increasing amounts of one factor are combined with fixed amounts of others, the additional (marginal) physical product attributable to each successive unit added will eventually begin to diminish. The variation in sales revenue will depend on the conditions of market demand for the product, that is, on what happens to selling price per unit of output as more is produced and marketed.

These two features explain the demand of an individual firm for a factor of production. If selling price per unit of the product remains unchanged throughout, then as more of the factor is employed its marginal physical product will eventually fall; therefore (at constant product prices) the additional revenue to be derived from the sale of the marginal physical product will also fall. In short, as increasing amounts of the factor are used, the value to the financier of successive units becomes less and less. It follows that in order to persuade a financier to employ more of the factor, a reduction in its rate of reward or price is necessary: conversely, the higher the factor price, the less will be demanded.

An industry's demand for the factor at a given price will be the sum of all the firms' demands at that price, except that as more of the factor is employed (thus producing more output to be marketed) the selling price of the output hitherto assumed to be constant will probably have to drop to persuade the market to take up the additional supplies. This is a further reason why the demand for a factor of production is likely to expand when its price falls and contract when it rises.

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