Distribution Contd Given The

Distribution Contd Given The

Distribution (cont'd)Given the conditions of demand, the equilibrium price of a factor will depend on its supply. It will be such as to induce a total demand from all employers just sufficient to clear the market of the factor supply called forth by it. At that price, if there is competitive behaviour, all units of the factor will receive a rate of reward just equal to the value of its marginal product. If any firm were paying less than this it could, by definition, increase its profits by hiring more of the factor; if it were paying more it could expand profits by hiring less. Competition among the factor units or their owners would ensure that all units received the same rate.

Under certain assumptions, this theory can be generalized to show that in competition all factors of production (including management) would receive a rate of reward equal to their marginal products, and that this would be consistent with the requirement for a general theory that the total of such income payments would precisely exhaust the total value of the products. The formal proof of this proposition is complicated: in simple terms what it amounts to is that if every hired factor is paid a reward equal to its marginal product, any residual must go in profits; but if in long-run competitive equilibrium no firm will be earning profits in excess of the minimum necessary to keep it in production (i.e. equal to the marginal product of management), the sum of the marginal products must precisely exhaust the total product.

It is in this sense that the marginal productivity theory can be said to form a general theory of factor prices. It has two major weaknesses. First, it takes the overall total of factors as given and says nothing about the forces determining the long-run supply, e.g. of labour. Secondly, its practical usefulness as an explanation of the demand for resources especially labour is limited because it is difficult to define and measure marginal product. But within those limits the theory helps to explain the 'prices' or rewards of the factors of production.

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