Marginal Productivity Theory of
The marginal productivity theory of distribution is the general theory
of distribution. The theory explains how prices of various factors of
production are determined under conditions of perfect competition. It
emphasizes that any variable factor must obtain a reward equal to its
There is no fundamental difference between the mechanism of
determination of factor prices and that of prices of commodities. Factor
prices are determined in markets under the forces of supply and demand.
But there is one difference. While the demand for commodities is direct
demand, the demand for factors of production is derived demand. For
example, there will be demand for workers engaged in construction
industry (e.g. masons) only when there is demand for housing.
According to the marginal productivity theory of distribution, in a
perfectly competitive market (for products and inputs), each factor will
be paid a price equal to the value of its physical product. Though the
theory is applicable to all factors of production, we may illustrate it with
reference to labour.
A firm will go on employing more and more units of a factor until
the price of that factor is equal to the value of the marginal product. In
other words, each factor will be rewarded according to its marginal
productivity. The marginal productivity is equal to the value of the
additional product which an employer gets when he employs an
additional unit of that factor. We assume that the supply of all other
factors remain constant.
We shall give a simple illustration of the marginal productivity theory
of distribution by making use of labour.
The aim of a firm is maximization of profit. It will hire a factor as
long as it adds more to total revenue than to total cost. Thus a firm will
hire a factor upto the point at which the marginal unit contributes as
much to total cost as to total revenue because total profit cannot be
The condition of equilibrium in the labour ma