3.
Marginal Productivity Theory
This is an economic theory that attempts to explain how the income generated in an economy
is distributed among various factors of production, primarily labour and capital, in a
competitive market economy. This theory states that the price of each input is determined by
its marginal productivity, which is the additional output generated by an additional unit of the
input. This theory was developed by several classical economists, including John Bates Clark
and Alfred Marshall. The central idea behind the theory is that individuals receive income in
proportion to their marginal productivity in the production process. This theory is based on
several key assumptions:
• The theory assumes perfect competition in product and factor markets. In a perfectly
competitive market, there are many buyers and sellers, and no single entity can influence
prices. This assumption simplifies the analysis and allows for the determination of factor
prices (wages and returns on capital) through market forces.
• The theory assumes that labour and capital are homogeneous, meaning that all units of
labor and capital are identical in terms of their productivity and characteristics. This
assumption simplifies the analysis by treating all workers and capital units as the same.
• The theory assumes that there are diminishing marginal returns to each factor of
production (labor and capital) when other factors are held constant. This means that as
more units of a factor are added to the production process while holding other factors
constant, the additional output produced by each additional unit of the factor will eventually
decrease.
• It is assumed that factors of production, such as labour and capital, are perfectly mobile
between industries and occupations. In other words, workers and capital can easily move
from one sector of the economy to another in search of the highest wages or returns.
• The theory often assumes full employment of labor, meaning that all available labor
resources in the economy are fully utilized. This assumption simplifies the analysis and
focuses on the distribution of income among fully employed factors.
• Firms are assumed to be profit-maximizing entities. They hire factors of production (labor
and capital) in quantities that maximize their profits. Firms will continue to hire factors as
long as the marginal revenue product (MRP) of a factor exceeds its cost (wage or rental
rate).
• The theory assumes that all market participants have perfect information about factor
productivity, factor prices, and market conditions. This assumption ensures that firms can
make rational decisions about hiring factors to maximize profits.
• The theory is often presented as a static analysis, assuming that economic conditions
remain constant over time. It does not consider dynamic changes in the economy,
technological progress, or long-term shifts in factor demand.
However, like any economic theory, the marginal productivity theory of distribution has faced
criticisms and limitations from various economists and scholars, which includes:
i. The theory often assumes perfect competition in factor markets, which may not accurately
reflect real-world conditions. In reality, labor and capital markets may be imperfect, with
factors such as wage bargaining power, discrimination, and market power influencing the
determination of factor incomes.
ii. The theory does not account for institutional factors such as labor unions, minimum wage
laws, and collective bargaining, which can significantly impact wage levels and the
distribution of income.
iii. The theory often assumes a fixed level of technology, ignoring the influence of technological
change on labour productivity and wages. In reality, technological advancements can have
a profound impact on the productivity of labor and may not be captured adequately by the
theory.
iv. Critics argue that the Marginal Productivity Theory of Distribution does not provide a
satisfactory explanation for income inequality. It focuses on how factors are paid according
to their marginal contributions but does not address the broader societal factors that can lead
to income disparities.
v.The theory primarily focuses on market-based production and does not account for non-
market activities, such as unpaid domestic labour, which are essential but often undervalued
aspects of the economy.
vi. The theory assumes perfect information, implying that firms can accurately measure the
marginal productivity of each factor. In practice, firms may face challenges in accurately
assessing the marginal productivity of labour and capital.
Despite these criticisms, the marginal productivity theory of distribution remains a fundamental
concept in economics and provides valuable insights into how factors of production are
rewarded in a market economy.
