Marginal Productivity Theory of Distribution
What is Marginal Productivity Theory of Distribution?
The marginal productivity theory of distribution says each factor of production is paid the value of its marginal contribution to output, so firms hire each input until MRP equals its price.
In competitive factor markets, a profit-maximizing firm keeps hiring an input as long as the marginal revenue product (the extra revenue from one more unit) exceeds its marginal resource cost, stopping where MRP = MRC. In equilibrium this means each factor, labor, capital, land, earns a payment equal to the value of what its last unit adds. The theory explains how the total product is 'distributed' among factors and provides the demand side of factor markets, though critics note it abstracts from bargaining power and market imperfections.
Marginal Productivity Theory of Distribution: a worked example
A farm sells apples in a competitive market at $5 a crate and hires pickers at the going wage of $60 a day. Marginal product for the first five pickers is 20, 18, 15, 12 and 10 crates. Multiply each by the $5 price for marginal revenue product: $100, $90, $75, $60 and $50. The farm hires the fourth picker, where MRP of $60 exactly equals the $60 marginal resource cost. A fifth would bring in $50 against $60 of wages, a $10 loss. With four pickers, output is 20 + 18 + 15 + 12 = 65 crates worth $325. The wage bill is 4 × $60 = $240, leaving $85 as the return to land, capital and the owner. That split of the $325 among the factors is what the theory calls distribution.
The mistake students make with marginal productivity theory of distribution
The hiring rule is MRP equals MRC, and only competitive hiring shortens it to MRP equals the wage. A farm that is the sole employer in its valley faces an upward sloping labor supply and must raise the wage for every picker to attract one more, so marginal resource cost climbs above the wage. Going from three pickers at $60 to four at $65 costs $65 for the new hire plus $15 of raises for the other three, a marginal resource cost of $80, not $65. Comparing MRP with the posted wage there overstates hiring.
Marginal Productivity Theory of Distribution questions
What is the difference between marginal product and marginal revenue product?
Marginal product counts the extra physical units one more worker produces, measured in crates, haircuts or widgets. Marginal revenue product converts that into money by multiplying marginal product by the revenue each unit brings in. Hiring decisions need the dollar figure, because a wage is a dollar amount and comparing crates with dollars answers nothing. In a competitive output market the multiplier is the product price. Where the firm has price-setting power over its output, the multiplier is marginal revenue instead.
How many workers should a firm hire?
Hire every worker whose marginal revenue product is at least as large as the marginal resource cost, and stop at the last one where the two are equal. Exam versions arrive as a table, so build the marginal revenue product column first, then walk down it and take the final row where the figure still clears the cost of that hire. A worker past that row brings in less than the hire costs and shrinks profit, while stopping a row early leaves a profitable hire unmade.
Does marginal productivity theory mean wages are fair?
Marginal productivity theory describes what a competitive firm is willing to pay, not what any worker deserves. A payment equal to marginal revenue product depends on the price the output happens to fetch and on how much capital the worker has to work with, neither of which the worker controls. Critics add that the prediction assumes many buyers and sellers with no bargaining power on either side, so wage-setting power, unions and discrimination all pull actual pay away from the theoretical benchmark.
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