B. INPUT PRICING BY MARGINAL PRODUCTIVITY

The theory of income distribution (or distribution , theory) studies how incomes are determined in an economy. Everyone can see the vast differences in incomes of different families. Economics helps explain these differences. Why are incomes in America more than 10 times greater than those in China or India? Why are women paid only two-thirds of the average wage of men? Why is Bill Gates worth almost $100 billion while half of American black families have zero ‘or negative What determines the profit rate on capital? Why are land prices so much higher in the city than in the desert? Our first answer ‘to these questions is that the distribution theory is a special case of the theory of prices. Wages·are really only the price of labor; rents are similarly the price for using land. Moreover, the prices .of factors of production are primarily set by the interaction between supply and demand for different factors=-just as the prices of goods are largely determined by the supply and demand for goods.

But pointing to supply and demand is just the dint step on the road to economic understanding. What lies behind supply and demand? The key to this question is the marginal-productivity theory of incomes. By applying the production theory of earlier chapters, we will see that the demands for factors of production can be expressed in terms of the revenues earned on their marginal products. This key finding on demand, combined with supplies of factors, will determine the prices and quantities of factor and thereby market incomes.

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