MODERN THEORY OF DISTRIBUTION
The marginal productivity theory, which we have discussed above only tells us how many workers will an employer engage at a given wage-level in order to maximize his profit. It does not tell us how that wage-level is determined. We also saw that the marginal productivity theory approaches the problem of the determination of the reward of a factor of production from the side of demand only. It ignores the supply side. Hence, the marginal productivity theory is not an ad explanation of the determination of the price.
The modem theory of factor price which ti factory explanation of factor Demand and Theory, Just of a commodity is determined by demand for, and supply of. a commodity, I yearly the price of a productive service also i determined by demand for, and supply of. that particular factor. We shall now analyse these t 0 aspects demand and supply.
Demand Side About the factor demand, we should remember two things;
((1) Demand for a factor is not a direct demand but a derived demand and tb J the demand for it is a jointly interdependent demand. The demand for a factor of production is not a direct demand; it is an indirect or derived demand. It is derived from the demand for the product that the factor produces. For instance, labor does not satisfy our wants directly. We want labor for the sake of the goods that it produces. The demand for a factor of production is, therefore, ultimately determined by the desires and preferences of the consumers for the final product. It follows, therefore, that if the demand for such goods increases, the demand for the factor, which help to produce these goods will also increase. Also, if the demand for goods is elastic or inelastic, the demand for factor, too will be elastic or inelastic. The higher the price of the commodity produced the higher the price of the productive service used. No factor of production works alone. It is generally required to work in combination with others. -The demand for a factor of production, therefore depends on the quantity and the prices of the other factors required in the process. Generally speaking, the demand price for a given quantity of a factor of production will be higher, the greater the quantities of co-operating productive services. The factors of production are not only complementary to one another, they also some times compete with one another and are, therefore, substitutes for one another. Hence, the price of one factor effect the price of another. Hence, their. cross elasticities are as important as their own elasticities. If more of a factor of production is currently employed, the marginal productivity of the factor will fall and the lower will be the demand price for the unit of the productive service. This is another rule connected with the demand for a factor of production. The demand price of a factor also depends on the value of the finished product in the production of which the factor is used. The demand price will generally be greater, the more valuable is the finished product in which the factor is used.
Also, the more productive the factor, the higher will be demand price of a given quantity of the factor. The demand for a productive service also depends upon technological changes. Improvement in technology makes a factor more productive and thus increases its demand. Qn the demand side, we have also to consider the elasticity of a factor demand. In this connection, we may note that the elasticity of .demand or a factor varies directly with the elasticity of demand for the final product. Also, the demand for a factor will be more inelastic, the smaller the cost of a given factor in the total cost of the final product. But the demand for a factor will be more elastic, the easier it is to substitute some other factor for it. Sum . The demand for a factor of production depends on (a) the demand for the commodity produced, (b) the price of the factor concerned, (c) the . quantity and the prices of the co-operating factors, (d) the quantity and the quality of the factor currently employed and (e) changes in technology. These are a few points connected with the demand for a productive service. We know that the demand curve of the industry is the sum-total of the demand curves of the various firms in the industry. By a similar summing up, we can have the demand curve of all the industries using a particular productive service. The demand of the employer for a factor depends on its marginal revenue productivity (in short marginal productivity) and the quantity of the factor that a firm will employ Will upend on the prevailing wage-level. That is, more labor will be employed if wages are low and less if the wages are higher. is the diagram representing the position of a firm regarding the employment of a factor say, labour. When the wage is OW. the firm is in equilibrium at the point E and the demand for the factor is ON; similarly. at OW’ wages the demand is ON’ ami at OW” the demand is ON”. MRP (marginal revenue productive curve) is the demand curve for a factor of production by individual firm. But for the determination of price it is not the demand of the individual firm that mailers. What matters is the total demand. i.e.. the sum-total of the demands of all firms in the industry. The total demand curve is derived by the industry. The total demand curve is derived by the lateral summation of the marginal revenue productivity curves of all the finns in the industry.(b). It may be carefully noted that Y-axes in both curves are drawn to the same scale. but X-axes are drawn on different scales.
We have supposed that there are 100 firms in the industry. At OW wage, the demand of the individual firm is ON. but the demand of the whole industry at the same wages is OM which is equal to 100 ON (because the number of lions in the industry is 100). In the same manner. at OW’ the demand of the firm i
ON’ but the demand of the entire industry is 0 1′.
which is equal to 100 ON’ and similarly at OW”. the
demand of the firm is ON” and that of industry OM”.
which is equal to 100 ON”.
It can be seen that the demand curve DD also
slopes downward to the right. The reason is that MRP
curve whose summation is represented by DD also
slopes down similarly to the right in the relevant portion.
This means that according to the law of diminishing marginal productivity, the more a factor i employed. the lower is the marginal productivity. Now we turn to the supply side.