ECONOMICS

GENCOM-COE-
Module-4-class-8
Theory of distribution
 Ricardo theory of distribution
 Marxian theory of distribution
 Modern theory of distribution
 Transfer earning
 Rent
 Wage
 Interest
 Profit
 Ricardo theory of distribution

 Ricardo was mainly concerned with the problem of distribution. His theory
of distribution was based on two separate principle—the marginal principle
and the surplus principle.

 The marginal principle states that the variable factor should be paid a reward
equal to its marginal productivity while the surplus principal states that the
fixed factor will earn the surplus of total product after payment have been
made to the variable factor according to marginal productivities.

 Ricardo consider three factors of production land labour and capital.

Accordingly, there are three classes in the economy—landlords, labourer and
capitalist. Ricardo was concerned with the distribution of total product
among these three classes. The total output is divided into three parts—rent,
wages and profits. The landlords gets rent, the labourer get wages and the
capitalist gets profits.
 Marxian theory of distribution

 Marxian theory of distribution is linked with his analysis of

economic development under capitalism.

 Marxs consider only two factors of production – labour and capital.

 The capital stock is owned by the capitalist who also hirer labour to
carry out production. Accordingly total income is distributed in two
parts—total wages and total profits.

 The value of any commodity produced under capitalism can be

broken down into three component parts: value
of constant capital (i.e. fixed capital and raw material)
used up, value of variable capital (i.e. wages) and the
surplus value. In notation total value=C + V+S.
 Modern theory of distribution

FACTOR PRICING

Land Rent

Modern theory of distribution Labour Wages

states that the price of the factors
of production is determined by Capital Interest
its total demand and total supply.
Entrepreneur Profit
 The theory of distribution explains how national income
(output) is distributed among the various factors of production.
The distribution of national income between the factors of
production is called functional distribution of national income.
Classical economists, Adam Smith, Ricardo and Marx were
concerned with the functional distribution of national income.

 There is a difference between the demand for a product and the

demand for a factor. While demand for consumer goods is, in
general, autonomous demand, demand for factor services is a
derived demand.
 The quantity demanded of a factor is determined by
its marginal revenue productivity (MRP) and the price
of the factor.
 Marginal revenue productivity (MRP) of a factor can be defined as
revenue that a firm can earn by employing one additional unit of a
factor.
 The quantity produced by the marginal labour is called marginal
physical productivity of labour (𝑀𝑃𝑃𝐿 ) Now, 𝑀𝑅𝑃𝐿 can be defined
as follows.

𝑴𝑹𝑷𝑳 = 𝑴𝑷𝑷𝑳.P

(where = 𝑀𝑃𝑃𝐿 marginal physical productivity of labour, and P =

constant price of the product)
Marginal Physical and Revenue Productivity of Labour

Variable Total 𝐌𝐏𝐏𝐋 P (Price) 𝐌𝐑𝐏𝐋

factor (L) production (units) (Rs) = 𝐌𝐏𝐏𝐋.P
(units) (P = MR)

1 20 20 5 100

2 38 18 5 90

3 52 14 5 70

4 58 6 5 30

5 58 0 5 0
 Derivation 𝐌𝐏𝐏𝐋 of 𝐌𝐑𝐏𝐋 and Curves

The 𝑴𝑷𝑷𝑳 and 𝑴𝑹𝑷𝑳 curves can

be derived by using the 𝑴𝑷𝑷𝑳 and
𝑴𝑹𝑷𝑳 data As the figures show, on
the assumption of diminishing returns
both 𝑴𝑷𝑷𝑳 and 𝑴𝑹𝑷𝑳 curves have
a downward slope. The 𝑴𝑹𝑷𝑳 curve
provides the basis of derivation of the
demand curve of labour. That is why
the marginal productivity theory is
called the theory of factor demand.
 Marginal productivity theory states that price of each factor
tends to be equal to its marginal productivity. More precisely, the
payment made to a factor (i.e., its price) equals the value of its
marginal product. The value of marginal physical product or,
what is also known as, marginal revenue productivity of a factor,
equals its marginal product multiplied by the prevailing price of
the product.

 For example, if labour market is in equilibrium, wage rate equals

marginal product of labour multiplied by the price of the
product. The classical theory of factor pricing emphasizes that,
in equilibrium, the wage rate can neither exceed nor be less than
the value of marginal physical product of labour.
 Transfer earning

 Transfer earning – The price

which is necessary to retain a
given unit of factor in a certain
industry may be called its transfer
earning
 Rent

Rent—Rent is a payment for

any factor of production over
and above the minimum
amount which is necessary
to keep the factor in a
particular occupation or
industry.

 Situational rent—The
high price accruing to
land because of its
situational advantage is
known as situational
rent.c
 Economic rent

Economic rent—Whenever a factors of

production – whether labour, capital, land
or enterprise – receive a payment over and
above its minimum transfer earning, it is
said to receive economic rent. Therefore=
actual remuneration for a factor unit minus
it’s transfer earning.

The main causes for the emergence of

economic rent is the scarcity of a factor
of production.
 When the supply of a
factor is perfectly
elastic, the factor will
be earning only
transfer income and no
rent.

 When the supply of a

factor is perfectly
inelastic the income of
the factory is
completely rent.
 Differential rent

 Differential rent—Rent
that arises from the
difference in the quality
of the different grades of
factors of production is
known as differential
rent.
 Quasi rent

Quasi rent—It can be defined as

the income which arises for man
made appliances and certain type
of labour which are fixed in a
short period. The concept of quasi
rent was popularised and
introduced by Marshall. As all
inputs are variable in the long run
their supply becomes more elastic
and quasi rent vanishes. It is the
difference between total revenue
and total variable cost.
 Scarcity rent

Scarcity rent—Scarcity rent is

paid by all lands including the
marginal land. Land is limited in
quantity. Its scarcity is a
permanent factor. When the
population increases, demand for
land increase to such an extent
that something has to be paid
even for the worst type of land
called the marginal land. These
payments is called scarcity rent
 Wage

 Nominal wage simply referred to the amount of money that

a worker may be getting nominal wages are paid and
received in terms of money.

 Real wage is the applied to the total amount of necessaries

comfort and other facilities which a worker may enjoy by
working at a job.

 By the supply of labour we mean the various number of

worker of given type of labour which would offer
themselves for employment at various wage rate. The shape
of the supply curve of labour for an industry rises upward
from left to right. The supply of labour for the entire
economy depends on economic, social and political factors
or institutional factors.
 BACKWARD BENDING SUPPLY CURVE OF LABOUR –

BACKWARD BENDING
SUPPLY CURVE OF
LABOUR –
Labour supply curve is usually
positive sloping higher wage
induces workers to work more
instead spending time on
leisure. But, further increase in
wage may cause workers to take
more leisure. Thus, this higher
wage reduce working hours.
This means that supply curve
of labour will bend backward.
 Interest

 Interest is the payment made and received for the use

of money or for the use of capital.
Gross interest = net interest + reward
 Net interest is pure interest or payment for the use of for risk + reward for inconvenience+
money or for the loan of capital. reward for management.

 Gross interest include net interest and a payment for

a number of other services like reward for risk, reward
for inconvenience and reward for management.
 Profit

Profit is the reward of entrepreneur. It Gross profit = total revenue – total explicit cost.
is the return on the 4th agent
production that is enterprise.
Net profit = gross profit – total implicit cost.
 Normal profit V/S Super normal profit

 Normal profit may be defined as

profit normally expected in any
business such profit is the minimum
necessary to induce the
entrepreneur to remain and work in
business.

 Super normal profit is there a

return above the normal profit. It is
excess profits which may be termed
as a residual surplus which is of the
nature of economic rent.
1.Transfer earning or alternative cost is otherwise known as—

[SSC Section officer( commercial audit) Exam. 2003]

a) Variable cost.
b) Implicit cost
c) Explicit cost
d) Opportunity cost

2. Economic rent does not arise when the supply of a factor unit is—

[SSC Combined Matric Level ( Pre) Exam. 2002]

a) Perfectly inelastic
b) Perfectly elastic
c) Relatively elastic
d) Relatively inelastic
3.The study of factor pricing is alternatively called the theory of—

[SSC CGL Tier-1 2013]

a) Functional distribution
b) Personal distribution
c) Income distribution
d) Wealth distribution

4. Backward bending supply curve belongs to which market?

[SSC CGL Tier-1(CBE) Exam - 2016]

a) Capital
b) Labour
c) Money
d) Inventories
5.The minimum payment to factor of production is called—

[SSC multi- Tasking Staff( Patna) Exam. 2014]

a) Quasi Rent
b) Rent
c) Wages
d) Transfer Payment

6. Any factor of production can earn economic rent, when its supply will
be—

[SSC CAPFs SI , CISF, ASI & Delhi police SI exam . 2014]

a) perfectly elastic
b) perfectly inelastic
c) elastic in nature
d) all of these
THANK YOU