Lecturer Notes on the Theory of Distribution

Meaning of Distribution:

By “distribution” in the present context, we do not mean the distributive activities of traders and middlemen.

“The economics of distribution,” says Chapman, “accounts for the sharing of the wealth produced by a community among the agents, or the owners of the agents, which have been active in its production.”

The theory of distribution is concerned with the evaluation of the services of the factors of production, a study of the conditions of demand for and supply of the units of these factors and the influences bringing about changes in their market price. In this sense, the theory of distribution is mostly an extension of the theory of value.

In the theory of distribution, however, we determine the prices not of the factors of production but of their services. For instance, in the factor market, it is not hectares of land which are being bought or sold, but the services of land. Similarly, neither labour nor capital goods are being evaluated, but the services of labour or of capital. Thus, rent is not the price of land but the price of service or use of land; wages, the price of the service of labour; interest, the price of the use of capital, and profit, the reward of entrepreneur’s services.

Functional vs. Personal Distribution:

It may be pointed out that the distribution discussed here is functional and not personal. It is distribution not among individuals but among agents of production. The same person may represent in his person all the four agents, e.g., a peasant-proprietor.

He is the entrepreneur, the labourer, the capitalist (for he has some capital of his own), the landlord all rolled in one. Here we do not discuss how much he earns as an individual out the reward that he gets separately for supplying each factor of production. Thus, we study distribution in the form of rent, wages, interest and profits and not among the different individuals in the nation.

It may also be understood that the prices of the factors of production are really the prices paid for them by the firms producing that commodity. From the point of view of the firms they are the costs of production. In other words, what is cost to a firm is income to the factors of production.

Wages, rent, interest, profit are the functional incomes respectively of labourer, owner of land, owner of capital and the entrepreneur. The reward that each factor gets is the price paid for his service by the entrepreneur. Thus, from one angle it is income and from the other it is cost.

National Dividend:

By the term ‘national dividend’ is meant that part of the annual national income of the country which is distributed among the various agents of production. Marshall defines national dividend thus: “The labour and capital of the country, acting on its natural resources, produce annually a certain net aggregate of commodities, material and immaterial, including services of all kinds. This is the national income or the national dividend.”

The word ‘net’ in this definition is important. It means that the entire national income of the year cannot be distributed among the agents which have contributed to its production. A part of it has to be kept back for the purpose of maintaining productive activity in the community. This may be called the replacement fund. For example, in the case of agricultural income, something must be kept for seed, maintenance of bullocks, etc. What remains is the national dividend.

The production of national wealth is compared to the pouring of water in a reservoir by four big pipes representing the four agents of production. Out of this reservoir, four small channels flow out in the form of rent, wages, interest and profit, the total of which constitutes the national dividend.

Thus, national dividend is at once the aggregate net product of, and the sole source of payment for, all the agents of production. The national income is not first produced, and then distributed. Production and distribution go on side by side. Hence it is said that the National Dividend is not a fund but a flow.

Why a Separate Theory of Distribution:

In distribution, we are concerned with factor pricing as distinguished from product pricing discussed already in the Theory of Value. In general, we can say that the price of the services of a factor of production is determined in the same way as the price of a commodity. That is why it is said that the general theory of demand and supply which determines the price of a commodity can also be applied to the determination of factor pricing.

But the general theory of value is not applicable to distribution in its entirety. This is so because of some fundamental differences between a commodity and a factor of production. For instance, the cost of production of an agent of production cannot be ascertained. As a matter of fact, it looks rather odd to speak of cost of production in the case of an agent of production, say, labour. What can you say about the cost of production of a worker or of a hectare of land?

Hence, though in the case of a commodity, we may say that value in the long run tends to approximate to the cost of production, yet such approximation is out of the question so far as an agent of production is concerned for the simple reason that the cost is not assert table.

In spite of these qualifications, the general theory of demand and supplies, does apply to the pricing of agents of production also. But since it requires essential modifications, it is necessary to have a theory of distribution distinct from the theory of product pricing.

Economists have propounded several theories of distribution; the margin­al productivity theory of distribution is the most well known among them. It has been severely criticised by modern economists, who have put forward the demand and supply theory which is now widely accepted. We shall explain both these theories in detail, but before we do that it is necessary to understand well the meaning and the various concepts of productivity.

Concepts of Productivity:

The term “product” or “productivity” is frequently used in economic theory for discussing product pricing or factor pricing. But it is very necessary to have a clear idea about the various concepts of productivity and differentiate between them.

Productivity means the quantity of the output turned out by the use of a factor or factors of production. For instance, how much wheat can be produced on 3 hectares of land under certain conditions or how much earth-digging can be done by 5 labourers. But how do we measure the product? Do we measure it in physical terms or in terms of value? Also, do we take the average product or the marginal product, i.e., the addition made to the total product by the employment of the marginal factor?

The answers to these questions give rise to different concepts of productivity or product which we may distinguish as under:

(a) Marginal Physical Product:

In this case, we measure the quantity of the product in physical terms. For instance, we may express it in terms of quintals of wheat or the number of chairs produced. But we are not concerned here with the total quantity of wheat or the average yield. We are concerned here with the marginal product which means an addition made to the total output of the commodity by the addition of one unit of a factor of production.

Suppose 2 hectares of land yield 30 quintals of wheat and 3 hectares, 40 quintals. The use of the third hectare has added 10 quintals. This is the marginal physical product. The total product has been increased by 10 quintals by the employment of the third or the marginal hectare. That is why it is called marginal product. But it is the physical product and not product in terms of value, which we explain below.

(b) Marginal Value Product:

We have explained abovewhat we mean by marginal product and we repeat that it is an addition to the total product by the addition of one more unit of a factor of production, say one hectare or one worker, or a unit of Rs. 1,000 in capital. When this marginal product is expressed not in physical terms but in terms of its value in the market, it is called Marginal Value Product.

This marginal value product means the value of additional product obtained by the employment of another unit of a factor of production. We can get value product by multiplying the physical product (i.e., the quantity of the commodity) by its price in the market.

(c) Marginal Revenue Product:

The marginal revenue at any level of firm’s output is the net revenue earned by selling another (additional) unit of the product. Algebraically, it is the addition to total revenue earned by selling n units of product instead of n — 1 unit when n is any given number.

The word net in the definition given above is important. If the price of a product falls when more of it is offered for sale, then that would involve a loss on the previous units which were sold at a higher price before, but will now be sold at a reduced price along with the additional unit. This loss must be deducted from the revenue earned by the additional unit.

The marginal revenue can be found by taking out the difference between the total revenue before and after selling the additional unit as under:

Total revenue of 7 units sold @ Rs. 16 = Rs. 112.

Total revenue of 8 units sold @ Rs. 15 = Rs. 120.

Hence, marginal revenue = Rs. 120—Rs. 112 = Rs. 8.

It will be seen that revenue means the sale proceeds and is found by multiplying the quantity sold by price.

Under perfect competition, marginal revenue (MR) is equal to price; hence there is no difference between the value of marginal product and the marginal revenue product; they are the same. But under imperfect competition marginal revenue (MR) is less than price, because the monopolist is able to maintain a higher price. In this case, there is a difference between these two concepts.