Introduction:
- The theory of factor pricing deals with the prices paid for factor services (land, labour, capital, entrepreneur) and received by the sellers of factor services. It deals with wage rate, interest rate specific rent and profit.
- In short theory of factor pricing studies how rent of land, wages of labour interest on capital and profit of entrepreneur is determined.
Why factor pricing is not studied along with product pricing:
- Theory of factor pricing deals with determination of prices of services of different factors of production, whereas theory of value deals with the determination of prices of goods produced. In both the theories prices are determined by the intersection of demand and supply curves. Therefore a question arises that why a separate study of factor pricing?
- This is because of the fact that the nature of demand and supply of factors and that of commodities. The difference in nature of demand and supply are as follows:
Difference in demand of factors and commodities: There are three main differences in the demand for factors and commodities.
These are:
- Derived Demand:Factors are demanded to produce commodities to satisfy consumer’s demand. Thus demand for factors is derived demand which is derived from the demand of commodities in the production of which it is used. For example demand for bricks, cement iron etc. is derived from the demand for a building.
- Joint Demand: Demand for factors is joint demand i.e. more than one factor is needed jointly to produce the commodity. For example one factor (labour) alone cannot produce apple. It is the outcome of efforts of Land, labour, capital and entrepreneur jointly.
- Dependability: The demand for factors depends upon their marginal productivities, while the demand for commodities depends upon their marginal utilities
Difference in supply of factors and commodities: There are two factors of difference between supply of factors and commodities:
Cost of production:
- Supply of commodities depends on its cost of production. But land has no cost of production to an economy. Also it is not possible to estimate the cost of production of labour.
- According to Modern economists supply of factors depend on their opportunity cost.
Relationship between price and supply
- There is positive relationship between price and supply of commodities, but there is no definite relation between price and supply of factors. Thus due to these differences, there is need for a separate theory for factor pricing.
Aspects of Marginal Productivity:
The three different aspects of marginal productivity are:
- Marginal Physical Productivity (MPP)
- Marginal Revenue Productivity (MRP)
- Value of Marginal Productivity (VMP)
1. Marginal Physical Productivity (MPP): In the words of M. J. Ulmer,” Marginal Physical Productivity may be defined as the addition to total production resulting from the employment of one more unit of a factor of production, all other things being constant.”It means marginal physical productivity measures productivity in physical terms. Suppose 5 labourer produce 20 meters of cloth and 6 labourer produce 24 meters of cloth. Thus, the marginal physical productivity of 6th labourer is 4 (24-20) meters. Marginal Physical Productivity can be expressed through the following formula:
MPP=TPP n – TPP n-1
Where :
MPP =1 Marginal Physical Productivity
TPP n =Total physical productivity of ‘n’ units of factor
TPP n-1= Total physical productivity of ‘n-1’ units of factor
In the words of M. J. Ulmer,” Marginal Revenue Productivity may be defined as the addition to total revenue resulting from the employment of one more unit of a factor of production, all other things being constant.” It measures productivity in monetary terms. It can be expressed as the product of marginal physical product (MPP) and marginal revenue (MR). It can be written as:
MRP a = MPP a * MP x
Where, a is a factor and x is a commodity
Suppose an additional labourer produces 4 meters of cloth and an additional meter of cloth fetches the additional revenue of Rs. 20. Then, the marginal revenue productivity is Rs. 80 (20 *4).
3. Value of Marginal Productivity (VMP):
- In the words of Ferguson,” the value of marginal product of a variable factor is equal to its marginal product multiplied by the market price of the commodity in question.”Thus the value of marginal physical productivity is the product of marginal physical product and average revenue (price).
VMP a =MPP a XAR x
Suppose an additional labourer produce 4 metre of cloth and the market price of cloth is Rs 25, then VMP is 4x25=100.
- Since the firm can sell any amount of commodities at the given market price under perfect competition, average revenue is equal to marginal revenue. Thus under perfect competition, MRP is equal to VMP. While under monopoly and monopolistic completion, average revenue is greater than marginal revenue. Thus VMP is greater than MRP under these two market conditions.
Marginal Productivity Theory:
The marginal productivity theory contends that in equilibrium each productive agent will be rewarded in accordance with marginal productivity.
Assumptions:
- There is perfect competition in the commodity and factor market
- All units of a factor are homogeneous
- The proportion in which factor are combined can be changed
- Each firm is guided by the objective of profit maximization
- Given the assumption that firm is guided by the objective of profit maximization, it will employ additional units of factor as long as addition made by it to the total product is more than its price. Thus firm will employ additional units of a factor as long as its marginal revenue product is greater than the price. Therefore the equilibrium of the profit making firm will be establish at the point where MRP = Price.
- As each firm wants to maximize its profit, it will produce its output with least cost combination. It occurs when the isoquant is tangent to iso cost line. Thus firm will employ factors where Slope of iso quant = Slope of iso cost line
- Slope of the iso quant is the marginal rate of technical substitution and slope of iso cost line is equal to the ratio of the price paid to the factors.
MRTPS =Pa/ Pb
MPa/MPb =Pa/Pb
Where MRTPS= Marginal rate of technical substitution
MPa =Marginal productivity of factor a
MPb = Marginal productivity of factor b
Pa = price of factor a
Pb =Price of factor b
Thus the profit maximizing firm will employ factors of production in such a way that the ratio of marginal productivity of all factor to their prices are equal.
- Under perfect competition, wage rate is determined by the industry or the combined forces of demand and supply. The only decision that a firm can take is about the number of labourers that it employ at the given wage rate.
- According to this theory a firm under perfect competition will employ that number at which price is equal to the value of its marginal product (VMP). Other things remaining the same, a firm will employ more and more labourers, their marginal physical productivity goes on diminishing. As price(AR=MR)of the product under perfect competition is constant, so when marginal physical productivity of labour go on diminishing ,marginal revenue product will also go on diminishing.
- In order to achieve the objective of profit maximization, a firm will employ labourer up to the point where their MRP is equal to wage rate (price). This can be explained with the following example.
|
No of labourer
|
MPP
|
Price of the product (AR=MR)
|
MRP=MPPXMR
|
Wage Rate(Rs)
|
|
1
|
10
|
2
|
10X2=20
|
8
|
|
2
|
8
|
2
|
16
|
8
|
|
3
|
6
|
2
|
12
|
8
|
|
4
|
4
|
2
|
8
|
8
|
|
5
|
2
|
2
|
4
|
8
|
It can be seen from the table that firm will employ 4 units of labour as at this point marginal revenue productivity is equal to wage rate of Rs 8.
Criticism of the theory: This theory has been criticized on the following grounds.
- It is based on unrealistic assumption of perfect competition
- Theory assumes that all the units of factor are homogeneous which is wrong. In reality different units of factor are heterogeneous.
- The measurement of marginal productivity of any factor is not possible in practical life.
- It ignores the influence of other factors on the productivity.
- As per theory if wage rate is higher, a firm will employ less ,however in reality, while employing labourer, a firm does not only take into consideration the wage rate alone but also consider many other factors such as amount of profit, demand of the product etc.
- According to Keynes, it holds good only under static condition when there is no change.
|
|
Participants