It is also known as the theory of factor pricing.

There are two aspects of this theory:-

  1. Personal Distribution:- Income distribution among individuals is known as personal distribution. The theory of personal distribution studies how personal income of individuals are determined and what causes the inequalities in their income.
  2. Functional Distribution:- This refers to how income is to be distributed among various factors of production. The theory of functional distribution studies how the relative prices of factors of production are determined. That is the reason why it has also been termed as the theory of factor prices.

Theory Of Distribution

  • Theory of distribution is a specific matter of study of the theory of price. As the prices of products can be described with the help of the interaction of the demand and supply forces, likewise its distribution can also be described by the determination of prices of the factors which are also explained with interaction of their demand and supply forces 
  • But the important point to keep in mind is that In the theory of distribution, we depict the prices of the services rendered by the factors of production and not of the factors of production
  •  For example, in the market of the factors of production, it is not the labour which is being bought or sold, but the services of labour. Similarly, land, capital, and entrepreneur goods are not being evaluated, but the services of such land, capital, and entrepreneur goods
  • Thus, rent is not the price of land but the price of services or use of land & wages is the price of the service of Labour & interest is the price of the use of capital, and profit is the reward of entrepreneur’s services
  • Hence we can observe from the above mentioned points that the need for the theory of distribution (or the theory of factor pricing) arose due to the shortcomings in the theory of product pricing

Classical Theory of Distribution

According to the classical theory of distribution, the prices of the services of factors of production are determined by the supply and demand forces of such services.

  • Rent:- As per the theory of rent propounded by Ricardo, rent is that portion of the produce of earth which is paid to the landlord for the original and indestructible powers of soil. He viewed rent as the differential surplus that some plots of land earn over and above the other
  • Wages:- As per the theory of wages propounded by economist T. R. Mealthis and J. S. Mill, labour is sold in the market and its value is determined like the other commodities. According to J. S. Mill, the wage rate depends on the ratio of workforce to the amount of working capital
  • Interest:- As per the theory of interest propounded by economist J. S. Mill, the interest is determined by the interaction of demand and supply forces of capital. The demand for capital is made for the purpose of investment and thus the demand for capital varies inversely with the rate of interest.
  • Profit:- As per this theory of profit, the value of a commodity is determined on the basis of the services of labour used in it

Marginal Productivity Theory Of Distribution

Marginal productivity theory was given by German Economist Von Thunen in 1826. According to this theory, prices of the factors of production depend on its productivity and it is determined by the marginal productivity of the factor concerned. In other words, under perfect competition, every factor of production gets remuneration equal to its marginal productivity.

  • Marginal Productivity:- It refers to the additional unit of product generated due to the employment of an additional unit of a factor of production.

Value of Marginal Physical Productivity = MPP* Price

Avg.  Gross Revenue Product=TRNo.of variables

Equilibrium where MRP = price of the factor

If MRP > p, increase the quantum of the factor concerned

If MRP < p, decrease the quantum of the factor concerned

  • Assumptions:- Assumptions of this theory are as follows:
  1. Perfect market competition in product market
  2. Variable proportion type production function (i.e. output can be increased by changing the factor ratio)
  3. Divisible factor
  4. Full employment
  5. Constant technology
  6. Factors can be substituted
  7. One variable input and the other is fixed

Conclusion

This article throws light upon the theory of distribution. We have so far analysed that the theory of distribution has been viewed differently by the classical economists and the modern economists. Accordingly, many theories have been propounded by economists in this regard. We have so far covered the classical theory of distribution and the marginal productivity theory of distribution.