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Unit V Income Distribution And Factor Pricing For Principles Of Micro Economics Bcom Sem 1 Delhi University Notes

Unit V Income Distribution And Factor Pricing For Principles Of Micro Economics Bcom Sem 1 Delhi University :    The total output of an economy is the result of the joint productive efforts of the various factors of production; land, labour, capital and enterprise. This total output ultimately gets distributed among the factors  that contributed to its production in the form of wages, rent, interest and profit. The purpose of the theory of  distribution is to explain the principles that govern this distribution. The distribution of total product depends on how the various factors are priced in the market. Thus, pricing of the various factors of production is the subject  matter of the theory of distribution.

There are two aspects of the factorial distribution of national income; (i) determination of the per unit prices of the different factors and (ii) the division of the national income as between the different factors, i.e.,  absolute and relative shares of different factors in national income. The first question is essentially a  micro-economic problem concerning the determination of equilibrium at the level of an individual firm or an industry. The second question concerns the factorial distribution of income at the level of the economy and,  therefore, forms part of macro analysis. Thus, we have micro and macro theories of distribution. In the  present  set of lessons we are concerned only with the micro theories of distribution i.e., the question of  factor-price determination.

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Unit V Income Distribution And Factor Pricing For Principles Of Micro Economics Bcom Sem 1 Delhi University Notes

Unit V Income Distribution And Factor Pricing For Principles Of Micro Economics Bcom Sem 1 Delhi University :  Just as the price of any commodity is determined by the interaction of the forces of supply and demand,  similarly the price of a factor is determined by the interaction of the forces of supply and demand for it. The  theory of distribution is, thus, a special case of the theory of price determination discussed in the earlier set of lessons. However, the supply and demand for factors exhibit some peculiarities which have to be taken into account while considering the pricing of particular factors. Herein lies the justification for a separate theory of factor  price determination. Let us first examine the demand for and supply of factors in some detail.

The theory of distribution or the theory of factor pricing deals with the determination of the share prices of four factors of production, viz., land, labor, capital and organization.

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Four Factors of Production, in Economics:

(i) The share of land, is named as Rent.

(ii) The share of labor as Wages.

(iii) The share of capital as Interest.

(iv) The share of organization as Profit.

The four factors of production in cooperation with one another produce annually a net aggregate of commodities, material and non-material. This we name as national income. The national income is to be shared among the four factors of production which have contributed to this production. In the theory of distribution, we are chiefly concerned wrath the principles according to which the price of each factor of production is determined and distributed.

 In the words of Chapman:

“The Economics of distribution or the pricing of factors 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”.

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Distribution is Functional and not Personal. I would like to make it clear that the pricing of factor of production discussed here is functional and not personal. By this we mean that when the reward of each factor is distributed, it is not paid to an individual but to the agents or factors of production. The individual may represent in his person as landlord (if he used his own land), the labor (if he works himself), the capitalist (if he has contributed his capital) and. the entrepreneur (if be organizes the business). The price of land, labor, capital and organization which is termed as rent, wages, interest and profit is in fact their functional income. They are the costs from the point of view of the firm but income from the point of view of factors of production.

Why a Separate Theory of Factor Pricing?

Unit V Income Distribution And Factor Pricing For Principles Of Micro Economics Bcom Sem 1 Delhi University :    It is often pointed out that the price of a factor of production is determined, like the price of a commodity, by the equilibrium of forces of demand and supply, If the demand of the particular factor rises, other things remaining the same, its price goes up and vice versa. The other economists who differ with this view are of the opinion that the theory of value is not applicable in its entirety to the pricing of factor of production. They believe that on the side of demand there is similarity between the two, because the value of a particular commodity and the price of a factor of production are governed by marginal utility and marginal productivity respectively. But on the side of supply, much difference exists between them. On the side of supply, the price of a particular commodity is determined by its marginal cost of production. But in ease of labor or an acre of land or a unit capital, it is not possible to ascertain exactly its costs of production. The other dissimilarity between the two is that the supply of a factor of production cannot be readily adjusted as we can do in the case of a commodity. For example, if the demand of a particular type of labor increases or the rent of land rises-up, it will not be possible to increase their supply immediately.

In the words of Marshall:

“Free human beings are not brought up to their work on the same principle of a machine, a house of a slave. If they were, there would he very little difference between the distribution and the exchange side of value”.

Thus, we come to the conclusion that though the value of the commodities and the prices of the factors of production are determined by demand and supply yet, due to some differences of the factors of production on the side of supply, there is a need for a separate theory of distribution.

Unit V Income Distribution And Factor Pricing For Principles Of Micro Economics Bcom Sem 1 Delhi University Notes

Unit V Income Distribution And Factor Pricing For Principles Of Micro Economics Bcom Sem 1 Delhi University :  Factors of production can be defined as inputs used for producing goods or services with the aim to make economic profit. In economics, there are four main factors of production, namely land, labor, capital, and enterprise. The price that an entrepreneur pays for availing the services of these factors is called factor pricing.

An entrepreneur pays rent, wages, interest, and profit for availing the services of land, labor, capital, and enterprise respectively. The theory of factor pricing deals with the price determination of different factors of production.

The determination of factor prices is always assumed to be similar to the determination of product prices. This is because in both the cases, the prices are determined with the help of demand and supply forces. Moreover, the demand for factors of production is similar to the demand for products.

However, there are two main differences on the supply side of factors of production and products. Firstly, in product market, the supply of a product is determined by its marginal cost of production. On the other hand, in factor market, it is not possible to determine the supply of factors on the basis of marginal cost.

For example, it is difficult to ascertain the exact cost of production for factors, such as land and capital. Secondly, the supply of factors of production cannot be readily adjusted as in the case of products. For instance, if the demand for a land increases, then it is not possible to increase its supply immediately.

Concept of Factor Pricing:

Factor pricing is associated with the prices that an entrepreneur pays to avail the services rendered by the factors of production. For example, an entrepreneur needs to pay wages to labor, rents for availing land, and interests for capital so that he/she can earn maximum profit. These factors of production directly affect the production process of an organization.

In context of an economy, these four factors of production when combined together produce a net aggregate of products, which is termed as national income. Therefore, it is important to determine the prices of these four factors of production. The theory of factor pricing deals with the determination of the share prices of four factors of production, namely land, labor, capital and enterprise.

Unit V Income Distribution And Factor Pricing For Principles Of Micro Economics Bcom Sem 1 Delhi University  -In other words, the theory of factor pricing is concerned with the principles according to which the price of each factor of production is determined and distributed. Therefore, the theory of factor pricing is also known as theory of distribution. According to Chapman, the theory of distribution, “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.”

There are two aspects of each factor of production, which are as follows:

i. Price Aspect:

Refers to the aspect in which an organization pays a certain amount to avail the services of factors of production. For example, wages, rents, and interests constitute the price of factors of production.

ii. Income Aspect:

Refers to another aspect in which a certain amount is received by a factor of production. For instance, rents received by a landlord and wages received by labor constitute the income generated from the factors of production.

Generally, it is assumed that factor pricing theory is similar to product pricing theory. However, there are certain differences between the two theories. Both the theories assume the determination of prices by the interaction of two market forces, namely demand and supply.

Unit V Income Distribution And Factor Pricing For Principles Of Micro Economics Bcom Sem 1 Delhi University Notes

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