The below mentioned article provides an overview on factor pricing and income distribution.
Factor pricing and income distribution are interrelated. The price of a factor (say wage) together with the quantity of the factor (demanded and supplied) will determine the reward to the factor.
For example, if the daily wage of an average worker is Rs. 20 and if 100 workers are employed by all firms in an economy, the total wage payment will be Rs. 20 x 100 = Rs. 2,000. This is the share of labour in national income. This indicates what (and how much, of different commodities and services) workers as a group can buy.
Three Main Questions:
The study of factor pricing and income distribution (i.e., functional distribution) raises three major questions:
(1) What is to be distributed?
(2) Among whom will the distribution take place?
(3) What share will each get? We may now discuss these three questions one by one.
1. As for the first question, we can easily say that the thing to be distributed is nothing but what is produced by the different factors or inputs in a year. This thing is known as the national income.
2. As for the second question, it can be said that the national income is to be distributed among the four major factors of production land, labour, capital and organisation. The share of land is called rent, that of labour is wages, that of capital is interest, and that of the organiser or entrepreneur is profit.
3. As for the third question, it can be said that the share of each is determined in accordance with one important theory, known as the Marginal Productivity Theory of Distribution, which was developed by the great neo-classical economist J. B. Clark at the end of the 19th century.
Factor Prices or Factor Earnings:
Factor prices or factor earnings are the remuneration for the services of the different factors of production. Production involves the employment of the different factors, broadly known as land, labour, capital and organisation. Their services are to be remunerated. This remuneration for the factors is called factor prices or factor earnings.
Such a remuneration constitutes earnings or incomes to the owners of the factors, but it represents the cost to the society or a business firm as prices are paid for their services. So, we can say factor prices = factor earnings. Such earnings are functionally and traditionally classified into rent, wages, interest and profit corresponding to the four factors—land, labour, capital and organisation.
Special Features of Factor Pricing:
The traditional theory regards factor pricing as a special case of price theory. As the price of a commodity is determined by its demand and supply, the price of a factor, labour or capital, is also determined by its demand and supply. But a separate theory is needed to determine the factor-prices because there are some peculiarities of demand and supply of a factor.
We may refer to four special features in this context:
(a) Derived demand:
It is observed that the demand for a factor, unlike the demand for a commodity, is a derived demand. It means that the demand for any factor of production depends on the existence of a demand for the goods that it helps to make. Thus, the demand for computer programmers or TV repairers is growing, as more and more electronic computers or TV sets are used. The demand for college teachers increases whenever the number of students in college increases or new colleges are opened.
(b) Joint demand:
The demand for a factor of production is essentially a case of joint demand. It means that, as one particular factor cannot produce anything, almost all the factors are demanded jointly and at a time to produce a particular thing. But, the goods are not jointly demanded except in the case of some special goods like bread and butter or rubber-stamp and stamp-pad, etc.
(c) A separate theory for each factor:
In general, no separate theory is needed for determining the prices of different types of goods; a single theory is enough for most of the goods (except for interrelated goods like joint products, etc.). But a separate theory is needed for each and every type of factor earning, such as rent, wage, interest and profit
(d) No homogeneous units of a factor:
The different units of a product may be homogeneous, but the units of a factor are not generally so. Moreover, the cost of production of a commodity can be easily determined. But the cost of a factor, land or labour, cannot be so determined.
For all these reasons a separate theory is needed for determining factor prices. But the determination of factor prices becomes more complex than the determination of the prices of goods. This happens so, because in the former case the conditions (i.e., market situations) in both factor and product markets are to be considered at the same time, but in the latter case the prices of goods are determined in different market situations assuming constant factor prices.