The Neo-Classical theory of distribution shows the division of National income among the factors of production.
1. Capital (K) and Labour (L) is constant
K = K
L = L
2. Factors of production are fully utilized that is, there exists full employment of labour. Therefore, the supply curve of factor is vertical.
3. No change in technology.
4. Output is fixed at a level Y .
5. Constant returns to scale.
It implies if we increase all inputs by a certain proportion (k), output will increase by the same proportion (k).
kY = f(kL, kK) where k is a positive constant.
6. Perfect competition.
7. Firms produce only output, households own capital directly. Since output (Y) is a function of input (K, L).
Production function: Y =f(K, L) …(i)
The output produced will depend on the contribution of factor to production. The national income generated will depend on the total output produced. Greater the output
produced more will be the generation of national income. Therefore, Y = Y implies that national income (Y) = total output produced (Y).
Determination of Factor Price:
Price of the factor is determined at the point where:
Supply of the factor (Ns) = Demand for the factor (Nd)
Ns = Nd
It implies, the price which each factor (labour, capital) receives (wage, interest) for their services rendered depends on the demand and supply of that factor.
Since supply of factor is fixed, the supply curve of factor is vertical straight line (Ns).
Demand for factor (Nd) is negatively related to the factor price.
This implies, if factor price (for e.g. wages) falls, demand for factor (labour) will increase and vice versa.
2. Price of the factors (w, r)
3. Amount of the factor (L, K)
where P, W, K are constant (bar means constant).