The following points highlight the five major defects of the marginal productivity theory.
1. One of the major assumptions of the theory is that there exists perfect competition in both the factor (labour) market and the product market. This assumption is not realistic because, actually, in almost all the markets, perfect competition does not exist.
First, in most of the product markets, product is not homogeneous and in the factor markets like those of labour services or land, the factor inputs to be bought and sold are not homogeneous.
Second, in the product markets, sellers or firms, and sometimes buyers also, do not behave like individual sellers and buyers each selling and buying at the given market price, a small fraction of the total quantity bought and sold.
Similarly, in the factor markets, buyers or firms and sellers of the factor, say, the workers, do not remain unorganised and they do not behave like individuals buying and selling at the given market price, small fractions of the total quantity bought and sold of the factor.
Since the assumption of perfect competition is not valid in the real world, since in most of the product and factor markets, competition is absent, or, at best, it is imperfect, W is not seen there to be equal to VMPPL—W is less than VMPPL. The deviation of VMPPL from W has been called exploitation of labour by the noted economist Joan Robinson (1903-1983).
2. The MPT assumes that in a production process, it is possible to vary the quantity used of a particular input keeping the other input quantities unchanged. This assumption is necessary to have the estimates of marginal product of a particular input. But the assumption is troublesome, for in many cases, the quantities of two or more inputs may have to be increased simultaneously.
For example, if the firm uses more of labour, it would have to increase capital at the same time. In some production processes inputs have to be used in a fixed ratio. So there may be many instances where it is not possible to use one input in an increased quantity keeping the other input quantities unchanged.
Of course, it is not always impossible to have estimates of marginal product even when the inputs are to be used simultaneously. This is done by bundling together these inputs in a fixed ratio and treating the bundle as a composite input.
3. The theory assumes that inputs can be measured in terms of infinitesimally small units, i.e., inputs are infinitesimally divisible. This assumption is also unrealistic, because in reality, there are limits to the divisibility of inputs.
4. This theory is called a theory of determination of input prices. But, as we have seen, the MPT proper stops short of determining the price of an input. We have seen that the theory actually analyses the demand side of a factor input and helps us to determine the profit-maximising quantity demanded of an input at a given price.
We have also seen that the theory has established that the firm would demand that quantity of an input at a given price at which the value of its marginal product would become equal to its price.
5. The theory contends that each factor of production would get a price which is equal to the value of its marginal product. Therefore, if the factor inputs in a production process are paid at the rate of their respective VMPP, the firm’s output should have been exhausted.
But it can be shown mathematically that this would be the case only when the production function of the firm is homogeneous of degree one, i.e., when there are constant returns to scale. If the returns to scale are increasing or decreasing, product exhaustion would not take place.