THEORIES OF

DISTRIBUTION
UNIT-5
BY: SWATI ROHATGI
INTRODUCTION
‘Distribution’ refers to the sharing of the wealth that is produced among the
different factors of production.
In the modern time, the production of goods and services is a joint operation. All
the different factors of production i.e., land, labour, capital and enterprise are
combined together in productive activity.
Main Problems of Distribution

1. How much property be distributed?

◦ Distribution is made of national income

2. Among what factors it should be distributed?

◦ land, labour, capital and enterprise

3. What should be the theory of distribution?

◦ Marginal Productivity Theory of Distribution
◦ Modern Theory of Distribution
MARGINAL PRODUCTIVITY THEORY OF
DISTRIBUTION
Q. What determines the prices of factors of production?
ANS: Price of a factor of production depends upon its marginal productivity

J.B. Clark, Marshall and Hicks are the main pro-pounders of this theory. Initially, the theory was
propounded as an explanation for the determination of wages (i.e., the reward for labour) but,
later on, it was generalized as a theory of factor pricing for all the factors of production.
EXPLANATION
The marginal productivity of a factor determines its price. In the long-run, the price or reward of
a factor tends to be equal to its marginal as well as average products. When the reward of each
factor in the economy tends to be equal to its marginal productivity, there is optimum allocation
of resources (factors) in different uses. Further, when all factors receive their shares according to
their respective marginal products, the total product will be exhausted.
Assumptions of Marginal Productivity
Theory
(i) There is perfect competition, both in the product market as well as in the factor market.
(ii) There should not be any technological change.
(iii) All units of a factor should be perfectly homogeneous i.e., they should be of equal efficiency. This means that
all units of a factor should receive the same price. The homogeneity of factors of units should imply that they are
perfectly substitutes of each other.
(iv) The firm aims at maximisation of profit. Therefore, it should seek and observe the most efficient allocation of
resources.
(v) The economy as a whole, should operate at the full employment level.
(vi) There should be perfect mobility of factors of production.
(vii) The bargaining power of the seller and the buyers of a factor of production should be equal.
(viii) The marginal productivity of an individual should be measurable.
(ix) There should not be any government intervention in the fixation of factor price, such as minimum wage
legislation or price control etc.
(x) The theory essentially considers long-run analysis in order to prove that the price of a factor will tend to be
equal to both average and marginal productivity.
 WAGE RATE IS EQUALISED WITH MARGINAL PRODUCT
OF LABOR
If the prevailing wage is less than the marginal productivity, then more labour will be employed. Competition among
employers will raise the wage to the level of marginal productivity. If on the other-hand, the marginal productivity is less than
the wage, the employers are losing and they will reduce their demand for labour. As a result, the wage rate will come down to
the level of marginal productivity. In this way by competition, wage tends to equal the marginal productivity. This applies also
to the other factors of production and their rewards.
THEORY OF RENT
▪Rent is the price paid for the use of land.
▪Supply of land is inelastic in nature.
▪Rent is the surplus earning of any factor of production in excess of the cost incurred to
obtain its services.
▪The determination of rent, the modem economists say, can be explained in the same
manner as the reward of other factors, that is by demand and supply forces.
 MODERN THEORY OF RENT
Demand and Supply Analysis:
Demand For a Factor: The demand for a factor which may be land, labor or capital is a derived
demand. Land, say for instance, is demanded for its produce. The higher the produce, the greater
is the demand for land. A firm will pay rent equal to the marginal revenue productively of land.
Supply of a factor: The supply of land to a particular use (say industry) is quite elastic. It can be
shifted to other uses by offering higher rent than that being earned by it now. The supply of a
factor (to an industry) is, therefore, rent elastic. If higher rent is paid, the supply of a factor can be
increased by withdrawing it from other uses.
Determination of rent. The economic rent is determined by the intersection of demand and
supply curves for a factor. The total earning of the workers employed is equal to the area OWEL.
At wage rate OW, there are workers who would work, at lower pay but they are also paid at OW
wage rate. Those workers whose transfer earnings are less than this wage rate will be getting
economic rent. The total economic rent earned by all the intra marginal workers is equal in the
area WES. The marginal worker i.e., Lth worker is not obtaining any rent or surplus.
Transfer earnings are the minimum reward required to keep factors of production, such as
labour, in its current occupation.
Economic rent is any amount earned by a factor of production, such as labour, above the
minimum amount they require to work in a current occupation.
MODERN THEORY OF RENT
The modern theory of rent is that it is the difference between the actual earning of a factor unit
over its transfer earnings. The transfer earnings of a factor of production is the minimum
payment required for preventing that factor for transferring it to some other use. It is called the
factor supply price in its present occupation.

RENT = PRESENT EARNINGS – TRANSFER EARNINGS

For example, a worker earns ₹6000 per month in a factory. In the next best employment, he can
get ₹5000 only per month. The surplus or excess of ₹1000 which a worker is earning over and
above the minimum payment necessary for inducting him to work in the present occupation is
the economic rent.
Economic Rent Depends on the Elasticity of Supply of the Factor of Production:
i) Perfectly elastic supply. When the supply of a factor of production is perfectly elastic, then
none of its income is economic rent. Its entire income is transfer earnings. Here, the supply
curve SS/ is a horizontal line. Whatever the amount of factor demanded, the supply price
remains at OS. Hence, it earns no surplus in the nature of rent.
Economic Rent Depends on the Elasticity of Supply of the Factor of Production:
(ii) Totally inelastic supply. When the supply of a factor is totally inelastic, then its transfer
earnings is zero. The entire income is economic rent. Here, the elasticity of the supply of factor
of production is zero. It does not increase at all as its demand increases. The supply curve is
vertical. The entire of factor income is a surplus which is shown by area ONST.
ROLE OF TRADE UNION AND COLLECTIVE
BARGAINING IN WAGE DETERMINATION

TRADE UNIONS LEADS TO HIGHER WAGES BUT

UNEMPLOYMENT
ROLE OF TRADE UNION AND COLLECTIVE
BARGAINING IN WAGE DETREMINATION
Collective Bargaining is a process of negotiating between employers and the
representatives of a unit of employees aimed at reaching agreements that
regulate working conditions

During the collective bargaining process, workers are represented through trade
unions. The process of collective bargain involves negotiation and discussion
between the management and trade union.
Collective Bargaining Steps
•Identifying the issues and preparing the demands
•Negotiating
•Coming to a tentative agreement
•Accepting and ratifying the agreement
•Administering the agreement
Case Study: Tata Motors and the Singur Land Dispute
•In 2006, Tata Motors planned to build a Nano car factory in Singur, West Bengal.
•The West Bengal government acquired 997 acres of land for the factory, but farmers and local residents
protested, saying it was done without their consent and would lead to displacement and loss of livelihoods.
•The Singur Krishi Jami Raksha Committee was formed by the farmers to fight for their rights.
•The dispute sparked a political controversy, and legal proceedings were initiated by the farmers and
residents.
•In 2011, the Supreme Court of India ruled that the land acquisition was illegal and ordered the land to be
returned to the farmers.
•The Tata Motors factory never became operational in Singur, and the company eventually relocated the
factory to Sanand, Gujarat.
•The dispute had significant implications for both Tata Group and the West Bengal government in terms of
reputational and financial losses.
•The case highlights the importance of effective stakeholder engagement and the need for a fair and
transparent land acquisition process.
•It also underscores the role of the legal system in resolving disputes and protecting the rights of affected
parties.
•The case study provides valuable lessons for companies and governments on the importance of responsible
business practices and stakeholder engagement.
Case Study: Maruti Suzuki and the Manesar Plant Violence
•In 2012, a violent incident took place at the Manesar plant of Maruti Suzuki, resulting in the death of a senior HR
executive and injuries to several others, including managers and workers.
•The incident was sparked by a dispute between the management and workers over the formation of a new union at the
plant. The management rejected the workers’ demand for a new union, which led to a strike and a subsequent lockout.
•During the lockout, a group of workers attacked the management officials, resulting in the violent incident. This
highlighted the long-standing issues of worker-management relations and labor rights in India.
•The incident was widely covered by the media, leading to calls for the government and stakeholders to take action to
prevent such incidents from happening again in the future.
•The incident also had severe financial implications for Maruti Suzuki, with a significant decline in the company’s market
share and financial performance.
•The incident highlighted the need for better worker-management relations and effective grievance redressal
mechanisms. It also underscored the importance of responsible business practices and the need for companies to ensure
that workers’ rights are protected and respected.
•In response to the incident, Maruti Suzuki and other companies in the automobile sector have taken steps to improve
worker-management relations and address workers’ concerns.
•The incident led to a review of labor laws in India, with the government proposing several amendments to provide better
protection for workers’ rights.
•The Manesar plant violence serves as a reminder that labor relations and workers’ rights are critical issues that need to
be addressed by companies and the government to ensure sustainable and responsible business practices.
Types of Collective Bargaining
Composite Bargaining
Composite bargaining has nothing to do with compensation. Instead, it focuses on
other issues, such as working conditions, job security, and other corporate policies,
These may include hiring and firing practices as well as workplace discipline. The goal of
composite bargaining is to come up with a suitable agreement leading to a lasting and
harmonious relationship between employers and their employees.
Concessionary Bargaining
As its name implies, concessionary bargaining focuses on union leaders making
concessions in exchange for job security. This is common during an economic downturn
or recession. Union leaders may agree to give up certain benefits in order to guarantee
the survival of the employee pool and, ultimately, of the business.
Types of Collective Bargaining
Distributive Bargaining
This process is characterized as benefitting one party financially at the expense of the other. This can come
through increased bonuses, salaries, or any other financial benefits. Distributive bargaining normally favors
workers over employers.
Unions must have a higher degree of power in order for distributive bargaining to work. Higher
membership means more power. If an employer refuses to accept a union's demands, it can call a strike.
Integrative Bargaining
Each party tries to benefit through integrative bargaining, which is why it's often referred to as a form of
win-win bargaining. Each side tries to consider the other's position and bring issues to the table that aim
to benefit both parties. As such, employees and employers both stand to lose and gain with integrative
bargaining.
Productivity Bargaining
This type of bargaining revolves around compensation and the productivity of employees. Labor union
leaders often use higher salaries and compensation as a way to boost employee productivity, which leads
to higher profits and value for the employer. In order for this kind of bargaining to work, both parties need
to agree to financial terms in order to increase productivity.
Advantages of Collective Bargaining
As the name implies, workers have a larger voice through collective bargaining.
Being in a group with the same goal(s) gives employees more power to negotiate
demands with their employers. Companies may be able to shut out the voices of
one or two employees but can't necessarily do the same with a larger group of
unified individuals.
Workplace conditions can see significant improvements and guarantee all workers
with the same protections under collective bargaining. This includes the
implementation of health and safety checks as well as suitable salaries, overtime
pay, and vacation time.
Employers and employees are fully aware of their rights and responsibilities under a
collective bargaining agreement. Once employment terms are negotiated, a contract
is drawn up. Both parties agree to the terms, which are clearly defined.
Disadvantages of Collective Bargaining
Collective bargaining is often a long, drawn-out process that can take weeks or even
months. Employers and labor union leaders may have to go back and forth with
employment terms. Union leaders are required to update employees and must put
the terms to a vote. If employees vote to reject a contract, the negotiating process
begins again.
Collective bargaining often comes at a high cost. Employees and employers may
have to take time off from work in order to negotiate. This means less time on the
job and, therefore, a drop in productivity. Lengthy negotiations can affect a
company's bottom line.
The process is often considered biased. Because employees are able to band
together under a single union, employers may be forced to negotiate and accept
unfavorable terms in order to keep their businesses running without much
disruption.
Keynes’ Liquidity Preference Theory of
Interest Rate Determination
Liquidity preference theory has the following assumptions:

•People and firms hold all their wealth in two ways, i.e., cash and bonds.
•Financial institutions (banking system) are well established.
•The supply of money is fixed.
•The same interest rate is charged for all types of financial assets.
•Demand for money for transactionary and precautionary motives is perfectly interest-inelastic.
•Everyone speculates.
Keynes’ Liquidity Preference Theory of
Interest Rate Determination
Keynes defines the rate of interest as the reward for parting with liquidity for a specified period of time.
According to him, the rate of interest is determined by the demand for and supply of money.
DEMAND FOR MONEY: Liquidity preference means the desire of the public to hold cash. According to Keynes,
there are three motives behind the desire of the public to hold liquid cash:
Transactions Motive: The transactions motive relates to the demand for money or the need of cash for the
current transactions of individual and business exchanges. Individuals hold cash in order to bridge the gap
between the receipt of income and its expenditure. This is called the income motive.
The businessmen also need to hold ready cash in order to meet their current needs like payments for raw
materials, transport, wages etc. This is called the business motive.
Precautionary motive: Precautionary motive for holding money refers to the desire to hold cash balances for
unforeseen contingencies. Individuals hold some cash to provide for illness, accidents, unemployment and
other unforeseen contingencies. Similarly, businessmen keep cash in reserve to tide over unfavourable
conditions or to gain from unexpected deals.
Speculative Motive: The speculative motive relates to the desire to hold one’s resources in liquid form to take
advantage of future changes in the rate of interest.
Keynes’ Liquidity Preference Theory of
Interest Rate Determination
SUPPLY OF MONEY: The supply of money refers to the total quantity of money in the country. Though the
supply of money is a function of the rate of interest to a certain degree, yet it is considered to be fixed by
the monetary authorities. Hence the supply curve of money is taken as perfectly inelastic represented by
a vertical straight line.
Determination of the Rate of Interest: Like the price of any product, the rate of interest is determined at
the level where the demand for money equals the supply of money. The vertical line QM represents the
supply of money and L the total demand for money curve. Both the curve intersect at E2 where the
equilibrium rate of interest OR is established.
Limitations of Liquidity Preference Theory
One of the biggest limitations of the liquidity preference theory is that it assumes that the
employment rate is constant. In reality, the employment rate is not constant and it is constantly
changing.
The second criticism is that this theory assumes a certain level of income.
The third criticism is that this theory claims that it is either cash or an investment in bonds. In today’s
scenario, many people have cash at their disposal for liquidity purposes and investments in bonds.
This theory completely ignores the scenario of receiving interest benefits for some funds and
receiving liquidity benefits for remaining funds.
The fourth criticism is that different interest rates exist in different markets at the same time, which
the liquidity preference theory completely ignores.
According to the experts, the liquidity preference is not the only criterion for interest rates. This
theory also does not take into account so many real elements. This ignorance is the fifth criticism.
The savings done by individuals is not considered under this theory.
PROFIT THEORIES
Profits are said to be the reward for enterprise, the fourth factor of production. Theories
have been developed to comprehend the notion of ‘profit’ to explore the sources of profit.

THEORIES EXPLAINING THE ROLE OF PROFITS IN A FREE ECONOMY ARE:

(1) Hawley's Risk Bearing Theory of Profit(F.B. Hawley): profit is a payment/ reward for the
assumption of risks by the entrepreneur. The 'greater the risk, the higher the profits. It is
because if the return on risky enterprise is at the same level as that obtained from the safe
investment, then not a single entrepreneur will invest his capital in a risky enterprise.
(2) Dynamic Theory of Profit (J.B. Clark): profit is a reward for inventing products and
techniques of production and for managing the functions of entrepreneurs under dynamic
conditions. Profit is recognition of dynamic entrepreneurship.
PROFIT THEORIES
(3) Innovation Theory of Profit(Joseph A. Schumpeter): profit can be made only by
introducing innovations in manufacturing methods as well as in the process of supplying
the goods.

(4) Uncertainty Theory of Profit(F.H. Knight): profits are the reward of uncertainty-
bearing rather than risk-taking which is insurable.

(5) Monopoly Theory of Profit(Kalecki): firms under monopoly or monopolistic

competition have greater control over the price of the product. They raise prices by
restricting the level of output and thus keep profit at higher level. Monopoly power,
thus, is the basic sources of business profits.