J.B. Clark, an American Economist, developed the marginal productivity theory of distribution. 1

Assumptions: Completely static society (i.e. no change in population, capital and technology) Perfect competition in the factor market Perfect mobility of labour and capital Labour is homogenous Perfect substitution between labour and capital. Marginal Productivity of labour ( MPL ) will decrease as more labours are employed, ceteris paribus. ( see also, Figure- 1) 2

3 Y X P M W O D L MPL Labour Marginal Productivity Curve Figure - 1

Analysis through Producer’s profit: The MPL decreases as labour increases. The wage rate is determined by the market, so the firm is wage rate taker. The equilibrium is at: W = MPL (i.e. at this level the producer gets maximum profit). If W > MPL, in other words, labour is employed more than OL, then the firm will have loss to an extent the difference between W and MPL. If W < MPL, in other words, labour is employed less than OL, then the firm can increase profit by employing more labour till OL unit of labour. 4

Wage rate determination by MPL: According the Clark, the supply of labour is perfectly inelastic. In the labour market wage rate is determined by the marginal product of the given labour force. Suppose (in Figure – 2) the available supply of labour force is OL and the marginal product is LE for OL. The equilibrium wage rate will be equal to LE or OW. If new wage rate is OW’ higher than OW then, employer will employ OL’ labour, hence LL’ remain unemployed. These unemployed labour will bid for lower wage to get employment and finally they will settle for OW. On the other hand at a lower wage rate, say OW’’ more demand for labour OL’’, shortage of labour by LL’’ and employers compete to get labour by bidding higher wage rate and finally, it is settled at OW level. 5

Wage Equilibrium at E 6 MPL, W S MP X Y O L’ L L’’ E E’ E’’ W’ W W’’ Figure - 2

Limitations: This theory has taken many assumptions which are unlikely in the real world. Under imperfect market it fails to determine factor process. It has not included the trade unions, which is a great force in determining wage rate without losing employment. This theory completely ignored the positive relationship between wages and the labour efficiency. Sometimes the profit maximisation is not the objective of the firms, so the firm can employ even at W > MPL. MPL cannot be measured separately, because many factors work simultaneously. 7