The marginal productively, theory is an attempt to explain the determination of the rewards of various factors in a competitive market.

Definition and Meaning:

By marginal productively theory of a factor is meant the _ value of the marginal' physical product of the factor, It is worked out by multiplying the price of the output per unit by units of output.

        Formula: VMP = MP?< P

Value of Marginal Product(V~P)"

= Marginal Physical Product x Price

The marginal productivity theory contends that in a competitive market, the price or reward of each factor of production tends to be equal to its marginal productivity.

Explanation:

The demand for various factors of production is a derived demand, The resources do not usually directly satisfy consumer wants, They are demanded because they help in producing goods and services, An entrepreneur while hiring a factor of production calculates the contribution which it makes to total production and the amount which has to be paid to it in a competitive market. An individual firm cannot influence the price of the factor of production. It has to take the ruling price in the market as given. The firm can employ as many number of factors units as it wishes at the ruling price of the factor.

It has been observed that as a firm hires increasing amounts of a variable factor to a combination of fixed amounts of other factors, the marginal productivity increases up to a certain stage of production and then it begins to decline. The buyers of a factor of production while deciding whether one more unit of factor should be employed or not, compares the net addition which it makes to total revenue and the cost which has to be incurred on engaging it If the marginal revenue product of a factor is greater than its marginal cost, the entrepreneur will employ that unit because it earns more than what he has to spend on employing the additional unit.

As he employs more and more units of factor of production, the marginal revenue productivity increases up to a certain limit and then it begins to decrease. On the other hand, marginal cost decreases as production is expanded: After a certain point, when business becomes, difficult to manage, marginal cost begins to increase. When both marginal revenue productivity of a factor and its marginal cost are equal, (MRP = Me) the entrepreneur stops giving further employment to a factor of production.

The last variable unit which an employer just thinks it worthwhile employing is called the marginal unit and the addition made to the total production by the employment of the marginal unit is called marginal  productivity or marginal revenue productivity. The entrepreneur will pay the remuneration to each factor of production according to its marginal revenue productivity.

Schedule and Example:

The marginal productivity theory is explained with the help of a schedule:

Demand for a. Factory or Resource (Daily)

In the figure above diagram, the supply of labour is perfectly elastic. The wage (W) is equal to average wage (AW) and marginal wage, (MW) = W = AW = MW.

At point E, the MRP of labour is equal to marginal wage (MW). The producer is in equilibrium at point E. He will employ, ON units of labour because when ON units of labour are employed, the marginal revenue productivity of labour MRPL = Wage. To the left of E the MRP of labour is higher than wage (MRP >W), the producer will increase the units of labour. To the right of the MRPL < wage, so the firm will curtail the units of labour. It is only at point E, the firm is in equilibrium where MRPL = Wage.