Q.Explain the marginal productivity theory of distribution.

This theory gives a single, general explanation of how every factor of production gets priced under competitive conditions.

The marginal productivity theory of distribution, developed by neoclassical economists such as J.B. Clark, Alfred Marshall, and Philip Wicksteed, offers one general explanation for how every factor of production -- land, labour, capital, and entrepreneurship alike -- is priced under conditions of perfect competition.

As a firm employs successive units of a variable factor while holding other factors fixed, the marginal physical product (MPP) is the addition to total output from the last unit employed. Because of the law of diminishing returns, MPP falls as more units of the factor are added. To express this addition in money terms, MPP is multiplied by marginal revenue (MR) -- the addition to total revenue from selling one more unit of output -- giving the marginal revenue product:

Under perfect competition, the firm is a price-taker, so MR equals price ($MR = P$), and MRP becomes identical to the value of the marginal product (VMP):

A profit-maximising firm compares a factor's MRP with its price (the wage rate for labour, rent for land, the interest rate for capital). As long as MRP exceeds the factor's price, hiring one more unit adds more to revenue than to cost, so the firm keeps hiring. It stops exactly where:

At this equilibrium, every factor is paid a price exactly equal to what it contributes at the margin -- no more, no less.

The theory assumes perfect competition in both the product and factor markets, homogeneous units of the factor, and full employment -- conditions that hold only approximately in the real world. It has been criticised for explaining only the demand side of factor pricing, leaving the supply side (and hence the actual market price) to be determined separately, and for assuming factors are paid strictly according to marginal contribution, when bargaining power, custom, and government policy also shape real-world factor prices. Even with these limitations, it remains the foundational principle from which the more specific theories of rent, wages, interest, and profit are all derived.

A frequent gap in essay answers is stating the formula MRP = MPP × MR without ever explaining what happens to it under perfect competition (that MR becomes equal to price) -- both halves are needed for a complete answer.