The theory of distribution or the theory of factor pricing deals with the determination of the share prices of four factors of production, i.e., land, labor, capital and organization.
Four Factors of Production, in Economics:
(i) The share of land, named as rent.
(ii) The share of labor, named as wages.
(iii) The share of capital, named as interest.
(iv) The share of organization, named as profit.
The four factors of production in cooperation with one another produce annually a net aggregate of commodities, material and non-material. This we name as national income. The national income is to be shared among the four factors of production which have contributed to this production. In the theory of distribution, we are chiefly concerned with the principles, according to which the price of each factor of production is determined and distributed.
Chapman, described the theory of factor pricing or theory of distribution, as:
“The economics of distribution or the pricing of factors accounts for the sharing of the wealth produced by a community among the agents or the owners of the agents which have been active in its production”.
Distribution is functional and not personal. I would like to make it clear that the pricing of factor of production discussed here is in functional and not in personal.
By this we mean that when the reward of each factor is distributed, it is not paid to an individual but to the agents or factors of production. The individual may represent in his person as landlord (if he used his own land), the labor (if he works himself), the capitalist (if he has contributed his capital) and. the entrepreneur (if be organizes the business). The price of land, labor, capital and organization which is termed as rent, wages, interest and profit is in fact their functional income. They are the costs from the point of view of the firm but income from the point of view of factors of production.
Why a Separate Theory of Factor Pricing?
It is often pointed out that the price of a factor of production is determined, like the price of a commodity, by the equilibrium of forces of demand and supply.
If the demand of the particular factor rises, other things remaining the same, its price goes up and vice versa. The other economists who differ with this view are of the opinion that the theory of value is not applicable in its entirety to the pricing of factor of production. They believe that on the side of demand there is similarity between the two, because the value of a particular commodity and the price of a factor of production are governed by marginal utility and marginal productivity respectively.
But on the side of supply, much difference exists between them. On the side of supply, the price of a particular commodity is determined by its marginal cost of production. But in ease of labor or an acre of land or a unit capital, it is not possible to ascertain exactly its costs of production. The other dissimilarity between the two is that the supply of a factor of production cannot be readily adjusted as we can do in the case of a commodity.
For example, if the demand of a particular type of labor increases or the rent of land rises-up, it will not be possible to increase their supply immediately.
In the words of Marshall:
“Free human beings are not brought up to their work on the same principle of a machine, a house of a slave. If they were, there would be very little difference between the distribution and the exchange side of value”.
Thus, we come to the conclusion that though the value of the commodities and the prices of the factors of production are determined by demand and supply yet, due to some differences of the factors of production on the side of supply, there is a need for a separate theory of distribution.