Personal and Functional Distribution of Income: Personal distribution of national income means the distribution of national income among various individuals in a society. It shows how inequalities of income emerge in the country.
On the other hand, the theory of functional distribution studies how the various factors of production are rewarded for their services. It studies how prices of factors such as rent of land, wages of labour, interest on capital and profits of entrepreneur are determined. The theory of distribution is concerned with functional distribution of income which is also called theory of factor pricing.
The Marginal Productivity Theory: According to the Marginal Productivity Theory the payment made to the factors of production is just equal to the value of their marginal product (VMP = MPxP) or the marginal revenue product(MRP).
If the prevailing wage is less than the marginal productivity of labour, then more labour will be demanded. Competition among employers will raise the wage to the level of marginal productivity. On the other hand, if 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 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 other factors of production and their rewards.
Wage Differential: Since labours are neither identical nor homogeneous different workers are paid different wages. Wage differentials may arise due to
(1) Dynamic (or disequilibrium) causes, and (2) Static (or equilibrium) causes.
Dynamic wage differentials arise due to disequilibrium in commodity and labour markets. Such differentials are therefore temporary and exist only till the disequilibrium persists.
The static wage differentials are those that persist in the state of labour market equilibrium. Such differences are not removed by the competitive forces of the market. Wage differentials of this type arise mainly due to the following reasons:
(i) qualitative differences in labour, i.e., non-homogeneity of labour;
(ii) difference in the nature of occupations in which labour is employed;
(iii) differences in the prices of product produced by labour; and (iv) market imperfections.
Bilateral Monopoly/Collective Bargaining: Bilateral monopoly exist in the factor market when there is a single buyer and a single seller of labour. Under such conditions labour is supplied by monopolist (a labour union) and demanded by a monopsonist (employers’ union). Wage determination in this kind of market situation is generally analysed under collective bargaining. It may be noted that the outcome of collective bargaining is not certain. That is, solution to a bilateral monopoly situation is indeterminate. The economic analysis of collective bargaining bring out the upper and lower limits within which the wage rate can be determined through the process of collective bargaining. The determination of wage rate, ultimately depends on a number of factors like bargaining powers and skills, economic and political power of labour unions and of employers’ union, the effect of government intervention, etc.
Scarcity Rent: Land is limited in quantity and with the growth of population it becomes scarce in relation to the demand for it. As the price of the agricultural produce (e.g. wheat) rises, the worst land is also subjected to intensive cultivation and it yields a surplus over cost. This surplus is not a differential one compared to no-rent land, which does not exist. It is due to the scarcity of land as such. Hence, it is called scarcity rent.
Differential Rent: Different pieces of land are not uniform in quality. Hence, with the increase in population successive inferior lands are taken into cultivation. In the process rent immediately arises on the better quality lands. The amounts of rent certainly depend on the difference of productive powers of these various grades of land. The marginal land gets no rent at all. Thus, rent arises on account of natural differential advantages enjoyed by a piece of land over the marginal land. The natural differential advantage may be due either to superior quality of land or its better situation. This is Ricardo’s theory of differential rent.
Quasi-Rent: The concept of quasi-rent was first introduced in Economics by Marshall. Quasi-rent refers to the whole of the income which some agents of production earned during the short period when their supply cannot be increased in response to an increase in the demand for them. For example, during war the demand for houses in towns increases but the supply cannot be increased because of scarcity of building material. This abnormal increase in the return on capital invested in buildings is quasi-rent. Quasi-rent is only a temporary surplus. It is not pure rent, because the supply of houses can be increased in the long run and quasi-rent disappears.
Quasi-rent may also be defined as the excess of total revenue (TR) earned in the short-run over and above the total variable costs (TVC). Thus, Quasi-rent = TR – TVC.
Transfer Earning: Transfer earning or opportunity cost is the amount which a factor of production could earn in its next best alternative use. In other words, it is the amount that a factor must earn to remain in its present occupation. For example, suppose a doctor earns Rs 10,000 per month from his private clinic. The alternative available to him is to serve in a hospital as an employee where he could earn Rs 8,000 per month. Thus, the doctor’s transfer earning is Rs 8,000 per month. He must earn a minimum of Rs 8,000 to remain in his private practice.
Economic Rent: Economic rent is the excess of actual earning of a factor over its transfer earning. It is a factor’s actual earning minus its transfer earning. For example, if the actual earning of a doctor in his private clinic is Rs 10,000 per month and if his next best alternative job (transfer earning) is to work as a hospital employee where he could earn Rs 8,000. Then, Rs 2,000 (Rs 10,000 – Rs 8,000) is the economic rent.
Abstinence or Waiting Theory of Interest: According to the Abstinence Theory saving is an act of abstaining from consumption. Since to abstain is painful, it is necessary to reward people for this act. This reward is in the form of the interest paid to those who saved, rather than consumed their incomes.
However, this theory has been criticized on the ground that it suggested positive discomfort, while the rich people save without the least inconvenience. Marshall then substituted the term “waiting” for “abstinence”. When a person saves, he does not refrain from consumption for all time but merely postpones present consumption to a future date. Thus, saving involves waiting. But since most people do not like to wait, an inducement is necessary to encourage this postponement of consumption.
Austrian or Agio Theory of Interest: According to this theory put forward by Bohm Bawerk, interest arises because people prefer present goods to future goods and therefore there is an ‘agio’ or premium on present goods. In other words, future satisfactions when viewed from the present angle undergoes a discount. Interest is this discount which must be paid in order to induce people to lend money or postpone present satisfaction to a future date.
Fisher’s Time Preference Theory of Interest: Fisher’s Time Preference theory emphasizes the fact that individuals prefer present satisfactions to future satisfactions. They are thus impatient to spend their incomes now. The degree of impatience depends on the size of the income, the distribution of income, the degree of certainty, and the temperament and character of the individual. Thus, the rate of individual time preference, after having been determined, tend to become equal to the rate of interest.
