Distribution: Wages, Rent, Interest and Profit
Distribution explains how factor incomes are determined: wages for labour, rent for land, interest for capital and profit for entrepreneurship. The exam tests marginal revenue product, wage differentials, economic rent, loanable funds and the distinction between normal and supernormal profit.
Wage determination
Labour demand is derived from the demand for output and is based on marginal revenue product (MRP) = marginal physical product × marginal revenue. A profit-maximising firm hires until MRP equals the wage rate. Labour supply depends on population, skills, working conditions, wages elsewhere and non-pecuniary benefits. Wage differentials arise from skills, training, risk, responsibility, bargaining power, discrimination and labour mobility. A minimum wage (SMIG in Cameroon) can raise pay but may reduce employment if set above equilibrium.
Rent, interest and profit
Economic rent is payment above transfer earnings, the amount needed to keep a factor in its present use. Land supply is often fixed, so a rise in demand mainly raises rent. Interest is the reward for lending capital and is determined by loanable funds and liquidity preference; it compensates for risk and inflation. Profit is a residual reward for entrepreneurship, bearing uncertainty and innovation. Normal profit is the minimum return needed to stay in business; supernormal profit is above that.
Worked example
A firm hires workers who each produce 20 units per day, sold at 1,500 CFA per unit. MRP = 20 × 1,500 = 30,000 CFA per worker per day. If the wage is 25,000 CFA, the firm should hire the worker because MRP exceeds the wage. If the wage rises to 32,000 CFA, that worker is not worth hiring. If the output price falls to 1,200 CFA, MRP = 24,000 CFA and the firm will hire only if the wage is 24,000 CFA or less.
Traps that cost marks
Do not base labour demand on average product; do not confuse economic rent with contract rent paid for a house; do not treat interest and profit as the same reward; and do not say normal profit is unnecessary. Remember that a factor's transfer earnings are its next best alternative.