Distribution and Factor Pricing
Domain 6 treats factor prices - rent, wages, interest and profit - as prices determined by the demand for and supply of factor services. Factor demand is derived demand, and the marginal productivity theory links a factor reward to its marginal revenue product (MRP = MPP x price).
Rent
- Ricardian (differential) rent: arises on superior land because of differences in fertility; marginal land earns no rent.
- Scarcity rent: rent also arises because land supply is fixed.
- Transfer earnings: the amount a factor must earn to remain in its present use; economic rent is any payment above transfer earnings.
- Quasi-rent: a short-run surplus earned by a fixed capital asset, not a permanent rent.
Wages, interest, profit
- Nominal versus real wage: real wage is the purchasing power of the nominal wage.
- Interest: gross interest includes pure interest plus reward for risk, inconvenience and management; net (pure) interest is the reward for waiting. Theories: loanable funds and liquidity preference.
- Profit: gross profit minus implicit costs and normal profit gives pure profit. Theories: risk-bearing (Hawley), uncertainty-bearing (Knight), innovation (Schumpeter).
Worked example
A worker adds 5 units a day, each selling at Rs 20, so MRP = 100. At a wage of Rs 80 the firm gains Rs 20 per worker and hires more, stopping where wage = MRP = Rs 80. If the product price falls to Rs 16, MRP falls to 80 and hiring stops at that same wage.
Traps
- Saying all land earns rent; Ricardian marginal land earns none.
- Treating quasi-rent as identical to economic rent.
- Excluding normal profit from cost; it is a cost, and only the surplus above it is pure profit.
- Writing that risk and uncertainty are the same - Knight separates insurable risk from uninsurable uncertainty.