Marshall on Distribution, Definition Of Marshall, Define Marshall

Marshall's explanation of the forces determining the prices of the factors of production and the distribution of income was consistent with the rest of his analysis. Here, as elsewhere, he often generously acknowledged the merits of criticism of his theories, for example, those attacking his marginal productivity theory of distribution. The same basic supply-and-demand analysis and distinc­tion between short run and long run that are used to explain the prices of final goods are also used to explain rents, wages, profits, and interest. The demand for a factor of production is a derived demand that depends upon the value of the marginal product of the factor. Marginal products are difficult to disentangle, however, because technology usually requires that an increase in one factor be accompanied by more of other factors. Marshall solved the problem of measuring marginal products by computing what he termed the net product at the margin. If an additional laborer requires a hammer, then the net product of the labor is the laborer's addition to total revenue minus the added cost of the hammer. Marshall then pointed out that it is incorrect to call the theory of factor pricing a marginal productivity theory of distribution, because marginal productivity measures only the demand for a factor, and factor prices are determined by the interaction of demand, supply, and price at the margin. After explaining his concept of marginal productivity and its measurement with respect to labor and wages, Marshall advocated a cautious interpretation of the marginal productivity theory:

This doctrine has sometimes been put forward as a theory of wages. But there is no valid ground for any such pretension. The doctrine that the earnings of a worker tend to be equal to the net product of his work, has by itself no real meaning; since in order to estimate net product, we have to take for granted all the expenses of production of the commodity on which he works, other than his own wages.

But though this objection is valid against a claim that it contains a theory of wages, it is not valid against a claim that the doctrine throws into clear light the action of one of the causes that govern wages.

The proportions in which factors are combined, he said, will depend upon their marginal products and their prices. An entrepreneur interested in maximiz­ing profits will want to produce a given level of output at the lowest possible cost, which will lead the firm to use factors of production in such a way that the ratios of their marginal physical products to their prices will be equal. If it does otherwise, it will be possible to substitute at the margin and achieve lower costs. Marshall did not dwell on the issue of product exhaustion and Euler's theorem; he accepted the Wicksteed-Flux conclusion that in long-run competitive equilib­rium, the total product is exhausted when each factor receives the value of its marginal product. Marshall's analysis of the returns to the separate factors of production—wages, rents, profits, and interest—is not particularly interesting. However, his development of the concept of quasi-rent in connection with his theory of factor prices and distribution deserves attention.

Quasi - Rent

With his concept of quasi-rent, Marshall not only provided insight into the workings of a market system but also threw new light on an aspect of the controversy between classical and marginal utility economists. Classical eco­nomics had contended that payments to the factors of production, with the exception of land, were price-determining. Prices of final goods depended upon costs of production at the margin. Because there is no rent at the margin, the classical doctrine (in the hands of J. S. Mill) held that wages, profits, and interest were price-determining. Prices were thus determined on the side of supply. The marginal utility writers joined the early critics of the classical cost doctrine in asserting that payments to the factors of production are price-determined. Marshall's analysis indicates that whether a factor payment is price-determining or price-determined depends upon the time period under consideration (which significantly influences the elasticity of the supply curve of the factors) and the particular perspective from which the analysis is made. Let us examine the payments called rent, wages, profits, and interest.

The return to land has historically been termed rent. In analyzing land rent, Ricardo had assumed that the supply of land was perfectly inelastic and that there were no alternative uses of land. The payment to the landlord for the use of land was price-determined rather than price-determining. The high price of corn was the cause of high rents. Although there were some criticisms of this theory from minor economists, the basic Ricardian analysis of rent remained unchanged through the time of J. S. Mill to the time of Marshall. Marshall recognized that the issues were much more complex. When viewed from the perspective of the entire economy, the rent of land was price-determined and therefore not a cost of production. From the perspective of the individual farmer or firm, however, rent was a cost of production and therefore was price-determining. The farmer who wants to rent land to grow oats must pay a price sufficient to keep the land from alternative uses. Unless the rent the oat farmer is willing to pay is higher than that of the barley farmer or the real estate developer, the oat farmer will not be able to rent the land in a competitive market. From the perspective of the individual farmer or firm, therefore, land rent is a cost of production that must be paid just as labor and capital costs must be paid.

Marshall also argued that under certain circumstances land rent was price-determining even from the point of view of the entire economy. For an economy with unsettled land that costs nothing, like the United States in the nineteenth century, rent may be considered as price-determining. Marshall reasoned that the original pioneers considered as part of their return for land settlement not only the immediate return from farming but also the appreciation in land prices that would take place as population moved toward the frontier areas. This expected land price appreciation is, therefore, part of the necessary supply price that must be paid in order to induce individuals to endure the hardships and dangers of frontier life. The rising land prices, equal to the capitalized value of the rising rents, can therefore be considered as a social cost. Rent under these circumstances is price-determining from the perspective of the economy. From the perspective of the economy, the supply curve of land is perfectly inelastic in a country in which all the land is settled, and rent is therefore price-determined. For a country with unsettled land, the supply curve of land slopes up and to the right; with higher rents, larger quantities of land will be settled and rent is price-determining. In a letter to Edgeworth, Marshall com­mented that it is wisest not to say that "Rent does not enter into cost of production": for that will confuse many people. But it is wicked to say that "Rent does enter into cost of production," because that is sure to be applied in such a way as to lead to the denial of subtle truths.

Marshall went on to show how in the short run the returns called wages, profits, and interest have some of the characteristics of rent. The wage paid to a particular type of labor (e.g., an accountant) in long-run equilibrium will be just sufficient to bid those persons in that occupation away from other occupations and hold them in their present use. This long-run wage is the supply price that must be paid by society in order to elicit the quantity supplied. Wages are therefore price-determining. Suppose there is an increase in the demand for the services of accountants and thus an increase in the wage of accountants. In the short run the supply of accountants is less elastic than in the long run. Increases in wages will not greatly influence quantity supplied, so the short-run wage will rise above the long-run wage. The higher short-run wage has no connection with the price necessary to keep individuals in the occupation and is therefore price-determined, not price-determining. The key to understanding these issues is in the elasticity of the supply curve. In the very short run, the supply curve of a particular kind of labor can be thought of as perfectly inelastic. An increase in demand will result in higher wages, with the quantity of labor supplied remaining constant. In the short run, the wage will fall slightly as individuals with acceptable training who were working in other occupations enter the occupation. In the long run, the supply curve will become even more elastic, and wages will fall to the long-run equilibrium value, the necessary supply price. In the short run and market period, therefore, wages are price-determined and are like rent. Marshall called these payments quasi-rents. "And thus even the rent of land is seen, not as a thing by itself, but as the leading species of a large genus."21 With his concept of quasi-rent Marshall illuminated the controversy over whether the payments to the factors of production are price-determining or price-determined. It all depends on the time period: in the long run wages are price-determining, but in the short run wages are price-determined and therefore like rent.

Marshall also applied his concept of quasi-rent to the analysis of profits in the short run. In perfectly competitive markets in long-run equilibrium, each firm will earn only a normal rate of profits. Normal profits are a cost of production and must be paid by the firm to hold capital in the firm, just as normal wages must be paid to attract and hold labor. If a firm does not earn normal profits in the long run, capital will leave the firm for other firms and industries in which a normal rate is earned. Thus, in the long run, normal profits are a necessary cost of production and therefore are price-determining. But in the short run the return called profits can be considered a quasi-rent, and thus it is price-determined. In the short run the costs of the firm can be divided into variable and fixed costs. The revenues of the firm must be sufficient in the short run to pay the opportunity costs of all the variable factors, or they will leave the firm. What is left over is the return to the fixed factors, which in the short run are perfectly inelastic in supply. Profits in the short run are a quasi-rent to the fixed factors and are price-determined. If total revenues exceed total costs, above-nor­mal profits are made; but where competition prevails, these will be eliminated in the long run. If total revenues exceed total variable costs but are less than total costs, losses are incurred; but these losses will disappear in long-run equilibrium. Profits, like wages, can be either price-determining or price-determined, depend­ing upon the time period under examination.

The concept of quasi-rent was applied to the analysis of interest in the short run. In the long run there will be a normal rate of interest, which is a necessary cost of production and therefore price-determining, although an old capital investment may earn above or below a normal rate of interest, depending upon supply and demand in the market. But because the capital is fixed, or sunk, in the short run, its return is a quasi-rent.

The analysis of quasi-rent in the broadest perspective can be used to point out some of the essential differences between classical economics, which emphasized the supply side, and the marginal utility writers, who emphasized demand. If the supply of factors of production is fixed, any factor's return is a quasi-rent and factor prices are price-determined. The return to the factors is considerably influenced by the level of demand. In the long run the supply of factors is not fixed, and long-run equilibrium prices of final goods must therefore be sufficient to pay for all the socially necessary costs incurred in production. Under these circumstances, the payments to the factors of production are price-determining, and the analysis of final prices must give greater attention to the role of supply. Analytically the returns called wages, profits, rents, and interest have much in common over the various time periods. Although, admittedly, nature provides no sharp divisions between time periods, Marshall's theory of generalized time periods and its accompanying doctrine of quasi-rent penetrated deep into the complex issues raised by the forces determining relative prices.