Factor Pricing

There are four factors of production which are land,labour,capital and entrepreneur. These factors of production get reward for their services in the form of rent,wages,interest and profit. A basic problem which a producer faces with it is how the share of different factors of production in the total product be determined? This is called the problem of distribution. There are two types of income distributions:

1. PERSONAL DISTRIBUTION : It refers to the distribution of national income among various individuals .It implies the distribution of income according to the size of income received by different individuals irrespective of sources of income.

2. FUNCTIONAL DISTRIBUTION : It deals with the distribution of income among four factors of production for services or functions performed by them. The most important theory for functional distribution is the marginal productivity theory of distribution. It helps in the distribution of all factor payments like rent,wages,interest and profit.


In simple words rent is a regular payment for the use of land, furniture and machine. In economics, rent is used in a very narrow or restricted sense and is referred to the price paid for the services of land and other free gifts of nature. There are two view points regarding rent

1 CLASSICAL VIEW: According to David Ricardo” Rent is that part of the produce of the earth which ism paid to the land lord for the use of the original and indestructible power of the soil”. Main points of rent according to Ricardo’s definition are;

(a )Rent arises on land only because of its inelastic supply

(b ). A tenant makes the payment to the land lord for the original and indestructible powers of the soil.

(c.) The fertility of land will determine the amount of rent.

2. MODERN VIEW: Economic rent is defined as any payment made to the factor of production in excess of the minimum amount necessary to keep the factor of production in its present employment. Thus RENT= Actual earning –Transfer earning.

Transfer earning is the amount which a factor of production must earn in its present occupation to prevent it from transferring to another occupation. It is also known as opportunity cost.

Actual earning on the other hand is what the factor of production earns in its present employment.

Some different concepts of rent are:

1. ECONOMIC RENT: According to prof. Boulding “ Economic rent may be defined as payment made to a factor of production in excess of the minimum amount necessary to keep the factor in its present occupation”

2. GROSS RENT: It is the rent which is paid for the services of land and capital invested on it .It includes the following:

(a) Payment for the use of land

(b) Interest on capital invested on it

(c) Wages for the services of land lord for supervising the investment in land.

3. CONTRACTUAL RENT: It is the payment made to the land lord by tenants under a contract through agreement between the two. Or is the total rent which is agreed upon between land owner and user of land on the basis of some contract which may be verbal or written .It may be more or less than the economic rent.

4. SCARCITY RENT: It applies to all the factors of production whose supply is less elastic .Scarcity rent arises due to the scarcity of factors of production.

5. DIFFERENTIAL OR SITUATION RENT: It refers to the rent arises due to the difference in the fertility of land .This type of rent arises under extensive cultivation. The surplus enjoyed by more fertile land over and above the less fertile land is known as differential rent. More fertile land is known results in more production thus they pay more rent. It is enjoyed by intra marginal land and not by marginal land.

6. QUASI RENT : The concept of quasi rent was developed by prof. Marshall .According to him quasi rent is the surplus earned by man made factors of production whose supply is inelastic or fixed in the short run but elastic in the long run. Factors like machines, buildings. Whose supply is inelastic in the short run earn rent which is termed as Quasi rent i.e. something like rent on land but not the same.

The supply of land always remains fixed both in the short run and long run. But the supply of man made factors is inelastic in the short run. Their supply can fully be changed in the long run. Thus man made factors of production earn rent only in the short run which disappears in the long run. If demand for these factors increases in the short run ,supply being constant the price will rise consequently they will start getting additional payment called Quasi rent.

As we know price must cover the variable cost in the short run,but in the long run it has to cover both fixed cost as well as variable cost. In short run variable cost must be recovered otherwise producers would stop producing .Whatever a firm earns over and above the variable cost is earned received by the fixed factors of production.Therefore Quasi rent is measured by the excess of total revenue earned in short run over and above the total variable cost. Symbolically Quasi rent= TR- TVC . It can be explained with the help of following graph also


1. Both rent and quasi rent have an element of surplus income.

2. Rent and quasi rent arise due to inelastic supply of factors of production.

3. Both rent and quasi rent arise due to increase in demand.


The payments which are made for the productive services of labour.Labour in economics is all kind of mental and physical exertion taken for the sake of earning money.


MONEY WAGES: Wages paid and received in term of money are called money wages or nominal wages It includes monetary payments only.

REAL WAGES : It refers to the basket of goods and services which the labour is able to purchase with the given income. Thus the amount of goods and services a given money wage can buy in the market at any particular time is called real wage. Infect real wage is the amount of purchasing power received by workers through his money wages.

PIECE WAGES : These are wages paid according to the number of units produced of a commodity by the worker.

TIME WAGES : These are the wages paid for the services of labourers according to the time spent.

WAGES IN KIND: When the labourer is paid in terms of goods rather than cash is called wages inkind.

Factors determining real wages:

(i) purchasing power (ii) working hours (iii) no. of leaves (iv) vacations (v) working conditions(vi) chances of promotion(vii) housing facility (viii) medical facility (ix) conveyance free education for children (x)

THEORIES OF WAGES : There are two theories of wages -

1.MARGINAL PRODUCTIVITY THEORY OF WAGES: According to this theory each worker is paid wages equal to its marginal productivity.

2. MODERN THEORY OF WAGES: Under the conditions of perfect competition both in labour and product markets wages are determined by the forces of demand and supply.


Collective bargaining is defined as a situation in which conditions of employment are determined by the agreement between the representatives of trade union on one hand and the representatives of employees association on the other .In other words when trade union bargains with the employers’ association for wage determination .It is called collective bargaining.

NEEDS FOR COLLECTIVE BARGAINING : Collective bargaining is needed for the following reasons:

1.To enable the employer to secure cooperation expected from workers and for keeping cordial relations between employers and employees.

2. To save the workers from exploitations in the hands of employees.

3. Mutual negotiations become essential for the solutions of the problem

4. Collective bargaining puts a check on the one sided decisions of the employers

5 It is needed for maintaining a peaceful industrial atmosphere.


Interest is the payment for the use of money or for the use of loan able funds .It means interest is the reward for the use of capital but it is not the income of the whole capital .It is the income of only that part of capital which is used for lendimg purpose.


NET INTEREST: It is the price paid for the use of capital only. It is the payment which is made by the borrower to the lender purely for the use of money capital.Net interest is also known as pure interest.

GROSS INTEREST : It signifies the total payment made by the borrower to the lender of the capital .It includes rewards like rewards for risk, for management, for inconvenience, other than net interest. Thus; GROSS INTEREST= NET INTEREST+REWARD FOR MANAGEMENT+REWARD FOR RISK+REWARD FOR INCONVINIENCE

COMPONENTS OF GROSS INTEREST : Gross interest includes the following components:

(i) Net interest: It is the price paid for the use of money capital for a particular period of time

(ii) Rewards for risk taking : When a lender lends some amount of money to the borrower he has to bear risk to some extent .According to prof. Marshall these risks can be divided into two:

(a) PERSONAL RISK :These are those risks which arise due to credibility and economic positions of the borrowers.

(b) BUSINESS RISK /TRADE RISK: These are those risks which arise due to business fluctuations in which money is invested. In small scale business and small trading activity risk is greater than the big corporate companies. Higher the risk higher will be the rate of interest and vice versa

(iii) REWARD FOR MANAGEMENT: The lender is required to spend some amount of money for maintaining accounts of loans and recovery of loans etc.They have to spend some money to buy stationery ,stamps etc. They have to pay wages to the staff working for them for this lender charges extra amount from the borrower in the form of management rewards.

(iv) REWARD FOR INCONVINIENCE: The lender while giving loans has to suffer many inconveniences like physical and mental exertion for undertaking money lending business .Thus the lender charges some extra money to get himself compensated for inconvenience. Greater the inconvenience higher will be the reward for it.


Profit is the reward given to the entrepreneur for his services .Every entrepreneur incurs various expense for producing goods and services and by selling them he gets revenue. The difference between TR and TC is called profit. In a technical form profit implies the positive residual of an entrepreneur after deducting TC from TR Thus Profit= TR-TC


(a) GROSS PROFIT: It is the difference between TR and explicit cost. It is that part of the income of a businessman which is available to him after all payments made the contractually hired factors of production. Thus Gross Profit = TR – Explicit cost

Components of gross profit

1. Reward for factors of production contributed by entrepreneur himself

2. Rent on entrepreneur’s own land : Generally when an entrepreneur starts a business he uses his own land and building .Thus the imputed rent on his own land and building will be included in the gross profit.

3. WAGE INCOME: These are the wages for the services of the family members of the entrepreneur.

4. INTEREST ON OWN CAPITAL : When the entrepreneur uses his own capital the interest on such capital in an imputed form will be a part of gross profit.

5. DEPRECIATION CHARGES: Depreciation is known as consumption of fixed capital .It refers to the fall in the value of fixed assets due to the normal wear and tear .Thus depreciation charges should be deducted from gross profit to arrive at net profit.

(b) NET PROFIT: Net profit is that part of profit which is calculated by deducting the implicit cost and the depreciation charges from the gross profit.

Thus , Net profit = Gross profit –depreciation – implicit cost of production

Net profit is also known as pure profit.

© NORMAL PROFIT: It is the minimum profit which is required by entrepreneur to remain in the business. This reward for the entrepreneur forms the part of the cost of production as the price is calculated on the basis of these costs. Thus Net Profit = TR=TC OR AR =AC

(D) SUPER NORMAL PROFIT / ABNORMAL PROFIT: The profit which is earned over and above the normal profit is known as supernormal profit. These profits are usually available to the entrepreneur only in the short run.

Super normal profit = TR...> TC OR AR> AC.

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