Module 73
Theories of Income
Distribution
In Module 70, we introduced the factor distribution of income and explained how the
marginal productivity theory of income distributionhelps to explain how income is divided
among factors of production in an economy. We also considered how the markets for
factors of production are broken down. There are different markets for different types
of factors. For example, there are different labor markets for different types of labor,
such as for computer programmers, pastry chefs, and economists. In this module, we
look at the marginal productivity theory of income distribution and the extent to
which it explains wage disparities between workers.
The Marginal Productivity Theory
of Income Distribution
According to the marginal productivity theory of income distribution, the division of
income among the economy’s factors of production is determined by each factor’s
marginal productivity at the market equilibrium. If we consider an economy-wide fac-
tor market, the price paid for allfactors in the economy is equal to the increase in the
value of output generated by the last unit of the factor employed in the market. But
what about the distribution of income among different labor markets and workers?
Does the marginal productivity theory of income distribution help to explain why
some workers earn more than others?
Marginal Productivity and Wage Inequality
A large part of the observed inequality in wages can be explained by considerations that
are consistent with the marginal productivity theory of income distribution. In partic-
ular, there are three well-understood sources of wage differences across occupations
and individuals.
The first is the existence of compensating differentials:across different types of
jobs, wages are often higher or lower depending on how attractive or unattractive the
What you will learn
in this Module:
module 73 Theories of Income Distribution 711
- Labor market applications of
the marginal productivity
theory of income distribution - Sources of wage disparities
and the role of discrimination
Compensating differentialsare wage
differences across jobs that reflect the fact
that some jobs are less pleasant or more
dangerous than others.