Economic theory 1

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1. Private and public price control.

Sometimes prices are not permitted to do their work.

Monopolies are able to exert control over prices; and

they use it, sensibly enough, to raise their profits

above the level allowed by competition. The monopolist

(or group of colluding enterprises) sets prices at a

level such that prices are above costs or, to use words

of identical significance, such that resources earn

more in the monopolized industry than they can earn

elsewhere. The basis of the monopoly is its ability to

prevent outsiders from entering the industry to share

in the unusual profits and, by the act of producing,

actually serve to eliminate them.

The fixing of prices by monopolists reduces the income

of society. This is, in fact, the only well-established

criticism (on grounds of efficiency) to be levied

against monopolies: there is no reason to assume that

they will make products less suited to consumer tastes

or innovate more slowly or pay lower wages or otherwise

misallocate resources. But the basic inefficiency led,

first in the United States in 1890 and then

increasingly in European nations, to governmental

policies to maintain or restore competition.

Public price control has two aspects. A large part of

public regulation is intended to correct monopolistic

pricing (or other failures of the price system); this

includes most public-utility regulation in the United

States (transportation, electricity, and gas, etc.).

Whatever the success of these endeavours–and on the

whole there has been a substantial decline in

confidence in the regulatory bodies–they are usually

instructed to achieve the goals of an efficient price

system. (see also Index: incomes policy)

Other public price controls are designed to serve ends

outside the reach of the price system. Prices of farm

products are regulated (raised) in most nations with

the intention of improving farmers’ incomes, and the

fixing of interest rates paid by banks is undertaken to

improve bank earnings. Such policies are invariably

defended on various economic and ethical grounds but

reflect primarily the political strength of large and

well organized producer groups.

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To cite this page:

“Economic Theory: Price: LIMITATIONS AND FAILURES OF

THE PRICE SYSTEM” Britannica Online.

<http://www.eb.com:180/cgi-bin/g?DocF=macro/5001/98/17.html&gt;

[Accessed 25 February 1998].

2.Quantity theory of money,

economic theory relating changes in the price level to

changes in the quantity of money. In its developed

form, it constitutes an analysis of the factors

underlying inflation and deflation. As developed by the

English philosopher John Locke in the 17th century, the

Scottish philosopher David Hume in the 18th century,

and others, it was a weapon against the mercantilists,

who were accused of regarding wealth and money as

identical. If the accumulation of money by a nation

merely raised prices, the argument ran, the

mercantilist emphasis on a “favourable” balance of

trade would increase the supply of money but would not

increase wealth. In the 19th century the quantity

theory contributed to the ascendancy of free trade over

protectionism. In the 19th and 20th centuries it played

a part in the analysis of business cycles and in the

theory of foreign exchange rates.

The quantity theory came under attack during the 1930s,

when monetary expansion seemed ineffective in combating

deflation. Economists argued that the level of

investment and government spending had more influence

than the supply of money in determining the level of

economic activity.

In the 1960s the tide of opinion reversed. Experience

with postwar inflations and new empirical studies of

money and prices restored some of the theory’s lost

prestige. One implication of the quantity theory is

that the size of the stock of money is of prime

importance in governmental policies aimed at

controlling price levels and maintaining full

employment.

To cite this page:

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[Accessed 25 February 1998].

3. THEORIES OF UTILITY

There are two sides to the analysis of price and value:

the supply side and the demand side. If cost can be

said to underlie the supply relationship that

determines price, the demand side must be taken to

reflect consumer tastes and preferences. “Utility” is a

concept that has been used to describe these tastes. As

already indicated, the cost-of-production analysis of

value given above is incomplete, because cost itself

depends on the quantity produced. The cost analysis,

moreover, applies only to commodities the production of

which can be expanded and contracted. The price of a

first-folio Shakespeare has no relation to cost of

production; it must depend in some sense on its utility

to purchasers as it affects their bids.

To cite this page:

“Economic Theory: Utility and value: THEORIES OF

UTILITY” Britannica Online.

<http://www.eb.com:180/cgi-bin/g?DocF=macro/5001/98/3.html&gt;

[Accessed 25 February 1998].

4. Wage theory,

portion of economic theory that attempts to explain the

determination of the payment of labour.

A brief treatment of wage theory follows…

The subsistence theory of wages, advanced by David

Ricardo and other classical economists, was based on

the population theory of Thomas Malthus. It held that

the market price of labour would always tend toward the

minimum required for subsistence. If the supply of

labour increased, wages would fall, eventually causing

a decrease in the labour supply. If the wage rose above

the subsistence level, population would increase until

the larger labour force would again force wages down.

The wage-fund theory held that wages depended on the

relative amounts of capital available for the payment

of workers and the size of the labour force. Wages

increase only with an increase in capital or a decrease

in the number of workers. Although the size of the wage

fund could change over time, at any given moment it was

fixed. Thus, legislation to raise wages would be

unsuccessful, since there was only a fixed fund to draw

on.

Karl Marx, an advocate of the labour theory of value,

believed that wages were held at the subsistence level

by the existence of a large number of unemployed.

The residual-claimant theory of wages, originated by

the American economist Francis A. Walker, held that

wages were the remainder of total industrial revenue

after rent, interest, and profit (which were

independently determined) were deducted.

In the bargaining theory of wages, there is no single

economic principle or force governing wages. Instead,

wages and other working conditions are determined by

workers, employers, and unions, who determine these

conditions by negotiation.

The marginal productivity theory of wages, formulated

in the late 19th century, holds that employers will

hire workers of a particular type until the addition to

total output made by the last, or marginal, worker to

be hired equals the cost of hiring one more worker. The

wage rate will equal the value of the marginal product

of the last-hired worker.

Supporters of this theory maintain that the test of an

economic theory should be its predictive power. They

hold that the marginal-productivity theory is a guide

to long-run trends in wage determination and applies

more generally than the bargaining theory of wages.

To cite this page:

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[Accessed 25 February 1998].

5. GENERAL THEORIES OF DISTRIBUTION

The theory of distribution deals with the way in which

a society’s product is distributed among the members of

that society. It involves three distinguishable sets of

questions. First, how is the national income

distributed among persons? How many persons earn less

than $10,000, how many between $10,000 and $20,000, how

many between $20,000 and $30,000, and so on? Are there

regularities in these statistics? Is it possible to

generalize about them? This is the problem of personal

distribution. Second, what determines the prices of the

factors of production? What are the influences

governing the wage rate for a specific kind of labour?

Why is the general wage level of a country not lower or

higher than it is? What determines the rate of

interest? What determines profits and rents? These

questions have to do with functional distribution.

Third, how is the national income distributed

proportionally among the factors of production? What

determines the share of labour in the national income,

the share of capital, the share of land? This is the

problem of distributive shares. Although the three sets

of problems are obviously interrelated, they should not

be confused with one another. The theoretical

approaches to each of them involve quite different

considerations. (see also Index: distribution theory,

wealth and income, distribution of)

To cite this page:

“Economic Theory: Distribution: the shares of the

factors of production: GENERAL THEORIES OF

DISTRIBUTION” Britannica Online.

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[Accessed 27 February 1998].

6. Aspects of distribution.

6.1. Personal distribution.

Personal distribution is primarily a matter of

statistics and the conclusions that can be drawn from

them. When incomes are charted according to the number

of people in each size category, the resulting

frequency distribution is rather startling. Generally

the top 10 percent of income receivers get between 25

and 35 percent of the national income, while the lowest

20 percent of the income receivers get about 5 percent

of the national income. The inequality seems to be

greatest in poor countries and diminishes somewhat in

the course of economic development.

There are various explanations of the inequality. Some

authorities point to the natural inequality of human

beings (differences in intelligence and ability),

others to the effects of social institutions (including

education); some emphasize economic factors such as

scarcity; others invoke political concepts such as

power, exploitation, or the structure of society.

For a long time economists were pessimistic as to the

possibilities of any substantial improvement in the lot

of those at the bottom of the income distribution. They

generally held that the scarcity of productive land and

the tendency of population to increase faster than the

means of subsistence imposed limits on distributive

justice. David Ricardo, in On the Principles of

Political Economy and Taxation (1817), held that the

landlords would receive an increasing part of the

national income while capitalists would get less and

less and that this shift in distribution would lead to

economic stagnation. Karl Marx prophesied that the

workers would be increasingly exploited and made

miserable and that these conditions would lead to the

downfall of capitalism. Neither prediction

materialized. Thus in the Western world the share of

rents has dwindled to a few percent of the national

income, while the share of labour has gradually

increased. For some time, economists believed that the

share of labour was more or less constant, but

investigations show that economic development is

accompanied by an increasing share of labour. Though

the statistics are complicated by technical problems,

it is safe to say that in the United States, the share

of wages rose from more than half the national income

at the beginning of the century to more than 70 percent

in the 1980s. (see also Index: labour economics)

Contemporary approaches to this aspect of income

distribution vary. Some are highly abstract and are

closely related to the study of the whole, the modern

macroeconomics of saving and investment. These will not

be dealt with here. A simple common-sense approach

employs an equation that starts by writing labour’s

share as the quotient of the total wage bill and the

national income, and then writes the wage bill as the

product of the wage level and the amount of labour

(wage bill = wage level [{times}]amount of labour);

next the national income is written as the product of

the national output and the price level (national

income = national output [{times}]price level); the

result is that the share of labour equals the quotient

of the average real wage rate and labour productivity,

the latter being the quotient of the national output

and the amount of labour. If these two variables move

in a parallel fashion, the share of labour is constant.

If the real wage rate increases faster than the amount

of labour productivity, the share of labour goes up.

Similar reasoning applies to the shares of capital and

land. This simple arithmetic is useful for an

understanding of what happens in the real world, but

for a profounder analysis one must turn to the theory

of functional distribution.

6.2. Functional distribution.

The theory of functional distribution, which attempts

to explain the prices of land, labour, and capital, is

a standard subject in economics. It sees the demand for

land, labour, and capital as derived demand, stemming

from the demand for final goods. Behind this lies the

idea that a businessman demands inputs of land, labour,

and capital because he needs them in the production of

goods that he sells. The theory of distribution is thus

related to the theory of production, one of the

well-developed subjects of economics. The reasoning

that synthesizes production and distribution theory is

called neoclassical theory.

To cite this page:

“Economic Theory: Distribution: the shares of the

factors of production: GENERAL THEORIES OF

DISTRIBUTION: Aspects of distribution.” Britannica

Online.

<http://www.eb.com:180/cgi-bin/g?DocF=macro/5001/98/61.html&gt;

[Accessed 27 February 1998].

7. Components of the neoclassical, or marginalist, theory.

The basic idea in neoclassical distribution theory is

that incomes are earned in the production of goods and

services and that the value of the productive factor

reflects its contribution to the total product. Though

this fundamental truth was already recognized at the

beginning of the 19th century (by the French economist

J.B. Say, for instance), its development was impeded by

the difficulty of separating the contributions of the

various inputs. To a degree they are all necessary for

the final result: without labour there will be no

product at all, and without capital total output will

be minimal. This difficulty was solved by J.B. Clark

(c. 1900) with his theory of marginal products. The

marginal product of an input, say labour, is defined as

the extra output that results from adding one unit of

the input to the existing combination of productive

factors. Clark pointed out that in an optimum situation

the wage rate would equal the marginal product of

labour, while the rate of interest would equal the

marginal product of capital. The mechanism tending to

produce this optimum begins with the profit-maximizing

businessman, who will hire more labour when the wage

rate is less than the marginal product of additional

workers and who will employ more capital when the rate

of interest is lower than the marginal product of

capital. In this view, the value of the final output is

separated (imputed) by the marginal products, which can

also be interpreted as the productive contributions of

the various inputs. The prices of the factors of

production are determined by supply and demand, while

the demand for a factor is derived from the demand of

the final good it helps to produce. The word derived

has a special significance since in mathematics the

term refers to the curvature of a function, and indeed

the marginal product is the (partial) derivative of the

production function.

One of the great advantages of the neoclassical, or

marginalist, theory of distribution is that it treats

wages, interest, and land rents in the same way, unlike

the older theories that gave diverging explanations.

(Profits, however, do not fit so smoothly into the

neoclassical system.) A second advantage of the

neoclassical theory is its integration with the theory

of production. A third advantage lies in its elegance:

the neoclassical theory of distributive shares lends

itself to a relatively simple mathematical statement.

An illustration of the mathematics is as follows.

Suppose that the production function (the relation

between all hypothetical combinations of land, labour,

and capital on the one hand and total output on the

other) is given as Q = f (L,K) in which Q stands for

total output, L for the amount of labour employed, and

K for the stock of capital goods. Land is subsumed

under capital, to keep things as simple as possible.

According to the marginal productivity theory, the wage

rate is equal to the partial derivative of the

production function, or [{partial deriv.}] Q/

[{partial deriv.}]L. The total wage bill is (

[{partial deriv.}] Q/[{partial deriv.}]L) [{dot}] L.

The distributive share of wages equals (L/Q) [{dot}] (

[{partial deriv.}]Q/[{partial deriv.}] L). In the same

way the share of capital equals (K/Q) [{dot}] (

[{partial deriv.}]Q/[{partial deriv.}] K). Thus the

distribution of the national income among labour and

capital is fully determined by three sets of data: the

amount of capital, the amount of labour, and the

production function. On closer inspection the magnitude

(L/Q) [{dot}] ([{partial deriv.}]Q/[{partial deriv.}]

L), which can also be written ([{partial deriv.}]

Q/Q)/([{partial deriv.}]L/L), reflects the percentage

increase in production resulting from the addition of 1

percent to the amount of labour employed. This

magnitude is called the elasticity of production with

respect to labour. In the same way the share of capital

equals the elasticity of production with respect to

capital. Distributive shares are, in this view,

uniquely determined by technical data. If an additional

1 percent of labour adds 0.75 percent to total output,

labour’s share will be 75 percent of the national

income. This proposition is very challenging, if only

because it looks upon income distribution as

independent of trade union action, labour legislation,

collective bargaining, and the social system in

general. Obviously such a theory cannot explain all of

the real economic world. Yet its logical structure is

admirable. What remains to be seen is the degree to

which it can be used as an instrument for understanding

the real economic world.

To cite this page:

“Economic Theory: Distribution: the shares of the

factors of production: GENERAL THEORIES OF

DISTRIBUTION: Components of the neoclassical, or

marginalist, theory.” Britannica Online.

<http://www.eb.com:180/cgi-bin/g?DocF=macro/5001/98/62.html&gt;

[Accessed 27 February 1998].

8. Criticisms of the neoclassical theory.

Returns to scale.

Neoclassical theory assumes that the total product Q is

exactly exhausted when the factors of production have

received their marginal products; this is written

symbolically as Q = ([{partial deriv.}] Q/

[{partial deriv.}]L) [{dot}] L + ([{partial deriv.}]Q/

[{partial deriv.}] K) [{dot}]K. This relationship is

only true if the production function satisfies the

condition that when L and K are multiplied by a given

constant then Q will increase correspondingly. In

economics this is known as constant returns to scale.

If an increase in the scale of production were to

increase overall productivity, there would be too

little product to remunerate all factors according to

their marginal productivities; likewise, under

diminishing returns to scale, the product would be more

than enough to remunerate all factors according to

their marginal productivities.

Research has indicated that for countries as a whole

the assumption of constant returns to scale is not

unrealistic. For particular industries, however, it

does not hold; in some cases increasing returns can be

expected, and in others decreasing returns. This

situation means that the neoclassical theory furnishes

at best only a rough explanation of reality.

One difficulty in assessing the realism of the

neoclassical theory lies in the definition and

measurement of labour, capital, and land, more

specifically in the problem of assessing differences in

quality. In macroeconomic reasoning one usually deals

with the labour force as a whole, irrespective of the

skills of the workers, and to do so leaves enormous

statistical discrepancies. The ideal solution is to

take every kind and quality of labour as a separate

productive factor, and likewise with capital. When the

historical development of production is analyzed it

must be concluded that by far the greater part of the

growth in output is attributable not to the growth of

labour and capital as such but to improvements in their

quality. The stock of capital goods is now often seen

as consisting, like wine, of vintages, each with its

own productivity. The fact that a good deal of

production growth stems from improvements in the

quality of the productive inputs leads to considerable

flexibility in the distribution of the national income.

It also helps to explain the existence of profits. (see

also Index: economic growth)

Substitution problems.

Another difficulty arises from the fact that marginal

productivity assumes that the factors of production can

be added to each other in small quantities. If one must

choose between adding one big machine or none at all to

production, the concept of the marginal product becomes

unworkable. This “lumpiness” creates an indeterminacy

in the distribution of income. From the viewpoint of

the individual firm, this objection to neoclassical

theory is more serious than from the macroeconomic

viewpoint since in terms of the national economy almost

all additions to labour and capital are very small. A

related problem is that of substitution among factors.

The production function implies that land, labour, and

capital can be combined in varying proportions, that

every conceivable input mix is possible. But in some

cases the input mix is fixed (e.g., one operator at one

machine), and in that situation the neoclassical theory

breaks down completely because the marginal product for

every factor is zero. These cases of fixed proportions

are scarce, however, and from a macroeconomic viewpoint

it is safe to say that a flexible input mix is the

rule. (see also Index: factor substitution)

This is not to say that substitution between labour and

capital is so flexible in the national economy that it

can be assumed that a 1 percent increase in the wage

rate will reduce employment by a corresponding 1

percent. That would follow from the neoclassical theory

described above. It is not impossible, but it requires

a very special form of the production function known as

the Cobb-Douglas function. The pioneering research of

Paul H. Douglas and Charles W. Cobb in the 1930s seemed

to confirm the rough equality between production

elasticities and distributive shares, but that

conclusion was later questioned; in particular the

assumption of easy substitution of labour and capital

seems unrealistic in the light of research by Robert M.

Solow and others. These investigators employ a

production function in which labour and capital can

replace each other but not as readily as in the

Cobb-Douglas function, a change that has two very

important consequences. First, the effect of a wage

increase on the share of labour is not completely

offset by changes in the input mix, so that an increase

in wage rates does not lead to a proportionate

reduction in total employment; and second, the factor

of production that grows fastest will see its share in

the national income diminished. The latter discovery,

made by J.R. Hicks (1932), is extremely significant. It

explains why the remuneration of capital (interest, not

profits) has shrunk from 20 percent or more a century

ago to less than 10 percent of the national income in

modern times. In a society where more and more capital

is employed in production, a continually smaller

proportion of the income goes to the owners of capital.

The share of labour has gone up; the share of land has

gone down dramatically; the share of capital has

gradually declined; and the share of profits has

remained about the same. This picture of the historical

development of income distribution fits roughly into

the frame of neoclassical theory, although one must

also make allowance for the short-run effects of

inflation and the long-run effects of technological

progress.

To cite this page:

“Economic Theory: Distribution: the shares of the

factors of production: GENERAL THEORIES OF

DISTRIBUTION: Criticisms of the neoclassical theory.”

Britannica Online.

<http://www.eb.com:180/cgi-bin/g?DocF=macro/5001/98/63.html&gt;

[Accessed 27 February 1998].

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Economic Theory]

9. Returns to the factors of production.

The demand side of the markets for productive factors

is explained in large degree by the theory of marginal

productivity, but the supply side requires a separate

explanation, which differs for land, labour, and

capital.

Rent.

The supply of land is unique in being rather inelastic;

that is, an increase in rent does not necessarily

increase the amount of available land. Landowners as a

group receive what is left over after the other factors

of production are paid. In this sense, rent is a

residual, and a good deal of the history of the theory

of distribution is concerned with the issue whether

rent should be regarded as part of the cost of

production or not (as in Ricardo’s famous dictum that

the price of corn is not high because of the rent of

land but that land has a rent because the price of corn

is high). But inelasticity of supply is not

characteristic only of land; special kinds of labour

and the size of the total labour force also tend to be

unresponsive to variations in wages. The Ricardian

issue, moreover, was important in the context of an

agrarian society; it lacks significance now, when land

has so many different uses.

Wages.

In analyzing the earnings of labour, it is necessary to

take account of the imperfections of the labour market

and the actions of trade unions. Imperfections in the

market make for a certain amount of indeterminacy in

which considerations of fairness, equity, and tradition

play a part. These affect the structure of wages–i.e.,

the relationships between wages for various kinds of

labour and various skills. Therefore one cannot say

that the income difference between a carpenter and a

physician, or between a bank clerk and a truck driver,

is completely determined by marginal productivity,

although it is true that in the long run the wage

structure is influenced by supply and demand.

The role of the trade unions has been a subject of much

debate. The naive view that unions can raise wages by

their efforts irrespective of market forces is, of

course, incorrect. In any particular industry,

exaggerated wage claims may lead to a loss of

employment; this is generally recognized by union

leaders. The opposite view, that trade unions cannot

influence wages at all (unless they alter the basic

relationship between supply and demand for labour), is

held by a number of economists with respect to the real

wage level of the economy as a whole. They agree that

unions may push up the money wage level, especially in

a tight labour market, but argue that this will lead to

higher prices and so the real wage rate for the economy

as a whole will not be increased accordingly. These

economists also point out that high wages tend to

encourage substitution of capital for labour (the

cornerstone of neoclassical theory). These factors do

indeed operate to check the power of trade unions,

although the extreme position that the unions have no

power at all against the iron laws of the market system

is untenable. It is safe to say that basic economic

forces do far more to determine labour’s share than do

the policies of the unions. The main function of the

unions lies rather in modifying the wage structure;

they are able to raise the bargaining power of weak

groups of workers and prevent them from lagging behind

the others. (see also Index: income and employment

theory)

Interest and profit.

The earnings of capital are determined by various

factors. Capital stems from two sources: from saving

(by households, financial institutions, and businesses)

and from the creation of money by the banks. The

creation of money depresses the rate of interest below

what may be called its natural rate. At this lower

rate, businessmen will invest more, the capital stock

will increase, and the marginal productivity of capital

will decline. Although this chain of reactions has

drawn the attention of monetary theorists, its impact

on income distribution is probably not very important,

at least not in the long run. There are also other

factors, such as government borrowing, that may affect

the distribution of income; it is difficult to say in

what direction. The basic and predominant determinant

is marginal productivity: the continuous accumulation

of capital depresses the rate of interest.

One type of earning that is not explained by the

neoclassical theory of distribution is profit, a

circumstance that is especially awkward because profits

form a substantial part of national income (20-25

percent); they are an important incentive to production

and risk taking as well as being an important source of

funds for investment. The reason for the failure to

explain profit lies in the essentially static character

of the neoclassical theory and in its preoccupation

with perfect competition. Under such assumptions,

profit tends to disappear. In the real world, which is

not static and where competition does not conform to

the theoretical assumptions, profit may be explained by

five causes. One is uncertainty. An essential

characteristic of business enterprise is that not all

future developments can be foreseen or insured against.

Frank H. Knight (1921) introduced the distinction

between risk, which can be insured for and thus treated

as a regular cost of production, and uncertainty, which

cannot. In a free enterprise economy, the willingness

to cope with the uninsurable has to be remunerated, and

thus it is a factor of production. A second way of

accounting for profits is to explain them as a premium

for introducing new technology or for producing more

efficiently than one’s competitors. This dynamic

element in profits was stressed by Joseph Schumpeter

(1911). In this view, prices are determined by the

level of costs in the least progressive firms; the firm

that introduces a new product or a new method will

benefit from lower costs than its competitors. A third

source of profits is monopoly and related forms of

market power, whether deliberate as with cartels and

other restrictive practices or arising from the

industrial structure itself. Some economists have

developed theories in which the main influence

determining distributive shares is the relative “degree

of monopoly” exerted by various factors of production,

but this seems a bit one-sided. A fourth source of

profits is sudden shifts in demand for a given

product–so-called windfall profits, which may be

accompanied by losses elsewhere. Finally, there are

profits arising from general increases in total demand

caused by a certain kind of inflationary process when

costs, especially wages, lag behind rising prices. Such

is not always the case in modern inflations.

10.

Dynamic influences on distribution.

Prices.

Neoclassical theory throws light upon the long-run

changes in distribution of income. It fails to take

account of the short-run impact of business

fluctuations, of inflation and deflation, of rapidly

rising prices. This failure is an omission, though it

is true that distributive shares do not fluctuate as

much as employment, prices, and the state of business

generally. This lagging in the behaviour of shares can

be understood by remembering that they are determined

by the quotient of the real remuneration of the factor

and its productivity; both variables move, according to

marginal productivity theory, in the same direction.

Yet inflation and deflation do have a certain impact

upon distribution: if purchasing power shrinks, profits

are the first income category to suffer; next come

wages, particularly through the effects of

unemployment. In a depression, the recipients of fixed

money incomes (such as interest and pensions) gain from

lower prices. In an inflation the opposite happens.

(see also Index: price system)

The traditional inflationary sequence was that as

prices rose, profits would increase, with wages lagging

behind; this would tend to diminish the share of labour

in the national income. Experience since World War II,

however, has been different; in many countries wage

levels tended to run ahead in the inflationary spiral

and profits lagged behind, although most entrepreneurs

eventually succeeded in shifting the burden of wage

inflation onto the consumers. The result of the postwar

inflation was a slight acceleration of the increase in

the share of labour, while the shares of capital and

land decreased faster than they would have in the

absence of inflation. Profits as a whole held their

own. The struggle among the various participants in the

economic process no doubt added fuel to the

inflationary fires.

Technology.

Another dynamic influence is technological progress.

The concept of the production function assumes a

constant technology. But in reality the growth of

production is much less the consequence of increased

quantities of labour and capital than of improvements

in their quality. This element in increased production

is distributed in a way not fully explained by

neoclassical theory. Part of the change in distribution

that is caused by technological progress can be

analyzed as resulting from changes in the elasticities

of production. If[Image] goes up, technological change

is said to be “capital-using,” and the share of capital

will increase. This is what, in fact, may have

happened; the change in technology has offset, though

it has not neutralized, the decline in the share of

capital caused by the employment of a higher amount of

capital per worker. But another part of the fruits of

technological progress is garnered by profit receivers,

probably quite a substantial part. Businessmen who are

quick innovators make high profits; in a rapidly

changing society, profits tend to be high, a

circumstance that is fortunate because profits are the

mainspring of economic change. The high rate of growth

experienced by the post-World War I Western world

stemmed from this profit-innovation-profit nexus.

To cite this page:

“Economic Theory: Distribution: the shares of the

factors of production: GENERAL THEORIES OF

DISTRIBUTION: Dynamic influences on distribution.”

Britannica Online.

<http://www.eb.com:180/cgi-bin/g?DocF=macro/5001/98/65.html&gt;

[Accessed 27 February 1998].

11. Personal income and neoclassical theory.

The neoclassical theory endeavours to explain the

prices of productive factors and the distributive

shares received by them. It does not come to grips with

a third category of distribution, that of personal

income, which is much more affected by institutional

arrangements and by characteristics of the social

structure. Profits in particular may be shared in

various ways: they may accrue to stockholders, to

workers, to management, or to the government; or they

may be retained in the corporation. What happens

depends on dividend policy, tax policy, and the

existence of profit-sharing arrangements with workers.

Neoclassical theory has little to say on these matters

or on the fact that in present-day capitalist society

the managers of big business are virtually in a

position to fix their own personal incomes. Managers

have so much power vis-ŕ-vis the stockholders and their

total share of profits is so relatively little that

their ability to pay themselves high salaries is

limited only by the conventions of the business world.

These high incomes cannot be explained by the

categories of the neoclassical theory, and they do not

constitute an argument against the theory. They may

well argue for changes in society’s institutions, but

that is a matter on which the neoclassical theory of

distribution does not pontificate. A great deal of

change could occur in the legal and social order

without any disturbance to the theory. (J.P.)

To cite this page:

“Economic Theory: Distribution: the shares of the

factors of production: GENERAL THEORIES OF

DISTRIBUTION: Personal income and neoclassical theory.”

Britannica Online.

<http://www.eb.com:180/cgi-bin/g?DocF=macro/5001/98/66.html&gt;

[Accessed 27 February 1998].

12. Consumption

In economics the word consumption means the using up of

goods and services. In modern economic terms it means,

specifically, “final” consumption as distinguished from

the using up of goods to produce other goods in a

manufacturing industry. Final consumption must also be

distinguished from the purchase by industry of fixed

assets such as buildings and machinery, which is known

as capital formation or investment. On the other hand,

consumption expenditure by private persons is

understood to include the purchase of durable goods,

such as furniture or vehicles, as well as works of art

that may increase in value over a period of time. The

acquisition of such goods should actually be considered

asset formation rather than consumption and should be

classified with the acquisition of other assets such as

houses, schools, roads, and hospitals.

In modern industrial economies, consumption as

previously defined accounts for 70 or 80 percent of

total national expenditure. Even in the Western

capitalist countries a significant part of total

consumption is determined directly by the expenditure

of public authorities. Some of the benefits of this

part of consumption, such as expenditure on defense or

on public health, are widely diffused; others are

directed by common consent to the benefit of particular

sections of the community. These consist in part of

specialized services such as education or medical care;

but other services–such as unemployment compensation,

state pensions for the elderly, and assistance to

families deprived of the support of a wage earner–are

designed to create greater equality in levels of

consumption than would otherwise be obtained.

To cite this page:

“Economic Theory: Consumption” Britannica Online.

<http://www.eb.com:180/cgi-bin/g?DocF=macro/5001/98/67.html&gt;

[Accessed 27 February 1998].

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