class 12 economics theory of factor pricing

concept 9:32 PM

Wednesday, December 9, 2020

Theory of factor pricing

Very short questions page 134

Question 1 to 12 copy { same ]

What is factor of productions and factor pricing ?

The factors which are used to produce goods an service are known as factors of production . They are

also known as inputs. Land, labor ,capital and entrepreneurs are the factors of production which

contributes in production of various goods and services .The price determination process of factors of

production is known as factor pricing . I t is also known as the theory of distribution

Difference between economic and contract rent

Economic rent contract rent

It is price paid for the use of it is the total payment made by tenant to

Original and indestructible power of soil the land lord as per their agreement

it is determined by the fertility of It is determined by the demand and supply
land of land

It is known as pure rent It is known as gross rent

It is related with opportunity cost It is not related with opportunity cost

Critically explain the Ricardian theory of Rent
for 8 marks

Introduction:

David Ricardo developed a theory to explain the process of determination of price of fixed factor,
land. It is popularly known as Ricardian theory of rent. According to Ricardo ,"Rent is that portion
of the produce of earth which is paid to the landlord for the use of original and indestructible
power of soil" .Ricardo said that scarcity of land is the main cause of rent and differences in
productivity is the basis for determination of rent.

Assumption:

Ricardian theory of rent assumes:
→ Cultivation over new land starts from most fertile to less fertile land .
→ Marginal land or no rent land plays vital role to determine the rent.
→ Rent can be obtained only from land
→ There exists perfect competition
→ land differs in quality or productivity

Suppose , there are four grades of land A,B,C,D . The total product and rent o each grades are as
follows:

Grades of land Total product production of marginal land Rent

A 82 8-2=6

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B 62 4

C 42 2

D 22 0

The rent paid by each grades of land are shown below

book page 118 figure

In the figure , grades of land are shown on x-axis and production on Y-axis .Each vertical
bars shows the total production of land .The shaded portion represents the rents paid by
A,B,C,D grades of land and D grade land is no rent land.

Criticism of Ricardian theory of rent

The main criticism of Ricardian theory of rent are explained in the following points
1) No original and indestructible power. According to Ricardo, rent is paid for the original and

indestructible power of soil. As cultivation is increase it decrease the fertility power .Global
warming ,climatic situation , sunshine, humidity, soil pollution, soil composition diminishes the
fertility power. Technology, capital can increase fertility.

2) Wrong assumption of 'No rent land': different land can be used for different purpose . So, there is
no marginal land in practice

3) rent enters in to price: According to Ricardo rent does not enter into price .Rent is depend upon
the fertility .Rent does not affect the price. But in practice rent affect the price of land.

4) Wrong assumption of perfect competition : According to Ricardo , perfect competition prevails
between the landlord and tenant in process of fixing rent. But in the world practice, mostly the
imperfect competition plays the role.

5) Grading of land is very difficult: the theory imagines various grades of land of cultivation .However,
it is not real because land cannot divide into various grades without cultivation of land . Different
land are suitable for different product.

6) Rent arises from all factors of production: the Ricardian theory assumes that land only earns
rent .However , modern economists argue that rent is earned not only by land but all other factors
those whose supply is fixed in quantity. So, the theory is criticized as incomplete theory.

Describe the Ricardian theory of rent

5 marks book page 347 Q 13

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5 marks book page 347 Q 13
Wage

The term wage refers to the the price paid for the use of labour . The term labour refers to the
efforts of human beings to perform a particular task, which is related to the economic activities . It
include both mental and physical efforts of human beings

Types of wage
Money wage: the amount of money paid as wage is called the nominal wage or money wage.
Nominal wage is thus the monetary expression of the reward for labour .It is the face value of
wage in money.

Real wage: It is all those advantages concession , facilities that a workers can receive for his / her
contribution in the production process .It includes all those extra benefits to a workers like
transport facility, free lodging ,free medical facility, free education for children, discount housing
loan , annual holiday allowance, festival allowance. It also related to purchasing power of the
person .By real wage , we also mean the amount of necessaries , comforts , luxuries and other net
benefits that he can purchased with money wages. So, real wage reflect the true economic
condition of a person.

Determining factors of real wages.

1) Price level : real wages is affected by price level ,If price level is high , purchasing power of labours
is decrease and vice versa

2) Extra facility : the facility like free education , subsidized goods, discount card, free medical facility,
insurance premium also ensures the improvement in living condition which indicate the real wage

3) Extra earning : in some jobs there is possibility of extra earning for example tuition class ,writing
books, consultancy service , bonus, tips overtime. These increase the real income.

4) Future prospects: some jobs hold good future prospects like promotion to executive level,
pension ,chance of higher study ,Job guarantee for other family members . These increase the real
income.

5) Social status: Real income also depend on the social status of jobs

6) Nature and regularity of employment :Permanent nature of jobs also ensure high real wage than
temporary and unpleasant risky jobs like coal ,mines, painting ,road construction.

7) Timely payment: timely payment can facility the workers to pan budget and get interest from
saving .Untimely payment creates uncertainty and unnecessary mental pressure. This reduces the
real wage.

Subsistence theory of wage

the subsistence theory of wage was originally introduced by French economist F. Quesnay. It was

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the subsistence theory of wage was originally introduced by French economist F. Quesnay. It was
further developed by classical economist such as Adam smith David Ricardo etc.

Assumption
1) population grows at faster rate( labour supply is infinitely elastic)
2) food supply is subjected to the law diminishing return
3) Economic activities under discussion are subjected to the long run

Subsistence theory of wage also known as the iron law of wage" .According to these theory wage
tend to remain at the level which is just enough to maintain the expenses of minimum necessities
or subsistence of workers .If level of wage increase, it increase the population .This increase the
supply of labour .It decrease the wage rate .If wage rate falls below the substance level it increase
the death rate and supply of labour decrease and increase the wage rate. In this way in long run ,
the wage remain at the subsistence level.
Criticism
1) one side : this theory has explain from the side of supply of labor at costar technology. with
increase in industrialization demand of a labour and wage both increase.

2) Ambiguous : the term " subsistence level" is different according to time , place, person . So it I s
ambitious .

3) Unrealistic. This theory is unrealistic in the sense that it is not applicable in the developed
counties .wage are more for comforts and luxuries in developed countries. But birth rate is low.

4) Wages are not uniform : unlike this theory wages of all workers are not uniform at the
subsistence level in reality . Wage differ from occupation to occupation and from place to place

5) Exploitation Tendency there is tendency towards exploitations in this theory .Because according to
the theory wages must be equal to the subsistence level and not for comfort and luxuries and
saving . This may discourage the people with high efficiency to work hard for more earning

6) Ignore the role of trade union : in the preset time trade union plays an important role
indeterminant the wage , Trade union bears strong bargaining power for fixed the wage despite
the supply of labor

7) subsistence is not basis of wage determination . Marginal productivity is the main determination
of wage

wage fund theory

The wage fund theory was developed by classical economist J.S Mill .According to J.S.Mill " wage
at any movement are determined by the amount of money in the wage fund and the total number
of workers in the country "
According to this theory wage rate is determined by following formula

Here wage fund refers to the part of capital which is separate for the payment of labor

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Here wage fund refers to the part of capital which is separate for the payment of labor
which is separate for the payment of labor .Numbers of workers refers to population
who are willing and active to work at existing rate. Average wage rate has direct and
proportional relationship with wage fund .Average wage rate has inverse relation with
population i.e. wage rate can be increase by increasing wage fund or control in population
Criticism
1) Wrong assumption about source of wage : theory assume that wage are paid from past
accumulation of capital separated for labor known as wage fund. In practice wage is paid
from the current production
2) Imaginary concept: Theory assume that wage rate is determine by the number of worker.
But wage rate is determined by efficiency and productivity of labour.
3) Static theory : The theory is based on the assumption of fixed wage fund. But fund varies
with phase of business ( recession, prosperity , depression recovery)
4) Wrong assumption of Homogeneous labor: this theory assumes that labour are
homogeneous in nature. But in reality they are heterogeneous
5) Ignore the role of trade union: The pressure from trade union also increase the wage
rate .In this regard ,the wage rate does not depend on wage fund and the availability of
number of labour
6) One side :the theory gives undue importance to only the supply of labour .However the
demand for labor also plays a significant role on fixing the wage rate
7) Fail to explain wage fund determination process : it does not explain in what basis the
wage find is separate from national income

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Interest 1:38 PM

Monday, December 14, 2020

Interest is the price paid for the use of capital .The additional amount of payment made by the
borrower to the lender for the use of capital is called interest. The real rate of interest is
related to the purchasing power .Nominal rate of interest is related to the monetary term

Types of interest
a) Net interest b) Gross interest

. a) Net Interest : Net interest refers to the payment for the use of only capital. It is also called
pure interest. It is narrow concept of interest

Gross interest: Gross interest refers to the entire payment made by a borrower to a lender on
a certain amount of loan received for the given period of time . It include the payment not only
for the capital but also for the risk, inconvenient and management of loan
Gross interest=Net interest + reward for risk + Reward for inconvenience + cost of
management

Classical theory of interest
the theory was initiated by the classical economist and developed by the Neo- classical
economist. It is properly known as saving investment theory. Saving and investment are
consider two real factors determining the rate of interest .According to this theory interest
which is measured in real term is the reward for the use of productive use of capital, which is
equal to the marginal productivity of physical capital .This theory hold the proposition that the
rate of interest is determined by the intersection of the demand and supply of capital .At the
equilibrium rate of interest total investment and saving are equal.

Supply of capital: supply of capital comes from saving . Saving is the surplus income which is
over and above the current consumption .According to this theory saving is a positive function
of rate of interest.

Demand for the capital .Demand for capital refers to the investment .Basically , investors
demand capital to invest on profitable business. According to this theory investment is the
inverse function of rate of interest

Determination of equilibrium rate of interest

the equilibrium rate of interest is determined at that point at winch both demand and supply
of capital are equal . In other words, at the point at which investment equal to saving
The concept can be explained with the given schedule and diagram
Rate of interest % Demand for capital Supply of capital

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Rate of interest % Demand for capital Supply of capital

1 100,000 20,000

2 80,000 40,000

3 60,000 60,000

4 40,000 80,000

5 20,000 100,000

Table: Determination of equilibrium rate of interest
in the above table the equilibrium rate of interest is 3% because at 3% of interest supply of capital and demand
of capita is 60,000 .At the higher level of interest the supply of capital is more than the demand of capital and at
the lower level of interest the supply of capital is less than the demand of capital.

1

fig : classical theory of interest
In the figure , rate of interest is measured in the y axis and demand of capital and supply of capital is
measured along the X-axis .The supply of capital curve(SS) is upward slopping and demand of capital
curve(DD) is downward sloping .E is the equilibrium point where demand of capital and supply of
capital is equal.

Criticism
The major criticism leveled against classical theory are as follows
1) Saving is not only interest sensitive: the theory assumes saving is a positive function of rate

of interest .But Keynes argued saving is a positive function of income rather than rate of
interest ,ability to save wiling to save and income .
2) Incomplete theory :the theory assumes that rate of interest is determined in the real
market by saving and investment. Modern economist argued it is determined by saving and
investment as well as money demand and supply
3) Money is not merely the medium exchange : The classical theory looks upon money merely
as a medium of exchange . It does not take into account the role of money as store of value.
4) Investment is not only interest elastic : the theory assumes that investment is interest
elastic .But Keynes argued investment depend s not on interest but on business
profitability , security , environment , business friendly environment.

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profitability , security , environment , business friendly environment.
5) Ignore Banked money: the classical theory pays no attention to the role of modern form

of money and bank credit in the determination of interest rate
6) Monetary factor is ignored : interest is monetary phenomena .Interest rate is determined

by supply and demand

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Profit 12:08 PM

Thursday, December 17, 2020

Profit is the residual income which is left after paying all the factors of production out put of the
recipient made from selling all the output . It is the reward for innovation coordination assuming risk
and bargaining sill by an entrepreneurship
type of profit
1) Net profit: net profit is also called the pure profit . It is the amount above the opportunity cost of
and entrepreneurs .It depends on the burgeoning skill and managerial skill to tackle the risk by the
entrepreneurs
2) Gross profit : it is the difference between the total receipt and total payment ie

Gross profit = total receipts- total expenditure
Gross profit includes
i) Rent of own land
ii) Wage of own labor
iii) interest of own capital
iv) net profit
v) depreciation charge
vi) monopoly wind fall gain
Risk Bearing theory of profits
risk bearing theory of profit was propounded by professor Howley an American Economist in
1907 AD. According to this theory the entrepreneurs earn profit because under trade various
risks .Taking risk is very difficult task because it gives trouble disutility . So entrepreneurs should
get some extra return which is called profit .Replacement risk, obscene risk uncertainty are some
type of risk.
Criticism
1) Narrow theory: This theory assumes risk is the main cause of profit .But innovation uncertainty
organization of others factors are also causes of profit
2) No direct relationship between risk and profit : the theory argued there is direct relationship
between risk and profit which is not always true
3) Entrepreneurs ha dynamic functions: the theory assumes the main function of entrepreneurs is to
take risk. However , entrepreneurs perform s dynamic functions such as innovation
coordination, non-routine decision making for firms

Uncertainty bearing theory of profit

This theory was propounded by F.H. Knight in 1921 AD . According to this theory , profit is the
reward for uncertainty bearing rather than risk bearing .Business cycle change in government
policy change in tase and preference of consumers ,competitive risk ,technological risk are non-
insurance risks which create uncertainty

Criticism of uncertainty bearing theory

1) No direct relationship between profit and uncertainty .this theory says that level of profit

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1) No direct relationship between profit and uncertainty .this theory says that level of profit
depends on the level of uncertainty . We may get high profit even in low uncertainty.

2) Ignores the others determinants of profit: this theory shows the direct relationship between
uncertainty and profit but it ignores other determinant of profit such as quantity of
determination of profit such as quantity of capital ,skill of labor skill of management, efficiency
of management, facility of labour technology

3) This theory is one sided theory: it does not explain about losses
4) Not suitable in monopoly market structure: there is le

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