Demand Supply Interaction
To determining the price of a factor of production we need both the demand curve and the supply curve of the factor of production. In fig. DD is the demand curve and SS is the supply curve of the factor of production. Now the equilibrium price of the factor of production will be determined by the point of interaction of the demand and supply curves. In the fig at point E the two curves interact each other and therefore the equilibrium price and remuneration of the factor will be less than its supply. In the case the competition among the sellers of factor will be tend to reduce the price to OW the demand for the factor will be greater than the supply of it the competition among the buyers of factor will tend to increase the price to OW at which the demand and supply of the factor of production will be equal.
Assumptions: the modern theory of distribution is based on certain assumptions. They are as follows:
(i) These exists perfect competition is commodity and factor markets.
(ii) The factor units of production are homogeneous and perfect substitutes of each other.
(iii) Each factor is perfectly divisible.
(iv) The law of variable proportions operates in production.
(v) The state does not intervene to equate the price of the factor service.
Critical Appraisal: since the modern theory of production includes the forces of both demand and supply of the factor in the determination of the factor price and therefore it can be said as improvement over the marginal productivity theory. It offers a more complete and more satisfactory explanation of the problem of distribution. But the modern theory of factor pricing presents a over simplified approach to an extremely complicated question. The theory rests upon highly unrealistic assumptions. In the view of the certain economists the real world is so far from these assumptions that the competitive model is of very limited use.
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