We showed previously that least cost production requires profit-maximizing firms to use combinations of resources so that the marginal physical products of particular resources are proportional to the prices of the resources. This concept translates into the principle of equal marginal productivities per dollar:
This is one application of the law of equal marginal advantage to production. Multiplying all MPPs by the price (P) of output reveals that competitive firms must operate so that the values of the marginal products of all resources (VMP = P MPP) are proportional to their prices:
But resource prices are equal to marginal factor costs if resource markets are competitive, and the market compels competitive firms to pay resource owners incomes equal to the resources' VMPs, so:
This suggests that a competitive market system tends to divide income according to the productive contribution of each individual's resources. Of course, product or resource markets are seldom purely competitive, but this brief review does
identify some central tendencies for the distribution of income in a capitalist economy.
Thismarginal productivity theory of income distribution also points to a key for personal wealth. People will be relatively prosperous if they control a lot of resources that make valuable productive contributions to output. Incentives embedded in the structures of wages, rents, interest incomes from capital, and profits are signals about how to alter resources and allocate them so that they are used most valuably
Marginal productivity theory encapsulates a lot of information about incentives in a market economy. For example, interest rate differentials may cause you to shift funds from a savings account into a money market fund. Higher interest rates may induce you to consume less and save more. If you enjoy art, economics, finance, and philosophy about equally well, pay differentials may channel you toward the more remunerative of these areas of study. Pay differentials are, for better or worse, signals about how society values (at the margin) having more people in particular occupations.
Consequently, musicians whose personal preferences run to classical may perform rock, and serious artists may be forced to live off of income generated by painting houses. This theory cannot even hint, however, at the most equitable income distribution---a normative question addressed in the next chapter.