Income Distribution

Economic efficiency can exist in a world of 2% millionaires and 98% paupers. Economic efficiency maximizes total social good, but says nothing about how well off individual families are. The average income of each family will be the nation’s GNP divided by the total number of families. However, the actual income of any individual family depends not only on this number but also on how much of a claim that family has on the nation’s output.

The income earned by factors of production are wages and salaries paid for labor, interest and dividends paid to the owners of capital, and rent paid to the owners of land and mineral resources. In all capitalist countries, labor earns by far the highest proportion of national income. While each individual has the same amount of time to offer prospective employers per week, the price for wages which different individuals can command varies enormously.

The demands for goods and services determine the demands for the factor inputs required to produce them. The supply curve of factors of production is determined by resource owners’ willingness to sell at various prices. Ignoring immigration, the supply of labor in any given country at a given wage rate is the number of people willing and able to work at that wage rate. The equilibrium wage rate for a given type of worker is determined by the demand and supply curves for workers of that type.

A profit maximizing firm will hire labor or any other resource up to the point where the marginal benefit of that resource equals its marginal cost. The marginal benefit of a resource is the change in revenue which would result from hiring one additional unit. The value of marginal product (VMP) curve shows the marginal benefit at each level of employment of a resource. The point where the VMP curve crosses the going price for the resource is the point where the firm ceases to employ more resources; i.e. the VMP, or marginal benefit, has become equal to the marginal cost.

If a worker wants to increase his income, he can either increase his VMP by investing in additional training or skills development; or he can reduce his consumption expenditure and become a resource owner, thus deriving income not only from the product of his own labor but from the profits of firms as well. His income might also increase (or decrease) if the relevant demand or supply curves shift, but he has no control over this.