Marginal Productivity Theory

Marginal Productivity Theory explains how wages and returns to resources are determined in a competitive market. It states that each input, like labor or capital, is paid based on its additional contribution to the production—its marginal product. For example, a worker is paid the extra value they generate beyond what the previous worker produced. If an input’s additional output is worth more than its cost, it will be employed. This theory helps explain why resources are allocated efficiently, as each resource is compensated according to its added value to production.