The Marginal Productivity Theory is based on the operation of the Law of Diminishing Returns. As we employ more and more of a factor in the production of a commodity, returns from its fall. We shall therefore employ a factor only so long as its productivity exceeds its remuneration.
According to this theory the entrepreneur or owner of a firm can measure the value of marginal productivity of factors of production, and thus he can try to equate it with the prevailing factor rate in the market. However it is sometimes difficult to know the value of marginal productivity of factors of production
Theory states that reward of each factor of production tends to be equal to its marginal productivity in other words "Distribution according to "Contribution". Marginal Productivity refers to the addition that the use of one extra unit of the factor makes to the total production.