I. Components of Marginal Product and Marginal Revenue

Marginal Product
The marginal product is the change in output that occurs when one more unit of input (such as a unit of labor) is added.

Marginal Revenue
Marginal revenue is the increase in total revenue that occurs with the production of one more unit of output.

Value of Marginal Product
For a particular resource, the value of marginal product (VMP) is the resource's marginal product multiplied by the product price.

Marginal Revenue Product
The marginal revenue product of a resource is defined as the increase in a firm's total revenue attributable to employing one more unit of that resource. The increase in output due to adding one more resource unit is called the marginal product. The marginal revenue product is calculated as the marginal product times the marginal revenue.

The Relationship Between MRP and Demand
Due to the law of diminishing returns, we expect that both the marginal product and the marginal revenue product for an input will decline as more of the input is deployed.

A firm seeking to maximize profit will increase employment of a variable input unit until the MRP of that input is just equal to what it pays for the input. This rule will be followed by price takers and price searchers.

As the price of an input goes up, fewer units of that resource will generate the MRP needed to entice the firm to employ that resource. The demand curve for a resource will be downward sloping, as shown in figure 4.1 below:

Figure 4.1: Results of Regulating Price and Output

Values for the demand curve will depend upon the price of the good being produced, the productivity of the resource in question, and the amount of other resources used by the firm.

A profit-maximizing firm will continue to employ units of a resource as long as the MRP associated with the unit exceeds the firm's cost. If we assume the units of each resource are perfectly divisible, then the following conditions will apply to a firm with 3 production inputs (A, B, and C).

MRPa=Pa

MRPb =Pb

MRPc= Pc

Pa is equal to the price (or wage rate) of resource A, Pb is equal to the price (or wage rate) of resource B, and Pc is equal to the price (or wage rate) of resource C.

Suppose resource A represents highly skilled labor and resource B represents labor with low skills. If a firm can get 100 units of additional output by purchasing $500 worth of highly skilled labor and only 50 additional units of output by hiring $500 worth of labor with low skills, then per unit costs will be reduced by hiring the highly-skilled labor. Expenses can always be reduced by substituting resources with relatively high marginal product per dollar spent for resources that have a relatively low marginal product per dollar. This substitution will continue to occur if per unit costs are to be minimized until the following relationship is achieved:

MRPa = MRPb = MRPcinan
-------- -------- --------
Pa Pb Pc

Note that this relationship also implies that if skilled laborers are three times as productive as unskilled labor, then firms will be willing to pay skilled laborers three times as much as unskilled labor.



The Demand and Supply of Financial and Physical Capital

Related Articles
  1. Investing

    Explaining Marginal Revenue Product

    Marginal revenue product (MRP) accounts for the change in revenue that results from the addition of one extra unit, keeping all other factors equal.
  2. Investing

    Understanding Marginal Cost of Production

    Marginal cost of production is an economics term that refers to the change in production costs resulting from producing one more unit.
  3. Small Business

    What's Marginal Revenue?

    In microeconomics, marginal revenue is the additional revenue generated by increasing sales revenue by one unit. Another way of saying this is that the marginal revenue is the revenue generated ...
  4. Investing

    Contribution Margin

    Contribution margin is a cost accounting concept that allows a company to determine the profitability of individual products.
  5. Managing Wealth

    What’s a Good Profit Margin for a New Business?

    Surprisingly, the younger your company is, the better its numbers may look.
  6. Investing

    A Look At Corporate Profit Margins

    Take a deeper look at a company's profitability with the help of profit margin ratios.
  7. Investing

    Buying on Margin

    When an investor buys on margin, he or she pays a portion of the stock price – called the margin -- and borrows the rest from a stockbroker. The purchased stocks then serve as collateral for ...
  8. Small Business

    How Gross Margin Can Make or Break Your Startup

    Find out how your startup's gross margin can impact your business, including why a mediocre margin may spell disaster for a budding business.
  9. Investing

    Natural Resource Investing

    ETFs and futures are just some of the various investment options available to natural resource investors.
  10. Insights

    Explaining Marginal Utility

    Marginal utility is the additional satisfaction a consumer gains from consuming one more unit of a good or service.
Frequently Asked Questions
  1. Depreciation Can Shield Taxes, Bolster Cash Flow

    Depreciation can be used as a tax-deductible expense to reduce tax costs, bolstering cash flow
  2. What schools did Warren Buffett attend on his way to getting his science and economics degrees?

    Learn how Warren Buffett became so successful through his attendance at multiple prestigious schools and his real-world experiences.
  3. How many attempts at each CFA exam is a candidate permitted?

    The CFA Institute allows an individual an unlimited amount of attempts at each examination.Although you can attempt the examination ...
  4. What's the average salary of a market research analyst?

    Learn about average stock market analyst salaries in the U.S. and different factors that affect salaries and overall levels ...
Trading Center