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. Trading

    Margin Trading

    Find out what margin is, how margin calls work, the advantages of leverage and why using margin can be risky.
  2. Investing

    A Look At Corporate Profit Margins

    Take a deeper look at a company's profitability with the help of profit margin ratios.
  3. 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.
  4. Managing Wealth

    What's a Good Profit Margin for a Mature Business?

    How to determine if the amount you clear dovetails with the competition.
  5. Investing

    The Difference Between Gross and Net Profit Margin

    To calculate gross profit margin, subtract the cost of goods sold from a company’s revenue; then divide by revenue.
  6. Trading

    Does NYSE Margin Debt Indicate a Continuous Rally in the U.S. Stock Market?

    Discover a tight correlation between NYSE total margin debt and the S&P 500 and why investors should be patient before overreacting to a correlation.
Frequently Asked Questions
  1. How Does Gross Margin and Net Margin Differ?

    Gross margin or gross profit margin and net profit margin are both profitability ratios used in determining the financial ...
  2. What is the difference between iShares, Vanguard ETFs and Spiders?

    iShares, Vanguard ETFs and SPDRs, or spiders, represent different exchange-traded fund families.
  3. How Does Gross Margin and Profit Margin Differ?

    Gross margin and profit margin are profitability ratios used in evaluating a company's financial health but have distinct ...
  4. What is the difference between closed-end credit and a line of credit?

    Understand the difference between closed-end credit, open-end credit, and lines of credit. Then find out how each are used ...
Trading Center