When a company is utilizing inputs to their optimal level, the marginal revenue product of an extra input of production is equal to the marginal cost of an extra resource.
Marginal Revenue Product and Optimal Input Level The market wage rate represents the marginal cost of labor that the company must pay each additional worker it hires. This is because, when there is perfect competition, the company is a price-taker, and it does not need to lower the price to sell additional units of output. It indicates the actual wage that the company is willing and can afford to pay for each new worker they hire, and the wage that the company pays is the market wage rate determined by the forces of supply and demand. The marginal revenue product of labor represents the extra revenue earned by hiring an extra worker. If the marginal revenue of the last employee is less than their wage rate, hiring that worker will trigger a decrease in profits. In a perfectly competitive market, the profit-maximizing hiring decision is to hire new workers up to the point where the marginal revenue product of the last employee equals the market wage rate, which is also the marginal cost of the last employee. Marginal Revenue Product of LaborĬompanies use marginal revenue product to determine the demand for labor, based on the level of demand for their outputs. Therefore, if John hires a new employee, the employee will generate an additional $2,000 in weekly revenue for the manufacturing plant. Assumes that each unit sells for $10, and John knows that a new employee will produce an extra 200 pairs of shoes every week, the marginal revenue product is calculated as follows: The formula for calculating marginal revenue product is as follows: MRP = MPP x MRįor example, assume that John is the manager of a shoe manufacturing plant, and he is considering hiring another employee to meet the increasing demand.
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How to Calculate Marginal Revenue Product When evaluating the demand for its products, the management uses the marginal revenue product for each unit to determine the number of resources to employ. They apply the concept of MRP in estimating costs and revenues, using the information to gain a competitive advantage against their rivals. Production input with a higher MRP will attract a higher price than the one with a lower MRP.īusinesses use marginal revenue production analysis to make key production decisions.Companies use marginal revenue product analysis to make decisions on production and optimize the ideal level of production factors.Marginal revenue product (MRP) indicates the change in total production output caused by using an additional resource.Marginal revenue product explains production in terms of the revenue produced. However, as MRP decreases, the employer is motivated to spend less on each additional input of production. The additional revenue generated from adding a unit of input determines the maximum price that a company is willing to pay for additional units of input.Īn input with a significant marginal revenue product value attracts a greater price than an input with a small marginal revenue product value. Company executives use the MRP concept when conducting market research, as well as in marginal production analysis. Marginal revenue product indicates the amount of change in total revenue after adding a variable unit of production. When calculating MRP, costs incurred on factors of production remain constant.
It can be analyzed by aggregating the revenue earned by the marginal product of a factor. It is an important concept for determining the demand for inputs of production and examining the optimal quantity of a resource. Marginal revenue product (MRP) explains the additional revenue generated by adding an extra unit of production resource. Updated MaWhat is Marginal Revenue Product (MRP)?