Marginal Revenue Product of Labour

… a core concept in Economic Analysis

MPL-MRU

Click for MRU Video

Concept description

The marginal revenue product of labour is the change in revenue that results from employing an additional unit of labour.

NOTE: Some authors (see Alex Tabarrok in the video link opposite and reference below) use the term marginal product of labour (measured in units of currency) synonymously with marginal revenue product of labour, while others (see descriptions below) use it as a quantity of output that must be multiplied by the marginal revenue of output to equate to the marginal revenue product of labour.

Relation to marginal product

Boundless (reference below) explains the relationship between the marginal product of labour and the marginal revenue of output as follows.

“The marginal revenue product of labor (MRPL) is the change in revenue that results from employing an additional unit of labor, holding all other inputs constant. The marginal revenue product of a worker is equal to the product of the marginal product of labor (MPL) and the marginal revenue (MR) of output, given by MR×MPL = MRPL. This can be used to determine the optimal number of workers to employ at an exogenously determined market wage rate. Theory states that a profit maximizing firm will hire workers up to the point where the marginal revenue product is equal to the wage rate, because it is not efficient for a firm to pay its workers more than it will earn in revenues from their labor.

“For example, if a firm can sell t-shirts for $10 each and the wage rate is $20/hour, the firm will continue to hire workers until the marginal product of an additional hour of work is two t-shirts. If the MPL is three t-shirts the first will hire more workers until the MPL reaches two; if the MPL is one t-shirt then the firm will remove workers until the MPL reaches two.

Let TR=Total Revenue; L=Labor; Q=Quantity. Mathematically:

MRPL= ∆TR/∆L

MR = ∆TR/∆Q

MPL = ∆Q/∆L

MR x MPL = (∆TR/∆Q) x (∆Q/∆L) = ∆TR/∆L

“Note that the change in output is not limited to that directly attributable to the additional worker. Assuming that the firm is operating with diminishing marginal returns then the addition of an extra worker reduces the average productivity of every other worker (and every other worker affects the marginal productivity of the additional worker) – in other words, everybody is getting in each other’s way.

“Because the MRPL is equal to the marginal product of labor times the price of output, any variable that affects either MPL or price will affect the MRPL. For example, changes in technology or the quantity of other inputs will change the marginal product of labor, and changes in the product demand or changes in the price of complements or substitutes will affect the price of output. These will all cause shifts in the MRPL.”

Relation to wage determination

The concept of marginal revenue product of labour is important in the theory of wage determination. Economics Help (reference below) explains how wages depend on a worker’s marginal revenue product as follows:

“MRP is determined by two factors:

  • MPP – Marginal physical product – the productivity of a worker
  • MR – Marginal revenue of last good sold – Effectively the price and demand for the good that the worker produces.

“Thus, if you imagine pay for strawberry pickers, the worker who picks much faster and fills his basket of strawberries should get paid higher than a lazy worker who falls asleep. For jobs such as strawberry picking, firms can pay piece – meal and link pay to productivity.

Wage determination for two different types of workers

wages

  • On the left, demand and supply are both elastic. This could be a cleaner – a job with relatively low skill requirements, meaning many people can do the job.
  • On the right, demand and supply are more inelastic, leading to a higher pay. This could be a job like an accountant. Relatively high skills required.

“Another factor that determines pay, is the demand for the good. For example, the best football players get paid much more than the best hockey players because there is much more demand for watching football games, there is more money in the sport so clubs are willing and able to pay much higher salaries to get the service of the best players.

“As well as demand, pay will be determined by supply. Workers who have specialist skills will generally be awarded with higher pay. You could say if someone spends 5 years to be trained as an accountant, they deserve higher pay to reimburse them for the investment of time in becoming skilled.”

Video resource

See the excellent 10-minute video by Alex Tabarrok, The Marginal Product of Labor, Marginal Revolution University, at http://www.mruniversity.com/courses/principles-economics-microeconomics/labor-economics-marginal-product-labor, accessed 2 April 2016.

Sources

Marginal Product of Labor (Revenue). Boundless Economics. Boundless, 21 July 2015, at https://www.boundless.com/economics/textbooks/boundless-economics-textbook/inputs-to-production-labor-natural-resources-and-technology-14/demand-for-labor-78/marginal-product-of-labor-revenue-298-12395/, accessed 1 April 2016.

Economics Help, What Determines Pay/Wages? at http://www.economicshelp.org/blog/1737/economics/what-determines-pay/, accessed 1 April 2016.

Atlas topic and subject

Labour Markets (core topic) in Economic Analysis.

Page created by: Ian Clark, last modified on 18 April 2016.

Image: The Marginal Product of Labor, Marginal Revolution University, at http://www.mruniversity.com/courses/principles-economics-microeconomics/labor-economics-marginal-product-labor, accessed 2 April 2016.