Marginal Revenue Product
What is Marginal Revenue Product?
Marginal Revenue Product (MRP) is the additional revenue a firm earns by employing one more unit of a factor of production.
MRP is calculated by multiplying the marginal product of a factor (the extra output from one more unit) by the marginal revenue from selling that output. Firms will hire a factor up to the point where its MRP equals its marginal resource cost (MRC); in a perfectly competitive factor market, MRC equals the factor's price. MRP is the firm's demand curve for a factor.
Marginal Revenue Product: a worked example
A salsa maker sells every jar for $4 in a competitive market. Adding a 5th worker lifts daily output from 90 jars to 108, so MP = 18 and MRP = 18 x 4 = $72. A 6th worker lifts output from 108 to 120, so MP = 12 and MRP = 12 x 4 = $48. If workers cost $60 a day, the 5th is worth hiring because $72 beats $60, and the 6th is not because $48 falls short. Notice the price never moved. MRP fell only because the extra output per worker fell.
The mistake students make with marginal revenue product
The frequent slip is multiplying price by total output instead of by marginal product, which turns MRP into total revenue and makes every worker look wildly profitable. MRP asks what the last worker adds, so it uses the change in output, never the level. A second trap: a firm with market power in its product market has marginal revenue below price, so multiplying marginal product by the sticker price overstates what the worker is worth.
Marginal Revenue Product questions
How many workers should a firm hire?
A firm should hire workers up to the point where marginal revenue product equals marginal resource cost. Before that point each extra worker brings in more than they cost, so stopping early leaves profit on the table, and past it each worker costs more than they add. In a competitive labor market MRC is just the wage, so the rule reads: hire until MRP equals the wage.
Why does the MRP curve slope downward for a competitive firm?
The MRP curve slopes down for a competitive firm because of diminishing marginal returns, not because of any fall in the product's price. With capital fixed, each extra worker adds less output than the one before, so marginal product falls, and a shrinking marginal product times a constant price gives a shrinking MRP. For a firm with market power both terms fall, so its MRP drops faster.
How do you calculate MRP for a firm with market power?
MRP for a firm with market power uses marginal revenue instead of price, because selling one more unit forces the price down on all units sold. If marginal product is 10 units and marginal revenue is $7, then MRP is 10 x 7 = $70, even though the posted price might be $9. Using that $9 price would overstate the worker's value by $20.
Formula / Example
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Related terms
Common comparisons
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