marginal revenue product

Marginal revenue productclick for a larger image
Fig. 120 Marginal revenue product.

marginal revenue product (MRP)

the extra REVENUE obtained from using one more FACTOR INPUT to produce and sell additional units of OUTPUT. The marginal revenue product of a factor is given by the factor's MARGINAL PHYSICAL PRODUCT (MPP) multiplied by the MARGINAL REVENUE of the product. (In the case of products sold in perfectly competitive markets, marginal revenue equals price so the MRP is equal to MPP x price.)

The marginal revenue product, together with the MARGINAL FACTOR COST, indicate to a firm how many factor inputs to employ in order to maximize its profits. This can be illustrated by reference to the utilization of the labour input under PERFECT COMPETITION market conditions. In a competitive LABOUR MARKET, the equilibrium WAGE RATE and numbers employed (We and Qe *, respectively, in Fig. 120) are determined by the intersection of the market demand and supply curves for labour. Because each firm employs only a small fraction of the total labour force, it is unable to influence the wage rate. Thus, the wage rate, and hence the marginal cost of labour (MFC), are constant to the firm -each extra worker adds exactly his wage rate to the firm's total factor cost (see Fig. 120 (a) ). The firm's MRP declines because although under competitive conditions the product price remains constant, the marginal physical product falls because of DIMINISHING RETURNS to the labour input.

The firm will maximize its profits by employing additional workers up to the point (Qe in Fig. 120 (a)), where the last worker's contribution to revenue (MRP) is equal to the going wage rate (MFC).