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evenue increases from $440 to $600. Thus, the MRP of Worker 3 is $160. For another example,
when the fifth worker is added, total revenue increases from $720 to $800. Thus, the MRP of
Worker 5 is $80.
A second way to calculate the MRP of each additional unit of labor is to multiply the marginal
physical product (MPP) of the labor unit by the marginal revenue of the output. In Example 2,
Percomp Company is a perfect competitor. Thus, the marginal revenue of the output is the same
as the selling price ($10 per Gadget). Multiplying this amount by the MPP of each worker gives
the MRP of each worker. For example, Worker 4 has an MRP of $120, which is the marginal
revenue of $10 per Gadget multiplied by the MPP of 12 units for Worker 4.
For the workers in Example 2, the MPP decreases as additional workers are added. This is due
to the law of diminishing marginal returns. (As larger amounts of a variable input are combined
with fixed inputs, eventually the MPP of the variable input declines.)
Since the MPP of the workers is decreasing, the MRP of the workers is also decreasing. Thus,
the MRP curve will always eventually slope downward due to the law of diminishing marginal
returns.
How many workers would Percomp Company (from Example 2) employ to maximize profits? We
can’t determine the answer to that question based solely on the marginal revenue product
generated by the workers. We also need to know the additional cost incurred by employing each
additional worker.
Marginal factor cost (MFC) – the additional cost from employing an additional factor unit.
A perfectly competitive labor employer is a small employer in a large labor market. A perfectly
competitive labor employer will have no market power (no ability to affect the wage rate in the
labor market). Thus, a perfectly competitive labor employer can hire additional workers without
affecting the wage rate in the market.
Example 3: Percomp Company (from Example 2) is a perfectly competitive labor employer. If the
cost of Percomp’s first worker is $80 per day, the cost of hiring each additional worker will be $80
per day, and the marginal factor cost of each worker will be the same as the wage rate ($80).
Profit-Maximization Rule for Employing Factors
In Chapter 21, we introduced the profit-maximization rule for producing output: Produce the
quantity of output where marginal revenue equals marginal cost.
The profit-maximization rule for employing factors is similar, but the terminology is different. Once
again, it is profitable to employ a factor if it generates more marginal revenue than marginal cost.
The marginal revenue generated by employing an additional factor unit is called marginal revenue
product. The marginal cost incurred by employing an additional factor unit is called marginal
factor cost. Thus, to maximize profits, a producer employs additional factor units up to the
quantity where marginal revenue product equals marginal factor cost (MRP = MFC).
Example 4: The graph on the next page shows the marginal revenue product (MRP) curve for
Percomp Company from Example 2. If the wage is initially $80 per day, then MFC 1 is the initial
marginal factor cost curve. The profit-maximizing quantity of workers would be indicated by the
intersection of MRP and MFC 1 . Thus, five workers would be employed.
If the wage rate increases to $130 per day, then MFC 2 is the new marginal factor cost curve. The
profit-maximizing quantity of workers would be indicated by the intersection of MRP and MFC 2 .
Thus, three workers would be employed. Notice that the MRP of Worker 3 ($160) exceeds the
MFC ($130). But Worker 4 would not be employed, since the MRP of Worker 4 ($120) is less
than the MFC ($130).
FOR REVIEW ONLY - NOT FOR DISTRIBUTION
Factor Markets 24 - 2