Marginal Product of Labor

As the word 'marginal' suggests, marginal product of labor is a theory that measures the productivity of extra units in an organization. Let us take a look at the topic in detail...
BusinessZeal Staff
Marginal product of labor is one of the important principles of economics. It is defined as the change in the output of an organization with the addition of an extra unit of input, while keeping the other factors constant. Most of the organizations make long-term plans. To achieve these goals, they measure the performance of their existing workforce to see if adding extra labor will bring in the desired results. With the addition of an employee, the output of a firm may increase, but it does not really signify success. In order to succeed, the firm needs to check whether the revenue that will be generated by the extra output is greater than the wages that have to be paid to that extra employee.

Formula for Marginal Product of Labor

The value of marginal product of labor is expressed mathematically as MP = ΔY/ΔX, where ΔX is the change in the input of the firm and ΔY is the change in the output. Let us look at the concept of marginal productivity of labor in respect to an organization. Suppose a company X has 99 employees and is producing an output Y. Now, the company decides to hire one extra employee. The productivity of this employee will increase the total productivity of the firm, but the change in output will be relatively smaller. This change to the output is the marginal revenue product. The marginal output of the company should increase in proportion to the number of extra units employed. If after hiring extra people, the output of the company does not increase as expected, then the hiring of extra units is not a good investment.

Law of Diminishing Returns

Law of diminishing returns states that adding more and more workers to the organization will not always yield higher outputs/profits. It states that hiring more inputs means paying higher wages and increased input costs to the company. When extra input is applied, the output will first increase, then it will be constant and finally it will show a downward trend. There will be a stage when the revenue generated by selling goods or services will be lesser than the amount paid to workers as wages. So, according to the law of diminishing returns, addition of staff may increase your output, but not necessarily the profits.

Average Product of Labor

Average product of labor is the total output produced by a firm divided by the number of workers. If an extra worker is added to the firm, the average product of labor tends to increase initially but after some point of time, the average product of labor becomes equal to the marginal product of labor and then decreases gradually.

Let us take another example. Suppose you are running a company in which the job of the employees involves working on computers. You could not change the number of computers you have but employ more people to work on them in such a way that when one group of employees take their breaks, the other group works on them. The other way can be splitting your employees into two groups so that one group works on the first four days of the week and the another group works on the remaining three days. The additional output that will be produced is the marginal product of labor. This extra output is small when compared to the situation in which you hire more workers and also increase the input by buying equal number of computers.

Marginal product of labor is an important metric for businesses when they are thinking of hiring more people. It is important to note that marginal product of labor is interconnected to several other factors like law of supply and law of demand, demand for an input, etc. Other theories like allocative efficiency which states that 80% of the output is produced by 20% of the top performing staff takes a contrary view at the productivity of labor. There are numerous theories that classical economics has to offer and all of them give an insight into the way a business should be conducted in order to achieve maximum profits.