Here are some important
terms to know:
Marginal
Physical Product (MPP)-The physical output that is due to the addition of
one more unit of a variable factor of production. The change in total product occurring when a
variable input is increased and all other inputs are held constant. (Also known as marginal product)
Law
of diminishing marginal product: The observation that after some point,
successive equal-sized increases in a variable factor of production, such as
labor, added to fixed factors of production will result in smaller increases in
output.
Marginal
Revenue Product (MRP):
The marginal physical product (MPP) times marginal revenue (MR) obtained from a
one-unit change in labor input.
Now let’s put these terms into use by solving some sample
problems…
Sample
Problem: Calculating Marginal Physical Product (MPP)
A
bakery owner is considering how many bakers it needs each day. If there are no bakers working, then 0 donuts
will be produced that day. If one baker
is working, then 20 donuts will be produced that day. If two bakers are working, then 50 donuts
will be produced that day. If three
bakers are working, then 75 donuts will be produced that day. Calculate the marginal physical product of
each quantity of labor (bakers, in this case).
Remember
that the marginal physical product is the change in output due to the increase
in one variable factor of production, which are bakers in this example.
To
calculate the MPP of Baker 1, we need to know that the previous output was 0
and now the new output is 20 donuts.
MPP
of Baker 1 = 20 – 0 = 20
To
calculate the MPP of Baker 2, we need to know that the previous output was 20
donuts and is now 50 donuts with the addition of the second baker.
MPP
of Baker 2 = 50 – 20 = 30
Using
the same methodology for the third baker:
MPP
of Baker 3 = 75 – 50 = 25
Notice that the
MPP of baker 3 is experiencing diminishing returns, since the MPP has fallen
from 30 to 25 when adding the 3rd baker.
Sample
Problem: Calculating Marginal Revenue Product (MRP)
Using
the problem above, let’s say that the donuts sell for $2 each. To calculate the MRP for each input level
(number of bakers), we take the MPP we calculated above and multiply it by the
marginal revenue. The marginal revenue
is the price that the donuts sell for.
MRP
of Baker 1 = MPP x MR = 20 x 2 = 40
MRP
of Baker 2 = 30 x 2 = 60
MRP
of Baker 3 = 25 x 2 = 50