Marginal Product:

Given the total product function for an input, both marginal and average products can be easily
derived. The marginal product of a factor, MPX, is the change in output associated with a oneunit
change in the factor input, holding all other inputs constant. For a total product function such as that
shown in Table 7.2 and Figure 7.2(a), the marginal product is expressed as MPX = ∆Q ∆X

where ∆Qis the change in output resulting from a one-unit change, ∆X, in the variable factor. This
expression assumes that the quantity of the other input, Y, remains unchanged. Marginal product is
shown in column 3 of Table 7.2

THE VALUE OF THE MARGINAL PRODUCT AND THE DEMAND FOR LABOR

Our profit-maximizing firm is concerned more with money than with apples. As a result, when
deciding how many workers to hire, the firm considers how much profit each worker would bring in.
Because profit is total revenue minus total cost, the profit from an additional worker is the worker’s
contribution to revenue minus the worker’s wage.

To find the worker’s contribution to revenue, we must convert the marginal product of labor (which
is measured in bushels of apples) into the value of the marginal product (which is measured in
dollars). We do this using the price of apples. To continue our example, if a bushel of apples sells for
$10 and if an additional worker produces 80 bushels of apples, then the worker produces $800 of
revenue. The value of the marginal product of any input is the marginal product of that input
multiplied by the market price of the output. Because the market price is constant for a competitive
firm, the value of the marginal product (like the marginal product it-self) diminishes as the number
of workers rises.
Now consider how many workers the firm will hire. Suppose that the market wage for apple pickers
is $500 per week. In this case, the first worker that the firm hires is profitable: The first worker yields
$1,000 in revenue, or $500 in profit. Similarly, the second worker yields $800 in additional revenue,
or $300 in profit. The third worker produces $600 in additional revenue, or $100 in profit. After the
third worker, however, hiring workers is unprofitable. The fourth worker would yield only $400 of
additional revenue. Because the worker’s wage is $500, hiring the fourth worker would mean a $100
reduction in profit. Thus, the firm hires only three workers.

It is instructive to consider the firm’s decision graphically. Figure 18-3 graphs the value of the
marginal product. This curve slopes downward because the marginal product of labor diminishes as
the number of workers rises. The figure also includes a horizontal line at the market wage. To
maximize profit, the firm hires workers up to the point where these two curves cross. Below this
level of employment, the value of the marginal product exceeds the wage, so hiring another worker
would increase profit. Above this level of employment, the value of the marginal product is less than
the wage, so the marginal worker is unprofitable.

Thus, a competitive, profit-maximizing firm hires workers up to the point where the value of the
marginal product of labor equals the wage. Having explained the profit-maximizing hiring strategy
for a competitive firm, we can now offer a theory of labor demand. Recall that a firm’s labor demand
curve tells us the quantity of labor that a firm demands at any given wage. We have just seen in
Figure 18-3 that the firm makes that decision by choosing the quantity of labor at which the value of
the marginal product equals the wage. As a result, the value-of-marginal-product curve is the labor
demand curve for a competitive, profit-maximizing firm.
WHAT CAUSES THE LABOR DEMAND CURVE TO SHIFT?

We now understand the labor demand curve: It is nothing more than a reflection of the value of
marginal product of labor. With this insight in mind, let’s consider a few of the things that might
cause the labor demand curve to shift.

The Output Price The value of the marginal product is marginal product times the price of the firm’s
output. Thus, when the output price changes, the value of the marginal product changes, and the
labor demand curve shifts. An increase in the price of apples, for instance, raises the value of the
marginal product of each worker that picks apples and, therefore, increases labor demand from the
firms that supply apples. Conversely, a decrease in the price of apples reduces the value of the
marginal product and decreases labor demand.

Technological Change Between 1968 and 1998, the amount of output a typical U.S. worker
produced in an hour rose by 57 percent. Why? The most important reason is technological progress:
Scientists and engineers are constantly figuring out new and better ways of doing things. This has
profound implications for the labor market. Technological advance raises the marginal product of
labor, which in turn increases the demand for labor. Such technological advance explains
persistently rising employment in face of rising wages: Even though wages (ad- justed for inflation)
increased by 62 percent over these three decades, firms nonetheless increased by 72 percent the
number of workers they employed.
The Supply of Other Factors The quantity available of one factor of production can affect the
marginal product of other factors. A fall in the supply of ladders, for instance, will reduce the
marginal product of apple pickers and thus the demand for apple pickers.

Diminishing Returns to a Factor Concept:

The law of diminishing returns states that the marginal product of a variable factor must eventually
decline as more of the variable factor is combined with other fixed resources. The law of diminishing
returns is sometimes called the law of diminishing marginal returns to emphasize the fact that it
deals with the diminishing marginal product of a variable input factor. The law of diminishing returns
cannot be derived deductively. It is a generalization of an empirical regularity associated with every
known production system. For example, consider an assembly line for the production of
refrigerators. If only one employee is put to work, that individual must perform each of the activities
necessary to assemble refrigerators. Output from such a combination of labor and capital is likely to
be small. In fact, it may be less than could be achieved with a smaller amount of capital, given the
inefficiency of having one employee accompany a refrigerator down an assembly line rather than
building it at a single station. As additional units of labor are added to this production system—
holding capital input constant—output is likely to expand rapidly. The intensity with which the
capital resource is used increases with additional labor, and increasingly efficient input combinations
result. The improved use of capital resulting from the increase in labor could cause the marginal
product, or rise in output associated with each successive employee, to actually increase over some
range of additional labor. This increasing marginal productivity might reflect the benefits of worker
specialization. An example in which the marginal product of an input increases over some range is
presented in Table 7.2. The first unit of labor (input X) results in 15 units of production. With two
units of labor, 31 units can be produced. The marginal product of the second unit of labor MPX=2 =
16 exceeds that of the MPX=1 = 15. Similarly, the addition of another unit of labor results in output
increasing to 48 units, indicating a marginal product of MPX=3 = 17 for the third unit of labor.

Eventually, sufficient labor is combined with the fixed capital input so that the benefits of further
labor additions will not be as large as the benefits achieved earlier. When this occurs, the rate of
increase in output per additional unit of labor, the marginal product of labor, will drop. Although the
marginal product of labor is positive and total output increases as more units of labor are employed,
the rate of increase in output eventually declines. This diminishing marginal productivity of labor is
exhibited by the fourth, fifth, sixth, and seventh units of input X in Table 7.2.

Conceivably, a point might be reached where the quantity of a variable input factor is so large that
total output actually begins to decline with additional employment of that factor. In the refrigerator
assembly example, this might occur when the labor force became so large that additional employees
actually got in each other’s way and hindered the manufacturing process. This happens in Table 7.2
when more than seven units of input Xare combined with two units of input Y. The eighth unit of X
results in a one-unit reduction in total output, MPX=8 = –1; units 9 and 10 cause output to fall by
two and three units, respectively
 The Supply of Labor

The trade-off between work and leisure:

One of the Ten Principles of Economics is that people face trade-offs. Probably no trade-off is more
obvious or more important in a person’s life than the trade-off between work and leisure. The more
hours you spend working, the fewer hours you have to watch TV, have dinner with friends, or pursue
your favorite hobby. The trade-off between labor and leisure lies behind the labor supply curve.
Another one of the Ten Principles of Economics is that the cost of something is what you give up to
get it. What do you give up to get an hour of leisure? You give up an hour of work, which in turn
means an hour of wages. Thus, if your wage is $15 per hour, the opportunity cost of an hour of
leisure is $15. And when you get a raise to $20 per hour, the opportunity cost of enjoying leisure
goes up. The labor supply curve reflects how workers’ decisions about the labor leisure trade-off
respond to a change in that opportunity cost. An upward-sloping labor supply curve means that an
increase in the wage induces workers to increase the quantity of labor they supply. Because time is
limited, more hours of work means that workers are enjoying less leisure. That is, workers respond
to the increase in the opportunity cost of leisure by taking less of it. It is worth noting that the labor
supply curve need not be upward sloping. Imagine you got that raise from $15 to $20 per hour. The
opportunity cost of leisure is now greater, but you are also richer than you were before. You might
decide that with your extra wealth you can now afford to enjoy more leisure; in this case, your labor
supply curve would slope backwards.

WHAT CAUSES THE LABOR SUPPLY CURVE TO SHIFT?:

The labor supply curve shifts whenever people change the amount, they want to work at a given
wage. Let’s now consider some of the events that might cause such a shift.

Changes in Tastes In 1950, 34 percent of women were employed at paid jobs or looking for work. In
1998, the number had risen to 60 percent. There are, of course, many explanations for this
development, but one of them is changing tastes, or attitudes toward work. A generation or two
ago, it was the norm for women to stay at home while raising children. Today, family sizes are
smaller, and more mothers choose to work. The result is an increase in the supply of labor.

Changes in Alternative Opportunities The supply of labor in anyone labor market depends on the
opportunities available in other labor markets. If the wage earned by pear pickers suddenly rises,
some apple pickers may choose to switch occupations. The supply of labor in the market for apple
pickers falls.

Immigration Movements of workers from region to region, or country to country, is an obvious and
often important source of shifts in labor supply. When immigrants come to the United States, for
instance, the supply of labor in the United States increases and the supply of labor in the
immigrants’ home countries contracts. In fact, much of the policy debate about immigration centers
on its effect on labor supply and, thereby, equilibrium in the labor market.