Marginal Revenue Product: Definition & Formula

Instructor: Adam Gifford
When should you hire an additional employee? When should you buy a new machine? These questions can be answered by understanding marginal revenue product. In this lesson we will cover the definition and formula to calculate marginal revenue product.

Should We Hire More People?

Denny is the manufacturing manager of Willer Mills. He is faced with the challenging choice of whether or not he should hire another person to meet the demands of increased production. This is a common challenge faced in many companies. Luckily for Denny, there is a method that can help with that decision. Denny needs to calculate the marginal revenue product of hiring another manufacturing employee. The marginal revenue product is defined as the additional revenue that will be generated by hiring another person, adding a new machine, or adding a new business location. People, machines, and business locations are all referred to as factors of input. So calculating marginal revenue product answers the question: How much more money will I make if I increase a factor of input?

Variables Needed to Calculate Marginal Revenue Product

There are two variables that Denny needs to know in order to determine marginal revenue product:

  1. The number of units that an additional employee or machine will add to the total production. This is referred to as marginal product. To keep things easy we will abbreviate marginal product as MP.
  2. The price that the units sell for on the market. We will abbreviate this as P.

Once these variables are determined, then Denny can go about determining whether or not he should hire a new employee.

Calculating the Marginal Revenue Product

The formula to determine Marginal Revenue Product is:

Marginal Revenue Product = Marginal Product * Price

We will abbreviate the formula as:

MRP = MP * P

Now that we have the formula we can go ahead and calculate the marginal revenue product. Denny has determined that an additional employee will be able to produce an additional 100 units per week. Each unit sells for $7.

MRP = MP * P

MRP = 100 * $7

MRP = $700

The marginal revenue product is $700. This means that if Denny hires a new employee, then that employee will generate $700 per week of revenue.

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