The Marginal Revenue Product of Labor

A firm hires workers the same way it buys any input: it asks what the next one is worth. A worker's value isn't some vague sense of effort or skill, it's measured in dollars, by how much extra output that worker adds and what that output sells for. That's marginal revenue product, MRP. It's the dollar-for-dollar answer to "what does hiring one more person actually get me?"

The mechanism is a straight multiplication: MRP equals marginal product (MP) times marginal revenue (MR). MP is the extra units of output the next worker produces. MR is the extra revenue from selling one more unit, which equals price in a perfectly competitive output market. So MRP = MP x P. Since workers almost always show diminishing marginal product after some point, each additional worker adds fewer units than the last. Multiply shrinking MP by a constant price and MRP falls too, the curve slopes down because production gets less productive at the margin, not because the price is dropping.

This MRP curve is also the firm's labor demand curve. A profit-maximizing firm hires workers up to the point where MRP equals the wage, the same logic as hiring any input up to where marginal benefit equals marginal cost. That links directly to what comes next: how firms decide the quantity of labor to hire in competitive versus monopsony labor markets, and how MRP changes when a firm must cut price to sell more, since then MR falls below price and MRP drops faster as output expands.