What Is Marginal Productivity?

You are free to use this image on you website, templates, etc., Please provide us with an attribution linkHow to Provide Attribution?Article Link to be HyperlinkedFor eg:Source: Marginal Productivity (wallstreetmojo.com)

This classical marginal productivity theory depends on the marginal revenue product (MRP). Producers and suppliers use it to analyze their outputs and make better production decisions. It applies to perfect competition with similar products, full factor utilized, and perfect mobility. However, it does not apply to imperfect competition. 

Key Takeaways

  • Marginal productivity refers to the net input made to total production by producing an additional output unit. Inputs include land, labor, capital, technology, and entrepreneurship. Economists also refer to it as the classical theory of distribution. In the 19 century, economists J.B Clark, Leon Walras, Enrico Barone, David Ricardo, and Alfred Marshall also worked on it. The three types of factor pricing theory include marginal physical productivity, marginal revenue productivity, and value of marginal productivity. In the marginal productivity curve, the overall productivity decreases as the number of inputs increases, shifting the MRP curve from left to right.

Marginal Productivity Theory Explained

Marginal productivity meaning implies the net addition made to the total production by producing an additional output unit. It analyzes the effect of increasing inputs on the prices of the factors of production. It is also known as marginal physical productivity or pricing theory. Here, the producer increases any factor (capital or labor) until it reaches the marginal cost, assuming other factors to be constant. However, if it exceeds the marginal revenue, overall productivity declines. 

Three types of factor pricing theory include marginal physical productivity, marginal revenue productivity, and value of marginal productivity. German economist, T.H. Von Thunen, put forth this classical theory in 1826. Later, neo-classical economists like John Bates Clark, Walras, Philip Henry Wicksteed, David Ricardo, and Alfred Marshall also worked to develop this theory. According to them, the early factor inputs provide a surplus to the firm. In simple terms, it follows the law of variable proportion. But, in the later stage, it gives declining returns due to a massive increase in factor units. 

In the early stages, total revenue rises when the producer increases the one-factor unit while the rest remains constant. After some time, the marginal revenue diminishes with every input increase. Finally, it reaches a point where it equals the marginal cost. It leads to diminishing marginal productivity. 

Since the marginal cost equals marginal revenue, the price of the factor remains the same as the industry. Now, the firm goes for closer substitutes to maximize profits. They replace the expensive factors with cheaper ones. For example, replacing labor with effective and cheap machines. If the firm employs more factors, it will make huge losses. 

However, this theory has certain assumptions like perfect competition, mobility, and most factor usage. As a result, many economists criticize the unrealistic assumptions of this classical theory of distribution. 

Formula

Here is the marginal productivity formula to calculate changes in production:

Marginal Productivity (MPn) = TPn – (TPn-1)

where TPn = Total factor productivity by “n” units of factor 

           TPn-1 = Total productivity by “n-1” units of factor.

One can use the following formula too to calculate it:

MP = ΔY / ΔX

Where ΔY is the change in output quantity resulting from input change. Y does not include external costs and benefits.

ΔX is the one-unit change in the firm’s input use,

Based on types, there are two more formulas for this classical theory:

Marginal revenue productivity (MRP) = MPP * MR

where MPP = Marginal physical productivity 

          MR = Marginal revenue

Value of Marginal Productivity (VMP) = MPP * AR

           AR = Average Revenue

Curve 

The tabular column given below represents the marginal productivity of labor:

In the given table, the producer increases the labor units gradually. During the initial stages, the wage rate of labor is $45. As the producer increases the number of laborers, the overall labor productivity decreases. At one point, the wage rate becomes equal to the marginal productivity of labor. If the firm continues to hire labor, it might make huge losses. 

The below graph shows the graphical representation of the marginal productivity graph:

In the marginal productivity graph, OQ is the number of factor units employed by the producer. In contrast, OP is the price paid to the factor. Therefore, the MRP curve declines as the producer hire more factor units (OQ2). If this continues, the firm will have a negative MRP curve.

At this point, the entrepreneur reduces the number of factor units to OQ1. In contrast, as the price of the factor increases to OP1, the additional productivity is the highest (i.e., CQ). Therefore, the producer needs to hire the right unit of the factor of production to achieve maximum productivity as close as possible to the factor price.  

Marginal Productivity And Total Productivity Relationship

Economists can explain the relationship in 3 phases. They are the following:

  • Marginal product rises when the quantity of variable input increases as the total product rises at an increasing rate.As firms employ greater quantities of variable inputs, the total product rises at a diminishing rate. In this case, the marginal product starts to fall.When the total product reaches its maximum, it starts to fall, the marginal product becomes zero, and it further becomes negative.

Examples 

Let us look at the marginal productivity examples to understand it better:

Example #1

Let us assume Stevie is the owner of the Grains and Sons Co. In a few months, their product demand has increased massively. So, Stevie decides to hire more land to increase its production. Stevie used to pay $2.6 million for 2000 square feet of land. At this point, the productivity margin was the highest. So, later on, Stevie hired more acres of land.

This decision resulted in increased units of labor and land. But the overall productivity declined drastically. In addition, the firm’s profits had also decreased due to the decision. As a result, he reduced the number of factor units to equal the price of each factor unit. 

Example #2

In New Zealand, Hastings District Council and Hawke’s Bay Regional Council conducted a meeting on August 9, 2022. The main idea of this meeting was to discuss the impact of soil on additional productivity. Soil scientist Keith Vincent discussed how land and climate had enhanced Hawke’s Bay’s land. In addition, certain land management techniques have increased productivity.

This article has been a guide to What is Marginal Productivity & its meaning. Here, we explain its theory, formula, and curve with examples. You can learn more about it from the following articles –

According to this law, increasing a factor unit decreases productivity margin after a certain point. Therefore, producers use this law when they want to increase production and profitability. 

Yes, the factor pricing curve can turn negative if the producer keeps increasing the factors. If the number rises to the extent that marginal cost exceeds marginal revenue. 

When one additional unit increase in capital leads to an increase in the overall output, it is known as the marginal productivity of capital. 

Various reasons decrease a firm’s overall productivity. The primary reason includes excess units of factors that lead to an increase in the marginal cost. Similarly, the firm’s profits decrease as they pay an extra marginal rate to the factor units. 

  • Production FunctionMarginal Rate of SubstitutionMarginal Product of Capital