What’s it: Marginal product refers to the additional output produced when a firm uses one additional input unit, assuming the other inputs are constant. Another term for the marginal product is a marginal return or marginal productivity.
How to calculate marginal product
To calculate the marginal product, you divide the change in total output by the change in input. In this case, you must choose one input variable as the denominator, whether it be labor or capital. The following is the marginal product formula:
Marginal product = Change in output / Change in quantity of input
If you focus on the labor input, the denominator in the above formula is the number of workers. Specifically, we call the result of the marginal product of labor.
Meanwhile, if the denominator is the change in capital, we call it the marginal product of capital.
I will take a simple example. For example, the company increased its production from 1,000,000 units to 1,200,000 units in line with strong demand. To do so, the company increased its employees from 1,000 workers to 1,500 workers. From this data, the marginal product of labor is 400 = (1,200,000-1,000,000) / (1,500-1,000).
The relationship between marginal product and the total output
The marginal product can be equal to zero, positive (more than 0), or negative. Each has an influence on the company’s total output. For ease of explanation, I assume the input is labor. Here is the data:
|Labor||% change in labor||Total output||% change in total output|
Increasing marginal product
An increasing marginal product is when the marginal product’s value is positive and increases when it adds input. For example, from the table above, the company posted increasing returns until the number of workers was three.
When the marginal return is positive and increases, total output grows at a higher percentage of the input increase. It shows you that the extra unit of input produces a higher output than the previous input. It occurs because the company derives significant benefits from teamwork or task specialization.
Decreasing marginal product
Decreasing marginal product occurs when the marginal product is positive, but at a decreasing rate of growth. The extra input unit produces less output than the previous input.
In this situation, the total output is still growing. However, the percentage increase in output is lower than the percentage increase in input. In the table above, it occurs in the workforce range of 4-9 people.
Another term for decreasing marginal product is diminishing the marginal product, decreasing marginal return.
Constant marginal product
Constant marginal product occurs when an increase in output equals an increase in input. The addition of one labor produces 1 additional unit of output.
Zero marginal product
Zero marginal product occurs when adding an input does not result in an increase in output. This is the optimum point.
Before this point, the firm can still increase the total output by adding more inputs. However, once it reaches this point, increasing input will only decrease total output.
In the table above, this point is reached when the company has 10 workers, and the total output is 195 units.
Negative marginal product
After reaching the zero marginal product, adding input will only decrease total output. From the table, when the company adds one worker and becomes 11 people, the total output actually decreases by 5 units, from 195 units to 190 units. Inefficiency and disorganization are the two causes of this reduction in output.
The relationship of marginal product to marginal cost
Marginal cost is the extra cost that the firm bears when it uses one more input. It has a negative relationship with marginal returns. The graph below shows the relationship between marginal cost and marginal product:
- When marginal return increases, the marginal cost falls. Producers face economies of scale because they can spread total fixed costs to a more massive output.
- When the marginal return reaches a maximum, the marginal cost reaches the minimum.
- When the marginal return falls, the marginal cost increases. Diseconomies scale occurs. For example, when manufacturers recruit more workforce, employees find themselves wasting time waiting to operate machines.
Why is the marginal product concept important in economics?
Marginal product is important for measuring company productivity and production efficiency. For example, a company can use it to decide whether employees’ addition will increase their revenue? Is the current number of employees less optimal? In their calculations, they might replace total output with total revenue as the numerator.
Although coming from microeconomic concepts, marginal returns are also an important concept when you study macroeconomics. One of them is explaining the economic production function to estimate long-run aggregate supply (potential GDP).
Economists use it to answer why increasing the stock of capital (to increase the capital-labor ratio) does not necessarily sustain long-term economic growth.
Since the marginal products of labor and capital decrease, the only source for achieving a sustainable economic growth rate is increased total factor productivity, which economists refer to as technological progress.
The difference in the scale of returns and marginal returns
The return to scale is different from the marginal product, and no direct relationship between the two.
The return scale describes how the output changes as all the inputs change. However, the marginal return tells you how output changes when one input changes, assuming the other input is constant.
In particular, production increases the scale of returns even though each input’s marginal product decreases as more inputs are used.