What Is Marginal Revenue Product (MRP)?
Let me explain what marginal revenue product, or MRP, really is. It's also known as the marginal value product, and it represents the marginal revenue you create by adding just one more unit of a resource. You calculate it by multiplying the marginal physical product (MPP) of that resource by the marginal revenue (MR) it generates. Remember, this assumes that your spending on other factors stays the same, and it's key for figuring out the best level of any resource in your operations.
Key Takeaways
- Marginal revenue product (MRP) is the marginal revenue created by using one additional unit of resource.
- MRP is used to make critical decisions on business production and determine the optimal level of a resource.
- The MRP assumes that the expenditures on other factors remain unchanged.
Understanding Marginal Revenue Product (MRP)
Economists like John Bates Clark and Knut Wicksell were the first to point out that revenue ties directly to the marginal productivity of extra production factors. As a business owner, you often turn to MRP analysis for making tough calls on production. Take a farmer deciding on buying another specialized tractor for wheat: if that tractor yields 3,000 more bushels (that's the MPP) and each bushel sells for $5 (the marginal revenue), then the MRP hits $15,000.
Keeping everything else constant, you'd only pay up to $15,000 for that tractor—anything more means a loss. Estimating these costs and revenues isn't easy, but if you nail MRP calculations, your business stands a better chance of thriving over competitors.
Special Considerations
MRP relies on marginal analysis, which is about how you make decisions incrementally, right on the edge. Say you buy a bottle of water for $1.50—that doesn't mean you value every bottle at that price; it's just that one more bottle is worth more than $1.50 to you at that moment. Marginal analysis focuses on these step-by-step costs and benefits, not the big picture.
Marginalism is a cornerstone in economics, leading to ideas like marginal productivity, costs, utility, and the law of diminishing returns. MRP plays a big role in setting wage rates too. It only makes sense to hire another worker at $15 an hour if their MRP exceeds that; otherwise, you're losing money.
In reality, workers get paid based on discounted marginal revenue product (DMRP), similar to discounted cash flow for stocks, because employers wait for revenue while workers get paid sooner. That discount gives employers a premium for the wait. DMRP influences bargaining power: if wages are below DMRP, workers can shop around; if above, employers might cut pay or staff. This pushes labor supply and demand toward equilibrium.
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