Question

Define "marginal product". How is it calculated? How is it used?

Answer 1

The term “marginal” refers to small, incremental changes. A marginal product is the incremental change in output attributed to a change in any single input item. For example, marginal product may be the increased number of products produced with the addition of one extra worker on a production line. Marginal product increases may also be attributed to other input factors besides labor.

Calculations of Marginal Product

The formula for marginal product is that it equals the change in the total number of units produced divided by the change in a single variable input. For example, assume a production line makes 100 toy cars in an hour and the company adds a new machine to the line. Now the line produces 500 toy cars in one hour. The change in the total number of units produced is 400. That’s the difference between the 500 toys the production line now makes versus the 100 toys it used to make. This was accomplished by the addition of one machine, so the marginal product is 400 divided by 1, or 400. Similarly, a restaurant makes 15 pizzas with four workers. Adding two more people allows the restaurant to make 30 pizzas. The marginal product is 7.5, or 15 additional pizzas divided by the two additional employees hired.

The Law of Diminishing Returns

The pizza restaurant example suggests that each additional worker added to the staff resulted in 7.5 additional pizzas ready to sell. So theoretically, adding 10 more workers should make 75 more pizzas available to the restaurant’s customers. However, the real world seldom follows theory that closely. Space in the kitchen might not allow that many additional workers. Perhaps the restaurant cannot procure or set up enough ingredients quickly enough to make all those pizzas, or any number of other factors can adversely affect how many pizzas are actually produced by more workers. When additions to marginal product slow and eventually turn negative, economists refer to the event as a diminishing return. More people or more of any production input no longer results in the same spike in output.

Maximizing Output

Companies may try adding employees or investing in new equipment as a means of raising output and then measure their success by examining the effect on marginal product. Thus, marginal product becomes a means of calculating whether their decisions brought about a successful conclusion. Other economic factors are also at play. For example, demand for a product might preclude whether adding more workers or more machinery results in decreasing marginal product or a diminishing return. In other words, it may be advantageous to add more pizza makers even if the additional workers result in fewer than 7.5 pizzas per worker.