Question

A profit-maximizing firm should keep on hiring labor as long as the marginal revenue product of labor is greater than the wage. True or False

Answer 1

Answer: TRUE. The marginal revenue product (MRP) also known as marginal value product of a labor is equal to the product of the marginal product of labor, MP (the increase in output from an increase in labor used) and the marginal revenue, MR (the increase in revenue from an increase in output): MRP = MP × MR. The theory states that for a profit-maximizing firm labors will be hired up to the point when the marginal revenue product is equal to the wage rate. If the marginal revenue brought by the laborer is less than the wage rate, then employing that laborer would cause a decrease in profit. This theory assumes that the expenditures on other factors remain unchanged.

Lets understand this with an example:

A Sports Apparel Company wants to know whether to hire another worker for producing more caps. If the extra worker can eventually produce 10 additional caps per day (MP), and each additional cap sells at the market for $5 (price of the product or marginal revenue), the MRP of the labor is $50. Holding other considerations constant, company will only hire an additional worker at wage rate of $50 per day only if he generates an additional revenue of $50 or more. Otherwise, it will take a loss.