8.3.4—MRP theory

Marginal revenue product (MRP) is the additional revenue created by one more worker: MRP = marginal physical product × marginal revenue. A firm hires labour up to the point where MRP equals the wage in a competitive labour market.

Because marginal physical product often falls as more labour uses fixed inputs, MRP can slope downward. The relevant revenue may be product price for a price-taking firm or marginal revenue for a price-setting firm.

If the next worker adds 6 units and each unit adds $8 of revenue, MRP is$48. Hiring is profitable when the wage is below $48, subject to other costs and constraints.

MRP is not just physical productivity, and the wage is not always equal to MRP if the firm has labour-market power.