The Demand for Labor and the Marginal Product of Labor

The marginal product of labor (MPL) is the increase in a firm’s revenues created by hiring an additional laborer.

A firm is willing to hire a worker when the worker increases the firm’s revenues more than the firm’s costs. Economists call the increase in revenue created by hiring an additional worker the marginal product of labor (MPL). The increase in costs created by hiring an additional worker is, for a competitive firm, simply the worker’s wage (including the cost of other compensation like health benefits). Thus, we can say that a firm is willing to hire a worker when the marginal product of labor is greater than the wage.

When the Miami Heat signed free agent LeBro James in 2010, they went from falling out of the playoffs in the first round to four consecutive Eastern Conference championships, including two NBA titles. Not only did the Heat win more games when they hired James (along with fellow free agent Chris Bosh), their attendance increased and they sold much more merchandise. In the long run, the value of their TV contract was higher too. When the Heat hired James, their revenues increased by a lot—LeBron James had a high marginal product—that’s why the Heat were willing to pay him more than $18 million a year. (Of course, the Heat aren’t the only ones who feel this way, so in 2014 the Cleveland Cavaliers were able to lure James away with a comparable financial package and the promise of better surrounding players, and that too was considered a good deal by virtually all commentators.)

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McDonald’s considers marginal product when the company hires people to keep its restaurants clean and in good running order. No one wants to eat in a restaurant that looks unclean so a cleaner restaurant increases profit. But how clean is clean enough? At some point, cleanliness costs more than it’s worth. Thus, to maximize profit, McDonald’s will hire janitors so long as the increase in revenue from hiring an additional janitor exceeds the janitor’s wage.

To make that more concrete, let’s consider the marginal product of labor as we vary the number of janitors, as in Table 18.1.

Table :

TABLE 18.1 The Marginal Product of Labor

Number of Janitors

Task

Marginal Product of Labor (MPL per hour)

One

Clean restrooms, once a day.

$35

Two

Empty trash.

$30

Three

Clean restrooms, second time in a day.

$24

Four

Wash floors.

$20

Five

Pick up outside trash.

$16

Six

Clean restrooms, third time in a day.

$12

Seven

Clean windows.

$11

Eight

Remove gum from the bottom of tables.

$8

You’ll notice a few things about these numbers. First, the marginal product of labor generally declines as more labor is hired. If there is one janitor, he or she will focus on the most important tasks so the marginal product of labor is high. As McDonald’s adds janitors, each subsequent janitor is assigned to a less important task so the marginal product of labor falls.

We can see from Table 18.1 that if McDonald’s hires three janitors, then the marginal product of labor (per hour) is $24. If McDonald’s hires four janitors, the marginal product of labor is $20, and so forth. But how many janitors will McDonald’s hire? That depends on the wage.

If a janitor’s wage is above $35 an hour, then McDonald’s will hire zero janitors. If the wage falls to, say, $32 an hour, McDonald’s will compare the additional revenues from hiring a janitor (the MPL), $35 an hour, to the cost of hiring the janitor, $32 an hour. Since the MPL is greater than the wage W, McDonald’s will make the hire. If the wage falls to $28, McDonald’s will hire a second janitor. If the wage falls to $22, McDonald’s will hire a third janitor and so forth.

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Notice that when the wage falls, McDonald’s hires more janitors and assigns them to less important tasks, so as the wage falls, so does the MPL. The wage and the marginal product of labor will always be very close together since McDonald’s will keep hiring workers so long as the MPL is greater than W.

If we know the marginal product of labor, we can derive the demand curve for labor. In Figure 18.1, for example, we show McDonald’s demand curve for janitors. From the figure and from Table 18.1, you can see that if the wage is $10, then McDonald’s will hire seven janitors.

The Marginal Product of Labor Determines a Firm’s Demand Curve for Labor The marginal product of the first janitor is $35. If the wage is above $35, McDonald’s will hire no janitors. If the wage falls to just below $35, McDonald’s will find it profitable to hire one janitor. The marginal product of the second janitor is $30. If the wage falls below $30, McDonald’s will hire its second janitor. If the wage falls below $24, McDonald’s will find it profitable to add a third janitor and so forth.

CHECK YOURSELF

Question 18.1

Why does the marginal product of labor fall as more workers are hired?

Of course, we still have not explained what determines the wage. To do that, we need to remember that many firms demand janitors, so the wage of janitors will be determined by the market demand and supply of janitors. But don’t worry, the market demand for janitors is very similar to McDonald’s demand for janitors. At a high wage, only some firms (and some consumers, such as the very wealthy) will demand janitors. As the wage falls, more and more firms will demand janitors and each firm will demand more janitors, as we saw with McDonald’s. Thus, the market demand for cleaners is downward-sloping, as usual.