Value of Marginal Product - Explained
What is the Value of Marginal Product
Written by Jason Gordon
Updated at July 1st, 2021
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Table of Contents
What is the Value of Marginal Product (VMP)?A Little More on What is the Value of Marginal ProductAcademic Research on the Value of Marginal Product (VMP)What is the Value of Marginal Product (VMP)?
The Value of Marginal Product (VMP) calculates the amount of a firm's revenue that a unit of productive output contributes. VMP helps to prevent labor exploitation in industries.
The Value of Marginal Product is a calculation derived by multiplying the marginal physical product by the average revenue or the price of the product. More simply, the formula for calculating VMP is:
- Physical Product x Sales Price of the Product.
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A Little More on What is the Value of Marginal Product
The definition of major terms that appear in the calculation of the value marginal product is crucial to the understanding of the term. Here are the terms that are important in VMP and their definition;
- Marginal Revenue - this is an increase in total revenue generated by increase in production. Marginal revenue can be generated by producing one more unit of output or selling an additional unit of a good.
- Marginal Product - this refers to the change in output as a result of additional labor or units.
- Value Marginal Product (VMP) - this is marginal product or output multiplied by the product price.
- Marginal Revenue Product (MRP) - This is an increase in a firm's revenue resulting from adding one more resource unit is called the marginal product.
As a result of the law of diminishing returns, marginal product and MRP will decline once more inputs are added. This is why many firms continue to use a variable input until it's MRP amounts to the cost of the unit.
In a bid to maximize profits, firms employ units of a resource of the MRP if the unit exceeds the firm's cost. If the divisibility of units is achievable, a firm with the production units (A, B, C) will experience these conditions;
- MRPa=Pa Pa (price of resource A)
- MRPb =Pb Pb (price of resource B)
- MRPc= Pc Pc (price of resource C)
Assuming that A = skilled labor and resource, B= Low-skilled labor, the relationship between MRP and demand in this case will be such that since skilled laborers are more productive than unskilled labor, firms will be willing to pay skilled laborers higher than unskilled laborers.
For instance, a firm can get more units by hiring skilled labors and less unit by hiring unskilled labors, hiring skilled labor will help in reducing 'per unit costs.'
Hence, this type of relationship exist between MRP and demand;
MRPa = MRPb = MRPcinan -------- -------- -------- Pa Pb Pc
Academic Research on the Value of Marginal Product (VMP)
- A model of dual labor markets when product demand is uncertain, Rebitzer, J. B., & Taylor, L. J. (1991). The Quarterly Journal of Economics, 106(4), 1373-1383.
- Managerial discretion and business behavior, Williamson, O. E. (1963). The American Economic Review, 53(5), 1032-1057.
- A reconsideration of the marginal productivity theory, Reder, M. W. (1947). Journal of Political Economy, 55(5), 450-458.
- CEO incentives and firm size, Baker, G. P., & Hall, B. J. (2004). Journal of Labor Economics, 22(4), 767-798.
- Managerial incentives and capital management, Holmstrom, B., & Costa, J. R. I. (1986). The Quarterly Journal of Economics, 101(4), 835-860.
- Incentive contracts and performance measurement, Baker, G. P. (1992). Journal of political Economy, 100(3), 598-614.
- Property rights, transaction costs, and X-efficiency: an essay in economic theory, De Alessi, L. (1983). The American economic review, 73(1), 64-81.
- Top-management-team tenure and organizational outcomes: The moderating role of managerial discretion, Finkelstein, S., & Hambrick, D. C. (1990). Administrative science quarterly, 484-503.
- Favoritism in organizations, Prendergast, C., & Topel, R. H. (1996). Journal of Political Economy, 104(5), 958-978.
- Expense preference and managerial control: The case of the banking firm, Hannan, T. H., & Mavinga, F. (1980). The Bell Journal of Economics, 671-682.
- A Framework For Organization Assessment, Van de Ven, A. H. (1976). Academy of management Review, 1(1), 64-78.
- The impact of subsidies on X-efficiency in LDC industry: theory and an empirical test, Martin, J. P., & Page, J. M. (1983). The Review of Economics and Statistics, 608-617.