Marginal Revenue Product and Optimal Employment
Levels: An Illustration of Student Involvement
in the Classroom
Dr. Eugene Steadman, Jr.
Professor of Business Administration
Graduate & Professional Studies Program
Averett University, Danville, VA
7th Annual Economics Teaching Conference
New Orleans, Louisiana
October 27, 2011
Major Areas Covered
•
•
•
•
•
•
•
Law of Diminishing (Marginal) Returns (MP)
Specialization/Division of Work Tasks
Marginal Revenue (MR)
Marginal Revenue Product (MP X MR)
Marginal Costs (MC, or Marginal Labor Costs)
Optimal Employment Level(s)
Minimum Wage Increase & Impact on
Employment Level
• Illegal Immigration Impact on Employment Level
• Efficiency Wages…and Minimum Wage Debate
A Suggestion to Achieve Better Student Learning Outcomes:
Involve Them in the Decision Process
• Put them to work in a hypothetical business:
making holiday wreaths
• Involves 10 distinct work tasks, from cutting on a
basic wire/metal bending machine, to painting
and drying the support structure, to mounting all
the ornaments, bows, pine cones, etc., to quality
control, to packing and shipping
Work Stations for
Holiday Wreath Manufacture
Arranging
Materials
Ship Final
Wreath to
Customer
Maintaining Machine
And Making Support
Structure
Packing
Painting and
Drying Support
Structure
Quality Control
Attaching Material
For Mounting
Decorations
Spray Reflective
Paint/Flecks on
Selected
Decorations
Green boughs,
Pine Cones
Nuts Added
Add Flowers
And Red Bows
Law of Diminishing Returns
Increasing Marginal Returns Up to Inflection Point – Increasing Slope of
Line (Pts A to B to C to D)
Decreasing Marginal Returns Past Inflection Point- Decreasing but
Positive Line Slope (Pts D to E to F to G to H)
Negative Marginal Returns Past Peak Point (H…to I, etc., line becomes
negative slope)
Daily Wreath Production as Function of Variable
Labor Input Factor
Number of Number of
Daily Wreath
Students
Machines
Output
0
1
0
1/Renee
1
6
2/Emily
1
14
3/David
1
24
4/Zack
1
32
5/Malika
1
37
6/Karl
1
39
7/Ron
1
38
8/Betty
1
35
Marginal Product
(MP)
0
6
8
10
8
5
2
-1
-3
Points: 1) students estimate daily wreath output levels, as fellow students are employed…Instructor
acts as facilitator, providing insights as needed
2) specialization of labor/division of tasks…is Emily more productive
than Renee, and David more productive than Emily? Why not hire 3
Davids, and get rid of Renee and Emily?
3) illustrates area of increasing returns (Renee, Emily and David), area of
diminishing returns (Zack, Malika, and Karl), and area of negative returns
(Ron, Betty)
4) important to emphasize that the “diminishing” occurs because the variable factor begins to
overwhelm the fixed factor, the machine…otherwise, every variable factor would keep
increasing its marginal product for adding several more students, but the machine has only so much capacity to produce
at the second work station
5) the number of machines is fixed at 1…but, this can be varied and is best illustrated using the “economies of scale”
concept
Holiday
Wreath
Costs
Holiday
Wreath Material
Material Costs
MP Order Quantities Av. Cost/Wreath($) Semi-Variable Material
Additional Material Costs
(Note 1)
(Note 2)
Costs @ Student MP ($) Per Student Hired ($)
0
0
0
0
0
6
1-10
3.00
18.00 (x 6)
18.00
8
11-20
2.75
38.50 (x 14)
20.50
10
21-30
2.50
60.00 (x 24)
21.50
8
31-40
2.25
72.00 (x32)
12.00
5
Same
Same
83.25 (x37)
11.25
2
Same
Same
87.25 (x39)
4.00
-1
Same
Same
85.50 (x38)
-1.75
-3
Same
Same
78.75 (x35)
-6.75
Notes: (1) Quantity (purchasing) discounts allow lower material costs per unit as more wreaths are produced.
(2) Includes materials (e.g., berries, wire, paint) & electricity/power costs.
Marginal Revenue and Marginal Revenue
Product
Number of Marginal
Students
Product (MP)
0
0 wreaths
1/Renee
6
2/Emily
8
3/David
10
4/Zack
8
5/Malika
5
6/Karl
2
7/Ron
-1
8/Betty
-3
•
•
•
•
Marginal
Revenue (MR)*
$25/wreath
$25
$25
$25
$25
$25
$25
$25
$25
Daily Marginal Revenue
Add.Material Costs
Adjusted MRP, Less Total Profit/
Product = MP X MR = MRP ($) Per Student Hired ($) Material Costs ($)
Revenue ($)
0 X $25 = 0
0
0
0
6 X $25 = 150
18.00
132
132.00
8 X $25 = 200
20.50
179.50
311.50
10 X $25 = 250
21.50
228.50
540.00
8 X $25 = 200
12.00
188.00
728.00
5 X $25 = 125
11.25
113.75
841.75
2 X $25 = 50
4.00
46.00
887.75
-1 X $25 = -25
-1.75
-23.25
864.50
-3 X $25 = -75
-6.75
-68.25
796.25
*Price of holiday wreaths held constant at $25 each. Each additional wreath creates $25 of revenue/income to the company. {You could
reduce prices as a f (quantity) and illustrate principle}.
Even though marginal revenue product is decreasing in the area of diminishing returns, please note that the total revenue continues to
increase up to the point where negative returns begin
On the basis of just maximizing total revenue, how many students would you utilize? Answer is 6, where the total revenue is a
maximum (assumption is “free” or “volunteer” no-cost labor).
“Profit” is now $887.75 per day, or $213,060 per 240 days per year, for a worthy cause. Any more
or less student workers will lower my profit.
How Much Should We Pay Each Student
to Work, Per Hour?
• Adding the major variable cost, labor, assume we pay
each student the current federal minimum wage
of$7.25/hour, but no benefits, for 8 hrs/day
• How many students should we now hire?
• Use the basic rule: go to the point where your marginal
revenue product = your marginal cost. Then, you’ve
“squeezed” every penny of profit that you can get. Each
student up to that point will have “earned their keep”
(covered their employment costs, from the sale of their
marginal output produced in concert with the other
production factors)
• Will it be the same level of 6 as shown on the previous
chart?
Marginal
Marginal Revenue
Revenue Product
Product Compared
Compared to
to
Marginal Cost
Student Daily
Number Wreaths MP MR MRP Adj. MRP MC Total Revenue Total Labor Cost Total Profit Added Profit?
0
0
0 $25 $0
$0
$0
$0
$0
$0
None
1/Renee
6
6
25 150
132.00
58
$132.00
$58
$74
$ 74.00
2/Emily
14
8
25 200
179.50 58
$311.50
$116
$195.50
$121.50
3/David
24
10 25 250
228.50 58
$540.00
$174
$366.00
$170.50
4/Zack
32
8
25 200
188.00 58
$728.00
$232
$496.00
$130.00
5/Malika
37
5
25 125
113.75 58
$841.75
$290
$551.75
$ 55.75
6/Karl
39
2
25 50
46.00
58
$887.75
$348
$539.25
-$12.50
7/Ron
38
-1
25 -25
-23.25
58
$864.50
$406
$458.50
-$80.75
8/Betty
35
-3
25 -75
-68.25 58
$796.25
$464
$332.25
-$126.25
Question: How many students do you hire? Do we stay with the 6 workers
previously? Answer: Look at the additions to your profit…to maximize profit,
you go to the point where the lowest additional profit occurs, i.e., hire just 5
students now. The prior sixth student will now not be able to cover their wage
cost and will not be offered a paying job! (This is a 16.7% reduction in workers).
•
My profits are now at $551.75 per day, or $132,420 per 240 days per year. Any more or less
student workers will lower my profit.
Students Protest – They Now Want
Students Protest – They Now Want Benefits!
Benefits!
• Students now demand comprehensive health
care benefits, and a 401-K savings plan…costs
add up to another $40 per student per day
(about a 40% overhead factor with today’s
workforce)
• That means my student cost per day is now $58
labor + $40 overhead = $98 per day, per
student.
• How does that change my employment levels, if
at all?
Marginal
Revenue Product
Product Compared
Compared to
Marginal Revenue
to
New
NewMarginal
Marginal Costs
Cost
Student Adj. Marginal
Number Revenue Product ($)
0
0
1/Renee
132.00
2/Emily
179.50
3/David
228.50
4/Zack
188.00
5/Malika
113.75
6/Karl
46.00
7/Ron
-23.25
8/Betty
-68.25
New Marginal Total Labor
Cost ($)
Cost ($)
0
0
98
98
98
196
98
294
98
392
98
490
98
588
98
686
98
784
Added Profit?
($)
No
34
81.50
130.50
90.00
15.75
-52.00
-121.50
-166.25
Question: How many students do we hire now? Do we stay with the 5 students we
hired the last time? Yes, at 5 students we are still adding to our profits, but
at a lower amount per student due to the increased overhead costs.
•
My profits are now at $551.75 - $40 X 5 = $351.75 per day, or $84,420 per 240 days per year.
Any more or less student workers will decrease my profit.
What
Happens
If You Occurs
Minimum
Wage
Increase
Increase the Minimum Wage?
•
•
Assume Government Imposes a Higher Minimum Wage of $9.25/Hour ($74/day) + Benefits ($40/day)
Assuming all else remains equal (e.g., profit margin), what happens to the level of employment?
Number of
Students
0
1/Renee
2/Emily
3/David
4/Zack
5/Malika
6/Karl
Adj.
MRP($)
MC($)
0
0
132
114
179.50 114
228.50 114
188
114
113.75
114
46
114
Addition to Profits ($)
0
18.00
65.50
114.50
74.00
-0.25
-98.00
Outcome on Students
None
Renee gets a nice raise
Emily gets a nice raise
David gets a nice raise
Zack gets a nice raise
Malika loses her job!
No chance of ever hiring Karl (6),
Ron (7), or Betty (8)
•
Renee, Emily, David, and Zack all get nice pay raises, but our prior co-worker, Malika, loses her job.
•
This represents a 20% reduction in my workforce!
•
With 4 employees, my profits are now at $272 per day, or $65,280 per 240 days per year. Any more or less student workers
will decrease my profit.
•
As most economists realize but many students and the public at large do not, ceteris paribus, increases in the minimum wage level,
particularly in today’s fierce global competitive environment, will cause job losses, unless increases in productivity, either through other
offsetting costs (e.g., pay increases are offset by decreased benefit costs) or through increases in marginal productivity, are adequate to
keep the same number of workers.
•
This serves to illustrate why training and education to enhance employee skills and productivity are so important in today’s
economy.
Effect on Employment Levels from Illegal Immigration
•
What if we can lower wage costs by hiring illegal immigrants at just $5 per hour ($40/day) and no
benefits, but with the same ability to assemble holiday wreaths (i.e., same productivity), how many
(lower-wage) workers could you hire?
Worker/Student Adj.MRP($) MC($) Addition to Profit($)
0
0
0
0
1
132
40
92
2
179.50
40
139.50
3
228.50
40
188.50
4
188
40
148
5
113.75
40
73.75
6
46
40
6
7
-23.25
40
-63.25
8
-68.25
40
-108.25
•
•
•
Worker Impact
No workers, no revenue, no variable costs
Hire Don Jose
Hire Oxana Voicu
Hire Don Juan
Hire Chow Teng
Hire Dona Marilyn
Hire Patty O’Brien
Do not hire Roberto Giorio
Do not hire Dona Tracey
From the previous level of employment (4), I am able to increase my workforce by 50% (add two
new workers)! (The other, prior workers all leave and look for better jobs?)
For jobs requiring little to no training, this labor displacement can occur in many occupations
At 6 employees, my profits now are at $647.75 per day, or $155,460 per 240 days/year. Any more
or less immigrant workers will lower my profit.
Efficiency
Wages
&onQuestions
on in
Efficiency
Wages and
Questions
Whether Increases
Minimum Wage Levels Cause Unemployment
Minimum Wage Increases & Jobs
•
“Efficiency Wages” are increases in wages, usually designed to keep specific “high value” or
“critical” employees from leaving…so, in this instance, you have a special case of increased
wages with no job losses, ceteris paribus. But, from personal experience, this can be explained in
economic terms; i.e., the wage increase is “paid for” by more output/results, or higher quality
results that bring more value or profit to the company
•
As noted by Professors Baumol & Blinder in their 12th Edition of “Economics, Principles & Policy”
(2012, Cengage), on page 497 is a policy debate portal on whether the minimum wage causes
unemployment. This “debate” is based on work done in the 1990s by economists David Card and
Alan Krueger and covered in their book, “Myth and Measurement: The New Economics of the
Minimum Wage,” Princeton University Press, 1995. Their research is based on increases in the
minimum wage in New Jersey, Texas, and California fast-food restaurants (1992, 1991, and 1988,
respectively), all of which did not seem to reduce employment. Their research was the basis for
increases in the federal minimum wage under President Clinton in 1996, and to some extent for
the current minimum wage of $7.25/hour.
•
For the first point above, “efficiency wages” are generally geared to specialized expertise, and not
to the unskilled or lower skilled labor upon which the minimum wage argument is usually based
(as in this presentation). For the second point, the assumption of ceteris paribus, for me, is
violated. When wages increase and no job losses occur as a result, either profit margins are
reduced; or wage costs are added to the fast-food menu prices; or the higher wages draw
higher-skilled workers into the restaurant, thereby causing an increase in customer revenues to
cover the costs; or as stated previously, if the same number of employees are kept, perhaps other
benefit coverages are reduced. But, no matter, you cannot defy the economic fact that there is
“no free lunch.” And, for the labor demand curve, the law of diminishing marginal utility is intact?
SUMMARY
•
Involving students and “making it personal” serves to reinforce several key economic concepts
•
Relationship of marginal productivity, marginal revenue, marginal revenue product, and marginal
cost interrelationships, in a business setting with student employees, seems to work well in
achieving student learning outcomes. Test scores in this area show very good results!
•
“Eyes are opened” from the impact on employment levels from (unwarranted) increases in the
minimum wage and from illegal immigration
•
Easier to see, for a profit-driven company, why hiring/laying off actions, such as those shown in
the holiday wreath business, can and do occur
QUESTIONS?
Contact: eugene.steadman@averett.edu