Reply To: diminishing mrp and mpp


Entrepreneurs estimate the MRP of an input to determine what they are willing to pay to hire it. MRP is what is behind an entrepreneur’s demand for labor and other inputs. MRP is the contribution another unit of an input makes to an entrepreneur’s revenue. For example, if Tim Cook is considering hiring another engineer at Apple, he needs to estimate what that person’s labor will add to Apple’s revenue beyond what Apple’s revenue would be if the engineer was not hired. If the engineer’s MRP exceeds the market wages to hire him, then it will add to Apple’s net income to so so. If the engineer’s MRP is less than the market wage to hire him, then he will not be hired.

MPP diminishes for adding more and more workers to a given set of complementary factors of production because of the fixed productive capacity of the complementary factors and the diversity of workers. If Apple posts a job opening and receives 100 applications, it will hire the most productive additional worker from the pool of applicants. If it wishes to expand its labor force further, it will have to hire less productive workers, in other words, workers from the same 100 applicants that it didn’t hire before. Moreover, as it expands its work force with a given set of complementary factors, the workers will eventually exhaust the productive capacity of the complementary factors of production. If Apple has an office complex designed for 1,000 workers to use and then it hires another 100 workers the office complex with be used less efficiently, e.g., shared offices, staggered work schedules, etc.

The reason why Apple is always hiring in the area of diminishing returns for labor is that to avoid doing so, it would have to invest in a much larger capital capacity such that adding workers to the bigger facility did not exhaust its productive capacity. But doing that means that Apple would have large excess capacity. It would have paid to build capacity that it cannot use. It’s more efficient to build smaller facilities and then duplicate them as they need arises. But that means, that entrepreneurs will always be in the diminishing marginal productivity area in the use of their variable inputs.