The marginal product of labor is an economic measurement of what happens when a company adds an additional worker to its operations. Most companies measure the productivity of their employees, and when forecasting future sales goals, the company looks at what will happen when an additional worker is added to the workforce. In economic terms, marginal revenue should increase by at least an equal amount. If marginal revenue does not rise and marginal costs increase, the additional labor is not a good investment.
Companies have an interest to measure their economic productivity from labor, as this expense is typically the highest cost of doing business. Marginal revenue and marginal cost calculations are common economic tools to determine at what point a company should stop increasing its production output. This concept falls under the economic theory known as an economy of scale. Companies achieving an economy of scale have lowered their production costs to a point where they achieve maximum revenue.
Breaking down revenues and costs into marginal units provide a micro-economic scale for wealth measurement. One individual worker can add significant costs outside of her stated wage, including training costs, benefits, background checks, additional workspace, and other costs, all of which must be accounted for in economic terms. When reviewing the marginal product of labor, the assumption is that all other factors remain constant. Labor cost is variable, meaning that producing more units will increase costs above the previous level experienced by the company.
A basic calculation for this measurement is that each worker can produce five widgets per hour. Therefore, adding one additional worker increases production output by five widgets per hour, which is the marginal product of labor. Adding more than one worker may result in fewer total units produced each hour, however. For example, adding two workers may only result in eight more widgets produced rather than ten. The reason for this phenomenon is that, holding all other factors constant, the company may not have the resources available or space needed to allow more workers to produce the maximum number of widgets.
When a company cannot maximize its marginal labor, a theory known as the law of diminishing returns will occur. This theory states that adding more workers will result in higher costs that the company cannot recoup through selling goods or services. Essentially, the marginal cost will exceed marginal revenue as discussed earlier, with additional workers continuing to add further marginal costs.