The marginal revenue product of labour is affected by many factors, including the physical productivity of labour, the wage rate and the demand for the product. The MPP of labour at first increases as more units of labour are added to the fixed factors. As a result of this the MRP will also be greater. Eventually, however, the law of diminishing laws of returns sets in and the addition of further workers results in a lower MPP, and therefore a reduction in the MRP. Since the MRP is the firm’s demand curve for labour, this explains why it is downward sloping after the onset of diminishing returns.
Another assumption is that the labour market is perfectly competitive so that no individual firm can affect the wage. In this case whenever the MRP is greater than the wage then it is profitable to increase the labour force. However if the wage were greater than the MRP then it would no longer be profitable to add extra workers. Extra workers will be employed so long as the MRP is greater than the wage, and the equilibrium level of employment is therefore where the two are equal. An increase in the wage rate will reduce the equilibrium level of employment, while a decrease in the wage rate will increase the equilibrium level of employment.
The demand for labour is a derived demand, influenced by the worker’s MRP and the price of the product sold in the market. An increase in demand for the product results in a higher price, and thus higher MR, shifting the MRP curve to the right (MRP to MRP1 in the first diagram). The firm will now employ more workers at any given wage rate. A decrease in demand for the product results in a lower price, and thus lower MR, shifting the MRP curve to the left (MRP3 to MRP2 in the second diagram). Similarly an increase in the productivity of all workers raises each worker’s MPP and thus causes the MRP curve to shift to the right (more workers employed at any given wage rate), while a decrease in the productivity of all workers reduces each worker’s MPP and causes the MRP curve to shift to the left (fewer workers employed at any given wage rate).
In conclusion the factors which affect the MRP are the productivity of workers, the wage rate and the demand for the product. Labour productivity is the most important factor; however the productivity of an individual worker is difficult to measure for employers especially when the output is a service, or where output is not marketed e.g. state education or health care.
