Chapter 17 Colander Lecture
Marginal Revenue Productivity Theory of Labor
I. The Demand for Labor – the demand for labor is a derived demand –
derived from the good or service that labor produces.
The Graphics of the Demand Curve for Labor
DL = MRPL = MPL X P O
MRP -- the change in TR brought about by the employment of an
additional unit of labor over and above associated costs.
MP -- The change in output resulting from the employment of an
additional unit of labor.
Po -- the price of the output produced by labor
In the short-run, MRP is negatively sloped because the law of
diminishing returns sets in causing the marginal physical product (MP)
to fall as more resources are hired.
Problem: Fill-in the missing numbers below and then graph the MRPL which is
the same as the demand curve for labor. Use a large graph.
Quantity of Units of Marginal Price of MRP
Labor Hired Output p/h Product Product
1 10 $5
2 18 5
3 24 5
4 28 5
5 30 5
Changes (Shifts) in the Demand for Labor of the Firm
Causes of shifts –
1. Changes in the demand for the final product (Po)
2. Changes in productivity of the resource due to changes in technology
3. Changes in the price of other resources depending upon whether they
are substitute factors or complementary factors. The net effect
then will depend on which is stronger – the output effect vs. the
Example – How was the demand the labor of longshoremen
affected with the advent of containerized cargo?
II. Supply Curve of Labor –
The supply curve of labor is positively sloped reflecting the fact that
more workers will offer their labor for hire as the wage rates go up.
The intersection of the supply of labor and the demand for labor will
determine the wage rate in competitive markets.
In competitive markets each firm’s demand is such a small fraction of
the available supply of labor that they cannot influence market wages
by hiring more or less workers -- i.e. they are wage takers.
The graphics of the supply of labor in a competitive labor market -
Marginal Labor Cost (MLC) – The change in a firm’s total cost that
results from adding an additional worker to production.
MLC = TLC / in labor hired
Problem: Fill-in the numbers in the table below and plot the supply curve and
the MLC on your graph.
Wages per hour Quantity Hired TLC (W x Q) MLC
How are Wages Determined in a Competitive Labor Market?
The answer for labor markets is the same as for product markets.
This time the magic line is found by producing to the point where MRP
= MLC. The marginal benefit of hiring the last worker (MRP) is equal
to the marginal cost of doing so (MLC).
MRP = MLC (MB = MC)
Problem – find the magic line on your graph and determine the equilibrium
wage rate and employment level in this competitive model.
The Supply of Labor in a Monopsony Labor Market
In a monopsony market the firm must raise wages to attract
additional workers thus the MLC is not equal to the supply curve of
Problem: Fill-in the missing numbers below and graph both the MLC and
supply curves for labor on a new graph.
Wage per Hour Quantity Hired TLC MLC
Now plot the original labor demand curve from the competitive model and
locate the new magic line.
Q- What will be the new wage and how many workers will be hired?
Summary of MRP theory
MRP theory basically says that if markets are competitive (lots of
buyers and sellers of labor) that workers will end up receiving a wage
equal to their MRP, that is, their worth to the firm. Exploitation of
workers is not possible due to competitive pressures of other
On the other hand, if labor is faced with a monopsony buyer of labor,
labor will be paid a wage below their MRP as the employer will use the
lack of competition from other firms to keep wages down. If one firm
attempts to exploit a worker by paying a wage below their MRP, then a
competitor will step in to offer higher wages because they can make
an profit in do so (MRP>MLC) .
Some Criticisms of MRP Theory
1. Do firms even know what a worker’s MRP is? What part of Microsoft’s
success is due to Bill Gates?
2. MRP theory focuses on competitive labor markets when in fact many
markets have some degree of monopsony power and can force wages
below MRP so you can’t say that worker’s are paid what they are worth.
3. MRP theory in assuming that markets are competitive is also assuming
that racial or sexual discrimination do not exist, and that all players have
equal and perfect information about job openings and wages elsewhere,
that they can readily move to new jobs and so on. How often is this true?
For these reasons (and many more) we see vast differences between
the real world distribution of income and the income distribution that
MRP theory would predict. There are many factors that determine wages
and worker productivity is only one of them. MRP is only a rough
predicator of wages in many cases.