Understanding the marginal product of labor (MPL) is essential for optimizing the labor force and its business productivity. Marginal product of labor is defined as the change in the level of output when a new employee is hired, given that all else remains constant. Hiring an additional person is a large cost, and businesses should be sure that the additional unit of labor will result in significant productivity increases.
The MPL number is significant because it helps businesses to understand how an additional employee will impact the productivity of its workforce, whether it be negatively or positively. Understanding this concept helps guide strategic decisions on resource allocation, including labor, equipment and capital.
The Law of Diminishing Marginal Productivity
While knowing what marginal productivity is gained from the addition of another employee, it's also important to understand how marginal productivity differs for each additional new hire and the trend of each one in relation to productivity. Measuring the marginal product of labor for each new employee hired will illustrate the law of diminishing marginal productivity.
The law of diminishing marginal productivity, also known as the law of diminishing marginal returns, is an economic principle that states that increases on the input side of production will result in marginal increases in productivity. However, productivity will decrease with each additional input until actually resulting in negative productivity returns.
Essentially, each additional unit of labor is not equal - each additional person employed contributes slightly less to the productivity of the business than the previous hire, until an additional hire actually detracts from productivity, all else remaining equal. The same concept applies to other productivity inputs, such as machines and other equipment.
Take a small sticker business, for example. It may be owned by one person who designs, prints, packages, and mails out the stickers while also maintaining the website, taking care of legal duties and keeping track of expenses. Hiring an additional person would contribute greatly to the productivity of the company, because that new hire could take care of the website, legal duties and expense tracking while the owner focuses on producing and mailing stickers. Instead of the owner having to split their time between production and administrative duties, they may now focus only on production.
If a third person is hired, they will contribute slightly less to the productivity of the company than the initial hire, since the same amount work is now being divided over three people instead of two. This pattern of diminishing returns continues until a certain point where, depending on the company, an additional hire actually makes the company less productive. Where exactly this point is will vary based on the company, its size, and other variables.
We can see this concept in graph form. Up to the first inflection point in the graph, the marginal product of each additional unit of labor is slightly less than the one before, but still sizable and significant. After the inflection point marked as the point of diminishing returns, the marginal product of labor begins to significantly level off and each new employee hired contributes significantly less than the initial hires. This continues until the next inflection point marked as negative returns. At this point, any additional employee hired will result in a decrease to productivity.
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Note that this law applies where all else is constant. The most recent employees hired are not necessarily worse or better than the initial employees hired; rather, it is assumed that each employee has the same skill level and level of productivity.
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