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How Resource Prices are
Determined: Marginal Product
Theory
Marginal Productivity Theory is the heart of the factor market
unit. You must master the details of marginal productivity and
complex terminology such as marginal physical product (MPP),
marginal revenue product (MRP), marginal resource cost (MRC),
and the MRP = MRC rule before you can grasp the main
concepts. Furthermore, you must understand that the demand
for a resource is derived from the demand for the goods and the
services produced by that resource. Finally, you must
understand how a firm hires resources when more than one
resource is involved. The material covered in activities 44-47 is
the most emphasized factor market questions on the AP Exam.
The visual below describes how many workers a firm will
hire if it is perfectly competitive in both the resource market
and the factor market.
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What is marginal physical product?
Answer: the resulting rate of change in a
firms output as a result of employing one
extra unit of a factor of production for
example labor
Why does marginal physical product decline
as input increases?
Answer: because of law of diminishing
marginal returns
What is marginal revenue product?
Answer: the change in total revenue
resulting from a unit change in a variable
input, keeping all other inputs unchanged.
How is marginal revenue product
calculated?
Answer: by dividing the change in total
revenue by the change in the variable input.
Why does marginal revenue product decline
as input increases?
Answer:
Profit Maximizing Rule for
Employing Resources
MRP = MRC
Marginal Revenue Product = Marginal Resource Cost
The Visual below shows how a firm maximizes profits if it is
a perfect competitor in the resource market but sells in an
imperfectly competitive market.
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What is the evidence that this is an
imperfectly competitive product
market?
Answer:
Why does the MRP of the imperfectly
competitive firm fall more rapidly than
the MRP of the perfect competitor?
Answer:
What are the implications of this?
Answer:
The Visual below shows how a firm maximizes profits if it is a perfect competitor in the
resource market but sells in an imperfectly competitive market.
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How many workers would be hired if
the wage were:
$13.95 one worker
Answer:
$11.95 two workers
Answer:
$9.95 two workers
Answer:
$7.95 three workers
Answer:
Given the same costs, what can we
conclude about workers hired in
perfectly competitive markets
compared with imperfectly
competitive product markets?
Answer: More workers will be hired
under perfectly competitive product
markets.
Activity 44
Activity 45
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Why is MRP downward sloping?
Answer:
What are the factors that can shift the demand for a
resource?
A. Change in product price
B. Change in productivity
C. Changes in the price of substitute or complimentary
resource depending on the substitution effect or output
effect.
What are the determinants of elasticity of resource
demand?
Answer: Rate of MRP decline, elasticity of product
demand, ease of resource substitutability, the proportion
of total costs that the resource represents.
Activity 46
Key Points:
 A monopoly firm will
hire fewer workers
than a perfectly
competitive firm.
 These examples
compare monopoly
and perfectly
competitive firms in the
product markets even
though the analysis is
in the factor markets.
Activity 47