Changes

Let’s start with this simple equation: Profits = Total revenue - Total cost. That’s easy enough.  Now let’s break it down, where P=Price, Q=Quantity, W=Wage, and L=Labor units:

Let’s start with this simple equation: Profits = Total revenue - Total cost. That’s easy enough.  Now let’s break it down, where P=Price, Q=Quantity, W=Wage, and L=Labor units:

:Profits = (P x Q) - (W x L) - other non-labor input costs

:Profits = (P x Q) - (W x L) - other non-labor input costs

Now suppose we add one more worker to our company.  We will have to pay him a wage of W, so the marginal factor cost of one more worker is W (assuming a competitive market).  What is his marginal benefit to our company?  It is P x MP.

Now suppose we add one more worker to our company.  We will have to pay him a wage of W, so the marginal factor cost of one more worker is W (assuming a competitive market).  What is his marginal benefit to our company?  It is P x MP.

When does a company hire that additional worker?  When the change in profit is greater than zero.  That occurs when (P x MP) > W.

When does a company hire that additional worker?  When the change in profit is greater than zero.  That occurs when (P x MP) > W.

Let’s apply this to an example.  Suppose a firm has a declining marginal product for each additional laborer hired, such that:

Example: suppose a firm has a declining marginal product for each additional laborer hired, such that:

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