Understanding the Concept of Marginal Revenue Product

Running a profitable business takes a lot of careful planning. Every new change made in the functioning of a company, as part of business management, in terms of the resource or manufacturing process, affects the revenue and production.

Economics theory, which applies mathematics in evaluation of the performance of any company can provide you with a clear picture of how each small change affects the company output in the long run. The health of any company can be evaluated in terms of a mathematical equation, which balances resources on one side, with productivity on another.

A large part of applied economic theory is devoted to the study of 'Marginal Productivity Theory'. The concept of marginal revenue product (MRP) is related to this important theory, which studies the impact of small incremental changes in the business process, on the end product, quantified by revenue and profits.

MRP is the ratio of the total change in the revenue of a business to the relevant change in a business process variable. It is the ratio of marginal change in total revenue of a company, with any unit incremental change, made in any factor, which is part of the manufacturing process.

This may include an increase in the total working hours of the company, an increase in number of production machinery units or any other such variable. Thus, it provides a direct measure of the impact that each small change has on company output and revenue.

There are two more concepts, which are directly related to the concept of MRP. The first one is marginal revenue, which is known to be the total increment in the end revenue of a company, through an increase in the number of products manufactured.

The second one is marginal product, which is the fractional increase in total number of produced units, resulting from an increase in any one of the manufacturing process variables. MRP can also be defines as the direct product of Marginal Revenue (MR) and Marginal Product (MP) for the same change in an input variable.

A change in input, which creates a higher revenue product, is certainly more desirable than one which creates a lower one. This change may be an expansion of workforce, an increase in hours of work or any change in the manufacturing process.

When a manager has several choices in front of him, when introducing any change in the working of the company, a calculation of the MRP helps in choosing which one would be the best. Here is the formula.

Marginal Revenue Product = (Change in Total Revenue)/(Incremental Change in Input Variable) = MR (Marginal Revenue) x MP (Marginal Product) 

Suppose that a company buys new machinery, which increases its total production units from 100 to 150 and causes an increase in revenue, by as much as USD 1000. What will be the marginal revenue product for this incremental change? According to the above formula,

MRP = [USD 1000 x (150 - 100)] = [$1000 x 50] = $50,000 

After comparing the MRP for each of the several alternative changes in resources at hand, you can choose the one which increases the productivity substantially.