The relationship between the marginal product of labor and the marginal cost helps determine whether it is worthwhile to produce additional products. The marginal product of labor refers to the number of products a company can manufacture if it hires more workers or assigns its current workers additional hours. The marginal cost refers to the amount it costs a company to produce each additional item.
Marginal Product of Labor
The marginal product of labor varies depending on the number of products a company is currently making. When the company doesn't have enough workers to use all of its equipment, an extra worker can produce many more items with its current equipment, so the marginal product of labor is high. If the company has more workers than available machines, it won't gain much by hiring additional employees, so the marginal product of labor is lower, which is known as the law of diminishing returns.
The marginal cost determines how much it costs to make each additional item. Marginal cost includes the marginal product of labor and the marginal cost of materials. The company may have to pay more money if it orders more materials, because its suppliers may only have the capacity to supply a small amount of raw materials at a low price and may have to pay its workers overtime or hire additional workers to provide more.
Marginal product of labor and marginal cost use different units. The marginal product of labor uses one labor unit, which does not have a specific definition. One definition of a labor unit is days worked, so a company can calculate the marginal product of labor as the number of products that all workers produce during one work day. Marginal cost is specific and refers to the amount it costs the company to produce one more inventory item.
As the marginal product of labor decreases, the marginal cost usually increases. If the company has to pay more money to each worker compared with the number of products that each worker makes, its labor cost for each item increases, so its cost to make each item will be higher. The marginal cost can only decrease when the marginal product of labor is falling if the company is spending less per item on additional materials than the extra amount that it is paying to its workers, which can happen if it gets a bulk purchase discount on materials.