What is the Marginal Product of Capital?
Marginal Product of capital refers to the change in the output produced by the company when an additional unit of the capital is employed while the other inputs are constant and it plays an important role for the management of the company because the decision with respect to the different investments in the company are taken after comparing the marginal product of the capital arrived with the respective cost of capital.
Marginal Product of Capital Formula
The formula for the calculation of the marginal product of capital is as follows:
Where,
- Change in Total Output = Change in the units produced by the company which is calculated by subtracting the level of old production from the level of the new production units.
- Change in Capital = Change in the capital of the company which is calculated by subtracting the previous amount of capital from the new amount of the capital.
Example of Marginal Product of Capital
Let’s take an example.
Company A ltd manufactures and sells the garments in the market. in recent months the company gained huge popularity in the market. The company is currently operating at its full capacity and manufacturing 100,000 units per month. Now the management wants to increase the production of the output in the company because of the expectation of the demand increase.
After a few days, the management of the company purchased new machinery for $ 50,000. This purchase of new machinery leads to an increase in the output produced by the company and the company is now able to produce 150,000 units per month. Calculate the marginal product of the capital.
Solution:
In the present scenario, the production of the units per month by the company per increased from the level of 100,000 to 150,000. so, the total change in output produced by the company comes to 50,000 units (150,000 – 100,000).
Also, this increase is possible only after the introduction of additional capital of $50,000 for the purchase of the new machinery. So, the change in the capital of the company comes to $50,000.
Now, the marginal product of the capital of the company will be calculated as follows:
Marginal Product of Capital (MPK) = 50,000 / 50,000 = 1
By this it can be concluded that with the increase in the additional capital of $50,000 company is able to increase the 50,000 units of its production and its marginal product of capital is 1.
Advantages of Marginal Product of Capital
The different advantages are as follows:
- It enables the company to know the effect of each of the additional unit of the capital on the level of its production.
- With the help of the marginal product of capital, the management of the company will be able to make the decision that whether it is worth to introduce new capital in the business i.e. if there is an increase in the level of production then the only company should deploy new capital and the point where the level of production starts decreasing with the additional capital, then the company should stop the investment of new capital.
Disadvantages of Marginal Product of Capital
Some disadvantages are as follows:
- The theory of the marginal product of capital is based on certain assumptions that are unrealistic in nature.
- In order to derive the marginal product of the capital in a proper manner, it is essential that other factors are constant and in case the other factors do not remain constant then probably the theory will not give the correct results and thus will be of no use.
Important Points
The different important points are as follows:
- It enables the company to know the effect of each of the additional unit of the capital on the level of its production.
- Each of the additional dollars of the investment by the company would lead to an increase in the output, but there will be a certain point where there will be no increase in the output and they will also start falling or the same may even become negative. This is known as the negative marginal productivity of the capital. In that case, if there is an increase in the level of production then the only company should deploy new capital, and the point where the level of production starts decreasing with the additional capital, then the company should stop the investment of new capital.
Conclusion
Thus it can be concluded that in economics marginal product of the capital is a change in the production output of the company from employing the additional unit of the capital.
It enables the company to know the effect of the each of the additional unit of the capital on the level of its production and help the management of the company is making the decision that whether it is worth to introduce new capital in the business or not because each of the additional dollars of the investment by the company would lead to the increase in the output, but there will be a certain point where there will be no increase in the output and they will also start falling or the same may even become negative.
However, It is based on certain assumptions that are unrealistic in nature, and also it is essential that other factors are constant and in case the other factors do not remain constant then probably the theory will not give the correct results to the users.
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