Marginal Product of Capital

Article byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

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. At the same time, the other inputs are constant. It plays an important role for the company’s management because the decision for the different investments in the company are taken after comparing the marginal product of the capital arrived with the respective cost of capital.

Key Takeaways

  1. The term “marginal product of capital” describes the difference in the company’s output when a new capital unit is used.
  2. Marginal product of capital enables the company to gauge the impact of each additional unit on its production levels.
  3. Sometimes, the marginal product of capital also leads to unrealistic assumptions that lead to the stagnant output.

Marginal Product of Capital Formula

The formula for the calculation of the marginal productMarginal ProductThe marginal product formula can be ascertained by calculating the change in production level and then dividing the same by the difference in the factor of production. In most cases, the denominator is 1, based on every 1 unit of increment in an aspect of production.read more of capital is as follows:

Marginal Product of Capital (MPK) = Change in Total Output / Change in Capital

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.

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Example of Marginal Product of Capital

Let’s take an example.

Company A ltd. manufactures and sells 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 company’s management 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. Next, calculate the marginal product of the capital.

Solution:

In the present scenario, the production of the units per month by the company 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 introducing additional capital of $50,000 to purchase the new machinery. So, the change in the company’s capital comes to $50,000.

Now, the marginal product of the capital of the company will be calculated as follows:

Marginal Product of Capital Example 1.0

Marginal Product of Capital (MPK) = 50,000 / 50,000 = 1

By this, we can conclude that with the increase in the additional capital of $50,000, the company can 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 units of the capital on its production level.
  • With the help of the marginal product of capital, the management of the company will be able to decide whether it is worth introducing 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. The company should stop the investment of new capital.

Disadvantages of Marginal Product of Capital

Some disadvantages are as follows:

  • The marginal product of capital theory is based on certain unrealistic assumptions.
  • To derive the marginal product of the capital properly, other factors must be constant. If the other factors do not remain constant, the theory will probably not give the correct results and thus will be of no use.
Marginal-Product-of-Capital

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, in economics, the marginal product of the capital is a change in the company’s production output from employing the additional unit of the capital.

It enables the company to know the effect of each of the additional units of capital on the level of its production and helps the company’s management decide whether it is worth introducing new capital in the business or not. This is because each of the additional dollars of the investment by the company would lead to an increase in the output. Still, 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 unrealistic assumptions. Also, other factors must be constant. If the other factors do not remain constant, the theory will probably not give the correct results to the users.

Frequently Asked Questions (FAQs)

What leads to an increase in the marginal product of capital?

It makes sense to boost production by adding capital when the marginal product of capital is larger than the cost of capital. However, adding additional capital reduces the firm’s profit as soon as it drops below the cost of capital.

What is the marginal cost of capital?

The marginal cost of capital is the cost of generating an additional dollar of a fund through equity, loans, etc., The total rate of return is what it is.

What is marginal product?

An input’s marginal product is the output that results from adding one unit of input, such as labor, to the current combination of productive elements.

What is the shape of the marginal product of capital curve?

The marginal product curve slopes downward as production rises before falling or taking a U-shaped shape.

This has guided the marginal product of capital and its definition. Here we discuss the formula to calculate the marginal product of capital along with an example, advantages, and disadvantages. You can learn more from the following articles –

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