Dr. Eugene Steadman, Jr. Professor of Business Administration Graduate & Professional Studies Program Averett Univer

1. Marginal Revenue Product and Optimal Employment Levels: An Illustration of Student Involvement in the Classroom Dr. Eugene Steadman, Jr. Professor of Business Administration Graduate & Professional Studies Program Averett University, Danville, VA 7th Annual Economics Teaching Conference New Orleans, Louisiana October 27, 2011

2. Major Areas Covered • Law of Diminishing (Marginal) Returns (MP) • Specialization/Division of Work Tasks • Marginal Revenue (MR) • Marginal Revenue Product (MP X MR) • Marginal Costs (MC, or Marginal Labor Costs) • Optimal Employment Level(s) • Minimum Wage Increase & Impact on Employment Level • Illegal Immigration Impact on Employment Level • Efficiency Wages…and Minimum Wage Debate

3. A Suggestion to Achieve Better Student Learning Outcomes: Involve Them in the Decision Process • Put them to work in a hypothetical business: making holiday wreaths • Involves 10 distinct work tasks, from cutting on a basic wire/metal bending machine, to painting and drying the support structure, to mounting all the ornaments, bows, pine cones, etc., to quality control, to packing and shipping

4. Work Stations for Holiday Wreath Manufacture Maintaining Machine And Making Support Structure Arranging Materials Painting and Drying Support Structure Attaching Material For Mounting Decorations Green boughs, Pine Cones Nuts Added Ship Final Wreath to Customer Packing Quality Control Spray Reflective Paint/Flecks on Selected Decorations Add Flowers And Red Bows

5. Law of Diminishing Returns Increasing Marginal Returns Up to Inflection Point – Increasing Slope of Line (Pts A to B to C to D) Decreasing Marginal Returns Past Inflection Point- Decreasing but Positive Line Slope (Pts D to E to F to G to H) Negative Marginal Returns Past Peak Point (H…to I, etc., line becomes negative slope)

6. Daily Wreath Production as Function of Variable Labor Input Factor Number of Number of Daily Wreath Marginal Product StudentsMachinesOutput(MP) 0 1 0 0 1/Renee 1 6 6 2/Emily 1 14 8 3/David 1 24 10 4/Zack 1 32 8 5/Malika 1 37 5 6/Karl 1 39 2 7/Ron 1 38 -1 8/Betty 1 35 -3 Points: 1) students estimate daily wreath output levels, as fellow students are employed…Instructor acts as facilitator, providing insights as needed 2) specialization of labor/division oftasks…is Emily more productive than Renee, and David more productive than Emily? Why not hire 3 Davids, and get rid of Renee and Emily? 3) illustrates area of increasing returns (Renee, Emily and David), area of diminishing returns (Zack, Malika, and Karl), and area of negative returns (Ron, Betty) 4) important to emphasize that the “diminishing” occurs because the variable factor begins to overwhelm the fixed factor, the machine…otherwise, every variable factor would keep increasing its marginal product for adding several more students, but the machine has only so much capacity to produce at the second work station 5) the number of machines is fixed at 1…but, this can be varied and is best illustrated using the “economies of scale” concept

7. Holiday Wreath Material Costs Holiday Wreath Material Costs MPOrder QuantitiesAv. Cost/Wreath($)Semi-Variable MaterialAdditional Material Costs (Note 1)(Note 2)Costs @ Student MP ($)Per Student Hired ($) 0 0 0 0 0 6 1-10 3.00 18.00 (x 6) 18.00 8 11-20 2.75 38.50 (x 14) 20.50 10 21-30 2.50 60.00 (x 24) 21.50 8 31-40 2.25 72.00 (x32) 12.00 5 Same Same 83.25 (x37) 11.25 2 Same Same 87.25 (x39) 4.00 -1 Same Same 85.50 (x38) -1.75 -3 Same Same 78.75 (x35) -6.75 Notes: (1) Quantity (purchasing) discounts allow lower material costs per unit as more wreaths are produced. (2) Includes materials (e.g., berries, wire, paint) & electricity/power costs.

8. Marginal Revenue and Marginal Revenue Product Marginal Revenue and Marginal Revenue Product Number of Marginal Marginal Daily Marginal Revenue Add.Material Costs Adjusted MRP, Less Total Profit/ StudentsProduct (MP)Revenue (MR)*Product = MP X MR = MRP ($)Per Student Hired ($)Material Costs ($)Revenue ($) 0 0 wreaths $25/wreath 0 X $25 = 0 0 0 0 1/Renee 6 $25 6 X $25 = 150 18.00 132 132.00 2/Emily 8 $25 8 X $25 = 200 20.50 179.50 311.50 3/David 10 $25 10 X $25 = 250 21.50 228.50 540.00 4/Zack 8 $25 8 X $25 = 200 12.00 188.00 728.00 5/Malika 5 $25 5 X $25 = 125 11.25 113.75 841.75 6/Karl 2 $25 2 X $25 = 50 4.00 46.00 887.75 7/Ron -1 $25 -1 X $25 = -25 -1.75 -23.25 864.50 8/Betty -3 $25 -3 X $25 = -75 -6.75 -68.25 796.25 • *Price of holiday wreaths held constant at $25 each. Each additional wreath creates $25 of revenue/income to the company. {You could reduce prices as a f (quantity) and illustrate principle}. • Even though marginal revenue product is decreasing in the area of diminishing returns, please note that the total revenue continues to increase up to the point where negative returns begin • On the basis of just maximizing total revenue, how many students would you utilize? Answer is 6, where the total revenue is a maximum (assumption is “free” or “volunteer” no-cost labor). • “Profit” is now $887.75 per day, or $213,060 per 240 days per year, for a worthy cause. Any more or less student workers will lower my profit.

9. How Much Should We Pay Each Student to Work, Per Hour? • Adding the major variable cost, labor, assume we pay each student the current federal minimum wage of$7.25/hour, but no benefits, for 8 hrs/day • How many students should we now hire? • Use the basic rule: go to the point where your marginal revenue product = your marginal cost. Then, you’ve “squeezed” every penny of profit that you can get. Each student up to that point will have “earned their keep” (covered their employment costs, from the sale of their marginal output produced in concert with the other production factors) • Will it be the same level of 6 as shown on the previous chart?

10. Marginal Revenue Product Compared to Marginal Cost Marginal Revenue Product Compared to Marginal Cost Student Daily NumberWreathsMPMRMRPAdj. MRPMCTotal RevenueTotal Labor CostTotal ProfitAdded Profit? 0 0 0 $25 $0 $ 0 $0 $0 $0 $0 None 1/Renee 6 6 25 150 132.00 58 $132.00 $58 $74 $ 74.00 2/Emily 14 8 25 200 179.50 58 $311.50 $116 $195.50 $121.50 3/David 24 10 25 250 228.50 58 $540.00 $174 $366.00 $170.50 4/Zack 32 8 25 200 188.00 58 $728.00 $232 $496.00 $130.00 5/Malika 37 5 25 125 113.75 58 $841.75 $290 $551.75 $ 55.75 6/Karl 39 2 25 50 46.0058 $887.75 $348 $539.25 -$12.50 7/Ron 38 -1 25 -25 -23.25 58 $864.50 $406 $458.50 -$80.75 8/Betty 35 -3 25 -75 -68.25 58 $796.25 $464 $332.25 -$126.25 Question: How many students do you hire?Do we stay with the 6 workers previously? Answer: Look at the additions to your profit…to maximize profit, you go to the point where the lowest additional profit occurs, i.e., hire just 5 students now. The prior sixth student will now not be able to cover their wage cost and will not be offered a paying job! (This is a 16.7% reduction in workers). • My profits are now at $551.75 per day, or $132,420 per 240 days per year. Any more or less student workers will lower my profit.

11. Students Protest – They Now Want Benefits! Students Protest – They Now Want Benefits! • Students now demand comprehensive health care benefits, and a 401-K savings plan…costs add up to another $40 per student per day (about a 40% overhead factor with today’s workforce) • That means my student cost per day is now $58 labor + $40 overhead = $98 per day, per student. • How does that change my employment levels, if at all?

12. Marginal Revenue Product Compared to New Marginal Costs Marginal Revenue Product Compared to New Marginal Cost Student Adj. Marginal New Marginal Total Labor Added Profit? NumberRevenue Product ($) Cost ($) Cost ($)($) 0 0 0 0 No 1/Renee 132.00 98 98 34 2/Emily 179.50 98 196 81.50 3/David 228.50 98 294 130.50 4/Zack 188.00 98 392 90.00 5/Malika 113.7598 490 15.75 6/Karl 46.0098 588 -52.00 7/Ron -23.25 98 686 -121.50 8/Betty -68.25 98 784 -166.25 Question: How many students do we hire now? Do we stay with the 5 students we hired the last time? Yes, at 5 students we are still adding to our profits, but at a lower amount per student due to the increased overhead costs. • My profits are now at $551.75 - $40 X 5 = $351.75 per day, or $84,420 per 240 days per year. Any more or less student workers will decrease my profit.

13. Minimum Wage Increase Occurs What Happens If You Increase the Minimum Wage? • Assume Government Imposes a Higher Minimum Wage of $9.25/Hour ($74/day) + Benefits ($40/day) • Assuming all else remains equal (e.g., profit margin), what happens to the level of employment? Number ofAdj. StudentsMRP($)MC($)Addition to Profits ($)Outcome on Students 0 0 0 0 None 1/Renee 132 114 18.00 Renee gets a nice raise 2/Emily 179.50 114 65.50 Emily gets a nice raise 3/David 228.50 114 114.50 David gets a nice raise 4/Zack 188114 74.00 Zack gets a nice raise 5/Malika 113.75114 -0.25 Malika loses her job! 6/Karl 46 114 -98.00 No chance of ever hiring Karl (6), Ron (7), or Betty (8) • Renee, Emily, David, and Zack all get nice pay raises, but our prior co-worker, Malika, loses her job. • This represents a 20% reduction in my workforce! • With 4 employees, my profits are now at $272 per day, or $65,280 per 240 days per year. Any more or less student workers will decrease my profit. • As most economists realize but many students and the public at large do not, ceteris paribus, increases in the minimum wage level, particularly in today’s fierce global competitive environment, will cause job losses, unless increases in productivity, either through other offsetting costs (e.g., pay increases are offset by decreased benefit costs) or through increases in marginal productivity, are adequate to keep the same number of workers. • This serves to illustrate why training and education to enhance employee skills and productivity are so important in today’s economy.

14. Effect on Employment Levels from Illegal Immigration • What if we can lower wage costs by hiring illegal immigrants at just $5 per hour ($40/day) and no benefits, but with the same ability to assemble holiday wreaths (i.e., same productivity), how many (lower-wage) workers could you hire? Worker/StudentAdj.MRP($)MC($)Addition to Profit($)Worker Impact 0 0 0 0 No workers, no revenue, no variable costs 1 132 40 92 Hire Don Jose 2 179.50 40 139.50 Hire Oxana Voicu 3 228.50 40 188.50 Hire Don Juan 4 188 40 148 Hire Chow Teng 5 113.75 40 73.75 Hire Dona Marilyn 6 46 40 6 Hire Patty O’Brien 7 -23.25 40 -63.25 Do not hire Roberto Giorio 8 -68.25 40 -108.25 Do not hire Dona Tracey • From the previous level of employment (4), I am able to increase my workforce by 50% (add two new workers)! (The other, prior workers all leave and look for better jobs?) • For jobs requiring little to no training, this labor displacement can occur in many occupations • At 6 employees, my profits now are at $647.75 per day, or $155,460 per 240 days/year. Any more or less immigrant workers will lower my profit.

15. Efficiency Wages & Questions onMinimum Wage Increases & Jobs Efficiency Wages and Questions on Whether Increases in Minimum Wage Levels Cause Unemployment • “Efficiency Wages” are increases in wages, usually designed to keep specific “high value” or “critical” employees from leaving…so, in this instance, you have a special case of increased wages with no job losses, ceterisparibus. But, from personal experience, this can be explained in economic terms; i.e., the wage increase is “paid for” by more output/results, or higher quality results that bring more value or profit to the company • As noted by Professors Baumol & Blinder in their 12th Edition of “Economics, Principles & Policy” (2012, Cengage), on page 497 is a policy debate portal on whether the minimum wage causes unemployment. This “debate” is based on work done in the 1990s by economists David Card and Alan Krueger and covered in their book, “Myth and Measurement: The New Economics of the Minimum Wage,” Princeton University Press, 1995. Their research is based on increases in the minimum wage in New Jersey, Texas, and California fast-food restaurants (1992, 1991, and 1988, respectively), all of which did not seem to reduce employment. Their research was the basis for increases in the federal minimum wage under President Clinton in 1996, and to some extent for the current minimum wage of $7.25/hour. • For the first point above, “efficiency wages” are generally geared to specialized expertise, and not to the unskilled or lower skilled labor upon which the minimum wage argument is usually based (as in this presentation). For the second point, the assumption of ceteris paribus, for me, is violated. When wages increase and no job losses occur as a result, either profit margins are reduced; or wage costs are added to the fast-food menu prices; or the higher wages draw higher-skilled workers into the restaurant, thereby causing an increase in customer revenues to cover the costs; or as stated previously, if the same number of employees are kept, perhaps other benefit coverages are reduced. But, no matter, you cannot defy the economic fact that there is “no free lunch.” And, for the labor demand curve, the law of diminishing marginal utility is intact?

16. SUMMARY • Involving students and “making it personal” serves to reinforce several key economic concepts • Relationship of marginal productivity, marginal revenue, marginal revenue product, and marginal cost interrelationships, in a business setting with student employees, seems to work well in achieving student learning outcomes. Test scores in this area show very good results! • “Eyes are opened” from the impact on employment levels from (unwarranted) increases in the minimum wage and from illegal immigration • Easier to see, for a profit-driven company, why hiring/laying off actions, such as those shown in the holiday wreath business, can and do occur QUESTIONS? Contact: eugene.steadman@averett.edu