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The value of marginal product (VMP) affects the labor market because it sets the wages that will be paid to various workers. The VMP can be defined as the amount of revenue that a firm gets by using the last unit of an input. Labor is one such input. The last unit of labor done has a certain value for the firm. That value is the VMP. According to economic theory, the VMP will end up equaling the worker’s wage. An increase in VMP will mean an increase in wages and a decrease in VMP will mean a decrease in compensation.
It is argued that the VMP should be equal to the employee wages because the two are interactive; VMP is based on the increased value that each employee contributes to the product. Since no worker can be guaranteed to contribute X product or Y value to the VMP, this is an unknown, and therefore volatile.
There are a variety of ways VMP can affect labor:
- If prices are set too high, demand for the product will drop, requiring a drop in labor.
- A similar effect will occur if the quality of the product does not match its price
- If one employee contributes significantly more to VMP than another, this will potentially upset the labor market within the company as it seeks more workers of a similar nature, or piles more responsibility on them, potentially driving them away.
The inverse of any of the above would drive an increase in labor demand.
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