Tuesday, December 14, 2010


There are certain economic principles that both previous students of Economics in the university and those who did not take the subject do not realize, that we are actually using those principles. One such principle is:

Firm profit is maximum at MR = MC .

Marginal Revenue is equal to Marginal Cost.

A particular entrepreneur has only 5 employees, not 4, not 6, not 10, etc. Why? Because in his calculations, having exactly 5 employees maximize his profit although he may not be using the "MR = MC" formula in his head.

If he will have only 4 employees, MR > MC, revenue can still be increased and profit can still be maximized by hiring another employee. But with 6 employees or more, MR < MC, the marginal cost per additional employee is larger than the marginal benefit of hiring that additional employee.

Business and ordinary personal decisions thrive on marginal analysis, the use or non-use of "extra" or marginal resource to attain a particular objective.

A friend commented that there could be "additional pros and cons surplus to be realized past MR = MC especially if the demand curve is not infinitely elastic, and that welfare economics may have something to add to it."

The "profit is maximum when MR = MC" postulation is applied in microecon and firm behavior, not much on macro and the whole economy and thus, not directly intended for societal welfare analysis. But I think there should be micro welfare implications there.

Continued innovation and firm or industry level training and retrainings should help raise MR per employee. As MR keeps rising, there is more leeway for the firm to expand hiring (which reduces unemployment and poverty) until MR equalizes the MC curve, then it stops hiring, at least temporarily.

While there are firm or industry-level additional costs in hiring each additional employee, it is actually government-imposed mandatory costs and contributions that raise the MC per employee. A businessman does not only give a worker his salaries and 13th month pay. There are mandatory costs like employer share of SSS, PhilHealth, Pag-IBIG, private HMO, etc. so that monthly cost per additional employee may not be small.

One implication here is that government should not further raise those existing mandatory and obligatory contributions. High MC per employee in the formal sector should dampen hiring somewhere as it may be difficult for some firms to raise employee MR to catch up with rising MC.

Low unemployment is a desirable outcome in itself as it reduces poverty. Further government intervention actually can cause diswelfare in society.

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