This technical note explores one of the most important topics for firms and their managers: labor. In particular, how many people should a firm hire, and how much should they be paid? The note uses the example of Wail Al-Hayani, the owner of a kitchen that provides fresh prepared food to quick-service restaurants, to explore hiring decisions and setting wages and salaries—and the marginal values that matter. If Al-Hayani hires more workers, it would mean extra output and revenue, so long as the value of the marginal product of labor exceeds the wage. To maximize profits, a competitive firm should hire workers up to the point where the value of the marginal product of labor equals the wage. Excerpt UVA-GEM-0132 Mar. 19, 2015 The Marginal Product of Labor A principal objective of economic thinking is to inform key decisions made by firms and their managers. One of the most important topics for managers concerns the basic choices about labor: How many people should I hire, and what should I pay them? Naturally, the answer to both questions has quite a lot to do with demand and supply, those staples of economic analysis. At its simplest, economics teaches us that demand in the labor market comes from firms and organizations and supply comes from individuals willing to work. So far, so good. But what matters most about supply and demand? When it comes to hiring decisions and setting wages and salaries, it is the margins that matter. For example, although much of the data around jobs and labor market activity is reported in averages—such as the average output per hour of all workers—these data reflect information on choices that have already been made. What matters in decisions about hiring and pay is not the past, but the future. In other words: What should I choose to do next? For this choice, the father of neoclassical economics, Alfred Marshall, demonstrated that it is the marginal values that matter. In economics, the word marginal means the difference made by one extra unit of something—a key marginal value for the labor market is the value of the extra output that an additional worker would provide. To explore this, consider Wail Al-Hayani, who is the owner of a central kitchen that provides fresh prepared food (excluding meats) to quick-service restaurants. About 60% of the necessary prep work (washing, cleaning, chopping, and storing) takes place in Al-Hayani's kitchen. Once prepped, the items are transported to restaurants around town. This aspect of Al-Hayani's business necessitates that he hire several food prep workers to staff the central kitchen. Only simple and inexpensive kitchen items are necessary for their work. Hiring more workers would mean extra output and revenue, but there are costs associated with adding staff as well. How should Al-Hayani think about the decision of whether or not to hire more workers? The Demand for Labor and Production . . .