Firms in competitive labor markets make hiring decisions at the margin. They compare the extra revenue generated by one more worker to the extra cost of employing that worker, stopping when additional hiring no longer raises profit.

The marginal hiring decision

Key comparison: benefit vs cost

In a perfectly competitive labor market, the firm takes the market wage as given, so the wage is the marginal cost of hiring another worker.

This diagram shows a competitive firm facing a horizontal market wage ($W_{mkt}$), meaning the marginal cost of hiring labor is constant at the wage. The firm hires labor up to the employment level where the labor-demand curve (the value of marginal product, $VMP_L$) equals the wage, which is the same stopping condition as $MRP=w$ in competitive output markets. Source

Continue hiring, stop hiring, or cut back

A firm evaluates the profit impact of the next worker:

Use the sign of $\Delta \pi$ to decide:

• If $MRP > w$, hiring the next worker increases profit, so the firm continues hiring.

• If $MRP = w$, hiring the next worker does not change profit, so the firm is at the profit-maximising stopping point (the “last worker” condition).

• If $MRP < w$, hiring the next worker reduces profit, so the firm should stop hiring (and if already employing that last worker, reduce employment until the condition no longer holds).

How the “stop point” is identified

The last unit rule (discrete workers)

In practice, labor is often hired in whole workers rather than tiny units. Then the firm chooses the largest number of workers such that:

• the last worker hired has $MRP \ge w$, and

• the next worker would have $MRP < w$.

This captures the syllabus idea: the firm continues hiring as long as the marginal revenue product exceeds the market wage, and it stops when that is no longer true.

The graph plots the marginal revenue product (MRP) of labor as a downward-sloping curve and the market wage as a horizontal line. The profit-maximizing quantity of labor occurs at the intersection where $MRP=w$; to the left, $MRP>w$ so hiring raises profit, and to the right, $MRP<w$ so additional hiring lowers profit. Source

Why $MRP$ typically falls as more labor is hired

The stopping point is usually reached because $MRP$ declines with additional workers, commonly due to:

This figure shows the marginal product of labor ($MP_L$) decreasing as more units of labor are employed, holding capital fixed. In many AP Micro setups, a falling $MP_L$ implies a falling $MRP$ (since $MRP = MP_L \times MR$, and under perfect competition $MR=P$), which helps explain why the hiring process eventually reaches the point where $MRP=w$. Source

• Diminishing marginal returns in the short run (adding labor to fixed capital eventually yields smaller extra output).

• Congestion/coordination limits that reduce the additional contribution of each new worker.

As $MRP$ falls, it eventually becomes equal to (and then below) the wage, triggering the stop decision.

What this rule does (and does not) depend on

Marginal, not average, performance

The hiring decision hinges on the marginal worker:

• A firm can have high average productivity and still stop hiring if the next worker’s $MRP$ is below the wage.

• Conversely, even if average outcomes look weak, the firm continues hiring whenever the next worker has $MRP>w$.

Profit maximisation, not revenue maximisation

The firm does not hire until total revenue is maximised; it hires until profit is maximised. Paying $w$ matters because it is the extra cost that must be covered by the extra revenue from the marginal worker.

Common mistakes to avoid

• Comparing total revenue from labor to the wage, instead of comparing marginal revenue to the marginal wage cost.

• Using average product or average revenue per worker in place of $MRP$.

• Forgetting the equality condition: the profit-maximising stopping point is where the last unit satisfies $MRP = w$ (or, with discrete workers, the last hired has $MRP \ge w$ and the next would have $MRP < w$).