In economics, the marginal product is the additional output that is produced by one more unit of an input. Therefore the marginal product of capital is the additional output that results from one additional unit of capital. It is called "marginal" because it measures the change in the amount of product produced when there is a small change in the amount of capital used. The marginal product of capital is important because it tells someone who is analyzing an operation, whether that operation is a factory assembly line or a heavy construction project, what affect an increase in capital will have on their production numbers. It is one way for managers to control the output of their operation. It is also helpful in making profitability decisions.
The following formula can be used to make this calculation:
Marginal Product of Capital= change in output / change in capital
Where: change in output = ( new output - original output )
change in capital = ( new # of capital units - original # of capital units )
We will use an example to illustrate.
Mr. Smith runs a factory making widgets. The factory consists of 100 units of capital and produces 200 units of output (widgets in this case) every day. Suppose that Mr. Smith added one additional unit of capital to his factory, thus increasing the number of units of capital to 101. Further suppose that this change in capital would cause his factory's daily production of widgets to increase to 202. Mr. Smith could calculate the Marginal Product of Capital of his factory simply by dividing the change in the number of units of output by the change in the number of units of capital:
( 202 - 200 ) / ( 101 - 100 )
This simplifies into:
( 2 ) / ( 1 ) = 2
So Mr. Smith knows that his Marginal Product of Capital equals two. In other words, if Mr. Smith adds one more unit of capital to his operation, the output of his operation will increase by 2.
This information is valuable to a manager like Mr. Smith because he can use it to make decisions about whether or not it makes sense for him to increase his capital base. In this example, if Mr. Smith thinks that the extra output of widgets is worth the investment of one additional unit of capital, he will probably make the investment.