Question

Using your knowledge of marginal revenue product, explain the following: a. A famous tennis star is paid \(\$ 200,000\) for appearing in a 30 -second television commercial. The actor who plays his doubles partner is paid \(\$ 500\). b. The president of an ailing savings and loan is paid not to stay in his job for the last two years of his contract. c. A jumbo jet carrying 400 passengers is priced higher than a 250 -passenger model even though both aircraft cost the same to manufacture.

Short answer

The Marginal Revenue Product (MRP) is used to assess the additional revenue a firm expects to earn by employing additional inputs. A famous tennis star is paid more because of the high additional revenue expected from his appearance in the commercial. An executive is paid to leave if their presence leads to decreases in the company's revenue. Larger aircraft's higher pricing can be attributed to the higher expected revenue from more passengers despite similar manufacturing costs.

Step-by-step solution

Defining Marginal Revenue Product(MRP)

Marginal Revenue Product (MRP) can be defined as the additional revenue that a firm generates by employing an additional unit of input, keeping all other inputs constant. It's calculated by multiplying the marginal physical product of the input by the marginal revenue generated from the additional output sold.

MRP and Tennis Star's Salary

A famous tennis star is given a high salary because the additional revenue that the firm expects to gain (through increased product sales due to the star's promotion) from using the tennis star in the commercial is significantly high. The actor who plays his doubles partner is paid less because his presence in the commercial isn't expected to bring in as much additional revenue.

MRP and Business Executive's Salary

If a business executive is paid not to work, it means the marginal revenue product of the executive is considered to be negative by the firm. In simpler terms, their presence, decisions or actions are expected to reduce the company's overall revenue.

MRP and Aircraft Pricing

The jumbo jet may be priced higher than the smaller jet because it's expected to generate more revenue (by accommodating more passengers) despite having similar manufacturing costs. Simply put, the per unit marginal revenue product is higher for the jumbo jet since it can carry more passengers.

Key concepts

Tennis Star Salary

When we apply the concept of marginal revenue product (MRP) to a tennis star's salary, we begin to see why they are compensated so highly compared to others in a similar role. A well-known tennis player can command a hefty paycheck, like $200,000 for a brief commercial appearance, because their reputation and popularity significantly boost the sales of the product they endorse. This increase in sales is the additional revenue generated, making the tennis star's MRP substantially higher.
To break it down further:

• The tennis star's endorsement is expected to capture the audience’s attention, leading to higher sales of the product advertised.
• Their fame acts as a multiplier, increasing the product's appeal and ultimately its market performance.
• This contrasts with their doubles partner who might not possess the same level of public influence, thus receiving a much lower payment of $500.

The key takeaway is that MRP influences how different roles within the same commercial setting are valued financially.

Business Executive Compensation

In the corporate world, a business executive's compensation reflects their contribution to the company's success, often assessed using the MRP method. However, there are scenarios when an executive might be paid to leave their position, often described as a 'golden handshake' or 'golden parachute.' This can seem counterintuitive at first glance, but it's usually tied to the executive's negative MRP.
A negative MRP can occur when:

• The executive's continued presence in the company could potentially harm its revenue, perhaps due to poor decision-making or a loss of stakeholder confidence.
• It's perceived that their departure could enhance operational efficiency and morale, leading to better financial performance.
• The cost of keeping the executive could outweigh the benefits, making it financially prudent to offer them a severance package to leave.

Ultimately, the firm's goal is to enhance overall revenue, even if it means paying executives not to work.

Aircraft Pricing

Aircraft pricing, particularly in cases like comparing a 400-passenger jumbo jet to a 250-passenger model, is influenced by the MRP concept. Despite potentially similar production costs, the larger aircraft can generate more revenue due to its higher passenger capacity.
Here's why the jumbo jet is priced higher:

• The ability to carry more passengers translates directly to higher potential ticket sales, thus increasing total revenue.
• The marginal revenue from each additional passenger is significant enough to justify a higher price point for the larger jet.
• The airlines' route and passenger demands may favor larger capacity jets when aiming to maximize profit on busy routes.

Hence, in line with MRP, the revenue potential tied to the passenger capacity of the aircraft dictates its market price, reflecting its greater profit contribution.