Would you describe yourself as a productive person? How do you measure productivity? In this explanation, you will learn about productivity in economics, what it means, and how it's calculated. You will also learn about ‘the productivity puzzle’. What is that? Read on to find out!
What is productivity?
Productivity is the amount of output you get from your input, such as time, energy, or resources. For instance, if you produce more goods or services using the same amount of resources, your productivity has increased. This measure is important because it shows how efficiently you are using your resources to achieve your goals.
From the macroeconomic perspective, the ability of a country to improve its living standard depends almost completely on its ability to increase productivity, which is also known as the key source of economic growth and competitiveness.
Productivity is a measure of the efficiency of production, which is calculated by dividing the output by the input. It is a ratio of output to input that indicates how much of the input was used to produce the desired output.
Productivity formula
Productivity is measured as a ratio of output to the input consumed:
\(\hbox{Productivity}=\frac{\hbox{Units of output}}{\hbox{Unitis of input}}\)
If the output produced increases while the amount of inputs remains the same, we say that the productivity has increased. Productivity increases as well when the same amount of output is produced with fewer inputs.
Let’s take a toy manufacturing factory. Suppose the factory produces 20 toys per day by employing 10 labourers collectively and all the other resources. We can calculate their productivity by using the formula above:
\(\hbox{Productivity}=\frac{\hbox{20 toys }}{\hbox{10 workers}}=\hbox{2 toys per worker}\)
Compare that figure to when the factory employs again the same number of workers (10) and they collectively manufacture 150 toys per day.
\(\hbox{Productivity}=\frac{\hbox{150 toys }}{\hbox{10 workers}}=\hbox{15 toys per worker}\)
Productivity has highly improved even though the number of workers has remained the same.
Productivity and production
It is a common problem that students confuse productivity with production. Both concepts are closely related but their meaning is different. Let’s explore them in detail.
Production is the process of converting raw materials into useful goods or services, while productivity refers to the effectiveness and efficiency of this process of production.
To give you a full image of the difference between productivity and production, we have created the comparison chart below.
| Table 1. Difference between production and productivity. |
|---|
Production | Productivity |
Production is the process of converting raw materials into useful outputs (goods or services). | Productivity is an indicator of effectiveness and efficiency in the process of production. |
Production is a process: the process of conversion. | Productivity is a measure: a measure of the optimum utilisation of the available resources of a firm. |
Production focuses on the availability of the factors of production (land, labour, capital, and entrepreneurship). | Productivity focuses on how well these factors of production are utilised. |
Production represents the number of a firm’s produced units in a given period. | Productivity represents the ratio of output to the input consumed. |
Production is expressed in absolute terms. E.g. 500 cars produced. | Productivity is expressed in relative terms. E.g. 20 h/ car. |
Types of productivity
You should know that for most purposes, productivity usually refers to labour productivity. However, other types of productivity are differentiated based on the production factors as they all contribute to a firm’s current output level and any output increase. Thus, the types of productivity, besides labour productivity, also include:
- Land productivity
- Capital productivity
- Entrepreneurial productivity
Labour productivity
Labour productivity is a measure of the amount of output produced by a worker in a given time period, such as an hour, day, or week. It is calculated by dividing the amount of output produced by the number of hours worked. Higher labor productivity can lead to higher profits for businesses and higher wages for workers.
Labour productivity is the output produced per unit of labour input.
Labour productivity formula
Labour productivity is calculated by using the following formula:
\(\hbox{Labour productivity}=\frac{\hbox{Output produced}}{\hbox{Labour input}}\)
Before we look at an example, note that labour input can be measured as the number of people employed or the number of labour hours (working hours). Therefore, labour productivity can be expressed as per worker or per hour worked.
Let’s carry on with the example of the toy factory. Let’s suppose a full-time worker works 40 hours a week and produces 120 toy cars in a given week.
We can calculate their productivity as:
\(\hbox{Labour Productivity}=\frac{\hbox{Output produced}}{\hbox{Labour input}}=\frac{\hbox{120 toy cars}}{\hbox{40 hours}}=\hbox{3 toys a week}\)
We say that the productivity of the worker in that week is 3 toy cars per hour.
Remember that some factors that can affect labour productivity include workers’ skills, technological change, management practices, and changes in other inputs (such as capital).
The importance of productivity
Productivity is important for maintaining and increasing economic welfare and prosperity as it can contribute to the following factors:
Higher profits. Productivity improvements mean that firms can increase their profits as the costs are now lower to produce a given level of output.
Lower prices. As productivity improves, not only do firms enjoy the benefits, but consumers also benefit. Consumers can enjoy lower prices of goods and products as the firms can offer that without reducing their profits or wages.
Higher wages. If productivity increases, the total costs of a firm fall and the firm is expected to increase workers’ wages. Profits can offset the effect of wage increases.
Economic growth. Increasing productivity allows firms and consumers to get faster and more of what they want in the same time. Firms produce a greater output using the same input level, increasing their revenues and profits and generating higher GDP. This leaves productivity improvements as the main drivers of higher living standards in the long term.
Why is UK productivity low?
Low labour productivity in the UK in recent years has been called the ‘productivity puzzle’.
The productivity puzzle refers to the sudden stagnation of productivity growth in the UK after the financial crisis of 2008–09.
While countries such as Germany and the USA improved their productivity level after the 2009 recession, the UK failed to recover from the low level of labour productivity. What made the UK economy perform less compared to other countries?
These are the factors that explain the productivity puzzle and that negatively impacted productivity:
Inadequate investment in new capital goods: if capital goods are not well maintained or of a good standard, this will significantly impact how well workers can do their jobs and lead to lower rates of productivity.
Relatively low wages in the UK economy: workers having high wages can be a good motivator for increasing their productivity. Lower wages, on the other hand, would serve as a demotivating force.
Employers used the wrong methods to manage the labour force: during the recession, employers would choose to use workers less intensively rather than laying them off. This would then cause a fall in labour productivity.
These are, thus, some of the factors that improve productivity:
Proper workforce: selecting the right employees for the right job leads to higher productivity.
Proper types of equipment and machinery: selecting and acquiring the right machines that can perform simplified and repetitive tasks strictly matching the requirements ensures better functioning of labour and, therefore higher productivity.
The total area and its location: the total area of different departments and the location of these departments play a major role in productivity as it can smooth the whole process of production.
The use of economic and renewable sources of energy: using renewable sources of energy has also proved to improve productivity significantly.
Proper management of all production factors: making the right choices aiming for the optimum utilisation of the production factors (especially capital and labour) would positively affect productivity.
How does productivity affect wages?
Productivity and wages are related because higher productivity generally should lead to higher wages. Workers who are more productive can produce more output in the same amount of time or with the same amount of resources, leading to higher profits for the company. In turn, companies may be willing and able to pay higher wages to more productive workers because they contribute more.
Higher productivity can also lead to higher wages through the supply and demand dynamics of the labour market. When workers are more productive, they become more valuable to employers, which can create upward pressure on wages as companies compete to attract and retain skilled workers. Conversely, if productivity is low, there may be less demand for labour, and wages may be lower as a result.
That's all in theory. How about reality?
In a capitalist system, business owners are incentivized to increase productivity because it can lead to higher profits. However, without pressure from workers through trade unions, business owners may not pass on the benefits of higher productivity to their employees in the form of pay.
Productivity - Key takeaways
- Productivity is known as the key source of economic growth and competitiveness.
- Production and productivity are two different but related concepts. Production is the process of converting raw materials into useful goods or services, and productivity to the effectiveness and efficiency of this process of production.
- For most purposes, productivity usually refers to labour productivity. However, there are other types of productivity differentiated based on the production factors, such as land productivity, capital productivity and entrepreneurial productivity.
- Productivity improvement is the main driver of higher standards of living in the long term as it contributes to higher profits, lower prices, higher wages, and stronger economic growth.
- To improve productivity firms should focus on selecting the proper workforce and the proper types of equipment and machines, organising the total area and its location, using renewable resources, and properly managing the production factors.
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