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?
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. A firm is productive when it is efficient and effective at the same time.
Productivity is a measure of effectiveness and efficiency on how a firm or economy can transform resources into goods or services (potentially creating more from less).
Concretely, productivity is measured as a ratio of output to the input consumed.
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:
Compare that figure to when the factory employs again the same number of workers (10) and they collectively manufacture 150 toys per day.
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.
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. |
Table 1. Difference between production and productivity.
Types of productivity
You should know that for most purposes, productivity usually refers to labour productivity. However, there are other types of productivity that are differentiated on the basis of the production factors as they all contribute to both a firm’s current level of output and to any increase in the level of output. Thus, the types of productivity also include:
- Land productivity
- Capital productivity
- Entrepreneurial productivity
Labour productivity
Labour productivity is the output produced per unit of labour input.
It can be calculated as:
Before we take a look at an example, note that labour input can be measured as the number of people employed or as 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:
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. Improvements in productivity 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 benefit too. 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. The effect of wage increases can be offset on profits.
Economic growth. Increasing productivity allows firms and consumers to get faster and more of what they want in the same amount of time. Firms produce a greater output using the same level of input, and therefore they increase their revenues, profits, and generate higher GDP. This leaves productivity improvements as the main drivers of higher standards of living in the long term.
Factors that affect and improve productivity
To talk about the factors that impact productivity, we can use the ‘productivity puzzle’ as an example.
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 are able to 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 significantly improve productivity.
Proper management of all production factors: making the right choices aiming for the optimum utilisation of the production factors (especially capital and labour) would have a positive effect on productivity.
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 on the basis of 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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