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Productivity
When you finish doing your homework, you might look back at the time you allocated and say, “That was a productive homework session.” Or when you get a new laptop from your parents or your school, you may say, “This laptop is going to help my productivity.”
We all use the words “productivity” or “productive” in everyday life to sort of describe how efficiently we use our time and resources to get things done - but what does productivity actually mean?
In economics, productivity is more focused on how effectively a business or country uses its resources (like labour, capital, and materials) to produce goods and services.
Definition: Productivity is defined as the measure of the efficiency with which goods and services are produced using the factors of production. It is typically expressed as the ratio of output to the inputs used in the production process.
👉 Higher productivity means more output is being produced with the same amount of input, which can lead to economic growth, higher wages, and better living standards.
💡 Did you know that improved productivity can boost average living standards?
“For an advanced economy like Scotland, increasing productivity is generally considered to be the most sustainable way of improving living standards in the long term.” fraserofallander.org
Why is this the case? Let's break it down:
Higher Efficiency and Bonuses
- Higher Efficiency: When workers are more productive, they can produce more in less time.
- Bonuses and Higher Wages: This efficiency may lead to bonuses and higher wages for workers.
- Result: More money in workers' pockets means they can afford better things, improving their living standards.
Higher Wages and Government Taxes
- More Tax Revenue: Higher wages mean workers pay more in taxes.
- Government Investment: The government can use this tax money to improve public services like education and healthcare.
- Result: Better education and healthcare lead to higher living standards for everyone.
Lower Unit Costs and Prices
- Lower Costs: Increased efficiency can reduce the cost of making products.
- Lower Prices: These savings can be passed on to consumers as lower prices.
- Result: Lower prices mean people's money can buy more, increasing their real income and improving living standards.
More Production and Reinvestment
- More Output: Firms can produce and sell more when productivity is high.
- Reinvestment: Profits can be reinvested to improve working conditions and technology.
- Result: Better working conditions and new technologies can further boost productivity and living standards.
For your exams, you may encounter a graph illustrating UK productivity trends similar to the one below. Explore the details below to better understand how UK productivity has evolved over time 👇
Understanding UK Productivity Trends
Graph Explanation:
- The graph shows UK productivity measured by output per hour and output per worker.
- There are four lines plotted:
- Output per Hour Trend Line: A trend line showing the predicted trend of productivity per hour from 1994 Q1 to 2020 Q1.
- Output per Worker Trend Line: A trend line showing the predicted trend in productivity per worker over the same period.
- Actual Output per Hour: Actual data points showing how productivity per hour changed over time.
- Actual Output per Worker: Actual data points showing changes in productivity per worker across the years.
Index (Q4 2007=100):
- The index indicates that productivity levels in Q4 of 2007 are set as the base (100). It helps track how productivity has changed relative to this base over time.
- Data collected spans from 1994 Q1 to 2020 Q1, providing a comprehensive view of long-term productivity trends in the UK.
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With reference to the above graph, describe trends in predicted and actual productivity (in terms of Predicted Output per Hour and Actual Output per Hour)
What are the “Returns to factors of production”?
"Returns to factors of production" refers to the income or rewards received by the owners of the different factors of production for their contribution to the production process.
Let’s revisit our 4 factors of production and list their corresponding returns:
Breakdown:
- Land: This includes all natural resources. The return to land is rent. Landowners receive rent as payment for the use of their land.
- Labour: This refers to the human effort used in production. The return to labor is wages. Workers receive wages as compensation for their labour.
- Capital: This includes all man-made resources used in production, such as machinery, buildings, and tools. The return to capital is interest. Owners of capital receive interest as income from lending or investing their capital.
- Entrepreneurship: This is the ability to combine the other factors of production to create goods and services. The return to entrepreneurship is profit. Entrepreneurs receive profit as a reward for their risk-taking and innovation.
In summary, "returns to factors of production" are the payments or income earned by the owners of land, labour, capital, and entrepreneurship for their contributions to the production process.
Businesses always aim to increase their returns to factors of production because this enhances their overall profitability and sustainability.
👨💻 For example: A tech startup focuses on innovation to increase its returns to entrepreneurship i.e profits.
- By developing cutting-edge software and investing in research and development, the company creates unique products that attract a large customer base.
- This leads to higher profits, rewarding the entrepreneur for their risk-taking and innovative efforts.
However, will continuously developing software always increase profits? Will returns always rise even in the long run? Can returns actually decrease instead?
To answer these questions we need understand the law of diminishing marginal returns.
👉 Remember the law of diminishing marginal utility states that as more of a good is consumed, the marginal utility gained from the consumption of an additional unit decreases.
In the same way:
The law of diminishing marginal returns states that as one factor of production (like labour) is increased while others are held constant, the additional output or returns will eventually diminish.
- i.e the change in total output will at first rise (increasing returns) and then fall (diminishing returns)
- There are diminishing returns to increasing an input when other inputs are fixed.
IMPORTANT TO NOTE - The law of diminishing marginal returns refers to short run production.
- The short run is a period during which at least one factor of production remains fixed.
- For example, on a potato farm, this means that certain resources like the land, machinery, and the farmer's management skills can't be easily changed or increased in the short term.
- For most firms, capital, land, and entrepreneurship are considered fixed factors, while labour is the variable factor of production.
Let's create a hypothetical scenario involving a farmer who grows potatoes.
🥔 Hypothetical Scenario: Potato Farm
The farmer employs an increasing number of workers and tracks the total output of potatoes.
- For the potato farm, capital (the farming equipment), land (the farmland), and entrepreneurship (the farmer's management and expertise) are considered fixed factors because they remain constant regardless of how many potatoes are being produced in the short run.
- However, labour (the workers who plant, tend, and harvest the potatoes) is a variable factor, as the farm can hire more workers or reduce the number of workers depending on the level of potato production needed in the short run.
The scenario will demonstrate the concepts of total output, average output, and marginal output.
Total Output of Potatoes as Number of Workers Increases:
Number of Workers | Total Output (kg) | Marginal Output (kg) | Average Output (kg/worker) | Returns to extra labour |
1 | 10 | 10 | 10 | |
2 | 25 | 15 | 12.5 | Rising |
3 | 45 | 20 | 15 | Rising |
4 | 60 | 15 | 15 | Diminishing |
5 | 70 | 10 | 14 | Diminishing |
6 | 75 | 5 | 12.5 | Diminishing |
7 | 75 | 0 | 10.7 | Diminishing |
8 | 70 | −5 | 8.75 | Diminishing |
- 🥔 Total Output:
- Total output is the total amount of potatoes produced by the workers. As more workers are employed, the total output increases but at a varying rate.
- 🆙 Marginal Output:
- Marginal output is the additional output produced by adding one more worker. Initially, marginal output increases, then it starts to decrease, and eventually, it can even become zero or negative.
- In our table, the marginal output increases from 10 kg to 20 kg, then starts decreasing and becomes zero when the 7th worker is added.
- When marginal output is increasing, the returns to extra labour is rising, when marginal output is decreasing, the returns to extra labour is diminishing
- 📧 Average Output:
- Average output is the total output divided by the number of workers. It gives an idea of how productive each worker is on average.
- If there is a total output of 60kg and there are 4 workers then the average output is 60/4 = 15
- In our table, the average output initially increases as workers are added, peaks when there are 3 workers, and then starts to decline as more workers are added.
Why This Happens
- 📈 Increasing Returns:
- When you start adding more workers, each additional workers might contribute significantly to increasing the farm’s output because they can help each other, specialise in tasks, and work more efficiently together.
- For example, with just one farmer, the farms make 10kg of potatoes a day. Adding a second farmer increases total output to 25kg of potatoes a day because they can share tasks and work more efficiently together - a benefit of specialisation
- 📉 Diminishing Returns:
- However, if you keep adding more workers without increasing the number of other factors of productions like land and capital (machinery), at some point, each additional worker will contribute less to total output
- This is because they start to get in each other’s way, and there are not enough machines for everyone to use at the same time. For example, adding a 6th worker might only increase output to 75kg of potatoes a day from 70kg of potatoes a day, as they wait around for machines to be free.
- After a certain point, adding more workers results in a less than proportional increase in total output. This happens because the additional workers have less land and tools to work with, leading to inefficiencies. This is reflected in the declining marginal output.
- 🔴 Zero or Negative Returns:
- Eventually, adding more workers may not increase total output at all and might even decrease it if the workers get in each other's way. This is when marginal output becomes zero or negative.
- When the 8th worker is added, the total output decreases from 75 kg to 70 kg, resulting in a negative marginal output of −5 kg. This illustrates the concept of diminishing returns where adding more workers beyond a certain point leads to a decrease in productivity.
In summary:
When you add more of one input (like labour) while keeping other inputs constant, you initially get increasing returns where each additional worker significantly boosts output. But after a certain point, you experience diminishing marginal returns where each additional worker adds less and less to total output because other resources (like machines) are limited.
How does this link to Specialisation?
As a business adds more workers (or other variable factors) to production, it will see increased output initially as each workers can specialise on specific tasks to increase productivity. However, this increase only happens for a limited time.
After reaching a certain point, the advantages of specialisation start to disappear because the workers might get in each other's way or have to share tools, making them less efficient as the other factors to productions are fixed (like machines for the workers to use).
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Knowledge checkpoint: Describe 3 ways a firm may attempt to improve productivity.
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