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Part II: Considering Which Side You’re On in the Decision-Making Process
Again, be careful when measuring technological change by using labor productivity, because technological change isn’t the only thing that influences labor productivity. For example, labor productivity is also affected by education, experience, motivation, and attitude of the worker.
Working harder: Calculating total factor productivity An alternative measure of productivity is total factor productivity. Total factor productivity measures changes in output relative to changes in the quantity employed of all inputs. Use the following formula to calculate total factor productivity, represented by the symbol α:
where q represents the firm’s quantity of output, I1 through In represent the quantity employed of inputs 1 through n, and p1 through pn represent the prices of inputs 1 through n. Suppose your firm produces 100,000 units of output. In order to produce that output, the firm uses 1,200 hours of labor, 600 machine-hours of capital, and 20,000 kilowatt-hours of electricity. If input prices are $10 per hour for labor, $5 per machine-hour for capital, and $0.04 per kilowatt-hour for electricity, you can use the following steps to calculate your firm’s total factor productivity:
1. Substitute the quantity of output, 100,000, for q.
2. For each input, insert the input price for p and the input quantity for I in the bottom of the equation.
In the example, p1 is $10 and I1 is 1,200; p2 is $5 and I2 is 600; and p3 is $0.04 and I3 is 20,000.
3. Calculate the value in the bottom of the equation.
4. Divide the top of the equation by the bottom of the equation.
So, total factor productivity equals
If prices are held constant over time, changes in total factor productivity represent changes in the firm’s efficiency. Increases in total factor productivity represent improvements in a firm’s efficiency that result from technological change.
