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Hoping for less by minimizing per-unit costs
112 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.
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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 I n 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 I $0.04 and I3 is 20,000. 1 is 1,200; p2 is $5 and I2 is 600; and p3 is
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.
Chapter 7: Innovation and Technological Change: The Future Is Now
Suppose that five years ago, your firm from the previous example produced 80,000 units of output by using 1,600 hours of labor, 500 machine-hours of capital, and 18,000 kilowatt-hours of electricity. If you hold input prices constant or the same as in the last example at $10 per hour for labor, $5 per machine-hour for capital, and $0.04 per kilowatt-hour for electricity, any change in the total factor productivity value results from changing input quantities. Using the same steps to calculate the firm’s total factor productivity:
1. Substitute the quantity of output, 80,000, for q. 2. For each input, insert the constant input price for p multiplied by the input quantity for I in the bottom of the equation.
So, p1 is $10 and I1 is 1,600; p2 is $5 and I2 is 500; and p3 is $0.04 and I3 is 18,000.
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
113
Based on the two examples, total factor productivity in the last year is 152.1 percent (6.329/4.162) of the first year’s value. Alternatively, total factor productivity increased 52.1 percent over the five-year period.
Spending on Research and Development
A business’s research efforts are ultimately directed at making an invention, regardless of its source, into an economic success. However, the uncertain outcomes of research and development make it one of the riskier areas of corporate decision-making.
Research and development encompass a variety of efforts:
✓ Basic research refers to efforts that lead to the creation of new knowledge or inventions. ✓ Applied research covers efforts directed toward a practical payoff. ✓ Development puts research findings into practice.
The likelihood of success for research and development projects is a function of overcoming three major hurdles. First, the project must be a technical success. After it’s a technical success, the research and development project must be a commercial success. Finally, the project must be an economic success; that is, it must be profitable for the firm.
