This document discusses labor productivity, including its definition, importance, trends, and relationship to wages, prices, and employment. Some key points: - Labor productivity is defined as total real output divided by the number of worker hours. It is an important factor in wage and living standard growth and in controlling inflation. - Long-term productivity growth is driven by capital investment, improved education/skills, technological progress, and efficiency gains. Cyclically, productivity declines in recessions and rises in expansions. - While productivity varies across industries, wages are relatively even, so output and employment shift toward more productive sectors over time. However, data shows no clear relationship between industry productivity and employment growth when demand factors

1. Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
Chapter 17
Labor Productivity: Wages, Prices,
and Employment

2. 17-2
1. The Productivity
Concept

3. 17-3
Labor Productivity
Labor Productivity =
Total product (real
GDP)
Number of worker hours
Productivity
IndexYear 2
=
ProductivityYear 2
ProductivityBase Year
* 100
Productivity can be calculated using data from different years
to form an index of productivity relative to a base year.

4. 17-4
BLS Index
• The BLS productivity
index is calculated by
dividing real output in
the private sector by the
number of hours
employed in the private
sector.
• The index understates
productivity growth in
that improvements in the
quality of output are not
taken into account.
• The index implies that
labor alone is the cause
of the rise in
productivity. Other
factors such as
increases in the amount
of capital and
technological progress
also play a role.

5. 17-5
2. Importance of
Productivity Increases

6. 17-6
Importance of Productivity
Increases
o Productivity increases are important
because:
• Productivity growth is the basic source of
increases in real wages and living
standards.
• Productivity growth is an anti-inflationary
force in that it offsets increases in nominal
wages.

7. 17-7
Productivity and Real
Compensation
• Because
real output is
real income,
the growth of
real output
per worker
hour and the
growth of real
compensatio
n per hour
are very
closely
related.

8. 17-8
Inflation and Productivity
o If nominal wages rise at a faster rate
than productivity rises, then the labor
cost per unit of output (unit labor cost)
will rise.
o If nominal wages rise at a slower rate
than productivity rises, then the labor
cost per unit of output will fall.

9. 17-9
Inflation and Productivity
o Since labor costs are between 70 and
75 percent of total production costs,
higher unit labor costs will lead to higher
inflation.
• Other factors also affect the inflation rate
such as the money supply.

10. 17-10
3. Long-Run Trend of
Labor Productivity

11. 17-11
Importance of Causes
of Productivity Growth
53%
12%
35%
Increased Efficiency Improved Labor Quality
Quantity of Capital
• Jorgenson, Ho, and
Stiroh estimate that
about one-half of the
productivity growth
over the 1959-2006
period was due to
increases in the
quantity of capital. The
other half was due to
increases in labor
quality and
improvements in
efficiency.

12. 17-12
Increases in Educational
Attainment
• One reason
that labor
quality has
increased is
that the
educational
attainment of
the population
(aged 25 and
older) has
increased over
time.

13. 17-13
Increased Quantity
of Capital
o A higher amount of capital increases
labor productivity.
• For example, one can dig more dirt per
hour with a bulldozer than with a shovel.
• Between 1959 and 1998, the amount of
capital per worker hour went up by about
50 percent.

14. 17-14
Increased Efficiency
o Increased efficiency can result from
• Technological progress including improved
capital and business organization and
managerial techniques
• Greater specialization as the result of scale
economies
• Reallocation of labor from less productive to
more productive sectors
• Changes in the legal, environmental
conditions, public policy
∞For example, lower trade barriers

15. 17-15
4. Cyclical Changes
in Productivity

16. 17-16
Business Cycle
and Productivity
o Labor productivity is procyclical.
• Productivity rises in economic booms and
falls during recessions.
o Productivity is procyclical because
• In a recession, a firm’s sales decline more
rapidly than its units of labor.
∞Some managers are a fixed cost of labor.
∞Firms are reluctant to fire workers with specific
training since they lose their training investment.

17. 17-17
Business Cycle
and Productivity
• Capital is not fully utilized during recessions
and so productivity falls.
• During recessions, demand falls the most in
the high productivity durable manufacturing
goods sector.
∞The share of manufactured goods in total output
falls, and so productivity falls during recessions.

18. 17-18
Implications
o The fall in productivity during recessions
makes them more severe.
• The productivity decline raises unit labor
costs, which lowers profits.
• Lower profits decrease investment
spending which intensifies the downturn.
• The reverse occurs during economic
recoveries.

19. 17-19
Implications
o Cyclical changes in productivity also
have implications for economic policy.
• Declines in productivity contribute to cost-
push inflation by raising unit labor costs.
• A cyclical rise in productivity during the early
stages of a recovery permits more
expansionary policy since it lowers unit
labor costs.

20. 17-20
Question for Thought
1. Describe and explain the cyclical changes that
occur in labor productivity. Of what significance
are these changes?

21. 17-21
5. Productivity and
Employment

22. 17-22
Demand Factors Constant
o Compensation rises more or less evenly
across industries, even though output
per hour varies greatly by industry.
• Labor supply shifts prevent wages from
diverging in the various industries.

23. 17-23
Demand Factors Constant
o This implies rising per unit costs and
reduced output and employment in
industries with slow productivity growth,
and falling per unit costs and output and
employment in industries with high
productivity growth.

24. 17-24
Productivity and
Employment, 1996-2006
-5%
0%
5%
10%
15%
20%
-15% -10% -5% 0% 5% 10%
Productivity (annual percent change)
Employment(annualpercentchange)
• Variable demand
factors confound
the actual
relationship
between
productivity growth
and employment
within industries.
• The data reveal
no systematic
relationship
between industry
productivity growth
and industry
employment
growth.

25. 17-25
Question for Thought
1. How do you account for the close correlation
between changes in the rate of productivity
growth and changes in the real wage rates for the
economy as a whole? Does this relationship also
hold true on an industry-by-industry basis?
Explain.

26. 17-26
6. The “New Economy”

27. 17-27
Labor Productivity Growth
Rates, 1948-2008
• Productivity
growth surged in
the second half of
the 1990s, after
being relatively
low for the prior
two decades.
• No consensus
exists as to whether
this increase in the
productivity growth
rate is a part of a new
long-run trend or
simply a temporary
aberration.

28. 17-28
Use of Information Capital
o Increased use of information capital
• Faster increases in the quantity of
information such as computers may have
increased productivity growth.
• Jorgenson, Ho, and Stroh's analysis
indicates 37 percent of the productivity
growth between 1995-2000 was due to
increases in the use of information
technology. The corresponding figure for
2000-2006 was 23 percent.

29. 17-29
Technological Progress
and Efficiency
o Technological progress and efficiency,
particularly in information technology, may
have increased the productivity growth rate.
• Jorgenson, Ho, and Stiroh find that about
one-fifth of the productivity growth between
1995-2006 was due to increased efficiency
in the production of information technology
products.
• About a fifth was caused by technological
progress and efficiency gains in the rest of
the economy.