Labor Productivity

Connections


Connections to Key Topics with Additional Resources

Topic Connections and Additional Resources
Scarcity, Choice, and Opportunity Cost

Highly productive workers usually have a proportionately high opportunity cost. If their current employer attempts to exploit them by paying wages below their opportunity cost, the workers are likely to quit and seek alternative employment.

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Production Possibilities Frontiers

Gains in Labor Productivity cause the production possibilities frontier (PPF) to shift outward. To see this, recall that the PPF represents the combinations of various goods and services than an economy can produce when all existing inputs (land, labor, capital) are used efficiently. When Labor Productivity increases, a larger quantity of goods and services can be produced with the existing set of inputs.

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Production and Costs

When Labor Productivity is held constant, then wage increases will shift the marginal and average cost curves upward. In contrast, if Labor Productivity increases but wages are held constant, then the marginal and average cost curves will shift downward. Under competitive conditions the equilibrium prediction is that wages will rise with gains in Labor Productivity, which may offset most of the downward shift in marginal and average cost.

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Monopoly

Before public utilities such as telephone and energy companies were deregulated, many were guaranteed prices sufficient to cover their average cost of production. Firms in a protected monopoly position will have little motivation to increase productivity.

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Income Distribution and Poverty

Highly productive workers in a market economy are expected to have higher incomes than their less productive fellow workers. Since the pace of technological change has increased in recent years, the income gap between technically skilled college-educated workers has grown relative to workers with weak technical skills and only a high school education. In fact, real wages for men with only a high school education have actually declined since the 1970's.

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Labor Markets

Gains in Labor Productivity cause the demand for labor curve to increase, and thus raise the equilibrium wage. When Labor Productivity increases, the revenue added by a unit of labor (marginal revenue product) also rises, and the labor demand curve is also the marginal revenue product of labor.

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Productivity and Growth

There is a direct and powerful link between productivity and economic growth. Increases in Labor Productivity mean that more output is produced for a given quantity of labor input. The value of this increase in output is manifested as economic growth. Higher wages paid to more productive workers provides the gain in purchasing power necessary for workers to share in the gain in material prosperity.

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Unemployment, Employment, and Inflation

Gains in Labor Productivity allow wages to rise without the threat of inflation. Higher Labor Productivity means that more output is produced for a given quantity of labor input. The firm can use some or all of the incremental revenue gain to raise wages without the need to raise prices.

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Developing and Transitional Economies In recent years the process of globalization of trade and investment has been accompanied by a decline in trade barriers and a rise in capitalism and democracy. Under these conditions, wages will be set globally based on the marginal revenue product of labor. Thus a key to economic development is to increase Labor Productivity. One path to higher Labor Productivity is improved education and technical training, and the removal of discriminatory and exploitative practices that prevent women and others from participating fully in the labor market. Also very important is the access to capital with which to fund technological advances that increase worker output.

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Resource Markets The labor market represents one of the most important examples of a resource market. Economic theory suggests that, all else equal, rising labor productivity will increase the demand for labor and consequently increase equilibrium wages and salaries.

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