Why Is Productivity Important in Economics?

The level of productivity is the most fundamental and important factor determining the standard of living. Raising it allows people to get what they want faster or get more in the same amount of time. Supply rises with productivity, which decreases real prices and increases real wages.

Productivity in Economics

In economics, physical productivity is defined as the quantity of output produced by one unit of input within one unit of time. The standard calculation gives us output per unit of time, such as five tons per hour of labor. An increase in physical productivity causes a corresponding increase in the value of labor, which raises wages. That is why employers look for education and on-the-job training. Knowledge and experience increase the human capital of the workers and make them more productive.

Impact on Wages

To see how productivity raises wages, consider the following example. An employer offers you $45 to dig a hole in their backyard. Suppose that you have insufficient capital goods, such as your bare hands or a spoon. Then, it might take you nine hours to dig the hole. Your labor is worth just $5 per hour in that case. If you had a shovel instead, it might have taken you only three hours to dig the hole. The market value of your labor output just rose to $15 per hour. With a big enough excavator, you might be able to dig it in 15 minutes and make $180 per hour. In a perfectly competitive market, labor earns its marginal product.

Role of Technology

New machines, technologies, and techniques are crucial factors in determining productivity. To take a historical example, consider the economy of the United States in 1790. At that time, nearly 90% of the working population were farmers. By 2000, only 1.9% of the population was employed in farming. On a percentage basis, agriculture consumed about 60 times as much labor in 1790. However, agricultural output is significantly higher today than in the 18th century. That makes food prices much lower today in real terms, and it frees up workers for other tasks. That is the way economic growth takes place when technology raises the productive capabilities of the people.

Relationship with Consumption

Growth in productive capital requires periods of underconsumption. Producers must devote less energy toward making consumable goods so they can build and use new capital goods. For instance, an office worker cannot create web content while setting up a new computer. These periods of underconsumption need to be funded, which is why businesses need investment for new capital projects. Ultimately, consumers must delay their own satisfaction to supply funding for companies in exchange for more consumption in the future. That is how capital investment leads to higher productivity and future economic growth.