Principles of Microeconomics

Principles of Microeconomics

Principles of Microeconomics

3. Producer Theroy

Everything has a cost, and that is true for firms as well as consumers. When firms produce goods, they incur costs that vary depending on how much they are producing. In this lecture, we will analyze firms' cost functions.


Labor productivity relates output to the labor hours used in the production of that output.


Productivity is the indicator that measures labor efficiency in producing goods and services in the economy. Costs is the indicator that measures the unit labor costs of producing each unit of output in the economy. Together, productivity and costs monitors inflationary trends in wages, which usually affect trends of inflation in other areas.


BREAKING DOWN 'Productivity And Costs '

Both the bond and equity markets seem to be affected in the same direction by productivity data. Because a more efficient workforce can lead to higher corporate profits, equity markets enjoy seeing good productivity growth. The bond markets, which enjoy a low inflationary situation, also prefer to see high productivity due to its role in keeping inflationary pressures low. As productivity growth occurs, inflation is stemmed, because the economy can sustain higher growth than could be possible with inefficiencies in the labor markets.


Labor Productivity

BLS (Bureau of Labor Statistics) measures labor productivity simply as output divided by hours worked. Historically, productivity has increased more often than not. So the fact that it's increasing is usually generally seen as a good sign: more productive workers are good for an economy. But in a recession, it increases further for another reason -- employers are demanding nearly the same amount of output from fewer workers. Here's a chart showing labor productivity since 1947, as far as BLS's data goes back:

productivity 10-03 - 1.PNG


So the bad news is that employers are getting more work out of fewer workers, rather than hiring. But the good news is that this behavior can only be sustained for so long. There are limits to how productive workers can be, so eventually employers will have no choice but to hire more as output continues to increase.


Here's another graph that shows unemployment and quarterly productivity growth since 1970:

productivity 10-03 - 2.PNG

You can see that the peaks in unemployment tend to coincide with the peaks in productivity. And it's pretty hard to see any unemployment peaks that don't also begin to decline as the productivity growth declines. Since productivity growth was less in Q4 than Q3, I would see this as a good sign for unemployment, based on this chart.


Labor Costs

BLS defines labor costs as the ratio of hourly compensation to labor productivity. So another sort of obvious phenomenon is that labor costs will decline for employers when productivity is increasing. In fact, they've decreased dramatically since the start of 2009. This chart shows labor costs with the index starting at 1 in 1947:

productivity 10-03 - 3.PNG


That recent recession caused the most dramatic decline in labor costs shown for a year in 2009 -- they declined by 17.3%. Again, that's the biggest decline in labor costs for a year since 1947. The good news here is that lower labor costs should make it easier to hire. As you can see, they're now back at 2006 levels.

So today's data is sort of bittersweet. Even though employers are managing to increase output without hiring, they can probably only do that for so long. And if history is any indication, some real employment growth shouldn't be too far off.


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