In economics, a measure of productive efficiency calculated as the ratio of what is produced to what is required to produce it. Any of the traditional factors of production—land, labour, or capital—can be used as the denominator of the ratio, though productivity calculations are actually seldom made for land or capital since their capacity is difficult to measure. Labour is in most cases easily quantified—for example, by counting workers engaged on a particular product. In industrialized nations, the effects of increasing productivity are most apparent in the use of labour. Productivity can be seen not only as a measure of efficiency but also as an indicator of economic development. Productivity increases as a primitive extractive economy develops into a technologically sophisticated one. The pattern of increase typically exhibits long-term stability interrupted by sudden leaps that represent major technological advances. Productivity in Europe and the U.S. made great strides following the development of such technologies as steam power, the railroad, and the gasoline motor. Later in the 20th century, advances in productivity stemmed from a number of innovations, including assembly lines and automation, computer-integrated manufacturing, database management systems, just-in-time manufacturing, and just-in-time inventory management. Increases in productivity have tended to lead to long-term increases in real wages.
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In economics, the theory that firms will pay a productive agent only what he or she adds to the financial earnings of the firm. Developed by writers such as John Bates Clark and Philip Henry Wicksteed at the end of the 19th century, marginal productivity theory holds that it is unprofitable to buy, for example, a man-hour of labour if it costs more than it contributes to its buyer's income. The amount in excess of costs that a productive input yields is the value of its marginal product; the theory posits that every type of input should be paid the value of its marginal product.
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Activity can be identified with production and consumption. Production is a process of combining various immaterial and material inputs of production so as to produce tools for consumption. The way of combining the inputs of production in the process of making output is called technology. Technology can be depicted mathematically by the production function which describes the function between input and output. The production function depicts production performance and productivity is the measure of it.
By help of the production function, it is possible to describe simply the mechanism of economic growth. Economic growth is a production increase achieved by an economic community. It is usually expressed as an annual growth percentage depicting (real) growth of the national product. Economic growth is created by two factors so that it is appropriate to talk about the components of growth. These components are an increase in production input and an increase in productivity.(Genesca & Grifell 1992, Saari 2006)
The figure presents an economic growth process. By way of illustration, the proportions shown in the figure are exaggerated. Reviewing the process in subsequent years (periods), one and two, it becomes evident that production has increased from Value T1 to Value T2. Both years can be described by a graph of production functions, each function being named after the respective number of the year, i.e., one and two. Two components are distinguishable in the output increase: the growth caused by an increase in production input and the growth caused by an increase in productivity. Characteristic of the growth effected by an input increase is that the relation between output and input remains unchanged. The output growth corresponding to a shift of the production function is generated by the increase in productivity.
Accordingly, an increase in productivity is characterised by a shift of the production function and a consequent change to the output/input relation. The formula of total productivity is normally written as follows:
According to this formula, changes in input and output have to be measured inclusive of both quantitative and qualitative changes. (Jorgenson and Griliches 1967). In practice, quantitative and qualitative changes take place when relative quantities and relative prices of different input and output factors alter. In order to accentuate qualitative changes in output and input, the formula of total productivity shall be written as follows:
A company can be divided into sub-processes in different ways; yet, the following five are identified as main processes, each with a logic, objectives, theory and key figures of its own. It is important to examine each of them individually, yet, as a part of the whole, in order to be able to measure and understand them. The main processes of a company are as follows:
Productivity is created in the real process, productivity gains are distributed in the income distribution process and these two processes constitute the production process. The production process and its sub-processes, the real process and income distribution process occur simultaneously, and only the production process is identifiable and measurable by the traditional accounting practices. The real process and income distribution process can be identified and measured by extra calculation, and this is why they need to be analysed separately in order to understand the logic of production performance
Real process generates the production output, and it can be described by means of the production function. It refers to a series of events in production in which production inputs of different quality and quantity are combined into products of different quality and quantity. Products can be physical goods, immaterial services and most often combinations of both. The characteristics created into the product by the manufacturer imply surplus value to the consumer, and on the basis of the price this value is shared by the consumer and the producer in the marketplace. This is the mechanism through which surplus value originates to the consumer and the producer likewise. Surplus value to the producer is a result of the real process, and measured proportionally it means productivity.
Income distribution process of the production refers to a series of events in which the unit prices of constant-quality products and inputs alter causing a change in income distribution among those participating in the exchange. The magnitude of the change in income distribution is directly proportionate to the change in prices of the output and inputs and to their quantities. Productivity gains are distributed, for example, to customers as lower product prices or to staff as higher pay. Davis has deliberated (Davis 1955) the phenomenon of productivity, measurement of productivity, distribution of productivity gains, and how to measure such gains. He refers to an article (1947, Journal of Accountancy, Feb. p. 94) suggesting that the measurement of productivity shall be developed so that it ”will indicate increases or decreases in the productivity of the company and also the distribution of the ’fruits of production’ among all parties at interest”. According to Davis, the price system is a mechanism through which productivity gains are distributed, and besides the business enterprise, receiving parties may consist of its customers, staff and the suppliers of production inputs. In this article, the concept of ”distribution of the fruits of production” by Davis is simply referred to as production income distribution or shorter still as distribution.
The production process consists of the real process and the income distribution process. A result and a criterion of success of the production process is profitability. The profitability of production is the share of the real process result the producer has been able to keep to himself in the income distribution process. Factors describing the production process are the components of profitability, i.e., returns and costs. They differ from the factors of the real process in that the components of profitability are given at nominal prices whereas in the real process the factors are at fixed prices.
Monetary process refers to events related to financing the business. Market value process refers to a series of events in which investors determine the market value of the company in the investment markets.
The scale of success run by a going concern is manifold, and there are no criteria that might be universally applicable to success. Nevertheless, there is one criterion by which we can generalise the rate of success in production. This criterion is the ability to produce surplus value. As a criterion of profitability, surplus value refers to the difference between returns and costs, taking into consideration the costs of equity in addition to the costs included in the profit and loss statement as usual. Surplus value indicates that the output has more value than the sacrifice made for it, in other words, the output value is higher than the value (production costs) of the used inputs. If the surplus value is positive, the owner’s profit expectation has been surpassed.
The table presents a surplus value calculation. This basic example is a simplified profitability calculation used for illustration and modelling. Even as reduced, it comprises all phenomena of a real measuring situation and most importantly the change in the output-input mix between two periods. Hence, the basic example works as an illustrative “scale model” of production without any features of a real measuring situation being lost. In practice, there may be hundreds of products and inputs but the logic of measuring does not differ from that presented in the basic example.
Both the absolute and relative surplus value have been calculated in the example. Absolute value is the difference of the output and input values and the relative value is their relation, respectively. The surplus value calculation in the example is at a nominal price, calculated at the market price of each period.
The next step is to describe a productivity model (Courbois & Temple 1975, Gollop 1979, Kurosawa 1975, Saari 1976, 2006) by help of which it is possible to calculate the results of the real process, income distribution process and production process. The starting point is a profitability calculation using surplus value as a criterion of profitability. The surplus value calculation is the only valid measure for understanding the connection between profitability and productivity or understanding the connection between real process and production process. A valid measurement of total productivity necessitates considering all production inputs, and the surplus value calculation is the only calculation to conform to the requirement.
The process of calculating is best understood by applying the clause of Ceteris paribus, i.e. "all other things being the same," stating that at a time only the impact of one changing factor be introduced to the phenomenon being examined. Therefore, the calculation can be presented as a process advancing step by step. First, the impacts of the income distribution process are calculated, and then, the impacts of the real process on the profitability of the production .
The first step of the calculation is to separate the impacts of the real process and the income distribution process, respectively, from the change in profitability (285.12 – 266.00 = 19.12). This takes place by simply creating one auxiliary column (4) in which a surplus value calculation is compiled using the quantities of Period 1 and the prices of Period 2. In the resulting profitability calculation, Columns 3 and 4 depict the impact of a change in income distribution process on the profitability and in Columns 4 and 7 the impact of a change in real process on the profitability.
Measurement results can be illustrated by models and graphic presentations. The following figure illustrates the connections between the processes by means of indexes describing the change. A presentation by means of an index is illustrative because the magnitudes of the changes are commensurate. Figures are from the above calculation example of the production model. (Loggerenberg van et al. 1982. Saari 2006).
The nine most central key figures depicting changes in production performance can be presented as shown in Figure. Vertical lines depict the key figures of the real process, production process and income distribution process. Key figures in the production process are a result of the real process and the income distribution process. Horizontal lines show the changes in input and output processes and their impact on profitability. The logic behind the figure is simple. Squares in the corners refer to initial calculation data. Profitability figures are obtained by dividing the output figures by the input figures in each process. After this, the production process figures are obtained by multiplying the figures of the real and income distribution processes.
Development in the real process, income distribution process and production process can be illustrated by means of time series. (Kendrick 1984, Saari 2006) The principle of a time series is to describe, for example, the profitability of production annually by means of a relative surplus value and also to explain how profitability was produced as a consequence of productivity development and income distribution. A time series can be composed using the chain indexes as seen in the following.
Now the intention is to draw up the time series for the ten periods in order to express the annual profitability of production by help of productivity and income distribution development. With the time series it is possible to prove that productivity of the real process is the distributable result of production, and profitability is the share remaining in the company after income distribution between the company and interested parties participating in the exchange.
The graph shows how profitability depends on the development of productivity and income distribution. Productivity figures are fictional but in practice they are perfectly feasible indicating an annual growth of 1.5 per cent on average. Growth potentials in productivity vary greatly by industry, and as a whole, they are directly proportionate to the technical development in the branch. Fast-developing industries attain stronger growth in productivity. This is a traditional way of thinking. Today we understand that human and social capitals together with competition have a significant impact on productivity growth. In any case, productivity grows in small steps. By the accurate measurement of productivity, it is possible to appreciate these small changes and create an organisation culture where continuous improvement is a common value.
Measurement of partial productivity refers to the measurement solutions which do not meet the requirements of total productivity measurement, yet, being practicable as indicators of total productivity. In practice, measurement in production means measures of partial productivity. In that case, the objects of measurement are components of total productivity, and interpreted correctly, these components are indicative of productivity development. The term of partial productivity illustrates well the fact that total productivity is only measured partially – or approximately. In a way, measurements are defective but, by understanding the logic of total productivity, it is possible to interpret correctly the results of partial productivity and to benefit from them in practical situations. Typical solutions of partial productivity are:
Single-factor productivity refers to the measurement of productivity that is a ratio of output and one input factor. A most well-known measure of single-factor productivity is the measure of output per work input, describing work productivity. Sometimes it is practical to employ the value added as output. Productivity measured in this way is called Value-added productivity. Also, productivity can be examined in cost accounting using Unit costs. Then it is mostly a question of exploiting data from standard cost accounting for productivity measurements. Efficiency ratios, which tell something about the ratio between the value produced and the sacrifices made for it, are available in large numbers. Managerial control ratio systems are composed of single measures which are interpreted in parallel with other measures related to the subject. Ratios may be related to any success factor of the area of responsibility, such as profitability, quality, position on the market, etc. Ratios may be combined to form one whole using simple rules, hence, creating a key figure system.
The measures of partial productivity are physical measures, nominal price value measures and fixed price value measures. These measures differ from one another by the variables they measure and by the variables excluded from measurements. By excluding variables from measurement makes it possible to better focus the measurement on a given variable, yet, this means a more narrow approach. The table below was compiled to compare the basic types of measurement. The first column presents the measure types, the second the variables being measured, and the third column gives the variables excluded from measurement.
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