Input Growth and Growth of Total Factor Productivity

Input Growth

Already, we are well aware that the productive capacity and potential GDP of an economy increase due to the following two reasons:

• the accumulation of inputs such as capital, raw materials, and labor used in the production process; and
• the discovery and efficient application of new technologies help yield more output from the same amount of input.

This model of input growth entirely depends on a production function. It gives a quantitative connection between the amount of output the economy can produce and the amount of input to be used in the production process. This model also incorporates the issue of technology. Thus, a two-factor production model with capital and labor as the inputs results in the following mathematical expression:

$$Y=A × F(L, K)$$

Where:

Y = level of aggregate output in the economy

L = quantity of labor (or number of workers in the economy)

K = capital stock in terms of structures and equipment employed in the production process

A = technological knowledge

Total Factor Productivity (TFP)

This scale factor mainly reflects the portion of growth that isn’t attributed to the effect of capital and labor inputs. The main factor that influences total-factor productivity is the change in technology. Also, it should be noted that like the potential GDP, total-factor productivity cannot be observed directly in the economy. We must, therefore, estimate it.

Further, note that output in any economy highly depends on the inputs and technology involved. Moreover, from a given amount of input, more technologically advanced economies will yield more output than their less technologically advanced counterparts. As a result, for the effect of total factor productivity to be assessed, two assumptions are necessary:

• assume that the factors of production have constant returns to scale. In such a case, doubling the inputs should also double the output; and
• assume that the total factor productivity exhibits diminishing marginal productivity with respect to any of the individual inputs.

Question

The growth rate of labor productivity can be described as:

A. the percentage change in the productivity of labor over time;

B. the real GDP that a worker can produce per hour worked; or

C. the percentage change in the level of aggregate output in the economy.

Solution

The correct answer is A.

Labor productivity refers to the real GDP that a worker can produce per hour worked. Hence, the growth rate of labor productivity refers to the percentage increase or decrease in the real GDP produced by a worker per hour worked.