Firms and production

Key learnings

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  Production vs productivity

  Production is the total output of goods and services a firm or economy makes in a period. Productivity is output per factor of production per period — usually labour productivity: output divided by the number of workers. Production can rise just by using more factors, but productivity only rises when each factor produces more. Hiring more workers raises production while productivity can stay the same; training workers so each makes more raises productivity.

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  How to raise productivity

  Labour productivity is raised by education and training (more skilled workers), better or more modern capital (machinery), the division of labour (workers specialise and get quicker), better management and motivation, and improved health. Higher productivity lowers a firm's average cost, so it can charge lower prices, earn higher profits, and compete in export markets. This is why firms and governments care so much about raising it.

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  Demand for a factor of production

  A firm's demand for a factor of production (labour, capital, land) is a derived demand — it comes from the demand for the goods that factor helps make. The two key influences are the price (cost) of the factor and its productivity. If capital becomes cheaper or more productive relative to labour, the firm uses more capital, and vice versa. So a fall in the wage rate, or a rise in labour productivity, both raise the demand for labour.

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  Labour- vs capital-intensive production

  Labour-intensive production uses a high proportion of labour relative to capital (hand-made pottery, hairdressing). Capital-intensive production uses a high proportion of machinery relative to labour (oil extraction, car assembly). Firms choose between them by comparing the relative cost and productivity of labour and capital. Capital-intensive methods often raise productivity and lower average cost, but raise set-up (fixed) costs and cut the number of jobs.