Relevant Review:

   Factor Markets

Factor Demand

   Monopoly

Cost Change

   An increase in productivity is about the only piece of economic news that seems to have no down side. Let's look at some of the microeconomic effects of increased productivity to see why.

   First, as you no doubt recall from your study of Factor Markets, the demand curve for any factor of production, including labor is the Marginal Revenue Product (MRP) curve, since MRP gives the added revenue for each added unit of the factor. MRP in turn is the product of Marginal Physical Product (MPP) and Marginal Revenue (MR).

   To the left is a graph of a Marginal Physical Product curve shifting upward. The MPP curve for US Workers, if we graphed it, would show an upward shift during the July-September quarter (though not as large of course). Along the horizontal axis N represents numbers of workers and on the vertical axis is Q, output. MPP is the added or marginal output of an additional worker. An increase in MPP means that if the firm hires another worker output will increase by more than before, the Marginal Product of the worker has risen.

   Since the Marginal Revenue Product of labor is also the demand for labor for any profit maximizing firm a shift in MPP also shifts the MRP curve, as shown to the right. This also means that the demand curve for labor shifts up.

   Something that many new economics students find troubling is the idea that firms will hire more workers if workers become more productive. The first instinct is just the opposite, that a firm will need fewer workers since each worker now produces more output. The trick here is to keep in mind that a more productive worker is actually a cheaper worker. Labor costs per unit of output are lower if workers are more productive. If an input (labor in this case) is cheaper more will be hired since the firm can lower costs and increase output, thus increasing profits.

   The labor market effects will tend to be as shown to the left. Because the demand for workers has risen from D₁to D₂(since demand is just MRP), numbers hired increase from N₁to N₂and wages increase from W₁to W₂. Unlike what, at first thought, might be expected to happen, an increase in productivity will tend to increase wages and numbers employed.

   Now, this increase hiring probably won't occur in industries that have colluded to keep output low and prices high since this behavior is somewhat different from pure profit maximizing behavior (though it has the same intent). The alert student will comment that such collusion is illegal. The alert professor will remind the student that illegal activities still occur, such as underage drinking, speeding, and collusion to name a few. That's why we have police, and for collusion the [Outside Econweb] US Department of Justice, and the [Outside Econweb] Federal Trade Commission, with similar problems that police face in stemming crime. We also remind the student that industries can agree to keep output down without actively colluding, see the section on oligopoly.

   Within the typical profit maximizing firm we can see the increase in worker productivity as a reduction in variable costs as shown to the right. We show a firm with a downward sloping demand curve that was already earning profits (green shaded area) before the increase in productivity. After productivity increases, variable costs fall shifting down the MC and ATC curves. Because MC is lower the firm produces more output (see why it will hire more workers?) and sells it at a lower price. At the same time profits increase to the blue striped area.

   Whatever else goes on in any economy, producing needed goods and services with the fewest resources is the ultimate goal. Increased productivity is good news all the way around. Too bad it isn't easier to attain.
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