Productivity

Productivity is the rate at which inputs can be transformed into outputs. An input's productivity is not constant. Rather, it depends on the level at which it is already employed, the level at which related inputs are employed, and the nature of available technology.

The production of physician office visits is illustrative. Suppose that a physician's production capacity is 10 visits per day. By employing an office assistant, our hypothesized physician might increase this capacity to, say, 15 visits. In this case, the office assistant's marginal productivity is 5 office visits.

Introducing a second assistant is likely to further expand the physician's production capacity. This assistant's “productivity” can be higher or lower than that of the first. A higher marginal product, say 6 additional office visits, could emerge from economies associated with specialization (for example, the first assistant specializes in maintaining the group's financial records and the second specializes in filing insurance claims). Nevertheless, the law of diminishing marginal returns says that the office assistants' marginal product (and that of every other input) must eventually fall. If this were not the case, a firm would have no boundaries.

Understanding the term “productivity” facilitates optimal decision making. For example, to maximize profits one needs to choose a combination of factor inputs so that each factor's productivity-to-cost ratio is identical. When this condition does not hold, a “free lunch” is available from hiring additional inputs whose ratio is high (for example, 20 units/$5) and firing those whose ratio is low (for example, 10 units/$5).