Explore the connection between the economic indicators and real-world issues. These lessons typically can be done in one class period.
Current Key Economic Indicatorsas of November 30, -0001
"The Bureau of Labor Statistics of the U.S. Department of Labor reported preliminary productivity data-as measured by output per hour of all persons--for the first quarter of 2001." The preliminary seasonally-adjusted annual rates of productivity growth in the fourth quarter were:
- -0.4 percent in the business sector;
- -0.1 percent in the non-farm business sector.
In manufacturing, productivity changes in the fourth quarter were:
- 0.3 percent in all manufacturing and a rate of 7.1% for the year;
- -0.1 percent in durable goods manufacturing and a rate of 10.4% for the year;
- 0.6 percent in non-durable goods manufacturing and a rate of 3.3% for the year.
Bureau of Labor Statistics Press Release, May 8, 2001.
The number most often discussed in press and television reports is the rate of increase in productivity in the non-farm business sector. The decrease of 0.1% is the first decrease since 1995. The trend has been a slowing productivity growth since the second quarter of last year. Productivity growth fell in the third quarter of 2000 and then again in the fourth quarter. Now, in the first quarter of 2001, the growth actually became a decrease.
The change in productivity is not too surprising. As spending and output falls (or growth decreases), businesses are normally slower to adjust hours worked and even slower in adjusting the number of employees. In the first quarter, output in the non-farm business sector did increase (+ 1.9 %) and hours of employees increased at a slightly faster pace (+2.0%). Thus the fall in productivity (1.9% - 2.0%). See the latest Unemployment case for a description of the actual decrease in employment during the month of April.
The increases in productivity for all of 2000 (annual average of 4.3 percent) exceeded increases in 1998 (2.7 percent) and 1999 (2.6 percent). The annual average of 4.3% in the business sector is the highest productivity increase since 1971; and for the non-farm business sector it represents the highest productivity increase since 1983.
The longer run trend in productivity has allowed real GDP per capita to increase. It also means that wages for workers can increase and can do so without excessive upward pressures on prices. However, during this quarter the opposite happened, but is not significant to actually appear in the data. Hourly compensation rose at an annual rate of 5.2 percent during the quarter. Unit labor costs are the costs of labor per unit of output. Thus the increase in unit labor costs is the percentage increase in hourly compensation minus the percentage increase in productivity. Or 5.2% minus (-.1%) = 5.2% (due to rounding). (See the discussion of the importance of productivity changes for inflation and real wages later in the case.)
The increase in unit labor costs provides some evidence that there are still some inflationary pressures. However the recent slowing growth in real GDP and increase in the unemployment rate to 4.5% provide evidence that inflationary pressures are unlikely to continue. In fact, many economists are still concerned about the possibility of a continued slowing of growth in the economy in the near future and the possibility of a recession.
Historical Data Trends
From 1950 to 1973, productivity grew at an average annual rate of 2.8 percent. But from 1973 to 1995, growth in productivity slowed to an increase at an annual rate of 1.4 percent. From 1995 to 1999, productivity again increased at an annual rate of 2.8 percent.
The slowdown, beginning in the 1970s, and the recent increases are not fully understood. The analysis of the Council of Economic Advisers is that about .47 percent of the recent increase can be explained by the effects of more computers and software being used in many businesses. Dramatic changes in the production of computers themselves helps explain about another .23 percent. The quality of labor (increased education and more experienced workers) explains about .05 percent.
The rest (.7) is not really understood fully. Most likely it is due to cyclical pressures (that is, fewer workers are being added to employment rolls, but those who are working are producing more) and perhaps to the effects of the Internet lowering business costs.
For the future, education and experience will not likely continue to make significant advances. The computer contribution to increases in productivity will probably drop. A consensus forecast is for a declining growth rate in productivity and therefore in real GDP.
|1950 -73||1973 - 95||1995 - 00||Future|
|Growth in hours worked||1.6%||1.7%||1.7%||1.2%|
(The numbers do not add in all cases due to rounding and the inclusion of slightly different measures in the productivity and hours calculations. However, increases in the growth in hours worked and increases in productivity will cause similar increases in the growth rates of real GDP.)
Definitions of Productivity
It is a challenge to understand all of the different productivity measures. Changes in productivity are calculated for the business sector, the non-farm business sector, manufacturing (including calculations for durable goods and non-durable goods manufacturing), and even non-financial corporations.
The broadest measure is productivity in the business sector, which comprises 77 percent of GDP. The business sector excludes government and nonprofit organizations, employees in private households, and the rental value of owner-occupied housing. The non-farm business sector excludes all of those activities plus farming and accounts for about 76 percent of GDP. Productivity in the non-farm business sector is the most commonly used measure in studies of productivity. The reason agriculture is removed is because output and therefore productivity are significantly influenced by weather changes.
Non-financial corporate output measures productivity for the non-farm business sector excluding such activities as banks, securities brokers, insurance carriers, and unincorporated businesses. It accounts for 53 percent of the value of GDP. Manufacturing includes about 17 percent of business employment. The manufacturing of durable goods includes machinery, computer equipment, electronics, appliances, automobiles and trucks, lumber, furniture, and stone, glass, and cement products (11 percent of employment). Manufacturing of non-durable goods (6 percent of employment) includes food, apparel, paper products, publishing, chemicals, and petroleum products. The manufacturing data are actually calculated from different sources than the overall statistics and can differ slightly from the other data.
How the Data are Calculated
Productivity data represent the amount of goods and services (in real terms) produced per hour of labor. They do not identify the separate contributions of labor, capital, and technology. Changes in productivity include the effects of all (except hours of work) possible influences on output - technology, ability, skills, and effort of labor, capacity utilization, managerial skills, and the amount of capital.
Other periodic announcements report multi-factor productivity indexes, which do measure the separate effects of hours of labor, education levels and experience of labor, amount of capital, and the effects of technology change.
Importance of Productivity Changes for Inflation and Real Wages
Along with the changes in productivity, the Department of Labor reports output, number of hours, average hourly compensation, and unit labor costs. For example, during the first quarter, non-farm business output increased at an annual rate by 1.9 percent and hours increased by 2 percent. Thus productivity (output/hours) increased by -0.1 percent. Hourly compensation increased by 5.2. Labor costs per unit of output also rose at annual rate of 5.2 percent. (Due to rounding, the effects of the .1 decrease in productivity does not appear to affect the unit labor costs.)
When productivity increases, it is possible for wages to increase without putting equal upward pressures on prices, and costs of producing to increase at a slower rate at the same time. It is possible for costs of producing to even fall.
Over time, changes in productivity will approximate changes in real wages. Increases in productivity are what allow us to be better off. The increased growth in productivity has meant that inflation is reduced, lower unemployment rates can be reached, and economic growth can increase.
Importance of Productivity Changes for Economic Growth
Our capacity to produce goods and services is determined by how much labor we have, how many hours workers work, the workers' skills and intensity of work, the amount of capital workers have with which to work, and changes in technology. Over time, real GDP in the US has increased for all of these reasons. We have a larger population with a larger percentage working. In the last ten years, the average worker has been working longer hours. The workers have significantly larger amounts of capital and new ways of producing and organizing production have been put in place.
The productivity measures capture the effects of the increased capital, the increased experience and education of workers, and the new technology. If productivity increases faster than population growth, real GDP per person can increase and we can all enjoy higher standards of living.
A Hint About News Reports
"Productivity Falls as Economy Slows"
Productivity almost always increases. News reports with headlines like the one above therefore are actually referring to falls in the rate of increase. The headlines referring to "falling productivity" most often mean that the increase in productivity is less than previous increases. The last time overall productivity actually decreased on an annual basis was in 1982 in a recession. And that is when we would normally expect productivity to fall. During the first quarter of 2001, productivity did fall. Quarterly decreases in productivity were also experienced during single quarters in 1994 and 1995.
The headlines associated with the first quarter announcement will be accurate.
"Productivity Fell 0.1% in 1st Quarter"
Labor productivity normally rises at a more rapid rate during the beginning of expansions and rises at slower rate during the end of expansions and the beginning of recessions.
Productivity Growth Difference by Industry
During 1998, the greatest changes in productivity in the manufacturing industry were in computer and office equipment (44%); industrial inorganic chemicals (26%); electronic components and accessories (25%); aircraft and parts (23%); miscellaneous furniture and fixtures (20%); fats and oils production (20%); hats, caps, and millinery (19%); pens, pencils, office, and art supplies (15%); and greeting cards (13%). Over two-thirds of the industries with increasing productivity also experienced decreasing unit labor costs. All industries experiencing decreasing productivity had rising unit labor costs.
In the services sector, the greatest increases in output per hour were in radio, television, computer, and music stores (20%); household appliance stores (19%); paint, glass and wallpaper stores (19%); portrait photography studios (15%); and used merchandise stores (15%). The larger industries such as hotels and motels and commercial banks did not experience increases in labor productivity and all experienced rising unit labor costs.
Productivity Differences Among Nations
Economic growth depends on changes in the levels of capital, labor and changes in technological growth. Although capital accumulation is crucial, in order for rapid and sustained productivity growth to be achieved, a country's resources must be employed with rising productivity. Productivity varies among countries for several reasons. The level of output per worker is dependent upon the quality of the inputs, technology used, and the social infrastructure and government of the country. Countries with poor trade regulations or corruption and government interference in production find it difficult to achieve the economic success of more developed nations.
The differences among countries' income per capita are also influenced by the hours worked per person and the portion of the population in the labor force. An increase in labor force participation will increase per capita GDP, since more workers are contributing to output. An increase in the hours per week has a similar effect. Therefore a country with a high labor force participation rate, a large number of hours worked per week, and a more rapid growth in labor productivity will likely experience higher levels of real GDP per capita and thus higher real incomes. (Lower unemployment rates will also contribute to higher per capita GDP.)
|Country||Per Capita GDP||% Labor Force Participation||Average Hours per Week||% Change in Labor Productivity|
|(Sources of Data: The International Monetary Fund, the World Bank, and the US Bureau of Labor Statistics)|
A Classroom Activity on Productivity
Assessing the Effects of Capital, Labor, Technology and Learning on Output
Economic growth is dependent upon changes in the levels of capital, the labor force, and technology in a country. Increased productivity and technological change will allow for increases in output and increases in wages without affecting the price level. The relationships among factors affecting productivity and output are illustrated in the following activity.
First, divide the classroom into four equal groups and distribute construction paper to each group. Explain that each group is a country and that the paper represents their natural resources. Tell two people in group one that they will have one minute to take their construction paper and tear it into circles the size of a fist. Their goal is to make the most circles in a minute. This may require some quality control to ensure that legitimate circles are being produced. When one minute has elapsed, collect and tally the number of circles. Show examples to the class and ask what should be done to increase the production of circles or the quality of circles.
These circles will probably be very rough around the edges and only approximate a circle. The teacher must make sure that the students are tearing fairly regular shaped circles in order for later sections of this activity to apply. Students may suggest that circle production can be increased by having more students participate, employing scissors or discussing the methods of tearing out circles. Suggestions on how to increase the quality of the circles may include using a compass or an object to trace as well as using scissors.
In the second round, distribute two scissors to two people in group 2. Explain that the two students will be given one minute to cut out as many circles (the size of a fist) as they can. When one minute has elapsed, collect and tally the number of circles. Discuss how the output changed with the addition of capital to this economy. Compare examples of the circles made with scissors to those made by tearing and determine if the addition of capital has increased the quality of the product. You may also discuss how you might count the number of rather crude circles in the first round, compared to the larger number of better circles in the second round.
With the addition of capital, more circles should have been produced, each more closely approximating a true circle. When more circles are produced in a given time period with the same amount of labor, this constitutes an increase in productivity. The quality of the circles will have also increased when scissors were used, because now the circles have a more regular shape and do not have ragged edges. Each of the more regular circles perhaps should be counted as more valuable than the rather crude circles. The challenge is to determine how much more valuable. In measuring GDP, we use the market value of the products.
In the third round, have four people in group 3 cut out circles with the same number (2) of scissors. Explain that they will have one minute to cut out as many circles as possible. When one minute has elapsed, collect and tally the number of circles. Discuss how the gross output changed with a larger labor force. Then divide the number of circles produced by four to determine the productivity.
When the labor force is doubled, more circles should be produced. They should be the same quality as the ones produced with the original labor force. Real output per capita will have increased as the number of circles produced divided by the size of the class will have increased. Determine if the productivity per worker increased. It should be approximately the same or may have decreased. One would expect a decrease in productivity, because of diminishing marginal returns when the amount of capital is held constant. Note that individual workers in the labor force may have different productivity levels and this in turn may have affected the outcome.
Finally, ask the entire class to discuss what other aspects of circle production might be altered in order to increase the number of circles produced or the quality of the circles. Then select four people and have them use whatever resources available to produce their circles. (They may use a compass, trace a coke can, or use other forms of approximating a circle.) When one minute has elapsed, collect and tally the number of circles. Discuss how the output changed with the addition of learning and innovation, and perhaps more capital. Compare examples of the circles made with the new technology and the additional learning, to those made by an increase in labor, to those made with scissors, to those made by tearing and determine if this additional information has increased the quality of the product.
By discussing how to approach the task of making circles, the group may come up with more efficient methods of production. For example, one student might trace circles on paper while the other student starts cutting circles out, this is specialization of tasks. The main effect here may be on the quality of the product. Output may fall and productivity may fall, but overall the circles should be of higher quality. Enhanced technology and capital, with labor at a constant, should increase productivity. Ideally, in this scenario, output and quality are the highest. Therefore, this should represent the highest levels of productivity.
- If these groups were four separate countries (one with just labor, one with labor and capital, one with a larger labor force and capital, and one with enhanced technology), which would have the highest productivity rates? Compute productivity and real GDP per capita (the size of the class) for each scenario.
[In order from lowest productivity to highest productivity are: labor (group 1), larger labor force and capital (group 3), labor and capital (group 2), and enhanced technology (group 4). Productivity is measured as output per worker in a given time segment and is the total output divided the number of workers. The real GDP per capita will likely be ranked group 1, group 2, group 3, and group 4.]
- Compare the circles from the economy with just labor and the economy with labor and capital. Which of the two produced the higher quality circles? Which circles do you value more? How might the quality of some circles be reflected in prices?
[The circles from the economy with labor and capital should be of higher quality. However, productivity may have fallen when the students devoted a little extra time to circle production. Since fewer more accurate circles were produced, these circles may be of higher value and that would be reflected in a higher value for this group. This higher value should be considered in measuring production.]
- When the labor force increased, did each of the workers have the same productivity rates? What do you think are the effects of higher education on productivity per worker? As an employer, which workers would you hire?
[Each of the four students probably produced a different amount of circles. Higher education levels will increase the skills and therefore productivity of workers. Workers with higher levels of productivity will experience a higher demand for their services in the market, and therefore be able to earn a higher wage rate.]
- What were the effects of a classroom discussion on circle production? How is this like trade between countries? Will trade increase productivity in individual countries?
[The classroom discussion allowed for a general collaboration of ideas, and the best methods of production were chosen from a number of suggestions. Trade between countries allows for a dispersion of ideas between different areas. When developing countries import products they acquire knowledge of product design and technology and may learn techniques that may increase production and efficiency of their own products.]
Other questions for Students
- Assume that hours worked increase by 1 percent and that GDP increased by 5 percent. Also assume that the GDP implicit price deflator increased by 2 percent. Calculate the increase in productivity.
[ Real output increased by 3 percent (5% - 2% = 3%). Productivity is output per hour worked. Thus the increase in productivity is 3 percent minus the change in the number of hours (one percent). Productivity increases by 2 percent.]
- Suppose the labor force increases by 1 percent and the hours per worker increase by 1 percent. Increases in the amount of capital increases output per worker by 2 percent. Prices increase by 3 percent. Increases in education and technology increases output per hour by 1 percent. What are the rates of increase in real GDP and GDP?
[Labor inputs increase by 2 percent. Output per hour increases by the contribution of capital, education, and technology - 3 percent. Real GDP will thus increase by 5 percent. Given an inflation rate of 3 percent, nominal GDP will increase by 8 percent.]
- An increase in government spending on research and development may enhance abilities to produce goods and in effect increase productivity. Is such spending wise?
[Obviously such spending has benefits. Production should increase and we will be better off as a result of the increased spending. However, economic analysis would tell us that there are opportunity costs. If other productivity enhancing activities are given up as a result of the increase in government spending, it is less clear that such spending is wise.]
- See activities and questions in "What's Happening in the New Economy?", an Economics Minute lesson posted March 4, 2000.
Sources of Additional Activities
- Advanced Placement Economics: Macroeconomics
. (National Council on Economic Education)
Unit 1: The Basic Economic Problem
- Focus on Economics: High School Economics
(National Council on Economic Education)
Lesson 9. Getting More or Using Less
Lesson 17. The Circular Flow of Economic Activity
- Capstone: The Nation's High School Economics Course
Unit 1: 9. The Circular Flow of Economic Activity
Unit 3: 6. Productivity
Unit 6: 2. Making a Macro Model: Consumers
Unit 6: 3. Making a Macro Model: Investment Handbook of Economic Lessons (California Council on Economic Education) Lesson 20: Plotting the Ups and Downs of the US Economy
Lesson 21: The Fluctuating Economy: A Look at Business Cycles
Lesson 23: Economic Growth
All are available in Virtual Economics, An Interactive Center for Economic Education (Council for Economic Education) or directly through the Council for Economic Education .