Question

Discuss in detail how economists measure productivity. Also discuss concepts behind labor productivity, the productivity paradox and explanations of the apparent productivity paradox.

Discuss in detail traditional financial methods used to evaluate investment decisions including present value (NPV), internal rate of return (IRR), and payback period including scenarios when one over the other would be more appropriate

Answer 1

In economics, productivity is measured by the output produced on per unit of input used in production process. Inputs consists of labor and capital used and output is measured by the revenues generated or the final goods and services produced for consumption. An economy is always looking to increase the productivity as that would mean more can be produced from fewer inputs.

As we know there are two inputs used namely labor and capital. Labor productivity is measured by the actual/real amount of GDP or final goods and services per hour of labor input. Labor productivity is increased by investments, use of new technology and human capital. Productivity paradox refers to the observation that more investment in information technology leads to a reduction in the labor productivity instead of increase. In the United States during the 1970s and 1980s even though there was a huge increase in the investment of capital in information technology field the labor productivity seemed to be declining. The main reason for this was the unwarranted assumptions about the effects of technology on productivity. Any new technology requires the labor force to properly get accustomed to it and make the optimum use of it in the production process. Improper handling of technology often leads to negative effect on the labor productivity.

Investment decision is taken on the basis of evaluation of the project through different methods. Methods like Net Present Value, Internal Rate of Return and payback period are prominent methods used for evaluation of project. Net present value calculates the present value of all the costs and revenues generated from the project discounted at a given rate of interest. Internal rate of return is the rate of interest used for discounting where the present value of costs and revenues are equal. Payback period is the time taken by the project to return the investment amount. The NPV method is used for mutually exclusive multiple projects and also for single project evaluation. IRR uses a single discount rate for every investment and is used for comparing multiple projects only. Payback period can be used extensively however, it does not take into consideration the time value of money.