# Total factor productivity

Total Factor Productivity (TFP) is an economic measure of output per unit of input in production. TFP is calculated as the ratio of aggregate output (real gross domestic product) to total inputs (labor and capital). It is a measure of economic efficiency, showing the level of output given the inputs used. TFP can be used to measure the efficiency of a particular industry or the entire economy. It can also be used to compare the productivity of different countries or regions.

TFP can be measured using the following formula: TFP = Real GDP/ Labor + Capital. This formula measures the growth of output relative to the growth of inputs. If output increases more than inputs, then TFP increases, indicating that the economy is becoming more efficient. Conversely, if output increases less than inputs, then TFP decreases, indicating that the economy is becoming less efficient.

TFP is an important measure of economic performance, since it tells us how efficiently an economy or industry is using its resources. It can help policy makers identify potential areas for improvement, such as increasing investment in technology or capital. By understanding TFP, governments can better allocate resources for maximum economic growth.

## Example of Total factor productivity

Total factor productivity can be seen in the following example. Suppose there is a company that produces 100 units of output with 10 units of labor and 5 units of capital. The TFP of this company would be calculated as follows:

TFP = 100/ (10 + 5)

TFP = 100/15

TFP = 6.67

This means that the company is producing 6.67 units of output for every unit of combined labor and capital inputs. This suggests that the company is making efficient use of its resources, since it is producing more than it is spending on inputs.

## Formula of Total factor productivity

TFP = Real GDP/ Labor + Capital

## When to use Total factor productivity

Total factor productivity is a useful measure for governments, businesses and economists to understand the output of an economy or industry. It can be used to compare the relative performance of different countries or regions, measure the efficiency of an industry, or assess the effectiveness of government policies.

• Governments can use TFP to assess the effectiveness of their policies, as it allows them to measure the output of the economy relative to inputs.
• Businesses can use TFP to compare their own performance relative to their competitors, and identify potential areas for improvement.
• Economists can use TFP to measure the efficiency of an industry or the economy, and identify potential problems or areas of improvement.

## Types of Total factor productivity

• Technical change: Technical change occurs when new technology is introduced, allowing for increased production with the same inputs. It can be measured by comparing the output produced with the same inputs over different periods of time.
• Allocative efficiency: Allocative efficiency occurs when resources are used in the most efficient manner to produce the maximum output. It can be measured by comparing the output produced with different inputs over the same period of time.
• Scale economies: Scale economies occur when larger firms are able to produce more output with the same inputs as compared to smaller firms. It can be measured by comparing the output produced with the same inputs by different sized firms.
• Dynamic efficiency: Dynamic efficiency occurs when firms are able to take advantage of new technologies and production methods. It can be measured by comparing the output produced with the same inputs over different periods of time.

## Steps of Total factor productivity

• Step 1: Calculate Total Output: Total output is the sum of all goods and services produced in an economy, measured in real terms. This can be calculated by adding up the value of all products and services produced in a given period.
• Step 2: Calculate Total Inputs: Total input is the sum of all inputs used in production, including labor and capital. Labor inputs can be measured by the number of people employed in the economy, and capital inputs can be measured by the amount of capital invested.
• Step 3: Calculate Total Factor Productivity: Total factor productivity is then calculated by dividing total output by total inputs. This gives a measure of the efficiency with which resources are used in production, and is a key indicator of economic performance.

## Advantages of Total factor productivity

• TFP provides a comprehensive measure of economic efficiency by taking into account both labor and capital inputs.
• It can be used to compare the productivity of different countries or regions.
• TFP can help policymakers identify potential areas of improvement.
• It can be used to measure the efficiency of a particular industry or the entire economy.

## Limitations of Total factor productivity

Despite its usefulness, TFP has several limitations. First, it is a relative measure of productivity, meaning that it is only useful when comparing two different economies or industries. Second, it does not take into account qualitative factors such as innovation or quality of inputs. Third, it does not take into account external factors such as population growth or subsidies. Finally, it does not account for the redistribution of income due to taxation or welfare programs.

## Other approaches related to Total factor productivity

• The CES production function: The Constant Elasticity of Substitution (CES) production function is used to explain how inputs interact to produce outputs. It is a generalization of the Cobb-Douglas production function, which is a linear combination of inputs. The CES production function takes into account the fact that different inputs may have different effects on output.
• The Data Envelopment Analysis (DEA) model: The DEA model is a nonparametric method used to measure the relative efficiency of firms or industries. It is used to measure how efficiently inputs are being used to produce outputs. The DEA model takes into account the fact that different firms may have different levels of efficiency, and allows for comparison between firms.

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