multifactor productivity. The basic concept is that MFP calculates output over all inputs. In the example given, the inputs are labor and capital. The MFP formula is used to measure the change in productivity that results from specific changes in the production process. In addition, the importance of firms studying productivity changes is explained. Firms need to understand the implications of changing different inputs, in order that they may seek the path of profit maximization. Sensitivity analysis to different changes can help with that process. In addition, the MFP concept is useful for firms seeking to maximize other variables besides profit. The same principles behind MFP can be applied broadly in business to ensure that the best decisions are being made and that productivity is being maximized.

The basic principle is that MFP is based on the outputs per a combination of labor and capital (Jaxworks, 2010). This is in contrast to the standard understanding of productivity that only relates output to labor. In the modern world, labor is just one input, and capital can be a considerable input as well. This is reflected in the increasing use of multifactor productivity in organizations. Therefore:

500 / ($800 + $3,400) = 0.119

In this equation, the $800 is the cost of five workers for sixteen hours multiplied by $10/hr. The $3,400 represents the capital outlay. After the changes have been made, the MFP is:

600 / ($800 + $3,600) = 0.136

This illustrates that there was an increase in multifactor productivity as a result of the changes that were made to the training and equipment. The productivity measure here has changed because the output has changed significantly (+20%) while the inputs have not changed as much (+5.9%). This is a positive outcome for the organization, because it has increased its inputs by a small amount, but increased its outputs by a much more significant amount.

2. It is important to be aware of productivity changes, because those changes represent deviations from the firm’s plans. It is important to be aware of productivity declines, because those will reflect is worsening of the firm’s earnings. Adjustments need to be made in order to correct whatever is causing the decline in productivity. If productivity increases, this may not be as serious, but it provides the opportunity for the firm to improve its efficiencies elsewhere as well, such as scheduling and ordering. In this case, the increase in productivity means that if demand remains the same, the company can decrease the length of its work day, delivering greater cost savings.

Banker, Datar and Kaplan (n.d) noted that accounting professionals often feel that variance analysis is sufficient for measuring and addressing productivity changes. The authors argue that even the best-designed managerial accounting systems do not deliver the same quality of information as an explicit analysis of productivity does. Noting the changes in productivity levels at the firm allows for direct comparison of inputs to outputs, something that most forms of variance analysis have a difficult time achieving. This helps the organization to make the necessary adjustments to improve productivity very quickly, as they immediately know the source of the problem and the best courses of action that can be undertaken to make productivity improvements. Using this equation, a number of different courses of action can be tested for their potential impact on the firm’s multifactor productivity.

3. The changes in the parameters of the productivity calculation are critical to understanding how and where to make adjustments to the company’s operations in order to improve productivity. The basic formula for calculating multifactor production can be subjected to sensitivity analysis, and this will show the impact of changes in the different parameters on the firm’s productivity. For managers, it is also important to understand the impact of all inputs — many MFP calculations go beyond labor and capital to include energy usage and other inputs. Indeed, when economists measure the MFP of a country they typically include a wide range of inputs required to deliver economic output (Lane Report, 2011).

4. Productivity is an essential component to understand the firm’s outputs. To understand this, the basic goal of business must be considered, and that is to maximize profit. The income statement shows that there are a number of components that go into profit, from revenue to cost of goods sold, down to income taxes. What multifactor productivity analysis does is that it focuses the firm on the direct components of production. Decisions about overhead and about revenue are to be analyzed elsewhere — this analysis is about having the most efficient manufacturing process possible.

In any production process, there are tradeoffs that must be made. Firms can invest heavily in machinery that displaces manual labor. Firms can extend work days rather than expanding their plants in order to raise production. The ultimately objective of any of these decisions, however, is to increase profit. While any one decision can be analyzed independent of others, that does not tell the company what the bottom line impact of the decision will be. Increasing the length of shifts will produce more output, and the impact on the cost of labor is easy to see, but analyzed on its own, the company may realize that such a tactic reduces its productivity. Firms maximize their profit at the point where they maximize productivity. For firms operating in any market structure, the marginal cost of producing an extra unit must be less than to the marginal revenue earned from that unit in order to earn additional profit (CliffNotes, 2011)

The multifactor productivity calculation allows firms to be able to analyze the change in productivity that changes in the production process will deliver. This in turn helps the firm to understand what its marginal cost of producing those additional units is, and whether that is more than or less than the marginal revenue earned from that production. As a result, the MFP calculation contributes to better decision-making at the firm level.

It also helps the firm to improve productivity. The MFP calculation demands that the firm understand its inputs, not just its outputs. This can help with many of the firm’s operational goals. Many firms have objectives that go beyond profit maximization — the MFP calculation allows the impact of any change in the production process to be analyzed in the context of not only the outputs but all other inputs as well. Thus, the firm has the knowledge required to make good decisions that will improve the productivity at all levels of the organization.

Works Cited:

Banker, R., Datar, S. & Kaplan, R. (no date) Productivity measurement and management accounting. Journal of Accounting, Auditing and Finance. Retrieved November 6, 2011 from http://astro.temple.edu/~banker/Accounting/32_Productivity%20Measurement%20and%20Management%20Accounting.pdf

CliffNotes. (2011). Profit maximization. Cliff Notes. Retrieved November 6, 2011 from http://www.cliffsnotes.com/study_guide/Profit-Maximization.topicArticleId-9789,articleId-9769.html

Jaxworks. (2010). Multifactor productivity. Jaxworks.com. Retrieved November 6, 2011 from http://www.jaxworks.com/calc5.htm

Lane Report. (2011). Multifactor productivity rose in 14% of detailed manufacturing industries studied in 2009. The Lane Report. Retrieved November 6, 2011 from http://www.lanereport.com/articles/fastlane_article.cfm?id=multifactor_productivity_rose_in_14_of_detailed_manufacturing_industries_studied_in_2009