The production activity of a business requires the combined input of various factors such as machinery, buildings, land and labour. These factors are usually divided into two categories: labour and capital. To measure the efficiency of these production factors in the production process, the produced goods & services are considered in relation to the production factors used. This relation is called productivity or factor productivity (when production factors are combined this is known as multifactor productivity).
Productivity analyses are an important indicator for economic policy. An increase in productivity substantially improves a country's standard of living. Wage growth, for example, is often related to increased productivity. Productivity is also a valuable indicator of the efficiency with which an economy uses the resources available to it. The growth of productivity is also often used to compare the relative performance of different national economies.
Labour productivity measures the efficiency with which human resources are used in the production process. It is one of the most commonly used productivity concepts in macroeconomic analyses. A distinction is made between labour productivity in the total economy and that of the business sector. The importance of labour productivity to economic growth should not be underestimated; it is an important indicator for economic policy. It is closely related to the concept of income and to a country's standard of living. An increase in productivity over an extended period can, by means of distributive transactions, lead to an increase in a country's incomes and living standards.
Capital productivity portrays the efficiency with which capital is used in the production process. It measures capital's capacity to contribute to value added. Capital productivity should not be confused with rate of return. The rate of return measures capital's capacity to yield an income (or profit) whereas capital productivity quantifies the efficiency of capital use in the production process.
Multifactor productivity (MFP) measures the efficiency with which the combined production factors labour and capital are used to produce goods and services. Under certain conditions, this can be used to measure a national economy's technological progress. MFP also reflects economies of scale, changes in the composition of the factor labour as well as statistical imperfections. MFP is measured as a residual value. In contrast to MFP, labour and capital productivity are partial productivity measures.