Technological change often takes the form of new methods of producing existing products together with new techniques of organization. These changes can result in greater productivity, giving a firm the ability to increase its ratio of output to input. Thus, the rate of technological change is often measured by changes in productivity. Measuring the impact of technological change, and its resulting impact on productivity, is a key challenge for firms.
In our practice at ALCG, we utilize two key methods for measuring the impact of changes in a firm’s technology. These methods arise from the key insight that any change to a firm’s technology should impact the ratio of output to input. Too often, continuous improvement activities are measured by means that do not reveal how a firm’s underlying productivity has been changed. This usually stems from managers having little or no information about their firm’s production function or factor productivity.
A firm’s production function shows the relationship between the quantities of various inputs per period of time and the maximum quantity of goods that can be produced per period of time. Given the production function for a particular firm, one can calculate the average product of an input and its marginal product. To maximize profit, a firm should utilize the amount of an input that results in making the marginal revenue product equal to the marginal expenditure.
From the production function, we can derive isoquants that show all possible (efficient) combinations of inputs that are capable of producing a particular quantity of output.
Once a firm’s production function is observable, comparison of the production function at two different time can show the amount of technological change that has occurred in the intervening time. If there are only two inputs, capital and labour, and constant returns to scale, the production function at a given time can be captured by a single isoquant. One can then simply look at the position of this isoquant at a later date to see the impact of technological change. The degree to which the isoquant shifts inwards is a measure of the impact of technological change that has taken place.
A second method we often use is to assess the impact of technological change is to measure total factor productivity. Total factor productivity relates changes in output to changes in both labour and capital inputs. The principal advantage of using total factor productivity over labour productivity as a measure is that, unlike the latter, it includes more types of inputs and not just labour alone.
Changes in total factor productivity measure changes in efficiency. because it is important for a firm’s managers to be aware of the extent to which productivity has increased in response to new techniques and methods, total factor productivity can be used over time to measure changes in the efficiency of a firm’s operations.