Using labor productivity in calculations

Question

If labor in country 1 costs $0.3/lb of product and in country 2 it's 8% wage rate of country 1 and 80% productivity of country 1..how do we factor in productivity to calculate the labor cost in country 2? Do you need to divide country 1's wage by 80%? If yes, why?

Answer 1

A lower productivity increases your "effective" wages.

If you want to product 1 unit of product:

With 100% assumed productivity you will need X units of labor
With 80% productivity you will need X/80% units of labor - so 1.25X units of labor to product the same 1 unit of product.

Once you have this ratio - then you plug-in the wage costs to get the effective wages.

For example, in my above example, with 80% productivity, your effective wages will be 25% higher than your normal wage because you will need 25% more labor units.

Hope this answers your question.

Answer 2

Hi there,

You have to create a simple formula for productivity.

If country 2 is 8% of the wages but greater than 8% of the productivty, they are more productive per dollar...so, in your current situation, country 2 is a far better option for production.

Think about it this way:

Country 1: 100lbs of product costs $30

Country 2: 80lbs of product costs $2.4....multiplying both 80 and 2.4 by 1.25 (to get to 100), we know that 100lbs of product costs $3.

In essence, Country 2 is 10% the cost of country 1 for the same amount of product.