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?
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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.
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.
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