Labor Cost Per Unit of Output

Definition


What is the Labor Cost Per Unit of Output -- Manufacturing?

The interpretation of labor cost per unit of manufacturing output (hereafter called unit labor cost) is straightforward--it is the cost of worker compensation and benefits per unit of manufactured output. Unit labor costs rise when compensation and benefits rise faster than labor productivity. To see this, recall that labor productivity can be measured as the quantity of output produced for a given hour of labor input. If labor productivity increases by 2 percent and worker compensation remains unchanged, then unit labor costs would decline. Conversely, if labor productivity remains unchanged but worker compensation and benefits rise by 4 percent, then unit labor costs would rise. Thus changes in unit labor costs reflect the net effect of changes in worker compensation and changes in worker productivity.

Labor is usually the single largest component of production costs. Accordingly, unit labor cost is an important indicator of trends in production costs, share prices, and inflation. Let's consider each of these relationships. First, a sustained rise in unit labor costs will cause an upward shift in a firm's average and marginal cost curves. Second, rising production costs will reduce profits, and if these effects spread across the economy they will be reflected in a decline in equity indices such as the S&P 500. Third, firms confronted with rising unit labor costs will be pressured to raise prices, which can trigger accelerating inflation. Consequently, unit labor cost is closely watched by monetary policy authorities at the Federal Reserve Bank and the Conference Board, which uses unit labor costs in its lagging indicators series of the Index of Economic Indicators.

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