Profits and productivity

In this study we consider the linkage between productivity change and profit change. We develop an analytical framework in which profit change between one period and the next is decomposed into three sources: (i) a productivity change effect (which includes a technical change effect and an operating efficiency effect), (ii) an activity effect (which includes a product mix effect, a resource mix effect, and a scale effect), and (iii) a price effect. We then show how to quantify the contribution of each effect, using only observed prices and quantities of products and resources in the two periods. We illustrate our analytical decomposition of profit change with an empirical application to Spanish banking during the period 1987–1994.