How Does Production Affect the Economy?

Various economic indicators measure the strength of the economy. News reports on the national gross domestic product, or GDP, jobless claims and housing starts, among others, occur regularly. Economists use GDP to measure the aggregate value of goods and services produced in the nation. Production levels, part of GDP data, play a vital role in the health of the economy, and they can affect the economy in positive and negative ways.

When production levels increase, manufacturers earn more profit through increased sale volumes. It also costs manufacturers less per unit when production levels rise. This cost reduction, called economy of scale, also adds to the bottom line. Some companies use this increase in revenue to develop new products, expand current operations and add more jobs.

Increases in production generally correspond with lower unemployment rates. Lower unemployment can result in higher wages as companies pay workers more to meet consumer demand. Higher levels of employment lead to increases in consumer spending. A decrease in production levels creates an opposite and negative effect on the economy. Higher unemployment leads to lower levels of consumer spending.

Levels of production affect the stock market. As production and profits increase, investor earnings tend to increase, pumping more money into the hands of investors. Just as higher production levels generally increase profits for companies, lower production levels decrease profits. Stock prices parallel this rise or fall of profits, and investors react to the changes. For example, when production declines, profits decrease and stock prices fall, investors worry that the economy is headed for a slowdown, possibly to the point of recession or an extended period of decline into depression. Investing slows. Conversely, when production is on the rise and profits increase, investor confidence is boosted and the markets flourish.

Increases in production create a ripple effect throughout various sectors of the economy. For example, when manufacturers demand more materials, the effects translate into more work and more profits for companies that specialize in the extraction of raw materials. They pass these materials along to companies that process raw materials, likewise creating more work and increasing profits in this sector.

When production increases and a U.S. company exports more products, the money from sales often returns to the local and national economies in some form. Higher levels of production also generate more tax revenue for the federal government and for state and municipal governments, providing possibilities of investment into infrastructures and yet more job creation.