THEORY OF THE FIRM II LECTURE TWO 7 WZ By the end of this lesson, the learner should be able to: ‘+ Understand the properties and the types of production functions. ‘* Distinguish between production function and an input requirement set.TYPES OF PRODUCTION FUNCTION. 1. The fixed proportion production function (Max Leontief). Tt takes the form; f(x minx s01,%,y.0-1,%,) iy it equates the ouput level othe smaest possible value of x, For example f(x) = min(oj,x,.21,x,) If ax, =10 & a,x, =15 Then f(x)=10 This function assumes that inputs are complements in production. The input requirement set is L shaped as show below2. Linear production function. It takes the form, Sle) = Sax, = (yx, +02, +...4.a,%, hee, > 0 ‘The function assumes that the inputs in production are perfect substitutes. The input requirement set is linear as shown below. Vv) 3. Generalized power function: Ittakes the formFo) = AT] she" Where; (x)= a, g(x)=0 cobb douglas function Where A is an efficiency parameter and measures the level of technical progress and ai, and at, are input elasticities of the output o factor shares i.e. S(x)= Ax! x? =aAxi yt Axixe =a, (elasticity) ‘The input requirement set is shown in the graph below.x, The inputs are imperfect substitutes in production, 4. Constant elasticity of substitution (C.E.S.) production function. It takes the form: SG) = Alar’ + (lan bes" Where: A is an efficiency parameter. € is substitution parameter, ic. it measures the ease with which two inputs can be substituted, is distribution parameter. It shows how the two inputs are distributed overthe production of one unit of output, V_ isthe degree of the homogeneity of the production function. It is a measure of returns to scale. THE MRTS VS ELASTICITY OF SUBSTITUTES), MRTS shows the rate at which input x, can be substituted for another input X, while output remains constant, i, it’s the adjustment of x, which is necessary to preserve output after X, changes, a wrers =e, = fAsa measure of degree of substitutability between inputs, MRTS suffers from a serious defect, i. The value depends on the units of measurements of the input involved in production, A superior measure in this regard is the elasticity of substitution (6). It’s defined as the proportionate change in the input ratio divided by the proportionate rate of change in MRTS. % change in input ratio % change in MRTS or, Example of a Cobb Douglas function Q= ALK? GAL 1K =pALeK™ fi _ GALORE fx BALKOr Site GAL*K! x PAL" 6 Ox BALK? x AL*K? ‘Example of a linear production function Q=al+ pK Example of a fixed proportion production functionQ=min(az, pK) if al. < PK Then Q = alQ= Ala + pK“'Y* ag 1 3 doa px-*Y tat“ t= AL Alas" + pk tp Under different assumptions about @, the C.E.S can collapse into any of the specific forms of production functions e.g. if€=0, then 6 =1, which resembles the Cobb Douglas production function and hence the two factors of production are imperfect substitutes. That is, C.E.S will manifest itself as a Cobb Douglas function,If€=—1, then 5 =o and the factors are assumed to be perfect substitutes. The C.E.S manifests itself as a linear funetion. If €=00 and 5-0 and the factors are assumed to be complements. The C.E.S manifests itself as the fixed proportions production function. Mlustration Given the CES production function Q= Alat-‘ +(\-a)K~“Y* 2 (on +(1-a)K~Y* Raising both sides by - ¢ Loe t of OM =(al-‘ +(1-a)K~) 4 Taking a total derivative ofthis function tall +-€(l-a)K~'8K on -t£ a= A O Dividing through by — ¢ oo a 60 = al“ + (l-a)K~“'8K. * Suppose f= 0O° 80 = als'aL + (\-a)K “eK 20 _ aol , (l-a)PK AQ. K Integrating the funetion back Ing | ints (1-a)ink A $2 Line sin) In INQ (peg 22 (irk) Q_pegre A Q= AL*K'™ (Cobb Douglas function) From equation * above, Suppose ¢=—1 g 60 = al"'aL +(l-a)K7eK Lay — aa +29 = aél. + (1-a)oK 4 Integrating the function back Afeo=afar+(-a)fexWhere A= 1 Q=aL+(t-a)K — (Linear production function) Alternative The L*hopital’s rule L(x) The rule states tha if lig: [y= 0.90 then we take the same limit but onthe differentiated function i tim £22) EG) Consider the CES production funetion Taking logarithms on both sidesQ in2 = tng? +n A nS = in KO) Q= AL*K' (Cobb Douglas function)SUMMARY In this lesson, we have defined and learnt the properties of a production function. We have also learnt the different types of production functions and how under certain assumptions, the CES type may give rise to any other specific production function.SELF-TEST QUESTIONS. ‘You are provided with the following production function where ) the output is and is the input: y = x", for what values of @ is the production function a legitimate function? Hint: check it against all the properties of a production function.