Chap IV - Cobb Douglas PF
Chap IV - Cobb Douglas PF
Chap IV - Cobb Douglas PF
Function
Chapter IV
• The simplest and the most widely used production
function in Economics is the Cobb-Douglas production
function.
• The reasons for its popularity are, it possesses some
interesting properties and its computational ease in the
empirical estimation.
• C.W Cobb and P.H. Douglas (1928) used this function
for estimating the relationship between inputs and
outputs in the American manufacturing industry
during 1899 to 1922.
Cobb- Douglas production function
• The Cobb- Douglas production function represents the
relationship of an output to inputs as follows
Y = A Lα Kβ,
Where:
• Y = total production (the monetary value of all goods produced in
a year)
• L = labor input
• K = capital input
• A, α and β are the output elasticity's of labor and capital,
respectively. These values are constants determined by available
technology.
Cobb- Douglas production function
Further, if: α + β = 1
• The production function has “constant returns to scale”. That is, if L
and K are each increased by 20%,
Y increases by 20%.
If: α + β < 1
• The production function has “decreasing returns to scale”. That is if
L and K are each increase by 20%, Y increases by 10% only.
If: α + β > 1
• The production function has “Increasing returns to scale”. That is if L
and K are each increase by 20%, Y increases by 40% .
Criticism of Cobb-Douglas Production Function
• Least-Cost Combination
• In a dynamic set-up, the prices of inputs are often
changing.
• As a result, the feasible combinations of inputs will have
to be worked out regularly in order to ensure the least-cost
combination.
• This is possible by substituting high const inputs by
relatively cheaper inputs so that the cost of production
might be reduced considerably.
Managerial Uses of Production Function
• Decision-Making
• Production function is a useful managerial tool to arrive at a
decision regarding the employment of a variable input factor
in the production process.
• So long as the marginal revenue productivity of a variable
factor exceeds its price, it may be worthwhile to employ it.
• Moreover it is also useful in the long run. If returns to
scale are increasing, it will be worthwhile to increase
production; the opposite is the case if there are diminishing
returns to scale.