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c 1998 Kluwer Academic Publishers. Printed in the Netherlands.

63

**Reliable Optimal Production Control with
**

Cobb-Douglas Model

ZHIHUI HUEY HU

Texas A&M University, College Station, TX 77841, USA, e-mail: zhuey@tamu.edu

(Received: 3 December 1995; accepted: 16 February 1997)

Abstract. Production is the most fundamental activity in our economy. In this paper, a Cobb-Douglas

production function is used as the mathematical model to describe the relationship among production,

labor and capital. Two reliable production optimal control problems are studied. Algorithms to find

dynamic optimal control intervals are provided with interval parameter presentations and interval

computations.

**1. Optimal Production Control with Cobb-Douglas Model: Traditional
**

(Non-Interval) Case

Production. Every day, various products are produced to meet different demands

in our society. Production is truly one of the most fundamental activities in our

economy.

Every producing firm wants to maximize its profits:

• In an equilibrium market, where the amount produced is more or less fixed (by

**the demand and by the firm’s market share), in order to maximize profits, the
**

firm needs to minimize production costs.

• In a seller’s market, in which the supply of a product is smaller than the demand

for it, maximizing profits means producing the maximum amount within the

available production costs.

Production function. In both cases, to optimize production, we must know how

the output Q depends on the production costs. The dependence of Q on controllable

parameters is called a production function.

One of the most widely used production functions was proposed by Cobb and

Douglas and has the following form (see, e.g., [3]):

Q = A ⋅ Lα ⋅ K β ,

(1)

**where L is labor (measured in certain units), K is capital, and A, α , and β are
**

(constant) parameters; these parameters depend on the firm, on the produced unit,

etc., and have to be determined experimentally.

Comment. In many real-life situations, α + β = 1. This equality has a simple

economic interpretation: if we increase both labor and capital twofold, we will thus

b. α . and Q. β . e. and b is the cost of acquiring a unit of capital. Subject to: Q = A ⋅ L α ⋅ K β . where λ is the (unknown) Lagrange multiplier.g. (3) β ⋅ L α ⋅ K β −1 = µ ⋅ b.r. We can simplify the problem by dividing the objective function by a (positive) constant A: L α ⋅ K β − µ ⋅ (a ⋅ L + b ⋅ K) → max. b. and C. a. thus getting: α K a ⋅ = β L b and (5) . each of the variables L and K. (2) where a is the cost of a unit of labor. we divide (3) by (4). and equating these derivatives to 0. Differentiating the new objective function w. β . Optimization problem for the seller’s market: Given: A. a.64 ZHIHUI HUEY HU produce twice as many units of the product. we have one of the following two optimization problems: Optimization problem for the equilibrium market: Given: A. This additional assumption makes the corresponding formulas simpler. we can even get an explicit expression for the solution.t. where we denoted µ = λ / A. Both conditional optimization problems can be solved by using the Lagrange multiplier method (see. α . Cost function. Lagrange Multiplier method reduces both problems to the same (unconditional) optimization problem: A ⋅ L α ⋅ K β − λ ⋅ (a ⋅ L + b ⋅ K) → max. Subject to: C = a ⋅ L + b ⋅ K. How we can solve these problems.. [7]). In both cases. we get the following equations: α ⋅ L α −1 ⋅ K β = µ ⋅ a. Minimize: C = a ⋅ L + b ⋅ K. The production cost C consists of the cost of labor + the cost of capital: C = a ⋅ L + b ⋅ K. Depending on the market. Maximize: Q = A ⋅ L α ⋅ K β . (4) To eliminate the auxiliary parameter µ from this system.

(7a) . a = [a. α +β a ⋅ β C . In real life. a]. (10a) 2. when α + β = 1. Q] (or C = [C. we know intervals of possible values of these parameters: A = [A. α ]. the parameters A. and β of the Cobb-Douglas model. α +β b ⋅ (9) (10) These formulas can also be simplified if α + β = 1: L = K= α ⋅C a β ⋅C b . (6) b α Substituting this expression for K in terms of L into the corresponding condition. (9a) . α ∗ = [α . (8a) α Optimal control for the seller’s market: L = K= α C . then it makes sense to try to follow recommendations (7)–(8) (or (9)–(10)) precisely. the required production level Q and the available total cost C are only approximately known. α . we get. A α b L = Q A (7) (8) Comment. the perunit costs a and b. and Q = [Q. β ∗ = [β . At best. using (6). A More Realistic (Interval) Case Why intervals? If we know all the parameters exactly.RELIABLE OPTIMAL PRODUCTION CONTROL WITH COBB-DOUGLAS MODEL 65 a β ⋅ . these equations take an even simpler form: L = K= Q α b ⋅ ⋅ A β a Q β a ⋅ ⋅ A α b β . β ]. β a 1 / (α + β ) Q β a α / (α + β ) K= ⋅ ⋅ . in both cases. . an (easily solvable) equation from which we can determine the optimal amount of labor L. b]. C]). b = [b. we can get an explicit expression for the optimal amount of capital K: K =L⋅ Optimal control for the equilibrium market: 1 / (α + β ) α b β / (α + β ) ⋅ ⋅ . A]. From this expression. As we have mentioned.

every variable occurs only once and therefore. b (10 ′ ) In these formulas. If we apply naive interval computations to thus re-written formula. since INTLIB does not contain the interval function “to-the-power” x y . (7 ′ ) . The decision maker will then use his experience and intuition to select the values K and L from these intervals. (7a). this can cause an overestimation. [5]. and (8a) requires some extra work: Namely. we first have to represent expressions of this type as exp(y ⋅ ln(x)): L = exp 1 ⋅ ln(Q) − ln(A) α+β + β α +β ⋅ ln(α ) − ln(β ) + ln(b) − ln(a) . To estimate the desired intervals K and L. Different values of the parameters A. K). [6]). Optimal interval control for the seller’s market. [1].. the variable α occurs both in the numerator and in the denominator. (10a ′ ) b In these formulas. [6]. lead to different optimal values of labor and capital. Formulas (9a) and (10a) that correspond to the seller’s market can be implemented in a straightforward way: L = α∗ ⋅ C a (9a ′ ) . β∗ ⋅ C . i. To implement interval computation on a computer. Optimal interval control for the equilibrium market. to replace each operation with real numbers by the corresponding operation with intervals. ….g. the results of interval computations also coincides with the exact intervals of possible values of K and L. L] of possibly optimal values of K and L. we used the INTLIB library [2]. The implementation of the formulas (7). K] and L = [L. we suggest to use (naive) interval computations [1]. a (9 ′ ) ⋅ C . (8).e. the results of interval computations coincides with the exact intervals of possible values of K and L (see. e.. To avoid it. we get the following expressions: K= L = K= 1 1 + (β ∗ / α ∗) 1 1 + (α ∗ / β ∗) ⋅ C . every variable occurs only once and therefore. it is reasonable to supply the decision-maker not with a pair of numbers (L.66 ZHIHUI HUEY HU Interval control. …. from the given intervals A. but with intervals K = [K . In the formulas (9) and (10). we rewrite α / (α + β ) as 1 / (1 + β / α ). In such situations.

for the seller’s market.. (10 ′ ). capital can be become more easily available. For the seller’s market.e. to check whether the old parameters Lold and Kold are still possibly optimal. whether they still belong to the new optimal intervals L and K). innovations can make the production process less labor-intensive. (8 ′ ) and only then apply interval computations: L = exp 1 α∗ + β ∗ + K = exp α∗ ⋅ ln(Q) − ln(A) 1 (α ∗ / β ∗) + 1 ⋅ ln(α ∗ ) − ln(β ∗ ) + ln(b) − ln(a) . we do not need to change anything in our production. For example. As a result. and the situation has changed.. then we need to choose new values for L and K. then we want to check whether these values L and K are still possibly optimal (i. …. (8 ′ ) These formulas can also be simplified if α + β = 1: Q ⋅ exp {β ∗ ⋅ ln(α ∗ ) − ln(β ∗ ) + ln(b) − ln(a) }. decisions are made in a dynamically changing environment. the above formula (9 ′ ). the parameters A. and . and (10a ′ ) give the exact interval of possibly optimal values. etc. β .RELIABLE OPTIMAL PRODUCTION CONTROL WITH COBB-DOUGLAS MODEL K = exp 1 ⋅ ln(Q) − ln(A) α+β + α ⋅ ln(β ) − ln(α ) + ln(a) − ln(b) α +β 67 . to compute the new “optimal” intervals Lnew and Knew . Optimal Control in a Dynamically Changing Environment Formulation of the problem. In real life. it is sufficient to: • use the new values of A. • If both values L and K are still possibly optimal. If we have been using some values L and K from the optimal intervals. (9a ′ ). A Q K= ⋅ exp {α ∗ ⋅ ln(β ∗ ) − ln(α ∗ ) + ln(a) − ln(b) }. etc. can change. A L = (7a ′ ) (8a ′ ) 3. α . Seller’s market: naive interval computations are sufficient. (7 ′ ) 1 ⋅ ln(Q) − ln(A) ∗ +β + 1 1 + (β ∗ / α ∗ ) ⋅ ln(β ∗ ) − ln(α ∗ ) + ln(a) − ln(b) . • If at least one of the values L and K is outside the corresponding new optimal interval. So.

…. the right-hand side takes its smallest possible value when Q takes its smallest possible value and A takes the largest. a / b]: a/b≤ α K ⋅ ≤ a / b. or.68 ZHIHUI HUEY HU • check whether Lold ∈ Lnew and Kold ∈ Knew . So: • if Lold 6 ∈ Lnew or Kold 6 ∈ Knew . we get two equivalent inequalities that are linear in α and β : K (12) (a / b) ⋅ β ≤ ⋅ α . …. equivalently. therefore.e. Since ln(x) is strictly increasing. We need to check whether these values are still possibly optimal. Q.. the existence of Q and A for which this equality is true is equivalent to the following double inequality: ln(Q) − ln(A) ≤ ln(L) ⋅ α + ln(K) ⋅ β ≤ ln(Q) − ln(A). The coefficients at α and β in the left-hand side are known constants.e. β L If we multiply both sides of each inequality by β . we. We are given the intervals A. Q ∈ Q for which these K and L are optimal. To check whether a change is needed or not. For equilibrium market. Equilibrium market: we need a new algorithm. need a new algorithm. α ∗ . Let us describe these conditions (1) and (5) in terms of α and β . we conclude that ln(L) ⋅ α + ln(K) ⋅ β = ln(Q) − ln(A). i. but • if Lold ∈ Lnew and Kold ∈ Knew .. α ∈ α ∗ . the corresponding formulas (7′ ) and (8 ′ ) can overestimate. for which the equations (1) and (5) are both true. Equilibrium market: towards a new algorithm. it does not necessarily mean that the old parameters are still possibly optimal: it can be that they are no longer possibly optimal. the right-hand side takes the largest possible value when Q = Q and A = A. Thus. and the (old) values K and L.e. i. b β L For given α and β . (11) The equation (5) can be re-written as a α K = ⋅ . within the interval [a / b. satisfying this equality means that its right-hand side must be within the interval of possible values of the ratio a / b. when Q = Q and A = A. then we definitely need to change the production parameters. but they nevertheless belong to the “overestimated” intervals (7 ′ ) and (8 ′ ). L . If we apply logarithm to both sides of the equation (1). i. (since a and b are positive). where there exist A ∈ A. Similarly.

: The Study of Economics: Principles.. 1979. The author also wants to thank the anonymous referees for their valuable suggestions. G.e.. has a solution). E. 4. Given: (old) values L and K. (14) β ≤ β ≤ β. 1962. K. and new intervals A. R. and Q.: Introduction to Interval Computations. Monterey.RELIABLE OPTIMAL PRODUCTION CONTROL WITH COBB-DOUGLAS MODEL 69 K ⋅ α ≤ (a / b) ⋅ β .: Algorithm 737: INTLIB: A Portable Fortran-77 Interval Standard-Function Library. B.. . Stanford University. 1991. Kearfott. Rand McNally & Co.: Interval Arithmetic and Automatic Error Analysis in Digital Computing. and Herzberger. R. Co. The existence of such a solution can be easily checked by linear programming methods. CT. Software 20 (4) (1994). K. Moore.: Methods and Applications of Interval Analysis. 7. Math. we arrive at the following method: Equilibrium market: a new algorithm. 5..: Introduction to Modern Micro Economics. Dushkin Publ. To check whether the values L and K are possibly optimal. b. Chicago. α ∗ . R. Lancaster. Dissertation. 1983. References 1. T. K and L are possibly optimal if and only if the system of linear inequalities (11)–(15) has a solution.. 1969. the conditions that α ∈ α ∗ and β ∈ β ∗ can also be represented in terms of linear inequalities: α ≤ α ≤ α. Hence. β ∗ . 2. Stewart. we must apply linear programming to check whether a system of inequalities (11)–(15) is consistent (i. ACM Trans. pp. Philadelphia. Dawande. His encouragement and suggestion of applying interval computations made this paper possible. CA. Ph. Acknowledgements The author wishes to acknowledge Professor Vladik Kreinovich of the Computer Science Department at the University of Texas at El Paso.D. J. Alefeld. Academic Press. Brooks/Cole Publ.: Calculus. 1991. Moore. Guilford. 3. J. Concepts & Applications. M. Du. 447–459.. Mings.. (13) L Finally. E. and Hu. New York. a. SIAM. 6. C. (15) Thus.

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