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# APPENDIX!

4,

COST-OUTPUT

RELATIONS

A.4.1

## A FUNCTIONAL RELATIONSHIP BETWEEN

COST AND OUTPUT LEVELS:

## A Functional relationship exists between the co'st of

production and the output levels,

## costs which will be incurred at alternative output levels:

Cost * f (output)

## But the output level in turn, is a function of factor inputs

used:
Output f (inputs)

## And the prices of the factor inputs used are termed

as the cost of producing a given level of output.

Thus at a

firm level, the cost purely deponds upon the two principal
factors: the'Character of the production process employed, and
the prices paid to different factor inputs.

## first decides the shape of the firm's cost function? whereas

the second ono determines the level'of cost.

## firm is one of many others to demand for the factor inputs, it

cannot influence the prices of the concerned factors.

Instead

## its output lovel is indirectly influenced by the prices it has

to pay to the factor-inputs.

## output leval, there is a corresponding change in the total cost.

Thus cost is directly related with the output lavel.
Cost function expresses the relation between the output
and the corresponding cost.

## Hera, the cost is expressed as a

A.452

function op output.

form ass
TC = a * &Q

(l)

## where TC is the total cost* C is the quantity cf output, a is

the intercept (a constant} and b is a parameter.
A number of special cost relations, which srs also
functions of the output levels, can bo derived from (l}
For example,
ATC

a + bQ
Q

&

(2)

AFC e a
Q
AVC ss bQ
Q

(3)

(4)

s= b

where ATC i3 average total cost, fifC is average fixed cost, At'C
is average variable coat end a sb and Q are as specified above.

## Total cost, as referred to above

of output.

is a linear function

They

## first decline and than increase with increase in output (q ).

For example, Cost Function in cubic form can bo written as
*?

*7

TC

sa a + btj +

cQ~

+ dQ

(s)

A 4 *3

When Q

0,
TC

a s and a

0.
/d o

## TC increases as Q increases; hones DC yjQJ is always

COSitlWO.

d(TC)
dQ

2eU + 3d5

On fcho b a s i s c s o t h / i

c c rd lb J c r iO ., ihf- n i " - o

(5 )

fC

d(WC)

- o

dO
i
0. 2c '5* SdU

'
~

fid >

d ir

minimum when

OR

6dQ

2c

is 2c
6d

~c
3d

iS~'3)

b < C

{'o*

d > 0

a h

## The. absolute value of PIC will bej

PIC = b * 2c

rx =

(\ \$-U)/ +

3d [

-I 1

{6s5}

oa

'
\v

3db - c?
bd
which should always be positive
9
Hare s 3cb - c"> C
(since c>
>
OR
3db > c~
OR

c <

<e. 5

i.

3db

## Th u s , under Ihs normal economic Unitec: ens, the uosf ?Icisnts

a, b, c, and d in the given cubic total cost ^unction should be
restricted as under %
(i)

a, c and d > 0

(ii)

b < 0

and (iii)
A4.1(1}

c2 < 3db
Statistical Cost function;
y

**

o)

'/

## factors and u is error tarsi, reflecting the stochastic nature

of the relationshipc

1/

Dohncton D,

## Co. Inc., New York, 1960), pp531~34,

ft. 455

written S3 *

* b1 Xit + b2 X2t +

+ bR XKt * ut

(1 .2 )

(t 1,2, . . . n)

## whar Y^ represents the cost in tins i , X ^ rap re sent 3 the rats?

of output in tine t end other Xss represent squared or cubed
terms In otjcpui, and tn*j rena?.jnq X'1s tn03o fscfcci- lu"ilc~
influence costa but whose affects is to be estimated and then
constant for examining the not relationship DetacQn costs

~>c

output.

## Three major hypotheses about short-run coat-output

variation may be characterised by the inclusion of first 3
second? and third-degree terms in output among the explanatory
variables.
Sines a livjear total cost function is i-neanpatibie
perfect competition assumptions, a cost function as a sscona
dagrsa polynomial in output is used as s
C iK 3 't h X t h X** -h *5
t
'
1 t
2 t
~t

r<)

7
1 t~9

whera 3 C,

total

cocc

in oeyioc t

ss output in period t

error term

A . 6 s6

I f ?.

' t-1

' j h a f O

t~1

t

FiC =

2bXt

(2.4;

2b2

2b_

## Statistical cost function examines the nature of tha

intra-firm rgjationahio between costs and output.

1/
findings

## total costs are linearly related to output - hence HC are sub

stantially constant o vsr a wide range of output; and (b) that, long-run
AC tends to decline with increase in the scale of output quickly at
first and then more slowly, but with little or no indication c,f
the expected rise at high output lavsis."
Tha cost function is stochastic.

No statistics! analysis

1/

## uohnston, 3 .1 "Statistical Cost Functions! A Reappraisal",

The Raviaw of Economics and Statistics, Vol,40, No.4,

1958 r p p !3 3 9 -3 5 0 .
2/

## Rugglos, R.s "The Concept of linear Total Cost output

Regression", American Economic Review. Vol.31, No.
1941, ppS332-335.

A.4S7

hypothesis.

Besides,

## no statistically significant improvement on the linear

hypothesis is mads by' the inclusion of second or higher degree
terms in output.

## Variations in the cost influence the output levels.

These variations are characterised by the reference period.
Hsnce, it is useful to differentiate bstwsen tho short run and
the long run cost behaviours.

## of tha short-run and the long-run are well known.

Of the known resource inputs that aro going into tho
production process, some are fixed and some aro variable inputs
in the short run, and hence the consequent cost structure
assumes certain type of shapes in the 3hori run.

On the other

hand, almost all the resource inputs being variable in the long
run, ths resulting cost takas an altogether a different
shape.

## approach to examine the cost behaviour at the macro level

(at the state level) industry groups teking a firm level cost
and output details.

A,4i8

A42

## The total cost in the shorttun has the faaturas

differsnt to that in the long run.

## In the short run. total

fixed cost, total variable cost end total cost concepts ara
worth examining. Total fixed cost is
n
TFC

P,X,

(1

'

## the quantity of the specified fixed incut, and n is the number

of various kinds of fixed input'sFixed costs do not vary with the change in the
output level.

output level.

## is to be increased; hence total variable costs increase with

the increase in the output level.
Thus, total variable coat is
m

ivc * ^

y:,

(2)

## quantity of a specified variable input, and m is ths number of

various kinds of variable inputs.

## zero, but TFC > 0 when output is zero.

Tha total cost la ths sum of the total fixed cost and
total variable cost.
TC x TFC + TUC

CO

A4f9

## Four major types of unit cost can bs derived from the

total cost concept.

## variable cast* average total cost and marginal cost

last on is very much important.

MC

The*

It can be expressed as

TVS

{&.}

A Q
It is of central interest for ths fact that it reflects those
costs which could bs controlled in the short-run,,

Ths dsfini

tions of AFC, AVC and MC era used while a^amining ths cost
behaviour both at the micro and macro levels*.
Those cost-output relations can be examined in ths

## context o? the following four types of short-run production

functions.
*>

(1 ) Q ra a

bx * cx

(incraasirig returns to
variable inputs)

(2)

Q m a + fex

(constant returns to
variable inputs)

(3)

Q s 0 + fex - cx

(decreasing returno to
variable inputs)

(4) Q

a + bx -5* cx

dx

## (increasing and aecroeoing

returns to variable inputa

whera8
Q is the output level0 x is the variable input and a is
ths constant

A.4*10

## A.4.2(l) Cost-output relation under increasing

returns to variable Inputs?

## With increasing returns to variable input, each

additional unit of variable input increases the total output
than does the previous unit.

Thus

*?

when

and

(1 .

Q = a + bK + cx
PiP a b

2cx

A? b

ex

Hence f
TC a + bQ ~ oQ^
TFC a a
TVC a bQ - cQ*

## Since firm's fixed inputs do not change in the short

run, a constant amount of cost results, irrespective of any
change in ths prices of the fixed input. Thus, 1TC hors,
includes, as referred to above, both explicit and implicit
costo.

## It doss not vary with ths changing output level.

TVC is continuously increasing with the increasing

output levels.

## additional variable inputs are added along with the fixed

inputs, the output doss increase, as pointed out above, but
with tha increasing TVC.

## The output increases with grontsr

and greater increments when ths variable inputs arc added or,
gradually and so is the resulting TVC.

But there is

A.4S11

and

that of TVC.

## the corresponding addition of the variable inputs, the result

ing TVC increases at a decreasing rate.

Thus?

TVC bQ - cQ2

(1.4)

## T V C is zero, when Q = 0? hones TVC function starts

1/
from the origin.
Given TC = TFC + TVC
the total cost function can be written a s 5

TC - a + bQ - cQ2

<1.2)

## uheres a represents TFC and

(bQ - cQ2 ) represents TVC

## The nature and behaviour of AVC can be deduced From

TVC function ass
AVC - ~ ~ = ~ r - ~

a(b - cQ) b - cQ

(1.5)

## The significant point here, to note, is that the unit

variable cost falls with the increase in the output

(q ) under

1/

## Q = bx + cxl is the production function

TVC = bQ - cG is the TVC function

<1}
(2)

## Hers these two equations have similar form, but-t'no

values of b and c in the production function (l) ars
different than the values of b and c in the TVC
function

(2).

}
,his is bsc&use the reJationohio between AVC and Yvs'
production function
AVC

KS

P yy

, ]
1 _!

VI

<> ;
i

wH o jc s *

Vi

VI

Under the

## conditions of increasing rstums tc variable input, ths AP.

VI
rises with every increase of variable input.

## The ATC function can be derived by diviriir-o the TC

function by Q as *
ATC ! a - t J & c s !

| + b - cQ

(1,6)

## ATC a AFC * AVC

*

ATC s ~ + b - CQ
u

(1.6)

whareS

and

AFC a ~

(1,7)

AVC a b - cQ

(l.5)

as referred to above.
There is a asympototic relationship between AVC and
ATC.

## It is not only unique to cost behaviour under the

condition

A.4*13

of increasing returns to variable inputs, but rpthar ;.a o ge;y?r.and necessary trait for all the types of production and cost

1/
situations.

## The marginal cost (MC) function can bs obtained by

differentiating either* the TC or the TVA function with Q as

and

TC a + oD - cO2

(l.2)

TVC bQ - cQ2

0.4)

nc

I
dQ

2JVC

_ b _ 2c Q

(1.3)

dQ

## sloping, which indicates the rising marginal product of

successive units of variable input. With the increasing MP
and Pyj remaining constant, MC must necessarily Fall.

## A,4.2(2) Cost-output relation under constant

returns to variable incuts

## With the constant returns to variable input, each

additional unit of variable inputs adds the same amount to
total output as tho previous one. Tnis means that output,
increases at a constant rate and the corresponding production
function is linear.

1/

## Thompson, Or. Arthur, As Economics of the Firm* Theory

and Practice, (Prentice-Hall, Inc., Englewood Cliffs,
Mew Oorsey, 1973), p.273.

A* A ? 1 &

of v a r i a b l e i n p u t a r e
input,

tha same

for e v e r y

unit of

variable

When

0 s= a + b x

and where

a -

(2,l)

0 ? the v a r i a b l e input

PIP = 5 ,

and

a n d b is c o n s t a n t

has its

AP a b

which

is scual

to t h e s l o p e o f

the production

function.

T F C is not e f f e c t e d by
i n p u t s a n d Q.

the r i i a t i o n r h i p

between variable

Here;

T F C => a

TVC
production
to a unit

(2.2)

function

function,
pries

is t i e d up w i t h t h a n a t u r e o f the
TVC rises

by a f i x e d a m o u n t

(P.(T) o f the v a r i a b l e i n p u t .
Vi

is l i n e a r a n d b e g i n s

from t h e c r r c l n ;

equivalent

## This means TVC

hence

T V C = bQ

(2.3)

B o t h T F C and T V C put

t o g e t h e r g i v e T C f u n c t i o n as;

T C <= T F C + T V C
T C = a + bQ

Tho

(2.4)

s h a p e s o f T C and T V C are

be s e p a r a t e d
ftt Q =

identical.

TC a n d T f C c u r v e s

by a c o n s t a n t v e r t i c a l d i s t a n c e e a u s l

can

to T FC.

## AFC doorcases continuously with Q increasing.

AFC a

TFC _ a
Q
Q

(2.5)

rvc _ bQ

(2.6 >

and s i m i l a r l y :
AV C

"

~Q

Ao4315

And

## graphically AVC here* is a horizontal line.

And, ATC under the condition of constant returns
to variable inputs is
ATC = T C = a + bQ

Q
Here, ~

&

+ b

(2.?)

## is AFC and b is AVC,- which again shows the

equation ofs
ATC = AFC + AVC.
ATC curve is asymptotic to the horizontal AVC curve and
decreases throughout.

## F!C being t h e f i r s t d e r i v a t i v e o f TC f u n c t i o n (os

TVC f u n c t i o n ) i s ?
NC **

dTC
dTVC
zzr
- 'JdQ
TA
dQ

* b

(2.8)

fib e rs b i s a c o n s t a n t .
Constant MC and AVC and gradually declining ATC are
the common features of

## A .4 . 2 ( 3 ) Cost-output relation under decreasing

returns to variable inputs^
With the decreasing returns to variable input, MP of
variable input declines throughout the output (Q) range.

Each

## additional unit of variable input added to the available fixed

input adds less to total output then the previous unit.
increases with a decreasing''rate.

When
(3<>1}

Q - a + fax ex'
Both MP and AP of the variable input are down sloping,
TFC is a horizontal line as usual, hence
7FC = a
where

(3*2)

is s constant.
TFi. close not vary uith chs ruontiiy- oi" output iQi,
Since each additional unit of variable input adds

## a cmailer increment in Q? TVC rises witn every additional unit

of variable inputs combined with the available fixed input.
The MP of variable input dsclinss gradually - makes Q to rise
even tnors slowly, while Tl!C increases steadily, at an
incroc3ing rata.
TVC ss bQ + cQ

{3,3}

and he nc e s
/\ 1w

TC = a + bQ + el*

it

## 'C increases at an increasing rats.

AFC, as usual, is a decreasing function,
asymptotic to the horizontal axis.
af;

TFC
Q~

anc

AWC

TVC

is

Its scuation io

a
~

:Q -t t:Q
3

~ b J- cU

## This moans that under the condition of decreasing returns to

variable inputs P M C rises with every increase in C .

A,4*17 '

ATC b

TC

+ bQ + cQ

a + b -5- cQ

(Z*7)

whare

Sine .

AFC

Q the

AVC

Cr-> b

4A,

Thus increasing

## or deecsasing of ATC rests an the decrease of AFC relative to

thg increase of AVC when Q Increases.

increase in AVC.

## The ATC curve turns upwards

With the production function showing decreasing returns
to variable inputs PIC function is *

TC o bQ -t cQ2

l3o4)

dTt
MC J q = b -v- 2cQ

,
|3.8y

## These cost functions do not typify ths entire output

range for many production processes, although thoy are typical
of production and cost behaviour at near capacity levels of
output.

no

## Thu r-<xnicti.'-. rune's?on inc:orpo^V:tif;,: In c :

n>vj

d ^ c r e a s i n ^ r e t u r n s t o v a r i a b l e i n p u t* p r o y i n o e u ^ o - u - i a l ?': !
o f t h e p ro d u c tio n nrtri coe i ta e rav icu rs found X''> t b s f i r s t t h r u s
ty p o s o f j?" oriu'Jtiori 'Jur>oiionr ,,
2 " a + &x -4 e .,2
uhero 6 i a th e o u tp u t,
in p u ts .

Kor:;

...4?
5;

r e c r e a n t s th a u n i t s of v a t i c

## in p u tc 2.r; th e beg in n in g and dscrciooinr r n tu rn c feu t'.sr ssis>;

ssfc in*

H3X'0g G2 ".v'-tUS.1.0
1f

T!

## TVC f u n c ti o n i n c l u d a s hare both in c r e a sin g and ciacreae--

in g r e t u r n s t o v a r i a b l e i r . p u t a .

## ybor-a inssoacl-'.x rs'etjrnf-

t o v a r i a b l e i n p u t s p r e v a i l , uheras i t ipevBiusnz- a t n r- in c rc e o !n g
r s t o o u s r t h e rang o f Q yhore d e c re a s in g r e t u r n s t o y c r i o b l c
in p u to CDH?flto

## rests with fch diminishing rasrginral returnE-

7ha equation uf

TVC i
TVC bQ - acT -> dST

;?i,3;

## 1C varies precisely at the seaa rat a does TVC,

TC os a t bQ - o? * dS**

Khar a

## e p re e e n ts TTC and- (fcQ

a t each v e lu a o f Cl

\<o4;

oO

. ciQ""1} rcpvoPHV. r- VC

JC
AVC

lQ - sq2 * dCT

b cQ + dQ

(4S)

increases.

## Thus. AVC curve is U shaped.

ATC can be c a l c u l a t e d by d i v i d i n g TC by Q

'u

g-~-

fta

+ b - cQ + dQ2

ATC ~

(4*6)

Hst >*
^C

n e f*

flFC T ~

&
q

if

Y)

## ATC ourva is asymptotic to the AVC curve and is alee li chapotl.

Howevero the minimum point of fchs ATC curve io at n larger
volume of output than ie the minimum point of the AVC curve.

AVC is minimum.

## of Qj the increase in AVC overrides the decrease in AFC.

this makes ATC to turn upward.

And

irs

tha short-run.

nc s

dTC
dQ

dTVC

dQ

* b - 2cQ t 3dq2

(4.8'.'

A, ^20

## (iC curve is here U-ohaperi.

raust ba decliningo

constant

## price for the \,aCiabJs input, the increasing ossurns tc

variable inputs results in declining MC and vice-varsa.
From the foregoing outline of cost behaviour under
four different sets of production functions ~ sash one untiei
particular type of returns tc variable inputs the following
generalizations could be mads :

(1)

## AFC curve is a rectangular hyperbola irrospactivs

of different shapes of othar cost curves0

It

(2)

points of AUC

## and ATC curves.

(3)

FiC reaches its nininura before fi'JC and ATS and At/C
reaches Its minimum before ATC,

A.4.3

## In ths long run ths tats! cost is oxpresosd as a

function of output level ond plant sirs t

C-

p Cq!k}-S-X(k)

## whsre k shows the size of thG plant

(l)
the greater the value

## of k the greater ths size of the plant.

In short-run5'ths

size.

1/

## The above function gives the minimum cost of producing

each output level with the facility to vary the size of olento
Thus such a clan'c s i r e i s s e l e c t e d vHsr t ^ s TC

pinimun

Th

cost

c u rv e s .

## Tile minimum AC is attained ct the 's o t s plant r,i& on

ths minimum TC is producing that cutout level#
Ths long-run Mu is 1hs rate cf change of TC assuming
that ell costa are variable*

## MC curve can be defined as the locus of thosa points on ths

uhort-run fiC curves which correspond is Inc. optimum plant sizs
for each output*
There is a ganerel acceptability cf ths o 'o sa rva h io r>
that given factor prices( .'long run aver~-.es
for low ranges of output*

ocvcg

( LKC) fallr

## first to ths easy handling of largo quantities of factor-inputs

initially., second to ths fact cf spreading of flKod cost, risk

3/

2/

## Henderson 3.S anci R*# Quandts Micro oconrcr.io Thapry.-'

A Mathematical Approach t.McGraw r.ill Back C%s, ttw Vc,;k.,
1971p p.75*
U!hitins T .Mo and II.H. Prestons"Ra.ndon Variations,
Risk and Returns to Scsle'% puarterly Journal of Economics
Vol.68 , 1954, pps5C3**512o

## of Indivisibility in labour and capital equipment.

Certainly

LAG declines first kith sirs, but there -s hardly any cqresnnmh
or. ii.f. shape wit-h cutpwt ir.rrsasi ng beyond a certain levrl,
Robinson, however strongly contends the rising aspects of LAC

if
goes or* incte3\$i'<9o

as outpc

ry

## et Ibird r l oy Klora^cc on Vj ground that it in not sppit'i csily

tested on a widB scale.

3/
functions
(a)

net U-nhapod.
(b)

## Thn first corseiusion seemc tc bo valid ers the ground

of technological consideration.

## production technology helps to achieve an increasing output

Level p.v3n yhilo keeping th-' v s r i o f . c

ki!.r.v'' .:-'l:i

## Tho firm can .

i c m produce more output kith;
,
tnaraorlssSj, ths same minimum cost as before.
Ths rising part

manageable bounds.

3/

## Robinson, E.A.G. x Ths Structure of Competitive) Industry,

(Cambridge, 193S).

2/

## Florence P.U.S.s The Logic of British and American

Industry, (tendon, 1953)

3/

## Walters, A .A .3"Procustion and Cosc Functions 3 in Co incest

Survey, aconoreetrisa< 1*01.31, No, 1-2, 1933, p.46.

4/

## Sandesara 3 .C.s"Economies of Scale - Some NotesH0

ftrtha Vikas, Vo1.2, 1975.

A-4S23

cost
*?V'C C3
itf s n

c u rv e .
o f f c ? r.
ic

e ra

D e s p ite

th is .

to

o ff

chop

sees j t'-t

la s t

s o m e tjL n o a

t;ha

rjs io o

&f> i

## C' 1,0 n ' t

9 th e
pc> r i

1s t

firm

has

o f" i t f !

to

cost

m ake
r. u ' . ' v c

o p c D a v e : i o n .

## Regarding the second conclusion that short-run DC

is c c n a t a r t ; m e n t i o n may be fardo o' s-cnte i n H i u j
'if

studies.

lS'I

in d u stf'

r.

## constant over aide range of output through making intensive

2/
study of business enterprisan0

siatsnt

## uo'T.asort also found it con-

11/
with a large body e? empirical 8uider.ee.

T?.o

## empirical evidence in favour of constant marginal cost is not

Cfohnstars,
Industry Study "ffiuiiiplo P r o d u c t - using
tintsseries data short run cost curve (1960)*
(Statistical Cost Analysis).
Dear., 3s Industry Study! 5Furniture*
using tic;
series data short run cost curve (194Hi
("Statistical Determination of coats with special
Reference to Marginal costs" Studies in Suctip^r.
Administration, Vol.7, 1935).
Industry Study Hosiery" using time ssrioc.
data Short run cost curve (1941)
(Statistical Cost Functions of & Hosiery Kill5 >
(Studies in Business Administrationt Voi.14, 1S41).
-j Industry Study *Departmental Stoca using tints "
series data - short run scat curve (1942)
- (Department Store cost Functions8 Studiaa In tlatbr
matical Economics and Econometrics (sd 0 <orton).pp 2 2 2 -2 5 4 5" 1 3 4 2 )7 "

## Vntema, T .0. i Industry Study fSteel1 using timeseries

data ~* short run cost curve - (lS40)
(Stao.I Pricae,. Volume end Costs" Li.S Staei Corp.j,
Tsmp. Mato Eso. Paparo. lfol,1s pp -223-322, 'PAG*.
Andrews, P.U.S.s Manufacturing Business, (London, 1949)

If

Dohnston, 3 .s Ibid.

30

overwhelming.

by

Ezakiol

## and biylie, Nordin, Ehrke ate., which revealed marginal cost

sit her declining or ircrsasinc 0

## evidence is coming forth, the constancy of marginal cost hao to

bs interpreted as a deviation from the established theoritiecl
concept of declining MC in tho beginning sr.d rising

on

## Unfortunatelys very limited work a n the coot behaviour

analysis of Indian industries could be cited,

However c mention

## may be made, here, of the few studies of Cost functions of Indian

2 / 3 / 4 /
Industry may by Guots, Alagh, Gupta, ... An average cost function
of twenty-nine manufacturing industries, using a time-serins

1/

Ezekiel,
and KH Wylie? Industry Groups 11Steal* =using time-series data short run cost curve,-.(]\$4-i}
{"Cost curyea for Steel Production' journal of
Political Economy, Vo.!046, 19 40, pp ?77-32lT\$
'Cost Functions for the Steel Industry" Journal of
American Statistical Associat i o n , Uol.36, 1941,
pps91-99.
Nordin, 3 A. .Industry Groups 5 Light Plant8 using timeseries data short run cost curve (1947), ('Nets
on a light Plant's Cost curves' Econometrics, Vol.15,
1947, pp. 231-235).
Ehrks, K.S Industry Group8 'Cement' using time-sarieo
data - short run cost curve (1933), (Oje Ufagyzsupung
in der Zementindustrie, 1858-1913, Jena r 1933}.

% [

## Gupta V.K.s Cost' functions. Concentration, and Barriaars

to entry in Twenty-Nine Manufacturing Industries of India0 ,
The Journal of Industrial Economics, Vol.17, N o .1, 1958.

3/

## Alagh, V.K.s "industrial Planning: Past Experience and Future

Tasks'*,Economic and Political' Weekly, August ly69, pp:M-107-lll.

4/

## Gupta, G.S.s "Economies of Scale in Cement Industry", Economic

and Political Weekly. Vol.X, No.13, March 1975 pp.551-556

A.4S25

details cf total cost and output Tor the psrioc! ISSA-IB. hsvs
been estimated by Gupta,, For the industrywis plants belonging
'jfjmbst

to each size-group
emolcyadj total rest and oubp

## were, calculated and than average

cost par rupee of output was worked out for estimating the cost
functions,,

industry as 3

## where Y is tha average cost and x is the size cf tha plant.

Davis has used this rvps of aquation while testing the

2/

## The shapes of the cost curve whether U-shapsd or L-shaped ars

empirically verified. Gupta found U-shaped long-run overage

2/
cost. curves in only fivs inaustrisa
twsnty~nin3 industries.

cut o' n s a ^ - j a of

## The L-shapao cost curves were observed

1/
among as many as eighteen cf :nssa industries
revealed a slightly rising leg of the L,

2/

## Davis H . T The Theory of Econometrics, (Priricipia Press,,

Bloomington, Ind., 1941), p, 125.

2/

## industries weras starch, machines, cement, cicilleries

and breweries, and rice rr.j 13 ioo

3/

## industries wsrsi seuingmaohlnad, fruit and vegetable

processing, sugar, electric lamps, electric fans, soap,
woollen textiles, bicyciest paoer and paper board,
ceramics, biscuit-rasklngt plywood and tea-chests, vegetable
oils (edible), glsas and glassuara, tanning, wheat
flour, cotton textiles and general and alectriGai sngineprir
Ths first three of these eighteen industries had a rising
leg of L-shaped average cost curves.

A4?2S

## contends that fchs sxlstencg of L-shaped long-run average cost

curves (LflC) in some industries does not rule out totally tbs
possibility of having U-shaped long-run average cost curves
among cults a large number of other induatriaec.

APPENDIX
5. TECHNOLOGICAL RELATIONS
SPATIAL DIMENSIONS

A.5

## Cobb-Douglas production function in the two-factor cess

is:
X

Ah^ l /

sU

(1)

where X stands for the net value added by manufacture, K for the
capital and L for the labour (number of technical and non-technical
workers of all categories including supervisory, and managerial

j/
catecory) employed;

if

## It shows the production technology existing among the

industry groups, and does not embody any technological progress.
It is homogeneous of degree

oi + jb , where Ot and j\$

measure

1/

## Cobb-Douglas production function can be specified with any

number of factor-inputs used in the production. Normally
the factor-inputs used in production are grouped together
under some distinct categories of inputs like capital (K),
Labour (L), fuel and power (R^) and other materials
There are strong relationships between K,L, R and R^.
None is independent of one another. However, the first
two primary inputs K and L are usually retained in the
final estimation of this production function.

2/

## Bronfsnbrenner, M. and P.H. Douglas s ''Cross-Section studies

in the Cobb-Douglas Function", Journal of Political Economy,
V/ol.47, December, 1939, pp:?61-?8S. Also see : C.U.Cobb
and Paul H. Douglass "A Theory of Production'1 American
Economic Review, Suppl. l/ol.18, 1928, pp.139-165.

A.5:2

.1/

cross elasticities

## of response of production (here X) with respect

to K and L respectively.

## variation wish rcsDsct to (w.r.t.) capital or labour input.

relationship is loo-linear,

This

## formulation that the considered factor inputs must be greater than

rero; in the absence of which the corresponding output levels cannot
bs defined mathematically.
production process.

## capital constant, adds p

case for capital.

## Hence, with the ore per cent increase each of

2/
both K and L leads c.utout to increase by ( ot + j2 ) par cant.

## The non-linear function is transformed into n linear

function by using the logarithmic transformation as:

(2)

## cX. and p refer to gross elasticity of output w.r.t. K and L

for the fact that they also account for the output elasticities
and R0 , Hoxe R_, end Fln
w.r.t. other factor-inputs c.uch as
form a group of intermedial e i n p u t s , U'wch are automotic/aiy
dropped out while estimating this Cobb-bouglas production function taking output in terms of value added by manufacture,
They are, however, retained os intermediate inputs in this
production function, when as assumed, they enter the production
function in the fixed proper tions or they are perfect substiuj.'. ^
among themselves ao well wi th the piimary inputs K and L.

2 /

## Walters A.A.: An Introduction to Econometrics, (MacMillan and

Co,Ltd., London, T 9 * 6 8 ) , p".275.

3 /

## An additive error term log u, with mean of zsro and a constant

finite variance has been assumed here and other subsequent equa
tions.

A.513

## This linear function is conveniently used in the inter-industry

group comparisons. cX and

## be compared among different industry groups.

The sum of these parameters { o< and E> ) shows the dogres

1/

p !>
+ p

o(

f
such a s :

<

>

## The sum of these coefficients shows the degree of homogeneity

of this function.

+ p>

is equal to one.

The maroina;

A.5.1

## Estimation of Marginal Productivity

Elasticity of the individual factor inputs is assumed to bo

## less than unity; hence their respective marginal productivity falls

with corresponding increase in the output.

## Tho average and marginal products are proportional.

factor of proportionality is the associated exponent m

The

tho consiJo;cc

production relation,
for examples
(a) Marginal productivity
of capital (MP,,)
K

Average capital
productivity

Klein Lawrence, R.s An Introduction toJlcof^jijgtxics^, (PrenticeHall of India Pvt. Ltd., 1969), p.92.

(b ) M arginal p r o d u c t i v i t y
o f Labour (F'1P? )

Average Labour
productivity j

-j'.. .u u

'-oi

## labour and that of labour for capita.1

* can bs 8si>fn3tod using the
marginal productivity indices of capital and labour as under s

## ( c ) - a r a x n a l r a t e c:f 'c e c b rc cai

s u b s t i t u t i o n of c a p i t a l
f o r la b o u r (MfiTS^ )
B-Tld

Mr3,

K
TP

## (d) Marginal rate of technical

suostiiufcion on iaocur for
capital (MRrSj^,)

* K
i
v,C
11> 1
L.

## an inclo.n o f e l a s t i c i t y o f t o c h o i r s ! '* ubsriiufcj cm

LTS

A P</L) / (K/L?
A MRTSRL/ M RrSKL

(1)

## nos important charset eristics of factor inputs m's hr,own on the

basis o f the coefficient of elasticity cf technical substitution.,.

Thus

When C7 ~
and

fsctcc input.!

&

"

.;>

r.sd mro.;,-v,i

## when C7S s=cj- faccor .inputs a m oerraoc mtsf ituto;

o,~

each other
Higher value of ETS leads to the hignec degm-e of subatitnf, nbl.ity
between factor .'.npurs .

fi.5s5

ft.5.2

## Elasticity of Substitution of Factor Inputs s

Cobb-Douglas Production Functions
The Cobb-Douglas production function dealing with two-

## elasticity of substitution as a measure of the relative responsive

ness of the capital-labour ratio to given percentage changes in
the marginal rate of technical substitution of capital for labour
1/

" RTV
b represents the coefficient of elasticity of substitution,.
where

b e.ETS

MRTS
Kl
. ^HsZkL. / A____

' (K/L)

FIRTS

(D

'KL

## Alternatively this car. be written

b =

(2)
kl a

where?
k
k stands for the capital-labour ratio (*j~.)5 s stands
for the ratio of the marginal papduct of labour (PIP. ) over the
'L.

2

## variations in k and s respectively along a constant product curve,

b refers to a pure number that measures the rate at which substitution
takes place between factor-inputs.

## I W S ^ is the slope of the

product isoquant.

JL/

## Richard D, Irwin/ Inc. 1969)f pps381-385.

2/

Allen,ft.G.04 Mathematical Analysis for Economist (London, fiecHillan and Co. 1930), p p 5340-344.

A5 ?6

## ctk' t h r f's-rtyrirp!..-:.:' l a b o u r and c a p i t a l - f o r

a f f s e t i n g an o p t i m a l r e s o u r c s a l l o c a t i o n , a r e combined i r s u c h
a way t h a t t h s r a t i o o f t h e i r m a r g in a l p r o d u c t i v i t i e s i,:> aciuei t o
one r j t i o or' fsex o r - p r ..

m,t.

mrts

(3)

IS*

w here u = t h e p r i c ? a r : a o c u r , and
r the p ric e of c a p i t a l .
E q u a t i o n ( 1 ) can ba r e w r i t t e n a s ;

A (k./y / A(w/t
" ( k/D V T f c ) ~
(5)

or

## f o r e x a m p le r fcbaxo i s s '|0 p e r c ^n t ir-cvao.sc ir- t h e o r i '

o f lab o u r r e l a t i v e t o th e a r ic e of c a p i t a l s t h a t I s

%A
or

(w/r)

~ 10

A.(w/y

r= oi

{w/r}*
t h e c a p i t a l ~ l a b o u r r a t i o i n c r e a s e s by 1G p e r cant,, t h a t i s s

%. A

(K/L)

k^ lT

= 20

T his i n d i c a t e s o b v i o u s l y t h a t b ( e l a s t i c i t y of s u b s t i t u t i o n
in c n ? 0
j/

## Tn.ts rr.sans th.'-t

giv-rn

v;,-;.!';egc nb-intjO

. iv /;- ,

f l t e h e f c t , O a l b R r t , A.s " C a p i t a l - l a b o u r s u b s t i t u t i o n i n t h e
M a n u f a c tu r in g s e c t o r of Panama", i n Economic Development, and
C u l t u r a l Change, V ol.2A f A p r i l , 1976.

A* 5 ;7

b 0,5
and

## Variations in the ratio of unit labour cost to capital

rental.i thus results in .either greater ih^n.

loss thar' or

-r...iXy

## proportionate changes in capital per unit of labour employed

according as the elasticity of substitution (b) is greater then,
. /

j-^ii'Sc

:*)r

vV

j.

u,,r

## thus measures the changes in the factor combinations in response

to the relative price, changes.

## labour can bs substituted for capital (or vice-'/eras) with output,

remaining constant.

## For Instance, tho relative share- of ioccur (wLj nr t;;.-,

wage rata times ths quantity of labour, and share of capital (rK)
or the rate of return on capital times the quantity of rapei'e? in
the total output x is
wL
X
an:

f j

(6)

17)

## Williams, Randolph L.s 'Capital-labour substitution in Jamaican

Manufacturing', The Developing Economies, Vol.12, No.2 . 1974,
p. 170,
'

A5 50

ft

'

<>

## W h e n b ~ 0 o S 5 an increase of w/r by 10 per cent causes

th s increase in K/L by 5 per cento
This means that
capitals

## as labour becomes mor e expensive relative to

the entrepreneurs

to

## function is characterised by less than unitary elasticity

substitution of capital for labour cannot

## sam e proportion as the change in the relative factor pricss

This snakes the labour's share to increase

## In the two factor-inputs case when ths return to one

factor increases relative to the return to the oth e r f a c t o r 5
the relative share of th e former increases

remains constant

1
/
(b) is lass then
in b always

An increase

## raises the rate of increase of output and a decrease

y
of uhich reduces the output rate.

h S O p . c i t p.581

_1/

Fitchett Delbert

2/

## Broun Murrays 5Technological Progress in the Theory of

Production' (Ch2) in On %he Theory And Measurement of
Technological C h a n g e (Cambridge at the University Press

1966).

A . 5 ;9

A -5 o2

(ccs) FP.ooucnem

## fu-mctigk cstip,att. qk-;

Constant-elasticity

of s u b s t i t u t i o n

production

funriior

J/
(popularly

known,

production

function.

function

cf

ss

unitary

production

handj

CSS

production

It

special

case,,

It

of

function,

line C E S

an

along

Cobh-Douglss

the

rsmavss

production

known

production

tbs

the

constant

ment

the

of

CES

elasticity

production

c
Y

is

bK

output

function

(net

ocher

However,

put

of

sub

forward

or

both

by

them

/
The

formal

state

i s

/r

(D

(l-b)l

value

the

v / j?

P \
-n

c r.

elasticity

substitution.

~p

Y ss
where

of

Limitation

{U O U 5 -.? !

characteristics

function.

of

production

function,

of

~.1sb~

r.sw

by

2
presume

serious

shown

measurement

other

in

Cobb-Douglas

substitution

explicit

with

function]

includes

elasticity

provides

stitution

the

as

added

by

manufacture),

and

are

3/
UDriabie

are

irsputs-CEpitai

parameters;

and

labour

represents

respectively,

the

degree

of

end

a,

homogeneity

and

of

the

function.

'}J

Arrow,
or

Cher.ery,

production

BeS . P i i n h a s .
and

2/

Sarthwal

end

R.fl.

H.fi,;

Solouj

"The

lasts

for

Indian

CES

function

its
of

is

limited

spsc.ificat.ion
production

K.3.,

of

this

HB,

"Capital-labour
Review

Economics

W o , 3,

production

popularised

Arrow

new

class

Chenery,

substitution

E c o n o m i cs

and

S t a t i s tics

1961.

R e v i e w a Uoi-4,

Function

Solow

See

L f f i c i e n c y *

N o , 3,

Empirical

3/

and

Economic

\Zol.43,

M n h a s

function.

is

1975,

to

of

Paper

Industry**,

p.174

unlike
two

Production

S o u t h e rn
"

the

CobbDouglas

factor-inputs.

and

estimation

with

very

difficult,

if

Function;

more

not

Some
Economic
~

product ion

This

is

than

two

impossible.

because
factors
CES
Contd.

4 . G 31 C

## CcS production function bee three parameters - two

introduced es constants of integration and one elfcributaoie to
the assumption that elasticity of auSstitution ic eon? lent <.
2, b and f

## are resosetivsiy called tns efficiency parameter,

1/
input intensity parameter .and substitution parameter,
also referred toss the Hicks ~ neutral parameter,

z is

The role cr

## 2 in CES function is identical to that of A in the Cobb-Dnuglu3

production function,

## for any given set of inputs in the same proportion.

parameter 2 shows the efficiency of technology.

The scare

## The efficiency oaracister (2) can be made eoual to one

by appropriate choice of output unite,

## a class of function known in the mathematical literature as

a mean value* of order

3/

5/

Contd..,
production functions, however, have been estimated taking
more than two factor-inputs. Sees Mukerji, V, >!"he CES
or SMAC Production Function with more tnen two Inputs;
A Generalization",
Indian Economic Journal, Vol.1?f No,3,

1964-65.

...

- -

j/

2/

## Crown, Murrary s Cr> the Theory and Measurement of Technoloo.s.cai.

Change, (Cambridge at the University Press, 1966)',
p,"45

3/

Arrow K.3,, H.B, Cbenery, 8.S. Minhas, and R.tt. Solowt "CapitalReviaw of Economics

## labour substitution and Economic Efficiency"

and Statistics; Vol.43, No.3, 1961, p,23G.

n5si *

) measures the

relat-iva

*i

Here.

fsr

equivalent to

## -sbsfc.ttut.ion parenstev as referred to 3bt

a function of the constant elasticity of substitution asj
p

__ _ (1 - <?)

' }

## The CES production function contains an unspecified

constant elasticity of aubstitufciou.
production function If

c'

2/
P
approaches zero.

The important

b
and

oo

<

>

upon

t'-'ci.:gn

>a
JJ

3>

## Kanthi, Mahendrs 5., and Pam Dhsiiwal* The Theories of

Production s A Survey" Arfcha-Uikas, Vcl.XI, No.l, 3ari.
1 9 7 5 , p . So

## See aisoi Henderson, 3.M., and R.E, Quandt; Pllcrp-ecpnmnlc

Theory; A Mathematical Approach (McGraw-Hill Book Company,
New York, and Xogakusha Company Ltd., Tokyo, 1971) p.S'6
2/

## When ^equals zero (input-output production function) chan-rc

In the ratio of unit labour cost to capital rsr.ts' (u/'j '
isavs the capital-labour (K/L) ratio unchanged.

_3/

## the lowest admissible value for P is -1, which implies an

infinite elasticity of substitution.

A5 s12

f ~O s

When

It becomes

(*)

Y = ZKb L 1 b
further,, when

P>

^ __j. +

p= -1,

P >/ 0
0,

And when

And when

P<

0 and

Here

f <. 0,

## the C5 production function to the Leontief production function.

1?
the curvature of the isoquants approaches a right angle.

Here

## It is to be noted that the distribution parameter b always

lies in the interval (0,1).

## values of 6 and r'IRTS (marginal rate of technical substitution),

the nearer the value of b to one, the smaller the labour to capital
2/

input ratio.

## technical substitution of labour for capital) rises at a given

C3pital-output ratio.

3/
2/

MRTS.a
LK

MP

PIP,

P8?.

A.5:13

## intensive at any production point? wnsn b is r.oarsr erg,

refers to input intensity.,

Thur,. b

## the technology is capital intensive.

{but not Identically thp name as)

It is closely related to
C

## O' in the case of the Cctb-i

production function.

## Uhon ^ y 1s -1 <" f* < 0 5 the factors of production resemble

each ether from technologies: 1 point of view,,
axes.

## factor-Input. regaining constant, the existing technology oermtts the

increasing factor-input to be substituted relatively easily for the
constant factor-input.

## For example, with the capital growing relative

to labour, capital becomes and/or treated as relatively cheap factorinput and is substituted for tha relatively expensive labour.

The

## corresponding technological process becomes capital intensive. Alter

natively, it becomes labour intensive, if labour grows and is available
reletivrly cheaply and abundantly; wbjcn sases the substitution
process - substitucing labour for the relatively expensive capital.
Either of these two factor-inputs tends to bring in non-neutral
technological change in tha production process.

## On toe other hand, technology considers the factor-inputs

so being relatively dipsimiiar If

if' < 1.

It is difficult, hers,

## to substitute the increasing factor-input for the constant one (less

abunoant factor-input).

## The output does not increase even if one

ASe14
factor-input increases indefinitely.

## The non-neutral technological change, as defined above,

nc-wever, affects the output level-

## or decreasing capital intensity chancsa the output level; although

the same depends on whether capital grows far exceedingly than labour.
Ths increasing capital

o f

when
^

if

>

\r

<

*5

## The C5, unlike the Cobb-Douglao and the Lsontief prediction

functions, allows the elasticity of substitution (
constant value.

<f

) to take any

## (like the Cobb-Douglas production function), it shows the direction

of change in relative factor shares.
stitution (

(S '

. . .

5./

ynG

j/

2/

3/

## Williams Ranoolph L.: "Capital-Lacuur substitution in

3amaican Manufacturing", The Developing economies, Vo 1.12,

A.5 s!5

## substitution in this function;, though imposing restriction on the

form of production possibilities, helps to arrive at certain estimate,
when the general formula of the elasticity of substitution does not
allow fur its direct calculations.

## The CS production function eliminates the difficulty

encountered with the Cobb-Douglas production function, which requires
estimations of both capital and labour inputs for estimating the
corresponding pararnoters*

## Capital stock data (in fact the utiliza

tion rate of the services of the capital stock) are fairly difficult
to gat.

y is
function

## used in the present exercises

y

Log ^

Log A + o{ Log y- + u

(5)

where s

2/ i,

## rate, Log A is the intercept, c( is tho coefficient of slasticity

of substitution and u is the error term .

1/

## Arrow, Chenery, F.inhae and Solows Op.cit., p.228, and also

see Plukerji, V.A: "A Generalised SHAC function with constant
ratios of Elasticity of Substitution1*, Revi ew of Economic
Studies, October 1963, p #225.

2/

A 5 : 1 6

and

equal to

o<

. A

## the coefficient of Log in equation 15) to bs the elasticity^ of

substitution cf a linear homogeneous CCS production function of tns
form as per equation (1 ) referred to above.

## fairly good seal of generalization of the Cobb-Oouglas production

function is made here,

Srhen

ot

function.

function.

f

And

## here, the CES departs from the CobbDouglas production function,

lillian's has suggested :uo alternate method; of estimating elasticity

2/

## For easy handling of this estimation, it has become the

popular method of estimating the elasticity parameter.
Set alsos Nerlove, Mj "Recent Empirical Studies of the CCS
and Related Functions" in Tha Theory end Empirical Analysis
of Production. National Bureau of Economic Research, Studies
in Income and Wealth, Vol.31, (New York s Columbia University
Press, 1967).

A5s1?

1/
of substitution between the factor inputs.

Substitution;

1st Method:
Log ~

log A

{ p Log V
I

## Log A. is the intercept,

j\$

(6)

x
=>
is the capital productivity,

where

+
9

is

## Both equations (5) and {6) are the log-linear forms of

the marginal productivity conditions for capital and labour
respectively for'maximising a profit function subject to the
production function as per equation-(1) above.

The intercept

## terms in equations (5) and (6) can be defined in terms of the

parameters of (1) as s

and

Log

Log Z ~ <s"log b

= (1-^)

2nd Method g
Log ~~
where wL
rf.

+u

(?)

1

is tho

( <Z )
\J

SSI

## Williams Randolph Ls Capital-labour substitution in Jamaican

Manufacturing ,-The Developing Economies, Uol12, No,2, 1974,

P.171-1S2.
2/ Capital productivity = Net value added by manufacture par unit
capital employed.

A.5 s18

(i-

## as referred to above in equation (3),

Here? the intercapt Log A2 can be defined in terms of equation {1}
13 8

'

## Log A, Log (1~b)

-g ~

i/
The relative factor shares method has been used by Kravis,

and Bell

Solow,

## Solow, whils using this CES production function contends

that a regression of the labour productivity () on the wage rate
ly shows a highly significant correlation in most of the industries,
though having a considerable variation in the regression coefficients
( ot ) among them.^ Different degress of substitutability are found
in different types of production technology existing in different

1/

## Kravis, I .8.: "Relative Income shares in Fact and Theory"!

American Economic Review, Uol,4S, Mo ,5, 1959.

2/

## Solow,, RM.^"Capital labour and Income in Manufacturing"

in The Behaviour of Income Shares, National Bureau of Economic
Research, Studies in Income and Health, Vol.2? (Princeton, N.3.
Princeton University Press, T364).

3/

## Bell, FW.s"A Note on tha Empirical Estimation of the CES

production function with the use of capital Data", Review of
Economics and Statistics, Vojl.47, No.3, 1965.

Solow, R
op.cit.

. M . sCapital,

## Labour and Income in Manufacturing,"

A .5 j 1 9

0r o u p s .

Industry

same

industry

technological

marginal

i,n

the

the

Such

groups

among

set

differs

up

difference

csss

same

The

function

niven

they

are

further

from

noticed

of

on

the

croup

assumes

tnem

across

the

linear

to

be

even

the

in

fact

another.

factor

within

same

for

cauntryto

ir, t h e

firms

pronounced

countries,

one

i a d u s t .r-

mo: e

are

different

be

aggregation

that

and

nav

cne

country.

envisages

c;if f e r e n c e s

tics

chat

But

very

substitutability

the

suc-.egj.ons

same

industry

homogeneous

operating

of

groups

production

ir, p e r f e c t

2/
markets.,

But

belonging

well

to

this

the

defined

market

operating

under

t\

Arrow,
pp t

2 /

more

K j ;

but

the

rather

model

has

fh&asry;

In

spread

do

fact,

across

have

to

assumption

competition

general

and

on

seems

been

to

operate

and

RJ1.

t i u t n

undor

are

linear

theoretical

suggested

i'.inhas;

they

same

be

fi.-m.

space

that

the

the

by

i" o l d u t :

S c l o e : o p .clt .

226-227.

Ohrymes

has

provided

geneity

and

perfectly

functions",
1965;
of

broad.

region,

Thus

function

H.B.

very

group'

given

perfect"

'Sortie E x t e n s i o n s

and

substitution

1970.
data

and

3.8.

Kadsnes

partly

functions",

tost

ic s ! :

of

P.3.,

Two Digit
of

such

the

Uis

Economics

Ohrymes,
for

o;

ccmpt.itive

of

Review

However,

s r - :'

Review

also

Correction",

3/

of

condition?.,

the

is

incuctry

production

limitation.

^/

same

boundary

different

homogeneous

assuror ioc

is

and

least

spur res

Hates

on

the

Economics

feldstein,

M . S .{"Alternative

Production

function

for

o e s -

of

Zarembka,

and

bias.

Methods

Britain",

JLno.fr

cl

Homo
o

Just. ,.>i
No.-i,

P .{"Elasticities
Industries:

Statistics,
iuc>

Vol.52,

partly

cn

of

LtS

No.1,
'o f r:i s o t

oroc.uctj.vr

S tatistics, lol.AS,
of

S u e rMar'a 1: ,

Estimation
and

of

Ohry.no

5 t a b l e t leu,

inconclusive

to

of

rsr:

Manufacturing

S o m e
Review

Cf l
anc

Economics

test,

assumptions
markets

Estimating

E c o n arnica,.

Uol.34,

No.3,1966

CES
M o . 136.

't C 'l

A 5 s20
which incorporates the conditions of both perfect and imperfect
markets, while estimating the CS production functions for British
manufacturing industries.

## Whether in fact, the firms belonging to

the same industry group(at the stats or the regional level) are
operating undar perfect or imperfect market conditions, the trua
values of elasticity of substitution (

## The bias is upward if the true value of

unity5 whereas it is downward if the true value of

1/

than unity.

df ie greater

## the same industry g-roup across space, being slightly varying, a

similar bias may arise? hones the interpretation of the estimated
values of the elasticity of substitutions ( ) as given by the
coefficient cK in equation (5) above, needs s.irification on the basis
of other relevant information pertaining to the concerned industry
group in a regional context.

1/

## Grilichss, Z.s "Production Functions in Manufacturings

Some Preliminary Results" in The Theory and Empirical
Analysis of Production, ed. ft. Brown, National Bureau
of Economic Research Studies in Income nr.a Wealth,
Vol.31 (New York, Columbia University Press, 1967), p.289.

A,5 s21

A.5.4

## A CHOICE FOR THE PRODUCTION FUNCTION F OR THE

ESTIMATION OF THE ELASTICITY OF FACTOR
SUBSTITUTION!
The production function states the output levels through

The most

## popular form of the two-factor case production function is the

Cobb-Oouglas

production function!

X = CXl.1-0<
where

X = output

'

(1)

A, and

a r c constants.

however, is of

A.5.4(1)

dX
nPL =

dL

Hp K

dX

,
,
o< o<
(l-cx) AK
L

= o< AK

0)

(2)

dK
Hence;
MRTS

-o<

( i~<)
C* AK

'!<L

AK

CK~1

HP,"

KL

MAT!

1/

wL

1/

_ ]
L

1- o(
L

P)

(4)

for labour.

A .5 s22

"

A ik/Q
"v:./rv
(k / l )
b -

/ Am'V

m
qtc^ |
wa r s

A(K/t)

wrtskl

( k/

MRTSk i

(5)

l)

d PIRTS..

dwrr

Thus,

(6)

1-o<

*N V

Q\

1-o<

cK

Jii/kL

CK

PIRTS,,.

isL

PIRTS,
XL

(K/L)T

XL

(iW)ff ft

(?)

## This means that b = 1 for all values of both the pasamsttru

and the independent variables .

## function of practically no use to estimate empirically the elasticity

of factor substitution.

## The CE5 production function permits the elasticity of

factor substitution to differ from unity,
constant.

The form of

## tuhare X/L = val u e

though assumed to be