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Profit maximization problem for Cobb–Douglas and CES production functions

Article  in  Computational Mathematics and Modeling · August 2010

DOI: 10.1007/s10598-010-9075-5

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Computational Mathematics and Modeling, Vol. 21, No. 3, 2010

PROFIT MAXIMIZATION PROBLEM FOR COBB–DOUGLAS

AND CES PRODUCTION FUNCTIONS

S. N. Avvakumov, Yu. N. Kiselev, M. V. Orlov, and A. M. Taras’ev

Production functions are used to model the production activity of enterprises. In this article, we formu-
late the necessary and sufficient conditions of strict concavity for Cobb–Douglas and constant elasticity
of substitution (CES) production functions. These conditions constitute the theoretical foundation for
analyzing the profit maximization problem. An optimal solution is constructed in analytical form and
some of its properties are described. Three approaches to solving the profit maximization problem are
considered and their equivalence is established. For a Cobb–Douglas production function we investigate
the dependence of the maximum profit on elasticity coefficients. A similar analysis is carried out also
for the CES production function. The article presents a systematic and detailed discussion of the relevant
topics. The topic is related to the investigation of innovation activity of enterprises. The theoretical re-
sults and the explicit analytical relationships provide a theoretical and algorithmic base for the “Planer”
optimization software—a useful product for the analysis of the production activity of enterprises modeled
by production function tools.

1. Introduction

We assume that the activity of an enterprise in a static framework (i.e., on short planning horizons) can be
modeled by a production function [1–4]. In this article we consider a Cobb–Douglas production function and
a constant elasticity of substitution (CES) production function. We solve the problem of profit maximization in the
presence of an arbitrary finite number of production factors. Three approaches are considered:
I. Unconstrained profit maximization:

Φ(x) → maxn .
x∈R+

II. Cost minimization (profit maximization) subject to a given output Y: evaluation of the maximum profit
function P (Y ) depending on the level of production (output) Y and subsequent solution of the ex-
tremum problem

P(Y ) → max .
Y

III. Profit maximization subject to a given level of expenditure (cost) Q : evaluation of the maximum profit
function P(Q) depending on the cost Q and subsequent solution of the extremum problem

P(Q) → max .
Q

In all these approaches the solution is obtained in analytical form and equivalence of the three approaches is
established in the following sense:

max Φ(x) = max P(Y ) = max P(Q). (1)

x∈Rn
+ Y >0 Q>0

Translated from Nelineinaya Dinamika i Upravlenie, No. 5, pp. 309–350, 2006.

336 1046–283X/10/2103–0336 
c 2010 Springer Science+Business Media, Inc.
P ROFIT M AXIMIZATION P ROBLEM FOR C OBB –D OUGLAS AND CES P RODUCTION F UNCTIONS 337

A compact analytical expression for the maximum profit (1) is obtained for both a Cobb–Douglas production
function and a CES production function. The utility of approaches II and III considered alongside approach I can
be motivated by practical considerations.
We state and prove the necessary and sufficient conditions of strict concavity of the production function by in-
vestigating its Hessian with the aid of Sylvester’s criterion. We also analyze the dependence of the maximum profit
on the production function parameters (for instance, the elasticity coefficients of the Cobb–Douglas production
function).

2. Cobb–Douglas Production Function. Profit Maximization. Three Approaches

2.1. Cobb–Douglas Production Function. Concavity Conditions. Theorem 2.1. We consider the Cobb–
Douglas production function
n
 ε
F (x) = A · xj j , (2)
j=1

depending on n factors of production

x1 > 0, . . . , xn > 0. (3)

We assume that the factors xj and the output Y = F (x) are expressed in money values. The vector
x = (x1 , . . . , xn )∗ consisting of the factors (3) varies in the positive orthant R+n . The multiplier A > 0 is the

known calibration factor that determines the level of production for unit values of all factors: A = F (1, . . . , 1).
The exponents ε1 , . . . , εn in (2) are the elasticity parameters that satisfy the constraints

εj ∈ (0, 1), j = 1, . . . , n. (4)

Given condition (4), the production function (2) is concave in each factor xj separately. However, condition (4)
n.
does not guarantee concavity of the function (2) in the positive orthant R+

Example 2.1. For n = 2, A = 1, ε1 = 1/2, ε2 = 3/4 the function (2) takes the form

1/2 3/4
F (x1 , x2 ) = x1 x2 . (5)

This function is concave in each argument x1 and x2 separately, because Fx1 x1 (x) < 0, Fx2 x2 (x) < 0, but it is
not a concave function in R+ 2 in its arguments x and x jointly, see Fig. 1, which shows the surface defined by
1 2
1/2 3/4
the equation z = x1 x2 . Indeed, the function

f (t) ≡ F (t, t) = t5/4 , t ≥ 0,

of the scalar argument t ≥ 0 is convex, and obviously f (0) = 0, f (1) = 1, f (1/2) = 1/25/4 < 1/2, so that
we have the inequality 1/2f (0) + 1/2f (1) > f (1/2) which may be rewritten as
 
1 1 1 1
F (0, 0) + F (1, 1) > F , .
2 2 2 2

This inequality shows that the function (5) is not concave on the set R+2 . The same conclusion is obtained from

the following observation: the eigenvalues of the Hessian of function (5) have different signs.
338 S. N. AVVAKUMOV, Y U. N. K ISELEV, M. V. O RLOV, AND A. M. TARAS ’ EV

1 1/2 3/4
F (x1 , x2 ) = x1 x2

0
0
x1 1
1 x2

Fig. 1

Remark 2.1. Function (2) is a positive homogeneous function whose degree is equal to the sum of elasticities

σn ≡ ε1 + . . . + εn > 0,

i.e.,

F (t · x) = tσn · F (x) ∀t > 0, n

x ∈ R+ .
n :
Hence we obtain the necessary condition of concavity of function (2) in R+

σn ≤ 1. (6)

In our example, the sum of elasticities is greater than 1: σ2 = ε1 + ε2 = 5/4 > 1. Note that for σn = 1
n . A geometrical interpretation of strict concavity of the Cobb–Douglas
function (2) is not strictly concave in R+
production function with n = 2, σ2 ∈ (0, 1) is given in Fig. 2.
In the constructions that follow the condition

σn ≡ ε1 + . . . + εn < 1 (7)

plays a central role. We have the following theorem:

n of the Cobb–Douglas produc-
Theorem 2.1. A necessary and sufficient condition of strict concavity in R+
tion function (2)–(4) is condition (7) for the sum of elasticities σn .
Proof. To investigate the property of strict concavity of function (2), find its Hessian
 n
 ∂ 2 F (x)
F (x) = (8)
∂xi ∂xj i,j=1
P ROFIT M AXIMIZATION P ROBLEM FOR C OBB –D OUGLAS AND CES P RODUCTION F UNCTIONS 339

1 F (x1 , x2 ) = x1 x2
1/4 1/2

0
0
x1 1
1 x2

Fig. 2

which is the (n × n) matrix of second-order partial derivatives of function (2). We have

εi
Fx i (x) = F (x), i = 1, . . . , n, (9)
xi

εi (1 − εi )
Fxi xi (x) = − F (x), i = 1, . . . , n, (10)
x2i

εi εj
Fxi xj (x) = F (x), i, j = 1, . . . , n, i = j. (11)
xi xj

Formulas (10), (11) lead to the following representation of the Hessian (8):

F  (x) = −F (x)H(x), (12)

where H(x) is a symmetrical (n × n) matrix of the form

⎛ ⎞
ε1 (1 − ε1 ) ε1 ε2 ε1 εn
− ... −
⎜ x21 x1 x2 x1 xn ⎟
⎜ ⎟
⎜ ⎟
⎜ ε2 (1 − ε2 ) ε2 εn ⎟
⎜ − ε1 ε2 . . . − ⎟
H(x) = ⎜
⎜ x1 x2 x22 x2 xn ⎟ ⎟. (13)
⎜. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .⎟
⎜ ⎟
⎜ ⎟
⎝ ε1 εn ε2 ε2 εn (1 − εn ) ⎠
− − ...
x1 xn x2 xn x2n

By formula (12) the condition of strict negative definiteness of the Hessian F  (x) is equivalent to the condition
of positive definiteness of the matrix H(x). Formula (13) shows that this matrix is representable as a product of
340 S. N. AVVAKUMOV, Y U. N. K ISELEV, M. V. O RLOV, AND A. M. TARAS ’ EV

three (n × n) matrices

H(x) = X HX, (14)

where the middle factor has the form

⎛ ⎞
ε1 (1 − ε1 ) −ε1 ε2 ... −ε1 εn
⎜ ⎟
⎜ −ε ε ε2 (1 − ε2 ) . . . −ε2 εn ⎟
⎜ 1 2 ⎟
 =⎜
H ⎟, (15)
⎜ ⎟
⎜ . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .⎟
⎝ ⎠
−ε1 εn −ε2 εn . . . εn (1 − εn )

and the identical first and third factors are diagonal:

⎛ ⎞
1/x1 0 ... 0
⎜ ⎟
⎜ 0 1/x2 . . . 0 ⎟
⎜
X=⎜ ⎟. (16)
. . . . . . . . . . . . . . . . . . . . . . ⎟
⎝ ⎠
0 0 . . . 1/xn

The matrix (14) is positive definite simultaneously with the matrix (15), since the quadratic forms with the matrices
H and H  are related by the equality

 z,
z ∗ Hz = z∗ H

where the n-dimensional vectors z and z ≡ Xz with the coordinates zi and zi = zi /xi , i = 1, . . . , n,
respectively are simultaneously nonzero.
It thus remains to check the conditions of positive definiteness of the symmetrical (n × n) matrix (15) that
depends on the positive elasticity parameters ε1 , . . . , εn .
To investigate positive definiteness of the matrix H  we invoke Sylvester’s criterion, which is expressed in
terms of positiveness of all the principal corner minors of the matrix H :

Δ1 > 0, Δ2 > 0, ..., Δn > 0. (17)

The minors Δ1 , Δ2 , . . . , Δn in (17) are explicitly expressible in terms of the elasticity parameters ε1 , . . . , εn .
Specifically, we have
⎧
⎪
⎪ Δ1 = ε1 (1 − ε1 ) ≡ ε1 (1 − σ1 ),
⎪
⎪
⎪
⎪
⎪
⎨Δ2 = ε1 ε2 (1 − ε1 − ε2 ) ≡ ε1 ε2 (1 − σ2 ),
(18)
⎪
⎪
⎪
⎪ .................................................................
⎪
⎪
⎪
⎩
Δn = ε1 ε2 · . . . · εn (1 − ε1 − ε2 − . . . − εn ) ≡ ε1 ε2 · . . . · εn (1 − σn ).

The first two formulas in (18) are verified directly, and the remaining formulas are easily proved by induction using
the recurrence

Δk = εk · Δk−1 − εk · (ε1 ε2 · . . . · εk ), k = 2, . . . , n. (19)

P ROFIT M AXIMIZATION P ROBLEM FOR C OBB –D OUGLAS AND CES P RODUCTION F UNCTIONS 341

To derive formula (19) for the evaluation of the determinant Δk we represent its last column as the sum of two
columns
⎛ ⎞ ⎛ ⎞ ⎛ ⎞
−ε1 εk 0 −ε1 εk
⎜ ⎟ ⎜ ⎟ ⎜ ⎟
⎜ −ε ε ⎟ ⎜ 0 ⎟ ⎜−ε ε ⎟
⎜ 2 k ⎟ ⎜ ⎟ ⎜ 2 k⎟
⎜ ⎟=⎜ ⎟+⎜ ⎟
⎜ ... ⎟ ⎜. . .⎟ ⎜ . . . ⎟,
⎜ ⎟ ⎜ ⎟ ⎜ ⎟
⎝ ⎠ ⎝ ⎠ ⎝ ⎠
εk (1 − εk ) εk −εk εk

and write the determinant as the sum of two computable determinants. We have
   
ε1 (1 − ε1 ) −ε ε . . . 0  ε1 (1 − ε1 ) −ε ε . . . −ε ε 
 1 2   1 2 1 k 
   
 −ε ε ε2 (1 − ε2 ) . . . 0   −ε1 ε2   ε2 (1 − ε2 ) . . . −ε2 εk 
 1 2
Δk =  +
 


. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
   
 −ε1 εk −ε2 εk . . . εk   −ε1 εk −ε2 εk . . . −εk εk 


 
1 − ε1 −ε1 . . . −ε1 
 
 
 −ε 1 − ε2 . . . −ε2 
 2
= εk · Δk + (ε1 ε2 · . . . · εk ) ·  .
 (20)
 . . . . . . . . . . . . . . . . . . . . . . . .
 
 −εk −εk . . . −εk 


The last determinant is easily computed after the evaluation of the kth column from all the previous columns:
it equals (−εk ). Allowing for the last remark, we obtain from (20) the recurrence (19), which in turn implies (18).
Indeed, by the induction hypothesis

Δk−1 = (ε1 · . . . · εk−1 ) · (1 − ε1 − . . . − εk−1 ) (21)

and using (19) we obtain

Δk = {(19)} = εk · Δk−1 − εk · (ε1 ε2 · . . . · εk ) = {(21)}

= εk · [ε1 · . . . · εk−1 · (1 − ε1 − . . . − εk−1 )] − εk · (ε1 · . . . · εk )

 k
 k

 
= εj · 1 − εj .
j=1 j=1

We have thus proved formulas (18) for the principal corner minors of the matrix H.  From (18), using assump-
tion (4), it follows that the system of inequalities (17) is equivalent to condition (7) for the sum of elasticities σn .
We have thus verified the following conditions under assumption (4):
– inequality (7);

– the system of inequalities (17);

342 S. N. AVVAKUMOV, Y U. N. K ISELEV, M. V. O RLOV, AND A. M. TARAS ’ EV


– positive definiteness of the matrix H;

– positive definiteness of the matrix H;

– negative definiteness of the Hessian F  (x) of the production function F (x);

– strict concavity of the Cobb–Douglas production function (2).

This completes the proof of Theorem 2.1. Q.E.D.

2.2. Profit. Let

n
 ε
F (x) = A · xj j (22)
j=1

be the Cobb–Douglas production function (2), (4), (7). Recall that the factors of production xj and the output
Y = F (x) are expressed in money values. We introduce the profit function

n

Φ(x) = F (x) − xj , (23)
j=1

i.e., the profit equals the value of output minus the cost.
We seek to maximize the profit (23). The maximization problem is solved by three approaches, which are
briefly described in the introduction. In what follows the three approaches are discussed in full detail.

2.3. Approach I. Profit Maximization. Direct Derivation of the Formulas for Maximum Profit and Profit
Maximizer. Relationship between Optimal Cost and Optimal Output. Theorem 2.2. The first approach solves
the maximization problem for the profit (23):

Φ(x) → maxn . (24)

x∈R+

The extremum problem (24) is a concave unconstrained maximization problem. The profit function (23) is strictly
concave in R+ n because it is obtained by subtracting a linear function from the production function (22). Figure 3

is a geometrical interpretation of the properties of the profit function.

The gradient of function (23) has the form

Φ (x) = F  (x) − η1 , (25)

where F  (x) is the gradient of the production function (22) and η1 = (1, . . . , 1)∗ is a constant vector with all
coordinates equal 1. The Hessians of the functions (22) and (23) are equal:

Φ (x) = F  (x). (26)

Hence, by Theorem 2.1, the matrix (26) is negative definite. To solve problem (24) we have to solve the vector
equation

Φ (x) = 0, (27)
P ROFIT M AXIMIZATION P ROBLEM FOR C OBB –D OUGLAS AND CES P RODUCTION F UNCTIONS 343

0.25

0.2
z
0.15

0
x1
1
10 x2

Fig. 3

which, as we shall see below, has a unique solution

n
x̄ ∈ R+ . (28)

The point (28) is the maximizer in the extremum problem (24)

x̄ = argmaxn Φ(x). (29)

x∈R+

The maximizer (29) and the maximum profit

Φmax ≡ maxn Φ(x) = Φ(x̄) (30)

x∈R+

are explicitly computable. We state the final result in the form of a theorem.

Theorem 2.2. Under conditions (4), (7), the maximizer (29) of extremum problem (24) exists, is unique, and
is described by the explicit formula

x̄ = ε · β σn /(1−σn ) , (31)

where ε = (ε1 , . . . , εn )∗ is the elasticity vector, and the scalar positive parameter is

β = [A · Π(ε)]1/σn ≡ [F (ε)]1/σn , (32)

n
 ε
Π(ε) ≡ εj j . (33)
j=1

The components x̄j of the maximizer x̄ are given by the formulas

x̄j = εj · β σn /(1−σn ) , j = 1, . . . , n. (34)

344 S. N. AVVAKUMOV, Y U. N. K ISELEV, M. V. O RLOV, AND A. M. TARAS ’ EV

The maximum profit (30) is given by the following expression:

Φmax = (1 − σn ) · β σn /(1−σn ) . (35)

n
The optimal output Ȳ = F (x̄) and the optimal cost Q̄ = x̄j are related by
j=1

Q̄
= σn , (36)
Ȳ

where

Ȳ = β σn /(1−σn ) , (37)

Q̄ = σn · β σn /(1−σn ) . (38)

Proof. The vector equation (27) determining the maximizer (29) takes the form (by (25))

F  (x) − η1 = 0. (39)

The vector equation (39) is expanded in coordinate form as the system of equations

Fx i (x) = 1, i = 1, . . . , n, (40)

or, using formulas (9) for the partial derivatives of the Cobb–Douglas production function F (x), in the form

εi
F (x) = 1, i = 1, . . . , n. (41)
xi

From (41) we obtain

xi = εi F (x), i = 1, . . . , n, (42)

or in a detailed form

xi = εi · A · xε11 · . . . · xεnn , i = 1, . . . , n. (43)

We rewrite system (43) in logarithmic form:

ln xi = ln (εi · A) + ε1 ln x1 + . . . + εn ln xn , i = 1, . . . , n. (44)

Setting

ξi = ln xi , i = 1, . . . , n, (45)

we obtain from (44) a linear algebraic system of a special form,

n

ξi − εj ξj = ln (εi · A), i = 1, . . . , n, (46)
j=1
P ROFIT M AXIMIZATION P ROBLEM FOR C OBB –D OUGLAS AND CES P RODUCTION F UNCTIONS 345

in the unknowns ξ1 , . . . , ξn (see (45)). To solve the equation system (46), multiply the ith equation in (46) by εi
and add up all the resulting equations. We thus obtain

n
 n
 n n
   
εi ξi − εi · εj ξj = εi ln (εi · A),
i=1 i=1 j=1 i=1

whence
n
 n
1 
εi ξi = εj ln (εj · A). (47)
1 − σn
i=1 j=1

From (46) and (47), (45) we obtain

n
 n

 1 
εj
ξi = ln (εi · A) + εj ξj = ln (εi · A) + ln (εj · A) ,
1 − σn
j=1 j=1

 n
1/(1−σn )

xi = eξi = εi A (εj A)εj
j=1

 n
 1/(1−σn )
 ε ε1 +...+εn
= εi A εj j A
j=1

= εi A1+σn /(1−σn ) [Π(ε)]1/(1−σn )

= εi [A · Π(ε)]1/(1−σn ) = εi β σn /(1−σn ) , i = 1, . . . , n,

see notation (7), (32), (33).

We have thus obtained formulas (34) for the components x̄j of the maximizer x̄. This proves the vector
formula (31) for the maximizer1 x̄.
Finally we evaluate the maximum profit

Φmax = maxn Φ(x) = Φ(x̄) = Ȳ − Q̄, (48)

x∈R+

where
n

Ȳ ≡ F (x̄), Q̄ = x̄j . (49)
j=1

εi
1
Equation (40) determining the maximizer can be solved by the following scheme: from (41) we obtain the relationships xi = xn ,
εn
σn /(1−σn )
i = 1, . . . , n − 1; substituting these relationships in (42) or (43) we find the factor xn = εn β , and then compute all the other
factors xi = εi β σn /(1−σn ) .
346 S. N. AVVAKUMOV, Y U. N. K ISELEV, M. V. O RLOV, AND A. M. TARAS ’ EV

The optimal output Ȳ is obtained invoking (41), (34):

x̄i
Ȳ = F (x̄) = = β σn /(1−σn ) . (50)
εi

The optimal cost Q̄ is computed using (34):

n
 n

 
Q̄ = x̄j = εj β σn /(1−σn ) = σn · β σn /(1−σn ) . (51)
j=1 j=1

We have derived the formulas (37), (38), see (50), (51). Formula (36) is a direct corollary of formulas (37) and (38).
This completes the proof of Theorem 2.2. Q.E.D.

Remark 2.2. Formula (36) establishes a relationship between the optimal cost and the optimal level of pro-
duction: the optimal cost is the “fraction σn ” of the optimal output; for σn ≈ 1 we have Q̄ ≈ Ȳ .

2.4. Approach II. Cost Minimization Subject to Given Output. Maximum Profit Function P (Y ) Depend-
ing on the Output Y. Optimal Output Yopt . Maximum Profit. Theorems 2.3, 2.4. Consider the extremum
problem
n

Q≡ xi → min (52)
F (x)=Y
j=1

minimizing the cost subject to a given output Y. Here F (x) is a Cobb–Douglas production function (22).
To solve the constrained extremum problem (52) we apply the Lagrange multiplier method. The final result is
presented in the form of a theorem.

 min in prob-
Theorem 2.3. Under conditions (4), (7) with a given parameter Y > 0 the minimum value Q
lem (52) is attained with the minimizer

 = ε · ν,
x (53)

where ε = (ε1 , . . . , εn )∗ is the elasticity vector and the positive scalar parameter is

1 1/σn
ν = Y , (54)
β

β = [A · Π(ε)]1/σn ≡ [F (ε)]1/σn , (55)

n
 ε
Π(ε) = εj j . (56)
j=1

j of the minimizer x
The components x  are defined by the formulas

j = εj · ν,
x j = 1, . . . , n. (57)
P ROFIT M AXIMIZATION P ROBLEM FOR C OBB –D OUGLAS AND CES P RODUCTION F UNCTIONS 347

min in problem (52) is given by the equality

The minimum value Q

 min = σn · ν ≡ σn Y 1/σn .
Q (58)
β

Remark 2.3. The minimizer in problem (52) and the values (54) and (58) naturally depend on the parame-
ter Y —the given output,

=x
x (Y ) ≡ ε · ν(Y ), (59)

1 1/σn
ν = ν(Y ) ≡ Y , (60)
β

Q min (Y ) ≡ σn · ν(Y ) = σn Y 1/σn .

 min = Q (61)
β

The profit (maximum for the given output Y ) is determined by the equality

 min (Y ) ≡ Y − σn Y 1/σn .
P(Y ) = Y − Q (62)
β

Proof. To solve the constrained extremum problem (52) we apply the Lagrange multiplier method. Rewrite
the constraint F (x) = Y in logarithmic form:

n

εj ln xj = ln (Y /A). (63)
j=1

Construct the Lagrange function for problem (52) subject to the constraint (63):

n
 n

 
L= xj − ν εj ln xj − ln (Y /A) ,
j=1 j=1

j and ν of the factors xj and the Lagrange

where ν is the scalar Lagrange multiplier. The optimal values x
multiplier ν respectively are obtained from the equations

εi
Lxi ≡ 1 − ν = 0, i = 1, . . . , n, (64)
xi

and the constraint

Lν = 0 ⇐⇒ (63). (65)

From (64) we obtain

xi = εi · ν, i = 1, . . . , n. (66)
348 S. N. AVVAKUMOV, Y U. N. K ISELEV, M. V. O RLOV, AND A. M. TARAS ’ EV

0.02 P
P = P(Y )
Pmax

Y
0 Yopt 0.1 Y+ 0.2

−0.02

Fig. 4

Substituting expressions (66) in the constraint (63) we obtain the equation

n

εj ln (εj ν) = ln (Y /A) (67)
j=1

for the Lagrange multiplier ν. Equation (67) is transformed to the form

n

(εj ν)εj = Y /A,
j=1

whence, using the notation (7), (56), (55), we obtain

 σn
σn σn Y 1
ν · Π(ε) = Y /A, ν = ≡ Y,
A · Π(ε) β

1 1/σn
ν= Y . (68)
β

Formula (68) gives expression (54) for the sought Lagrange multiplier.
Thus, based on Theorem 2.3 (see Remark 2.3), formula (62) for the maximum profit function P(Y ) subject
to given output Y has the form
σn 1/σn
P(Y ) = Y − Y . (69)
β

Here the power exponent is 1/σn > 1.

Theorem 2.4 (on the properties of function (69), see Fig. 4). Given condition (7),

(i) the function (69) is concave in the argument Y ≥ 0;

P ROFIT M AXIMIZATION P ROBLEM FOR C OBB –D OUGLAS AND CES P RODUCTION F UNCTIONS 349

(ii) the function (69) is positive for 0 < Y < Y + , where

 σn /(1−σn )
+ β
Y = ,
σn

P(Y )|Y =0 = P(Y )|Y =Y + = 0, P(Y ) < 0 for Y > Y +, P (0) = 1;

(iii) the function (69) attains its maximum value

Pmax ≡ max P(Y ) = P(Yopt ) (70)

Y >0

at a unique point Yopt ∈ (0, Y + ), and the maximizer Yopt of this function is defined by the formula

Yopt = β σn /(1−σn ) (71)

as the root of the equation P (Y ) = 0. The maximum (70) has the following explicit expression:

Pmax ≡ (1 − σn ) · β σn /(1−σn ) ; (72)

(iv) we have the equality


 min (Y ) 
Q
 = σn . (73)
Y 
Y =Yopt

Proof. We have

1 1 1 − σn 1/σn −2
P (Y ) = 1 − Y 1/σn −1 , P  (Y ) = − Y < 0, Y > 0.
β β σn

The last inequality proves strict concavity of the function P(Y ). Solving the equation P (Y ) = 0 we obtain
formula (71) for the maximizer. Formulas (72) and (73) are verified directly. Q.E.D.
Relationship (73) is consistent with the previous conclusion (36) on the relationship between the optimal
cost Q̄ and the optimal output Ȳ .
n
2.5. Approach III. Maximization of the Output Y Subject to Given Cost Q = xj . Maximum
j=1
Profit Function P (Q) Depending on the Cost Q. Optimal Cost Q
 opt . Maximum Profit. Theorems 2.5, 2.6.
Consider the extremum problem

Y ≡ F (x) → nmax (74)

j=1 xj =Q

maximizing the output  Y subject to the given cost Q. In the constrained extremum problem (74) with a sin-
n
gle equality constraint xi = Q the function F (x) is a Cobb–Douglas production function (2), (4), (7).
j=1
The result of solving problem (74) is summarized in Theorem 2.5.
350 S. N. AVVAKUMOV, Y U. N. K ISELEV, M. V. O RLOV, AND A. M. TARAS ’ EV

Theorem 2.5. Under conditions (4), (7) with a given parameter Q > 0, the maximum value Ymax in prob-
lem (74) is attained with the maximizer

 = ε · ν,
x (75)

where ε = (ε1 , . . ., εn )∗ is the elasticity vector, and the positive scalar parameter is

Q
ν = . (76)
σn

j of the maximizer x
The components x  are defined by the formulas

j = εj · ν,
x j = 1, . . ., n. (77)

The maximum output Ymax is given by

 σn
β
Ymax = Qσn , (78)
σn

where

β σn = A · Π(ε) ≡ F (ε), (79)

β = [F (ε)]1/σn , (80)

n
 ε
Π(ε) = εj j . (81)
j=1

Remark 2.4. The constant β (see (80), (55)) in Theorems 2.5 and 2.3 is the same.

Remark 2.5. The maximizer (75) in problem (74) and the values (76) and (78) naturally depend on the given
level of costs Q :

=x
x (Q) ≡ ε · ν(Q), (82)

Q
ν = ν(Q) ≡ , (83)
σn
 σn
β
Ymax = Ymax (Q) ≡ Qσn . (84)
σn

The profit (maximum for the given cost Q) is determined by the equality
 σn
β
P(Q) = Ymax (Q) − Q ≡ Qσn − Q. (85)
σn
P ROFIT M AXIMIZATION P ROBLEM FOR C OBB –D OUGLAS AND CES P RODUCTION F UNCTIONS 351

Proof. We solve the extremum problem (74) by the Lagrange multiplier method. Write the objective function
in logarithmic form:
n

ln (Y /A) = εj ln xj . (86)
j=1

By (86), problem (74) is equivalent to the problem

n

εj ln xj → nmax . (87)
j=1 xj =Q
j=1

Construct the Lagrange function for problem (87):

⎛ ⎞
n
 n

1⎝
L= εj ln xj − xj − Q⎠,
ν
j=1 j=1

where λ = 1/ν is the scalar Lagrange multiplier. The optimal values x

j and ν of the factors xj and the
parameter ν respectively are obtained from the equations

εi 1
Lxi ≡ − = 0, i = 1, . . . , n, (88)
xi ν

and the constraint

n

Lλ = 0 ⇐⇒ xj = Q. (89)
j=1

From equations (88) we find

xi = εi ν, i = 1, . . . , n. (90)

Substituting expressions (90) in the constraint (89) we obtain the equation

n

ν· εj = Q (91)
j=1

for the parameter ν. Using notation (7), we obtain from (91)

Q
ν= . (92)
σn

Formulas (90) and (92) produce expression (76) for the multiplier ν, the coordinate formulas (77) and the
. Formulas (78)–(81) for the maximum output Ymax are obtained by direct
vector formula (75) for the maximizer x
352 S. N. AVVAKUMOV, Y U. N. K ISELEV, M. V. O RLOV, AND A. M. TARAS ’ EV

0.02 P
P = P(Q)
Pmax

Q
0  opt Q+
Q 0.1 0.2

−0.02

Fig. 5

manipulation:

n
 n

ε
Ymax = F (
x) = A · j j = A ·
x (εj ν)εj = A · Π(ε)
ν σn
j=1 j=1

 σn  σn
Q β
= β σn = Qσn . (93)
σn σn

Formula (78) is proved by (93). Q.E.D.

Thus, by Theorem 2.5 (see Remark 2.5), formula (85)—the maximum profit P(Q) given the cost Q—has
the form
 σn
 β
P (Q) = Qσn − Q. (94)
σn

Recall assumption (7): σn ∈ (0, 1).

Theorem 2.6 (on the properties of function (94), see Fig. 5). Under condition (7):

(i) the function (94) is concave in the argument Q ≥ 0;

(ii) the function (94) is positive for 0 < Q < Q+ , where

 σn /(1−σn )
+ β
Q = ,
σn

P(Q)|Q=0 = P(Q)|Q=Q+ = 0, P(Q) < 0 for Q > Q+ , P (+0) = +∞;

P ROFIT M AXIMIZATION P ROBLEM FOR C OBB –D OUGLAS AND CES P RODUCTION F UNCTIONS 353

(iii) the function (94) attains its maximum

Pmax = max P(Q) = P(Q

opt ) (95)
Q>0

 opt ∈ (0, Q+ ), and the maximizer Q

at the unique point Q  opt of this function is determined by the
formula
 opt = σn · β σn /(1−σn )
Q (96)

as the root of the equation P (Q) = 0. The maximum value (95) has the following explicit expression:

Pmax = (1 − σn ) · β σn /(1−σn ) . (97)

Proof. We have
 σn
β
P (Q) = σn Qσn −1 − 1,
σn
 σn
β
P (Q) = − σn (1 − σn )Qσn −2 < 0, Q > 0.
σn

The last inequality proves strict concavity of the function P(Q). Solving the equation P (Q) = 0 we obtain
 σn
1−σn β
Q = σn = σn1−σn · β σn ,
σn

 opt . Finally, let us evaluate the maximum Pmax of the func-

which leads to formula (96) for the maximizer Q
tion (94):

Pmax = max P(Q) = P(Q

opt )
Q>0

 σn
β  σn − Q
 opt
= Q opt
σn
 σn  σn
β
= σn · β σn /(1−σn ) − σn · β σn /(1−σn )
σn

2
= β σn +σn /(1−σn ) − σn · β σn /(1−σn )

= (1 − σn ) · β σn /(1−σn ) .

Q.E.D.

Note that the maximum values of profit (72) and (97) obtained in Theorems 2.4 and 2.6 are equal:

Pmax = Pmax ≡ Pmax .

354 S. N. AVVAKUMOV, Y U. N. K ISELEV, M. V. O RLOV, AND A. M. TARAS ’ EV

2.6. Equality of the Maximum Profit in the Three Approaches. Theorem 2.7. In Theorem 2.2 we have
found

Φmax ≡ maxn Φ(x) = (1 − σn ) · β σn /(1−σn ) , (98)

x∈R+

see (35). In Theorem 2.4 we have obtained the formula

Pmax ≡ max P(Y ) = (1 − σn ) · β σn /(1−σn ) , (99)

Y >0

see (72). In Theorem 2.6 we have computed

Pmax ≡ max P(Q) = (1 − σn ) · β σn /(1−σn ) , (100)

Q>0

see (97). In all three formulas the parameter β is the same:

β = [F (ε)]1/σn , (101)

see formulas (32) in Theorem 2.2, (55) in Theorem 2.3, (80) in Theorem 2.5.
We thus have the following theorems:

Theorem 2.7. The values

Φmax = maxn Φ(x),

x∈R+

 
Pmax = max max Φ(x) ,
Y >0 F (x)=Y

 
Pmax = max nmax Φ(x)
Q>0 j=1 xj =Q

obtained for the maximum profit in the three approaches are all equal (see formulas (98)–(101)).

2.7. Dependence of the Maximum Profit Φmax (ε) on the Elasticity Vector Subject to a Given Sum of
Elasticities σn . Theorem 2.8. Theses 2.1 and 2.2. For the maximum profit we have obtained the expression

Φmax (ε) = (1 − σn ) · [A · Π(ε)]1/(1−σn ) . (102)

Assume that the sum of elasticities σn ∈ (0, 1) is a given parameter. It is relevant to estimate the range of the
maximum profit (102) as a function of the elasticity vector ε. The vector ε characterizes the enterprise technology.
The kernel in the right-hand side of (102) is the product

n
 ε
Π(ε) = εj j . (103)
j=1
P ROFIT M AXIMIZATION P ROBLEM FOR C OBB –D OUGLAS AND CES P RODUCTION F UNCTIONS 355

0.8
π
0.6

0.5
0.4
ε2
0
ε1 0.5 0

Fig. 6

The range of (103) determines the range of Φmax (ε) given that

εj > 0, j = 1, . . . , n; ε1 + · · · + εn = σn . (104)

We have the following theorem:

Theorem 2.8. Under conditions (104) we have the inequality

 σ σn
n
≤ Π(ε) < (σn )σn . (105)
n

Inequality (105) is unimprovable,

 σ σn
n
min Π(ε) = Π(ε)|ε1 =...=εn =σn /n ≡ , (106)
ε:(104) n

sup Π(ε) = (σn )σn . (107)

ε:(104)

Analysis of assertions (105)–(107) for a given sum of elasticities σn ∈ (0, 1) leads to two qualitative conclu-
sions (theses):

Thesis 2.1. Equating the elasticity coefficients has a detrimental effect on profit (“equality” of elasticity
coefficients minimizes the maximum profit).

Thesis 2.2. Existence of one dominant elasticity coefficient is beneficial for maximum profit.
The qualitative conclusions suggested by Theses 2.1 and 2.2 may be formalized if the constraints (104) on
elasticity coefficients are augmented with additional conditions on the parameters εj .
Figure 6 plots the concave surface described (for n = 3, σ3 = 3/4) by the equation

z = π(ε1 , ε2 ), ε1 > 0, ε2 > 0, σ3 − ε1 − ε2 > 0,

356 S. N. AVVAKUMOV, Y U. N. K ISELEV, M. V. O RLOV, AND A. M. TARAS ’ EV

where

π(ε1 , ε2 ) = Π(ε1 , ε2 , ε3 )|ε3 =σ3 −ε1 −ε2 .

This figure presents a geometrical picture of the properties of the function π from Theorem 2.8 for the case of
three factors.

Remark 2.6. The results of this section suggest an interesting geometrical interpretation in the plane of the
variables QY (cost-output), see Section 4. These considerations apply to both Cobb–Douglas production functions
and CES production functions.

3. Constant Elasticity of Substitution (CES) Production Function. Profit Maximization. Three Approaches

3.1. CES Production Function. Concavity Conditions. Theorem 3.1. A constant elasticity of substitu-
tion (CES) production function has the form
 n
−σ/ρ

F (x) = A · αj x−ρ
j . (108)
j=1

The function (108) depends on n factors of production

x1 > 0, . . . , xn > 0. (109)

The vector x = (x1 , . . . , xn )∗ consisting of the factors (109) varies in the positive orthant R+
n . The multiplier

A > 0 is the calibration factor, A = F (1, . . . , 1); α1 > 0, . . . , αn > 0 are known weights (the allocation
coefficients) subject to the constraint
n

αj = 1; (110)
j=1

the parameter σ (the degree of homogeneity) is assumed positive:

σ > 0; (111)

the substitution coefficient ρ is subject to the constraints

ρ = 0, σ + ρ > 0, 1 + ρ > 0. (112)

The production function (108) is a homogeneous function of degree σ, i.e.,

F (t · x) = tσ · F (x) ∀t > 0, n
x ∈ R+ . (113)

Let us investigate the conditions of concavity and strict concavity of the production function (108)–(112).
A necessary condition of concavity of this function has the form

σ ≤ 1. (114)
P ROFIT M AXIMIZATION P ROBLEM FOR C OBB –D OUGLAS AND CES P RODUCTION F UNCTIONS 357

4
z

0
0
x1 2
2 x2
0

Fig. 7

n , the function f (t) ≡ F (t, . . . , t) = tσ · F (1, . . . , 1) = A · tσ

Indeed, if the function F (x) is concave in R+
of a single scalar argument t ∈ [0, +∞) should also be concave and concavity condition (114) holds. Therefore
in what follows we assume that

0 < σ ≤ 1.

For σ = 1 the concavity is not strict. We will show below that the strict inequality

0<σ<1 (115)

n . Recall assumption (112), when condition (115)

ensures strict concavity of the CES production function in R+
implies the inequality

1−σ
> 0. (116)
σ+ρ

Figure 7 plots the surface defined by the equation z = F (x1 , x2 ) for n = 2, A = 2, α1 = 1/2, α2 = 1/3,
ρ = 1, σ = 3/4.
We have the following theorem:

n of the
Theorem 3.1. Inequality (115) is the necessary and sufficient condition of strict concavity in R+
production function (108)–(112).

Proof. To investigate the property of strict concavity of function (108), we calculate its Hessian

 n
 ∂ 2 F (x)
F (x) = (117)
∂xi ∂xj i,j=1
358 S. N. AVVAKUMOV, Y U. N. K ISELEV, M. V. O RLOV, AND A. M. TARAS ’ EV

which is the (n × n) matrix formed from the second-order partial derivatives of the function (108). Evaluate the
partial derivatives of first and second order of the function (108). We have

n

F (x) = A · [q(x)]−σ/ρ , q(x) ≡ αj x−ρ
j ,
j=1

 
σ
Fx i (x) = A · − · [q(x)]−σ/ρ−1 · qx i (x), qx i (x) = −ραi x−ρ−1
i ,
ρ

whence

Fx i (x) = M(x) · αi x−ρ−1

i , i = 1, . . . , n, (118)

where

M(x) = Aσ · [q(x)]−σ/ρ−1 . (119)

The first-order derivatives have been found and are written in the form (118)–(119). They are all positive.
Let us now evaluate the second-order derivatives. We have (for i = j )

Fxi xj (x) = αi x−ρ−1

i · Mxj (x),
 
σ  −σ/ρ−2 
Mxj (x) = Aσ · − − 1 q(x) · qxj (x), (120)
ρ

σ+ρ
Fxi xj (x) = M(x) · · αi x−ρ−1
i αj x−ρ−1
j , i = j.
q(x)

Now,

Fxi xi (x) = Mxi (x) · αi x−ρ−1

i + M(x) · (−ρ − 1)αi x−ρ−2
i

 
σ
= Aσ · − [q(x)]−σ/ρ−2 · qx i (x) · αi x−ρ−1
i − M(x) · (ρ + 1) · αi x−ρ−1
i
ρ

σ+ρ
= M(x) · · (αi x−ρ−1
i )2 − M(x) · (ρ + 1) · αi x−ρ−1
i
q(x)
 
σ+ρ −ρ−2 1+ρ −ρ
= −M(x) · · αi xi · − αi xi .
q(x) σ+ρ

Finally
 
σ + ρ  2 1 + ρ q(x)
Fxi xi (x) = −M(x) · · αi x−ρ−1
i · −1 , i = 1, . . . , n. (121)
q(x) σ + ρ αi x−ρ
i
P ROFIT M AXIMIZATION P ROBLEM FOR C OBB –D OUGLAS AND CES P RODUCTION F UNCTIONS 359

Note that Fxi xi (x) < 0 for (1 + ρ)/(σ + ρ) > 0, 1 − σ > 0 (the law of decreasing marginal return).
Formulas (120), (121) lead to the following expression for the Hessian (117):

σ+ρ
F  (x) = −M(x) · · G(x), (122)
q(x)

where by (112) the scalar multiplier is

σ+ρ
M(x) · > 0,
q(x)

and the symmetrical (n × n) matrix G(x) has the form

⎛ ⎞
(α1 x−ρ−1
1 )2 d1 (x) −α1 x−ρ−1
1 α2 x−ρ−1
2 ... −α1 x−ρ−1
1 αn x−ρ−1
n
⎜ ⎟
⎜ ⎟
⎜ −α x−ρ−1 α x−ρ−1 (α −ρ−1 2
) (x) −α −ρ−1 −ρ−1 ⎟
⎜ 1 1 2 2 x
2 2 d 2 . . . x
2 2 α n x n ⎟
⎜ ⎟
G(x) = ⎜ ⎟; (123)
⎜ . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .⎟
⎜ ⎟
⎜ ⎟
⎝−α1 x−ρ−1 1 αn xn −ρ−1
−α2 x2 −ρ−1
αn xn −ρ−1
... (αn xn −ρ−1 2
) dn (x) ⎠

here
1 + ρ q(x)
di (x) = · − 1, i = 1, . . . , n.
σ + ρ αi x−ρ
i

The condition of strict negative definiteness of the Hessian F  (x) is equivalent, by (122), to the condition
of positive definiteness of the matrix G(x). This matrix, as we see from (123), is representable as the product of
three (n × n) matrices,


G(x) = X · G(x) · X, (124)

where
⎛ ⎞
d1 (x) −1 . . . −1
⎜ ⎟
⎜ −1 d (x) . . . −1 ⎟
⎜ 2 ⎟
 ⎜ ⎟
G(x) =⎜ ⎟, (125)
⎜ . . . . . . . . . . . . . . . . . . . . . . . .⎟
⎜ ⎟
⎝ ⎠
−1 −1 . . . dn (x)

 
X = diag α1 x−ρ−1
1 , . . . , αn x−ρ−1
n . (126)

The matrix (124) is positive definite simultaneously with the matrix (125).
It thus remains to check the conditions of positive definiteness of the symmetrical matrix (125) that depends
on the vector x ∈ R+ n and the parameters of the production function (108).
360 S. N. AVVAKUMOV, Y U. N. K ISELEV, M. V. O RLOV, AND A. M. TARAS ’ EV


To investigate positive definiteness of the matrix G(x) we apply Sylvester’s criterion, which stipulates positive
definiteness of all the principal corner minors of this matrix:

Δ1 > 0, Δ2 > 0, ..., Δn > 0. (127)

Consider the minor Δ1 = d1 (x), which may be written in the form

1 + ρ α1 x−ρ −ρ
1 + . . . + αn xn
Δ1 = d1 (x) = · −1
σ+ρ α1 x−ρ
1

1 − σ α2 x−ρ −ρ
2 + . . . + αn xn
= + .
σ+ρ α1 x−ρ
1

n and may take any positive value for x ∈ Rn . Under our assumptions we
The last fraction depends on x ∈ R+ +
obviously have

n 1−σ
Δ1 > 0 ∀x ∈ R+ ⇐⇒ ⇐⇒ 0 < σ < 1. (128)
σ+ρ
For the minors Δ1 , Δ2 , . . . , Δn we have the recurrences
 k−1
1 + ρ q(x) (1 + ρ)q(x) 1
Δk = Δk−1 − , k = 2, . . . , n. (129)
σ + ρ αk x−ρ
k
σ+ρ α1 x−ρ
1 · . . . · αk−1 x−ρ
k−1

To derive this formula, we represent the last column of the determinant Δk as the sum of two columns and
decompose this determinant into the sum of two easily computable determinants. The result is the recurrence (129),
which is applied to check the following formulas for the minors Δ1 , Δ2 , . . . , Δn :
⎧ n
⎪
⎪ 1 − αj x−ρ
⎪
⎪ σ j=2 j
⎪
⎪ Δ1 = + −ρ ,
⎪
⎪ ρ+σ α x
⎪
⎪
1 1
⎪
⎪
⎪
⎪ ⎛ ⎞
⎪
⎪  
⎪
⎪ 2 n
⎪
⎪ ρ+1 1 ⎝1 − σ ρ+1
⎪Δ2 =
⎪ q(x) −ρ −ρ αj x−ρ
j + αj x−ρ
j
⎠,
⎪
⎪ ρ + σ α x α x ρ + σ ρ + σ
⎪
⎪
1 1 2 2 j=1 j=3
⎪
⎪
⎪
⎨
⎛ ⎞
 2  3  n (130)
⎪ ρ+1 1
⎪
⎪
⎪ Δ3 = q(x) 3 ⎝1 − σ αj x−ρ +
ρ+1
αj x−ρ ⎠,
⎪
⎪ ρ + σ −ρ ρ + σ j
ρ + σ j
⎪
⎪ αj xj j=1 j=4
⎪
⎪ j=1
⎪
⎪
⎪
⎪
⎪
⎪ .........................................................................
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪  n−1
⎪
⎪ ρ+1 1 1−σ
⎪
⎪ Δn = q(x) n · q(x).
⎪ ρ+σ
⎩ αj x ρ + σ
j
−ρ
j=1

From the formulas (130) we see that, given condition (116), inequalities (127) hold for the principal corner

minors of the matrix G(x), which implies its positive definiteness.
P ROFIT M AXIMIZATION P ROBLEM FOR C OBB –D OUGLAS AND CES P RODUCTION F UNCTIONS 361

0.4
Φ
0.2

0
2
x2
2
0 x1
0

Fig. 8

Thus, we have verified the following conditions under our assumptions about the production function (108):
– condition (116);
– the system of inequalities (127);

– positive definiteness of the matrix G(x);
– positive definiteness of the matrix G(x);
– negative definiteness of the Hessian F  (x) of the production function F (x);
– strict concavity of the CES production function (108).
This completes the proof of Theorem 3.1. Q.E.D.

3.2. Profit. The profit function is described by the formula (see (23))

n

Φ(x) = F (x) − xj , (131)
j=1

where now F (x) is the CES production function (108)–(112), (115).

Figure 8 plots the surface defined by the equation z = Φ(x1 , x2 ) (n = 2, A = 2, α1 = 1/2, α2 = 1/3,
ρ = 1, σ = 3/4). It illustrates the extremum property of the profit function. Figure 9 shows the level lines of the
same function; the curve Φ(x1 , x2 ) = 0 bounds the convex region where profit is positive.

3.3. Approach I. Profit Maximization. Direct Derivation of the Formulas for Maximum Profit and Profit
Maximizer. Relationship between Optimal Cost and Optimal Output. Theorem 3.2. Consider the CES produc-
tion function

F (x) = A · [q(x)]−σ/ρ , (132)

n

q(x) = αj x−ρ
j . (133)
j=1
362 S. N. AVVAKUMOV, Y U. N. K ISELEV, M. V. O RLOV, AND A. M. TARAS ’ EV

2 x2
Φ(x1 , x2 ) = 0

x1
0 1 2

Fig. 9

Within the framework of the first approach, we solve the maximization problem for the profit (131):

Φ(x) → maxn . (134)

x∈R+

The concave unconstrained maximization problem (134) is solved by the same scheme as problem (24) for the
n . Its gradient is
Cobb–Douglas production function. The profit function (131) is strictly concave in R+

Φ (x) = F  (x) − η1 , (135)

where F  (x) is the gradient of the production function (132), η1 = (1, . . . , 1)∗ . The Hessians of the func-
tions (131) and (132) are equal:

Φ (x) = F  (x). (136)

By Theorem 3.1 the matrix (136) is negative definite. To solve problem (134) we have to solve the vector equation

Φ (x) = 0, (137)

which has the unique solution

n
x̄ ∈ R+ . (138)

The point (138) is the maximizer in extremum problem (134):

x̄ = maxn Φ(x). (139)

x∈R+
P ROFIT M AXIMIZATION P ROBLEM FOR C OBB –D OUGLAS AND CES P RODUCTION F UNCTIONS 363

The maximizer (139) and the maximum profit

Φmax ≡ maxn Φ(x) = Φ(x̄) (140)

x∈R+

admit a constructive description (see Theorem 3.2).

Theorem 3.2. Under the condition 0 < σ < 1 the maximizer (139) in problem (134) exists, is unique, and
is described by the formula
⎛ 1/(1+ρ) ⎞
α1
⎜ ... ⎟
⎜ ⎟
x̄ = m · ⎜ ⎟ (141)
⎝ 1/(1+ρ) ⎠
αn

with the components

1/(1+ρ)
x̄i = m · αi , i = 1, . . . , n. (142)

Here
 1/(1−σ)
Aσ
m= 1+σ/ρ
≡ (M(x̄))1/(1−σ) , (143)
α∗

n
 1/(1+ρ)
α∗ = αi . (144)
j=1

The maximum profit (140) is determined by the equality


−σ/ρ
Φmax = mσ · Aα∗ − m1−σ α∗ . (145)

The maximum profit (145) may be alternatively represented as

Φmax = (1 − σ) · β σ/(1−σ) , (146)

where the constant β is given by the equality

A1/σ σ
β= (1+ρ)/ρ
. (147)
α∗

!
n
The optimal cost Q̄ = x̄j and the optimal output Ȳ ≡ F (x̄) are representable in the form
j=1

Ȳ = β σ/(1−σ) , Q̄ = σ · β σ/(1−σ) . (148)

364 S. N. AVVAKUMOV, Y U. N. K ISELEV, M. V. O RLOV, AND A. M. TARAS ’ EV

They are related by the constraint

Q̄
= σ. (149)
Ȳ

Remark 3.1. The representation (146), (147) of Φmax for the CES production function is analogous to rep-
resentation (35) of Φmax for the Cobb–Douglas production function. The difference is only in the calculation
formulas for the parameter β, see (147) and (32).

Proof. The main equation for solving problem (134)

Φ (x) = 0 (150)

is rewritten in the form

F  (x) = η1 , (151)

or in coordinate form

Fx i (x) = 1, i = 1, . . . , n. (152)

The first order partial derivatives of the function F (x) have been found previously (see (118)):

Fx i (x) = M(x) · αi xρ−1

i ≡ m1−σ · αi x−ρ−1
i , i = 1, . . . , n. (153)

By (153) the system (152) takes the form

x1+ρ
i = M(x) · αi , i = 1, . . . , n. (154)

We write formula (154) for i = n :

x1+ρ
n = M(x) · αn , i = 1, . . . , n − 1. (155)

Dividing (154) and (155) term by term, we obtain

 1+ρ
xi αi
= , i = 1, . . . , n − 1. (156)
xn αn

From (156) we have

 1/(1+ρ)
αi
xi = · xn , i = 1, . . . , n − 1. (157)
αn

Formula (157) shows that the sought optimal values of the factors x1 , . . . , xn−1 are expressed by explicit formulas
in terms of the optimal value of the factor xn . Let us proceed to compute the last factor xn . Substituting (157)
P ROFIT M AXIMIZATION P ROBLEM FOR C OBB –D OUGLAS AND CES P RODUCTION F UNCTIONS 365

in (133) we proceed with some manipulations:

n−1
 1/(1+ρ) −ρ
 αj
q(x)|xi = (157),i=1,...,n−1 = αj xn + αn x−ρ
n
αn
j=1

  −ρ/(1+ρ)  −ρ/(1+ρ) 
α1 αn−1
= x−ρ
n α1 + · · · + αn−1 + αn
αn αn


1/(1+ρ) 1/(1+ρ)
= x−ρ
n · αρ/(1+ρ)
n · α1 + · · · + αn−1 + α1/(1+ρ)
n = x−ρ ρ/(1+ρ)
n · αn · α∗ ,
(158)

see notation (144) for the parameter α∗ . Thus, by (158) we have

ρ/(1+ρ)
αn
q(x)|xi = (157),i=1,...,n−1 = α∗ . (159)
xρn

Substituting (159) in (15) and using (119), we obtain

 (ρ+σ)/ρ
xρn
x1+ρ
n = Aσ · αn · ρ/(1+ρ)
,
αn · α∗

or

xρ+σ
n
x1+ρ
n = Aσ · αn · (σ+ρ)/(1+ρ) (ρ+σ)/ρ
,
αn α∗

or
(1−σ)/(1+ρ)
αn
x1−σ
n = Aσ · (ρ+σ)/ρ
,
α∗

or
 1/(1−σ)
Aσ
xn = (ρ+σ)/ρ
· α1/(1+ρ)
n .
α∗

Thus, see notation (143), we have obtained

xn = m · α1/(1+ρ)
n . (160)

The unknown factor xn has been expressed in terms of known parameters. Applying formulas (154), we find
the remaining unknown factors x1 , . . . , xn−1 :
 1/(1+ρ)
αi 1/(1+ρ)
xi = · xn = m · αi , i = 1, . . . , n − 1. (161)
αn
366 S. N. AVVAKUMOV, Y U. N. K ISELEV, M. V. O RLOV, AND A. M. TARAS ’ EV

By (161), (160) the components x̄i of the maximizer x̄ of problem (134) have been determined and are given by
the formulas
1/(1+ρ)
x̄i = m · αi , i = 1, . . . , n. (162)

We have proved assertions (141)–(144) of Theorem 3.2.

In conclusion, let us evaluate the maximum profit

n

Φmax ≡ maxn Φ(x) = Φ(x̄) = F (x̄) − x̄j , (163)
x∈R+
j=1

where

F (x̄) = Ȳ (164)

is the optimal output,

n

x̄j = Q̄ (165)
j=1

is the optimal cost.

To evaluate the optimal cost Q̄, substitute expressions (162) in (165), which gives

n
 1/(1+ρ)
Q̄ = m · αi = m · α∗ . (166)
i=1

To evaluate the optimal output Ȳ substitute expressions (162) in (164), which gives

Ȳ = F (x̄) = A [q(x̄)]−σ/ρ , (167)

n
 n
  n

1/(1+ρ) −ρ 1/(1+ρ)
q(x̄) = αi x̄−ρ
i = αi m · αi =m −ρ
· αi = m−ρ · α∗ , (168)
i=1 i=1 i=1

−σ/ρ
Ȳ = Amσ · α∗ . (169)

Finally, let us evaluate the maximum profit using formulas (163), (169), (166):

−σ/ρ
Φmax = Ȳ − Q̄ = Amσ · α∗ − m · α∗ . (170)

We have thus obtained formula (145) for Φmax .

From (169), (166) we obtain (149):

Q̄ mα∗ 1 (σ+ρ)/ρ 1
= −σ/ρ
= · m1−σ α∗ = · Aσ = σ.
Ȳ Amσ α∗ A A
P ROFIT M AXIMIZATION P ROBLEM FOR C OBB –D OUGLAS AND CES P RODUCTION F UNCTIONS 367

Let us now verify equivalence of the representations (170), (169), (166) and (146)–(148) for the parameters Φmax ,
Ȳ , Q̄. Applying (166), (143), we obtain after obvious manipulations:
 1/(1−σ)
Aσ
Q̄ = {(166)} = m · α∗ = {(143)} = 1+σ/ρ
· α∗
α∗

 σ/(1−σ)
A1/σ σ
=σ· (1+ρ)/ρ
= {(148)} = σ · β σ/(1−σ) .
α∗

We similarly obtain
 σ/(1−σ)
σ −σ/ρ Aσ −σ/ρ
Ȳ = F (x̄) = {(169)} = Am · α∗ =A 1+σ/ρ
· α∗
α∗

 σ/(1−σ)
A1/σ σ
= (1+ρ)/ρ
= {(148)} = β σ/(1−σ) .
α∗

We have proved formulas (148). They obviously imply relationship (149). This completes the proof of Theo-
rem 3.2. Q.E.D.

3.4. Approach II. Cost Minimization Subject to Given Output. Maximum Profit Function P (Y ) Depend-
ing on Output Y. Optimal Output Yopt . Maximum Profit. Theorems 3.3, 3.4. We consider the extremum
problem
n
Q≡ xi → min (171)
F (x)=Y
j=1

minimizing the cost subject to given output Y.

Here F (x) is a CES production function (108)–(112), (115). Applying the Lagrange multiplier method we
obtain the following result:

Theorem 3.3. Under conditions (108)–(112), (115) with a given parameter Y > 0, the minimum value
 min in problem (171) is attained for the minimizer
Q
⎛ ⎞
1/(1+ρ)
α1
⎜ ⎟
x ·⎜
=μ ⎝
... ⎟,
⎠ (172)
1/(1+ρ)
αn

where
 1/σ
1/(1+ρ) Y 1/ρ
 = (ρ · ν)
μ = · α∗ , (173)
A
n
 1/(1+ρ)
α∗ ≡ αj . (174)
j=1
368 S. N. AVVAKUMOV, Y U. N. K ISELEV, M. V. O RLOV, AND A. M. TARAS ’ EV

j of the minimizer x
The components x  are determined by the formulas

1/(1+ρ)
j = μ
x  · αj , j = 1, . . . , n. (175)

min is given by
The minimum value Q
 min = μ
Q  · α∗ . (176)

Remark 3.2. The minimizer (172) in problem (171) and the values (173) and (176) naturally depend on the
given output Y as the parameter:
⎛ ⎞
1/(1+ρ)
⎜α1 ⎟
⎜ ⎟
=x
x (Y ) ≡ μ
(Y ) · ⎜ ... ⎟, (177)
⎝ ⎠
1/(1+ρ)
αn

 1/σ
Y 1/ρ 1
(Y ) =
μ · α∗ ≡ · Y 1/σ , (178)
A β

 min = Q
min (Y ) = μ σ
Q (Y ) · α∗ ≡ Y 1/σ . (179)
β

The profit (maximum for the given output Y ) is determined by the equality

min (Y ) ≡ Y − σ Y 1/σ .
P(Y ) = Y − Q (180)
β

Proof. We solve the constrained extremum problem (171) by the Lagrange multiplier method. Rewrite the
constraint F (x) = Y in equivalent form as

n
  −ρ/σ
Y
αj x−ρ
j − = 0. (181)
A
j=1

Construct the Lagrange function for problem (171) subject to the constraint (181):
⎛ ⎞
n
 n
  −ρ/σ
= Y
Λ xj + ν ⎝ αj x−ρ
j −
⎠, (182)
A
j=1 j=1

j and ν of the factors xj and the multiplier ν

where ν is the scalar Lagrange multiplier. The optimal values x
respectively are obtained from the equations

 x ≡ 1 − ρναi x−ρ−1 = 0,
Λ i = 1, . . . , n, (183)
i i

and the constraint

  = 0 ⇐⇒ (181).
Λ (184)
ν
P ROFIT M AXIMIZATION P ROBLEM FOR C OBB –D OUGLAS AND CES P RODUCTION F UNCTIONS 369

From equations (183) we obtain

xρ+1
i = ρναi , i = 1, . . . , n, (185)

1/(1+ρ) 1/(1+ρ)
xi = (ρν)1/(1+ρ) · αi ≡μ
 · αi , i = 1, . . . , n. (186)

Substituting expressions (186) in the constraint (181), we obtain the equation

n
    −ρ/σ
1/(1+ρ) −ρ Y
αj μ · αj = , (187)
A
j=1

 = (ρν)1/(1+ρ) . Equation (187) is rewritten as

which can be solved to find the parameter μ

n
  −ρ/σ
−ρ −ρ/(1+ρ) Y

μ · αj · αj =
A
j=1

or
 ρ/σ
Y
ρ = α∗ ·
μ ,
A
whence
 1/σ 1/ρ
1/ρ Y α∗ 1
=
μ α∗ ≡ 1/σ
Y σ. (188)
A A
We have thus found the minimizer components (see (186), (188)):

1/(1+ρ)
j = μ
x  · αj , j = 1, . . . , n. (189)

min :
From (189) we obtain formula (176) for Q

n
 n

min = 1/(1+ρ)
Q j = μ
x · αj =μ
 · α∗ .
j=1 j=1

Q.E.D.

By Theorem 3.3 the maximum profit P (Y ) subject to the given output Y is determined by formula (180):

min (Y ) ≡ Y − σ Y 1/σ ,
P(Y ) = Y − Q (190)
β

where
A1/σ σ
β= (1+ρ)/ρ
. (191)
α∗
Recall that 1/σ > 1 by (115).
370 S. N. AVVAKUMOV, Y U. N. K ISELEV, M. V. O RLOV, AND A. M. TARAS ’ EV

Theorem 3.4 (on the properties of function (190)). Under condition (115), the function (190) has the follow-
ing properties (see Fig. 4):

(i) the function (190) is concave in the argument Y ≥ 0;

 σ/(1−σ)
+, + β
(ii) the function (190) is positive for 0 < Y < Y where Y = and the parameter β has
σ
the form (191),

P(Y )|Y =0 = P(Y )|Y =Y + = 0, P (Y ) < 0 for Y > Y + , P  (+0) = 1;

(iii) the function (190) attains its maximum

Pmax ≡ max P(Y ) = P(Yopt ) (192)

Y >0

at a unique point Yopt ∈ (0, Y + ), and its maximizer Yopt is determined by the formula

Yopt = β σ/(1−σ) (193)

as the root of the equation P (Y ) = 0. The maximum value (192) admits the following explicit expres-
sion:

Pmax = (1 − σ) · β σ/(1−σ) . (194)

Note that Φmax , see (146), and Pmax , see (194), are identical.
The proof of Theorem 3.4 is a verbatim repetition of the proof of Theorem 2.4.

n
3.5. Approach III. Maximization of the Output Y Subject to Given Cost Q = xj . Maximum
j=1
Profit Function P (Q) Depending on the Cost Q. Optimal Cost Q
 opt . Maximum Profit. Theorems 3.5, 3.6.
Consider the extremum problem

Y = F (x) → nmax (195)

j=1 xj =Q

maximizing the output Y subject to given cost Q. Here F (x) is the CES production function (108)–(112), (115).
The Lagrange multiplier method leads to the following result:

Theorem 3.5. Under conditions (108)–(112), (115) with a given parameter Q > 0, the maximum output
Ymax in problem (195) is attained for the maximizer

⎛ ⎞
1/(1+ρ)
Q ⎜ ⎜α1 ⎟
... ⎟
=
x ·⎜ ⎟, (196)
α∗ ⎝ ⎠
1/(1+ρ)
αn
P ROFIT M AXIMIZATION P ROBLEM FOR C OBB –D OUGLAS AND CES P RODUCTION F UNCTIONS 371

where
n
 1/(1+ρ)
α∗ ≡ αj . (197)
j=1

j of the maximizer x
The components x  are determined by the formulas

1/(1+ρ)
αj
j = Q ·
x , j = 1, . . . , n. (198)
α∗

The maximum output Ymax is given by

 σ
β
Ymax = Qσ , (199)
σ

where

A1/σ σ
β= 1+1/ρ
, (200)
α∗

n
 1/(1+ρ)
α∗ = αj . (201)
j=1

Remark 3.3. In problem (195) the maximizer (196) and the maximum (199) depend on the cost Q :

⎛ ⎞
1/(1+ρ)
Q ⎜ ⎜α1 ⎟
⎟
=x
x (Q) ≡ ·⎜ ... ⎟, (202)
α∗ ⎝ ⎠
1/(1+ρ)
αn

 σ
β
Ymax ≡ Ymax (Q) = Qσ . (203)
σ

The profit (maximum subject to the given cost Q ) is determined by the equality

 σ
β
P(Q) = Ymax (Q) − Q ≡ Qσ − Q. (204)
σ

Proof. The constrained extremum problem (195) is solved by the Lagrange multiplier method. Rewrite
problem (195) in the form
 −ρ/σ n

Y
≡ αj x−ρ
j → nextr . (205)
A j=1 xj =Q
j=1
372 S. N. AVVAKUMOV, Y U. N. K ISELEV, M. V. O RLOV, AND A. M. TARAS ’ EV

Write the Lagrange function for problem (205):

n
 n

 
=
Λ αj x−ρ +λ· xj − Q , (206)
j
j=1 j=1

where λ ≡ ρ/ν is the scalar Lagrange multiplier. The optimal values of the production factors and the Lagrange
multiplier are obtained from the equations

 x ≡ −ραi x−ρ−1 + ρ = 0,
Λ i = 1, . . . , n, (207)
i i
ν

and the constraint

n

  = 0 ⇐⇒
Λ xj = Q. (208)
λ
j=1

From equations (207) we find

x1+ρ
i = ναi ,

xi = (ναi )1/(1+ρ) = (ν)1/(1+ρ) · (αi )1/(1+ρ) , i = 1, . . . , n. (209)

Substituting expressions (209) in the constraint (208) we obtain the equation

n

1/(1+ρ) 1/(1+ρ)
ν · αj =Q (210)
j=1

for the parameter ν. From (210), using the notation (201), we find

 1+ρ
1/(1+ρ) Q Q
ν = , ν= . (211)
α∗ α∗

From (209) and (211) we obtain explicit formulas (198) for the maximizer components

Q 1/(1+ρ)
i =
x · αi , i = 1, . . . , n, (212)
α∗

or
1/(1+ρ)
α
i = n i
x 1/(1+ρ)
Q, i = 1, . . . , n. (213)
αj
j=1

These formulas describe the optimal allocation of the costs Q to all factors. We have derived formulas (198)
and (196).
P ROFIT M AXIMIZATION P ROBLEM FOR C OBB –D OUGLAS AND CES P RODUCTION F UNCTIONS 373

We can now find the maximum output Y :

Ymax = F ( x)]−σ/ρ ,
x) = A · [q( (214)
n
 n
  −ρ  ρ n
Q 1/(1+ρ) α∗ 1/(1+ρ) α1+ρ
∗
x) =
q( −ρ
αj x j = αj α = · αj = . (215)
α∗ j Q Qρ
j=1 j=1 j=1

Substituting (215) in (214) we obtain

 −σ/ρ  σ  σ
α1+ρ
∗ AQσ A1/σ β
Ymax = A · = = Q =σ
Qσ , (216)
Qρ α∗
σ(1+ρ)/ρ (1+ρ)/ρ
α∗ σ

see notation (197), (200). We have derived formula (199) for the maximum output. This completes the proof of
Theorem 3.5. Q.E.D.
By Theorem 3.5, the maximum profit P(Q) subject to given cost Q is determined by formula (204):
 σ
β
P(Q) = Qσ − Q. (217)
σ

Under our assumptions, σ ∈ (0, 1).

Theorem 3.6 (on the properties of function (217), see Fig. 5). Under conditions (108)–(112), (115) the func-
tion (217) has the following properties:
(i) the function (217) is concave in the argument Q ≥ 0; ;
 σ/(1−σ)
β
(ii) the function (217) is positive for 0 < Q < Q+, where Q+ = ,
σ

P (Q)|Q = 0 = P(Q)|Q=Q+ = 0, P (Q) < 0 for Q > Q+ , P  (+0) = +∞;

(iii) the function (217) attains its maximum

Pmax ≡ max P(Q) = P(Q

opt ) (218)
Q>0

 opt ∈ (0, Q+ ), and the maximizer Q

at a unique point Q opt of this function is determined by the formula

 opt ≡ argmax P(Q) = σ · β σ/(1−σ)

Q (219)
Q>0

as the root of the equation P (Q) = 0; the parameter β is given by (200). By (217), (219) the maxi-
mum (218) has the following expression:

Pmax = σ · β σ/(1−σ) . (220)

The proof of Theorem 3.6 is a verbatim repetition of the proof of Theorem 2.6.
374 S. N. AVVAKUMOV, Y U. N. K ISELEV, M. V. O RLOV, AND A. M. TARAS ’ EV

3.6. Equality of the Maximum Profit in the Three Approaches for the CES Production Function. Theo-
rem 3.7. Theorem 3.7 for the CES production function is an analogue of Theorem 2.7 for the Cobb–Douglas
production function.

Theorem 3.7. For the CES production function, the values of the maximum profit obtained in the three ap-
proaches

Φmax = maxn Φ(x),

x∈R+

 
Pmax = max max Φ(x) ,
Y >0 F (x)=Y

 
Pmax = max nmax Φ(x)
Q>0 j=1 xj =Q

are equal to one another, and in the present case

Φmax = (1 − σ) · β σ/(1−σ) ,

where
n

A1/σ σ 1/(1+ρ)
β= (1+ρ)/ρ
, α∗ = αj .
α∗ j=1

3.7. Dependence of the Maximum Profit Φmax on the Allocation vector α = (α1 , . . . , αn ) Subject to
Given Parameters σ, ρ. Theorem 3.8. Theses 3.1 and 3.2. For the maximum profit with a CES production
function we have obtained the expression
 σ/(1−σ)
A1/σ σ
Φmax (α) = (1 − σ) · (1+ρ)/ρ
, (221)
α∗ (α)
where
n
 1/(1+ρ)
α∗ (α) = αj , (222)
j=1

n

αj = 1, αj > 0, j = 1, . . . , n. (223)
j=1

Assume that the parameters A > 0, σ ∈ (0, 1), and ρ are given. It is relevant to estimate the range of the
maximum profit (221) depending on the vector α subject to (223). The kernel of the right-hand side of (221),
where the dependence on the parameter α is concentrated, has the form

1
h(α) ≡ (1+ρ)/ρ
. (224)
α∗ (α)

The range of possible values of the function (224) determines the range of Φmax (α) (subject to (223)). We have
the following theorem:
P ROFIT M AXIMIZATION P ROBLEM FOR C OBB –D OUGLAS AND CES P RODUCTION F UNCTIONS 375

0.5
1
0 α2
α1
1

Fig. 10

Theorem 3.8. Under conditions (223), we have the inequality

1
≤ h(α) < 1. (225)
n

Inequality (225) is unimprovable:

1
min h(α) = h(α)|α1 =...=αn =1/n = , (226)
α:(223) n

sup h(α) = 1. (227)

α:(223)

Analysis of assertions (225)–(227) for given parameters A > 0, σ ∈ (0, 1), ρ = 0, ρ > −1 leads to the
following qualitative conclusions (theses):

Thesis 3.1. Equating the allocation coefficients α1 , . . . , αn has a detrimental effect on profit (with equal
allocation coefficients α1 = . . . = αn = 1/n the maximum profit is minimal).

Thesis 3.2. Existence of one dominant coefficient αj is beneficial for maximum profit (as one of the alloca-
tion parameters approaches 1 and the other parameters go to zero, the maximum profit approaches its supremum).
The qualitative conclusions suggested by Theses 3.1 and 3.2 may be formalized if the constraints (223) are
augmented with additional constraints.
Figure 10 plots the convex surface defined by the equation (for n = 3, ρ = −1/2 )

z = h(α1 , α2 , α3 )|α3 =1−α1 −α2 .

This surface has a similar shape for other values of the parameter ρ ∈ (−1, 0), ρ > 0. This figure presents a
geometrical picture of the properties of the function (224) for the case of three factors. It is useful to compare
Fig. 10 representing the situation for CES production function with the corresponding Fig. 6 for Cobb–Douglas
functions.
376 S. N. AVVAKUMOV, Y U. N. K ISELEV, M. V. O RLOV, AND A. M. TARAS ’ EV

4. Investigating the Profit Maximization Problem: Interpretation in the Cost–Output (QY ) Plane.
QY -Characteristics. The Reachability Set D for Nonnegative Profit

When investigating the Cobb–Douglas function, we constructed in Subsec. 2.4 the maximum profit func-
tion (69) depending on the output Y,
σn 1/σn
P(Y ) = Y − Y , (228)
β

and in Subsec. 2.5 we constructed the maximum profit function (94) depending on the cost Q :

 σn
β
P(Q) = Q − Q. (229)
σn

Similar formulas have been constructed for the CES production function. The relationship among these formulas
is described by the following theorem:

Theorem 4.1. The functions (228) and (229) are related by the equalities

 
P (Y ) = P(Q), (230)
Y =(β/σn Q)σn



P(Q) = P (Y ). (231)
Q=σn /β Y 1/σn

Relationships (230), (231) are directly verified. Indeed, we have

    σn
 σn 1/σn  β
P(Y ) = Y − Y  = Q − Q = P(Q),
Y =(β/σn Q)σn β Y =(β/σn Q)σn σn

  σn 
 β  σn 1/σn
P(Q) = Q − Q  =Y − Y = P(Y ).
Q=σn /β Y 1/σn σn Q=σn /β Y 1/σn β

In the plane QY consider the curve defined by the equation

 σn
β σn 1/σn
Y = Q ≡ H(Q) ⇐⇒ Q = Y ≡ h(Y ) (232)
σn β

and located in the first quadrant of the QY -plane. The curve (232) is called the QY -characteristic, see Fig. 11.
Of special interest is the part OB of this curve, which lies above the bisector Q = Y of the first coordinate
angle: 0 < Q < Q+ , 0 < Y < Y+ . On the bisector OB = {Y = Q} the profit is zero. Above this bisector,
i.e., for Y ≥ Q, the profit is negative. For optimal values of output Ȳ and cost Q̄ we obtained the following
expressions in Theorem 2.2, see (37), (38):

Ȳ = β σn /(1−σn ) , Q̄ = σn β σn /(1−σn ) , (233)

P ROFIT M AXIMIZATION P ROBLEM FOR C OBB –D OUGLAS AND CES P RODUCTION F UNCTIONS 377

Y T
B
Y+

Ȳ M̄
0.5 Y=Q

0 Q̄ 0.5 Q+ Q

Fig. 11

where
1
Ȳ = Q̄, (234)
σn
see (36). The point M̄ (Q̄, Ȳ ) with the coordinates (233) lies on the QY -characteristic OB. At the same time,
by (234) the point M̄ (Q̄, Ȳ ) lies on the straight line

1
Y = Q, (235)
σn

1
with the slope > 1. The tangent M̄ T to the QY -characteristic at its point M̄ has unit slope,
σn

H  (Q)|Q=Q̄ = 1, h (Y )|Y =Ȳ = 1.

This corresponds to the fact that the profit

P =Y −Q

takes its maximum value for Y = Ȳ , Q = Q̄. On each straight line from the family

Y = Q + C,

where C > 0 is an arbitrary constant, the profit maintains a constant value

P = C, 0 < P ≤ Φ̄max ≡ (1 − σn ) · β σn /(1−σn ) .

The convex set bounded by the bisector OB from below and the piece O M̄ B of the characteristic from above
is the set of possible values of the pairs (Q, Y ) where the profit P = Y − Q is nonnegative. This set—the cres-
cent OM̄ BO —is naturally called the reachability set D in the QY -plane for the profit maximization problem
subject to profit nonnegativity, see Fig. 11.
378 S. N. AVVAKUMOV, Y U. N. K ISELEV, M. V. O RLOV, AND A. M. TARAS ’ EV

We have thus proved the following proposition:

Theorem 4.2. The optimal point M̄ (Q̄, Ȳ ) lies at the intersection of the QY -characteristic (the upper
bound of the reachability set D) and the straight line (235), such that the tangent to the characteristic at its
point M̄ is parallel to the bisector OB and

Ȳ = Yopt = β σn /(1−σn ) ,

Q̄ = Qopt = σn · β σn /(1−σn ) ,

where the parameters Yopt , Q

opt are described in Theorems 2.4 and 2.6 for the Cobb–Douglas production function
and in Theorems 3.4 and 3.5 for the CES production function.

Thus, assuming nonnegative profit P = Y − Q ≥ 0, the representing point (Q, Y ) remains inside the
set D. Each point of the curve O M̄ B —the upper bound of the reachability set D —has the extremum properties
identified in Theorems 2.4, 3.4 and 2.6, 3.6. Among all the points (Q, Y ) of the curve OM̄ B the absolute
greatest profit is attained at the point M̄ .
Note that this geometrical interpretation of the profit maximization problem in the QY -plane is visually at-
tractive, using as it does integral cost–output parameters that are important for applications, and is valid for any
number n of production factors. Furthermore, this interpretation is applicable for both the Cobb–Douglas produc-
tion function and the CES production function: for the latter we should take σ = σn and use formula (147) for
the parameter β, see Theorem 3.5, whereas for the Cobb–Douglas function this parameter has the form (80), see
Theorem 2.5. It seems that these features do not exhaust the range of options provided by the proposed interpreta-
tion of the profit maximization problem.
We are grateful to A. V. Kryazhimskii for valuable discussions and collaboration in issues related to innovation
activity of enterprises [5, 6]. The material of this article has been applied in the development of the “Planer”
analytical optimization model [7].
The study has been supported by the Ministry of Science grant 31.049.11.1007 and grants for the support of
leading scientific schools NSh-1846.2003.1, 791.2003.1, Russia’s Universities grant UR.03.03.008, and Russian
Foundation for Basic Research grant RFFI 02-01-00769.

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activity of enterprises: topical issues and model approaches” [in Russian], MIAN, Moscow (2003).

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