7.

9 The Cobb- Douglas Production Function:

The Cobb-Doulas production function, in its stochastic form, may be expressed as
 𝑌 = 𝛽 𝑋𝛽2𝑋𝛽3𝑒𝜇𝑖……………………(1)
𝑖 1 2𝑖 3𝑖

Where ,

Y= output

X2= labor input

X3= Capital input

µ=Stochastic disturbance term

e= base of natural logarithm

From (1) it is clear that the relationship between output and the two inputs is nonlinear.
However, if we log- transform this model, we obtain:

𝑙𝑛𝑌𝑖 = 𝑙𝑛𝛽1 + 𝛽2𝑙𝑛𝑋2𝑖 + 𝛽3𝑙𝑛𝑋3𝑖 + 𝜇𝑖

= 𝛽0 + 𝛽2𝑙𝑛𝑋2𝑖 + 𝛽3𝑙𝑛𝑋3𝑖 + 𝜇𝑖

Where 𝛽0 = 𝑙𝑛𝛽1

Properties:
1. β2 is the (partial) elasticity of output with respect to the labor input, that is, it measures the percentage
change in output for , say, a 1% change in the labor input holding the capita input constant.

2. β3 is the (partial) elasticity of output with respect to the capita input, that is, it measuresthe percentage
change in output for , say, a 1% change in the capita input holding the labor input constant.

3. The sum (β2+ β3) gives information about the returns to scale, that is , the response of output to a
proportionate change in the inputs. If this sum is 1, then there is constant return to scale, that is doubling
the inputs will double the output and so on. If sum is less than 1, there are decreasing return to scale-
doubling the inputs will less than double the output. Finally, if the sum is greater than 1, there are
increasing return to scale- doubling the inputs will more than double the output.