15.14 THE VARIABLE ELASTICITY SUBSTITUTUON (V.E.S.
) PRODUCT
FUNCTION
The C.E.S. production had, indeed, made improvement upon the C-D
production function While the latter had assumed that Es or σ was 1 the
former held that the Es or σ could vary between 0 and ∞. However, the
magnitude of Es was thought as constant for all the combinations of
capital and labour. In addition, in both C-D production function and the
C.E.S. production function, the variable capital-labour ratio (K/L), which is
highly significant, had been overlooked. Sato and Hoffman dropped the
assumption of constancy of elasticity of substitution and attemped to
develop a production function with variable elasticity of substitution
(V.E.S.). This production function involved the capital-labour ratio in a
direct, strategic and more realistic manner. In addition, contributions in
the development of V.E.S. production function were made by writers like
Fletcher, Lu, Ferguson, Hilderbrand, Zellner, Revanker, Kadiyala and
Lovell.
The V.E.S. production function derived by Lu and Fletcher was based upon
the assumption that the Es was linearly dependent upon the ratio of factor
inputs. In Sato's version of the production function, the Es or a was treated
as the linear function of time. Zellner and Revanker gave a generalised
V.E.S. production function with variable returns to scale. Another
generalised approach to the V.E.S. production function was given by
Kadiyala in which the C-D production function and C.E.S. production
functions are treated as the special cases of this production function.
Some Prominent Forms of the V.E.S. Production Function
Some prominent forms of this production function developed by different
theorists are mentioned below:
1. Ferguson's Approach: Ferguson developed his version of the V.E.S.
production function in 1965. He developed it from the side of C-D
Production Function. It was stated as below:
K
β( )
Q= A Lα K 1−α e L
In this model, A is the efficiency parameter and Q is output.
In the logarithmic terms, the above production function can be stated as:
log Q=log A +αLog L+(1−α )log K + β (K /L)
The elasticity of substitution (σ) in this production function is given by
β (K / L)
σ =1−
[α + β( )
K 2
L
] −α
Here β> 0 and σ varies monotonically along an isoquant having the slope
K/L.
If β= 0, the Es or σ becomes equal to unity and the V.E.S. production
function conforms to the C-D production function.
2. Lu and Fletcher Approach: Lu and Fletcher gave the V.E.S. production
function in 1968 of the following form:
( )( )e
β1 β2
Q w K λt
=A
L L L
where Q Index of output, L= Index of labour, K Index of capital, t= Time
variable and w= Real wage
In the above equation, A, β 1 , β 2 and λ are the parameters to be estimated.
The elasticity of substitution corresponding to the above form of the
production function is
β1
σ=
(
1−β 2 1+
wL
rK )
The ratio (wL/rK) in the above relation gives the relative factor shares of
labour and capital, This ratio changes when K/L and change
disproportionately. In such a situation, the Es or σ will become variable. f
β 2=0 , then σ will become equal to β 1.
Another form of the V.E.S. production function was given by Lu and
Fletcher in 1969. It is expressed as
[ ( ) ]
− μ(1+ p ) −p
−p K
Q=γ λK +(1−λ) η L .v
L
Here y, λ, n, μ and p are the parameters and v is the random term.
This form of the V.E.S. production function conforms to the C.E.S.
production function if η=1.
This production function was stated in terms of the average product of
labour by Lu and Fletcher and was stated as below:
( )e
β2
Q β K U
=A W 1
L L
Here U is a random term.
It can be expressed in logarithmic terms as below
log ( QL )=logA + β logW + β log ( KL )+U
1 2
The random term U is equal to
3. Hilderbrand and Lu Approach: These writers have suggested the
following form of the V.E.S. production function
1
m mn (1−m) n
Q= A [(1−δ )K + δ K L ]
A significant property of this form of the production function is that the
average product of labour becomes a log-linear function of wage rate (w)
and the capital-labour ratio.
4. Revanker's Approach: Revanker gave another form of the V.E.S.
production function in 1971. He assumed that σ varies with the capital-
labour ratio around the intercept term of unity. His production function
model is given as :
¿¿
q=γ K ¿
Q
where γ > 0, ∝> 0, q= (the average product of labour)
L
L
0<δ <, 0 ≤δρ ≤ 1 and > (1- δ )/(1- ρ δ )
K
The elasticity of substitution (σ) can be derived as the linear function of
(K/L.). It can be expressed as:
σ =1+ β ( KL )
If β=0, then σ=1 and the V.E.S. production function can take the form of
the Cobb-Douglas production function.
5. Kadiyala's Approach:
production function was suggested by Kadiyala in 1972. The form of this
production function is
2ρ ρ1 ρ2 2 ρ v/ 2 ρ
Q= A [α 1 L +2 α 2 L + α3 K ]
In this form of the production function, if it is supposed that α 2 = 0, this
production function will assume the form of the C.E.S. production function.
6. Lovell's Approach: Lovell gave a VES production function in 1973. The
form of his production function is as follows:
1
Q=γ [ (1+ β) KL−p −M δ +α L1− β M δ ]
1+ β+ δ
Here γ , α , β , δ are the arbitrary parameters. β and δ are more than unity.
The elasticity of substitution (a) for this form of the production function
can be derived as
σ =1+ ( αβ K1/ L )
In this case, σ will vary monotonically with (K/L) along an isoquant, when
α≠ 0. If α = 0, then σ= I and the V.E.S. production will get reduced to the
form of the C-D production function. If α > 0, the elasticity of substitution
will exceed unity (o>1) and it will decrease with an increase in the capital-
labour ratio (K/L.).
The various empirical studies attempted in the case of the manufacturing
industries in the United States, Japan and India have supported the
fundamental contention of this production function that the elasticity of
substitution undergoes variation and it does not remain constant.
