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Chap IV - Cobb Douglas PF

The Cobb-Douglas production function relates output of a company to inputs using an equation where output (Y) equals a constant (A) multiplied by labor input (L) raised to the power of its output elasticity (α) and capital input (K) raised to the power of its output elasticity (β). It was developed by Cobb and Douglas to model the American manufacturing industry. The function exhibits constant, decreasing, or increasing returns to scale based on whether the sum of α and β is equal to, less than, or greater than 1, respectively. It is widely used due its simplicity but has limitations such as only including two inputs.

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56 views8 pages

Chap IV - Cobb Douglas PF

The Cobb-Douglas production function relates output of a company to inputs using an equation where output (Y) equals a constant (A) multiplied by labor input (L) raised to the power of its output elasticity (α) and capital input (K) raised to the power of its output elasticity (β). It was developed by Cobb and Douglas to model the American manufacturing industry. The function exhibits constant, decreasing, or increasing returns to scale based on whether the sum of α and β is equal to, less than, or greater than 1, respectively. It is widely used due its simplicity but has limitations such as only including two inputs.

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727822TPMB005 ARAVINTHAN.S
Copyright
© © All Rights Reserved
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The Cobb-Douglas Production

Function

Chapter IV
• The simplest and the most widely used production
function in Economics is the Cobb-Douglas production
function.
• The reasons for its popularity are, it possesses some
interesting properties and its computational ease in the
empirical estimation.
• C.W Cobb and P.H. Douglas (1928) used this function
for estimating the relationship between inputs and
outputs in the American manufacturing industry
during 1899 to 1922.
Cobb- Douglas production function
• The Cobb- Douglas production function represents the
relationship of an output to inputs as follows
Y = A Lα Kβ,
Where:
• Y = total production (the monetary value of all goods produced in
a year)
• L = labor input
• K = capital input
• A, α and β are the output elasticity's of labor and capital,
respectively. These values are constants determined by available
technology.
Cobb- Douglas production function
Further, if: α + β = 1
• The production function has “constant returns to scale”. That is, if L
and K are each increased by 20%,
Y increases by 20%.
If: α + β < 1
• The production function has “decreasing returns to scale”. That is if
L and K are each increase by 20%, Y increases by 10% only.
If: α + β > 1
• The production function has “Increasing returns to scale”. That is if L
and K are each increase by 20%, Y increases by 40% .
Criticism of Cobb-Douglas Production Function

• It includes only two factor inputs-capital and labour


• Labour input may be measured in number or man hours.
But it is difficult to measure capital input due to its
depreciation over a period of time.
• It assumes constant returns to scale which may not be
always possible
• This function assumes that there is perfect competition in
the market.
Managerial Uses of Production Function

• Least-Cost Combination
• In a dynamic set-up, the prices of inputs are often
changing.
• As a result, the feasible combinations of inputs will have
to be worked out regularly in order to ensure the least-cost
combination.
• This is possible by substituting high const inputs by
relatively cheaper inputs so that the cost of production
might be reduced considerably.
Managerial Uses of Production Function

• Decision-Making
• Production function is a useful managerial tool to arrive at a
decision regarding the employment of a variable input factor
in the production process.
• So long as the marginal revenue productivity of a variable
factor exceeds its price, it may be worthwhile to employ it.
• Moreover it is also useful in the long run. If returns to
scale are increasing, it will be worthwhile to increase
production; the opposite is the case if there are diminishing
returns to scale.

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