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Function And Old Neoclassical Equilibrium

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Question:

Discuss About The Function And Old Neoclassical Equilibrium?

 

Answer:

Introduction

This study analyses the assumptions of neo classical production function critically. Neo-classical production function is the function of two inputs such as labour and capital. A Neo classical production function has several assumptions to simply the analysis. Cobb-Douglas production function is mostly used neo classical production function in economic analysis. Several authors have criticized some of the assumptions.

Assumptions of neo classical production function

The assumptions of neo classical production function are as follows:

  1. i) The production function is differentiable with positive marginal productivity of the factors o production.
  2. ii) The factors exhibit the law of diminishing returns.

iii) The factors of production are substitutable among themselves in a perfectly competitive market. Factors are perfectly mobile.

  1. iv) Absence of externality in production

Philosophical critics

According to the claim of the heterodox economics, the nature of neo classical production function, the substitution effect has not much effect in real economy (Fuss and McFadden 2014). However, in the view of Chen (2012), Cobb-Douglas production function has many real life applications. Moreover, the production only considers the effect of change in capital and labour. It cannot explain the residual element of the production function such as technology in Solow growth model.

Schefold (2014) stated that neo classical production function estimates elasticity of output with respect to labour and capital according to the. However, this method of measuring output elasticity is not the correct one. Practically this estimation shows the share of profit in production and share of wage in income.

Another assumption of the neo-classical theorists is that both the product and factor market are perfectly competitive, which is unrealistic. There exist other types of market structure such as monopolistic competition, monopoly and oligopoly. Therefore, production function varies across different sectors of the economy (Davis 2013).

The neo classical production function assumes perfect mobility among the factors, which is not always possible in reality. Some of the industries are capital intensive, whereas some of are labour intensive. Hence, the mobility of factors is constrained by their productivity and requirement in the industry (Felipe and McCombie 2014).

As depicted by Dosi et al. (2014), mathematical model of Cobb-Douglas model has similarity with the equation of national accounting identity derivative. However, Schefold (2014) mentioned that Cobb-Douglas production function correctly establish relationship with the national accounts, if the wage share is constant and technological progress is considered in production function.

Fuss and McFadden (2014) cited that technological progress in the neo classical production function has been assumed linear. Dosi et al. (2014) contradicted this view to state that technological progress fluctuates overtime.

Every production process has some externalities irrespective of primary, secondary or tertiary sectors of the economy. The externality may be positive or negative. Therefore, the assumption of no externality is unrealistic.

 

Conclusion

The analysis of production function is an important concept in mainstream Neo classical economics. Main inputs in this production function are labour and capital. Technology is used in this model as a residual factor in the production. This factor facilitates the production process. Despite having numerous uses, many economists have criticised this production function due to some of its unrealistic assumptions. The report has critically analysed the limitations of these assumptions

 

References

Chen, B.Y., 2012. Classification of $ h $-homogeneous production functions with constant elasticity of substitution. Tamkang Journal of Mathematics,43(2), pp.321-328.

Davis, J.B., 2013. The theory of the individual in economics: Identity and value. Routledge.

Dosi, G., Grazzi, M., Marengo, L. and Settepanella, S., 2014. Production theory: accounting for firm heterogeneity and technical change.

Felipe, J. and McCombie, J.S.L., 2014. The aggregate production function:‘Not even wrong’. Review of Political Economy, 26(1), pp.60-84.

Fuss, M. and McFadden, D. eds., 2014. Production Economics: A Dual Approach to Theory and Applications: Applications of the Theory of Production (Vol. 2). Elsevier.

Klump, R., McAdam, P. and Willman, A., 2012. The normalized CES production function: theory and empirics. Journal of Economic Surveys,26(5), pp.769-799.

Pahlavan, R., Omid, M. and Akram, A., 2012. Energy input–output analysis and application of artificial neural networks for predicting greenhouse basil production. Energy, 37(1), pp.171-176.

Raurich, X., Sala, H. and Sorolla, V., 2012. Factor shares, the price markup, and the elasticity of substitution between capital and labor. Journal of Macroeconomics, 34(1), pp.181-198.

Schefold, B., 2014. Marx, the Production Function and the Old Neoclassical Equilibrium: Workable under the Same Assumptions?. In Contribution to the Conference What have we learnt on Classical Economy since Sraffa (pp. 16-17).

Zhelobodko, E., Kokovin, S., Parenti, M. and Thisse, J.F., 2012. Monopolistic competition: Beyond the constant elasticity of substitution.Econometrica, 80(6), pp.2765-2784.

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