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b) Perfect substitutes: , = + .
Note: The Cobb-Douglas production function captures both the perfect substitute and
complement cases. Cobb-Douglas middle section looks similar in shape to perfect
substitutes and the extreme sections look similar in shape to perfect complements.
Elasticity
4 :4
%2 5677 ;2 3
4 4
a) Elasticity (generic definition) = = 8 :8 =
%3 5677 ;3 2
8 8
Econ: Whats the % change () in A for each 1% change () in B. In other words, if I increase
B by 1%, by how many percentages does A change?
?@
A CD I EFJ = Econ: If I increase K by 1% by how many
=,I = ?J = = where I =
CI = 2FJ I percentages does f increase?
J
Elasticity (continued)
:(JMB)
(JMB) EFB
c) Elasticity of substitution = = :(|PQR|) Recall that = EFJ
|PQR|
Percentage response in the capital/labor ratio to a 1% increase in TRS (its absolute value)
is a measure if how easily the firm can substitute K for L
A larger implies that its easier to substitute one input for the other (isoquants are flatter)
A smaller implies that its more difficult to substitute one input for the other (isoquants are
more curved, closer to L-shape)
Returns to scale
a) f displays constrant returns to scale (CRS) if:
> 1, , = (, )
Note: The figure on the left shows the different shapes of the production function
depending on whether it displays decreasing, constant and increasing returns to scale. In
fact, we could have a production function like the one displayed on the right figure: at low
levels of input/output, it displays IRS, then very briefly CRS and finally it displays DRS at
high levels of input/output.
Short-run vs. Long-run
a) In the short-run, one input is fixed, and cannot be changed. Usually, we assume that K
\: (
is fixed at \, ). In that case, labor (L) is the only variable of choice.
Note: We dont use a specific period of time to define what the short-run and long-run are.
It will depend on the nature of the technology / firm.