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= + +
c
= =
c
c
= =
c
c
= =
c
1 1 2 2
1 2
2 1 1
2
L
x w x w
x x
L
w x w
x
c
c
= =
c
c
( )
1
*
2 1
2 2 2 1 2
1 2
0 , ,
w w L
y x x x w w y y
w w
o
o
o |
| o |
+
+
| | | |
c
= =
| |
c
\ . \ .
( )
1
*
2
1 1 2
1
, ,
w
x w w y y
w
|
o |
o |
+
+
| |
=
|
\ .
( )
1 1
2 1
1 2 1 2
1 2
1
2 1
1
2
, ,
w w
C w w y w y w y
w w
w w
y
w
w
|
o
o | o |
o | o |
|
o
o | o |
o |
o |
o |
o |
+ +
+ +
+ +
+
+
+
(
(
| | | |
(
(
= +
| |
(
(
\ . \ .
(
(
(
= +
(
(
Thus, in the end, we are left with a cost function
that relates input prices and output levels to the
cost of production based on the economic
assumption of optimizing behavior.
Following Chambers critique, recent trends in
economics skip the first stage of this analysis by
assuming that producers know the general shape
of the production function and select inputs
optimally. Thus, economists only need to
estimate the economic behavior in the cost
function.
Following this approach, economists only
need to know things about the production
function that affect the feasibility and
nature of this optimizing behavior.
In addition, production economics is
typically linked to Sheppards Lemma that
guarantees that we can recover the
optimal input demand curves from this
optimizing behavior.
Production Function Defined
Following our previous discussion, we
then define a production function as a
mathematical mapping function:
:
n m
f R R
+ +
=
( c
=
c
1
x
2
x
1
x
2
x
The elasticity of scale takes on three
important values:
If the elasticity of scale is equal to 1, then the
production surface can be characterized by
constant returns to scale. Doubling all inputs
doubles the output.
If the elasticity of scale is greater than 1, then
the production surface can be characterized by
increasing returns to scale. Doubling all inputs
more than doubles the output.
Finally, if the elasticity of scale is less than 1,
then the production surface can be
characterized by decreasing returns to scale.
Doubling all inputs does not double the output.
Note the equivalence of this concept to the
definition of homogeneity of degree k:
( ) ( )
k
f x f x =
For computational purposes
( )
( )
1 1
1
ln
ln
n n
i
i
i i
i
f x
f x
x y
= =
=
( c
c
= =
c c