ECN 2311: TOPIC 4
Homogenous Functions
Applications to Production Theory
Returns-to-Scale
Marginal product describe the change in
output level as a single input level
changes. (e.g Short-run change in
Labour)
Returns-to-scale describes how the
output level changes as all input levels
change, e.g. all input levels doubled.
(Long-run)
Returns-to-Scale
If, for any input bundle (x1,…,xn),
f (tx1 , tx2 ,, txn ) t. f ( x1 , x2 ,, xn )
then the technology described by the
production function f exhibits constant
returns-to-scale, e.g. doubling all input
levels doubles the output level (t=2).
Returns-to-Scale
If, for any input bundle (x1,…,xn),
f (tx1 , tx2 ,, txn ) tf ( x1 , x2 ,, xn )
then the technology exhibits decreasing
returns-to-scale, e.g. doubling all input levels
less than doubles the output level (t=2).
Returns-to-Scale
If, for any input bundle (x1,…,xn),
f (tx1 , tx2 ,, txn ) tf ( x1 , x2 ,, xn )
then the technology exhibits increasing
returns-to-scale, e.g. doubling all input levels
more than doubles the output level (t=2).
Homogenous Production Function
Definition: A production function is homogeneous
of degree if
F(tK, tL) = t F(K,L) for all t.
i.e multiplying all input levels by the
same factor t, output increases by the
factor t
If = 1 CRS
If > 1 IRS
If < 1 DRS
Homogenous Production Function
Note: Not all production functions are
homogeneous.
Exercise: Check whether the following functions
are homogenous and of what degree.
(i) f ( K , L) L2 K
(ii) f ( L, K ) L1 / 4 K1 / 2
(iii ) f ( L, K ) L1 / 2 K1 / 2
(vi) f ( L, K ) 1 L K
Euler’s Theorem
For any multivariate function y f(x1,x2 , ,xn )
which is homogeneou s of degree k , we can write
kf ( x1,x2 , ,xn ) x1 f1 xn f n
, where f i
is the partial derivative of the function w ith respect to
its ith variable
• That is, the sum of the products of each independent
variable and its partial derivative must be equal to k
times the value of the function
Euler’s Theorem: Special case, k=1
f ( x1,x2 ,,xn ) x1 f1 xn f n
In this case, Euler’s theorem implies that the total
product will just be exhausted if the factors of
production receive the value of their product.
Example: Assume a two variable linearly
homogenous production function
Q f ( K , L)
Euler’s Theorem: Special case, k=1
QK K QL L Q,
PQK K PQL L PQ,
Euler’s Theorem: Special case, k=1
TP PQK K PQL L PQ,
Properties of Cobb-Douglas Production Function
Y=AKL
Euler’s theorem:
MPK K MPL L ( )Y
Where is the degree of homogeneity
(show)
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