Unemployment

By Arjun Raina 
Unemployment (or joblessness), as defined by the International Labour Organization, occurs when people are without jobs and they have actively sought work within the past four weeks. The unemployment rate is a measure of the prevalence of unemployment and it is calculated as a percentage by dividing the number of unemployed individuals by all individuals currently in the labor force. In a 2011 news story, BusinessWeek reported, "More than 200 million people globally are out of work, a record high, as almost two-thirds of advanced economies and half of developing countries are experiencing a slowdown in employment growth," the group said.

History

There are limited historical records on unemployment because it has not always been acknowledged or measured systematically. Industrialization involves economies of scale that often prevent individuals from having the capital to create their own jobs to be self-employed. An individual who cannot either join an enterprise or create a job is unemployed. As individual farmers, ranchers, spinners, doctors and merchants are organized into large enterprises; those who cannot join or compete become unemployed.

Recognition of unemployment occurred slowly as economies across the world industrialized and bureaucratized. The recognition of the concept of "unemployment" is best exemplified through the well documented historical records in England. For example, in 16th century England no distinction was made between vagrants and the jobless; both were simply categorized as "sturdy beggars", to be punished and moved on.

The closing of the monasteries in the 1530s increased poverty, as the church had helped the poor. In addition, there was a significant rise in enclosure during the Tudor period. Also the population was rising. Those unable to find work had a stark choice: starve or break the law. In 1535, a bill was drawn up calling for the creation of a system of public works to deal with the problem of unemployment, to be funded by a tax on income and capital. A law passed a year later allowed vagabonds to be whipped and hanged.

In 1547, a bill was passed that subjected vagrants to some of the more extreme provisions of the criminal law, namely two years servitude and branding with a "V" as the penalty for the first offense and death for the second. During the reign of Henry VIII, as many as 72,000 people are estimated to have been executed. In the 1576 Act each town was required to provide work for the unemployed.

The Elizabethan Poor Law of 1601, one of the world's first government-sponsored welfare programs, made a clear distinction between those who were unable to work and those able-bodied people who refused employment. Under the Poor Law systems of England and Wales, Scotland and Ireland a workhouse was a place where people who were unable to support themselves, could go to live and work.

Definitions, types and theories

Economists distinguish between various overlapping types of and theories of unemployment, including cyclical or Keynesian unemployment, frictional unemployment, structural unemployment and classical unemployment. Some additional types of unemployment that are occasionally mentioned are seasonal unemployment, hardcore unemployment, and hidden unemployment.

Though there have been several definitions of voluntary and involuntary unemployment in the economics literature, a simple distinction is often applied. Voluntary unemployment is attributed to the individual's decisions, whereas involuntary unemployment exists because of the socio-economic environment (including the market structure, government intervention, and the level of aggregate demand) in which individuals operate. In these terms, much or most of frictional unemployment is voluntary, since it reflects individual search behavior. Voluntary unemployment includes workers who reject low wage jobs whereas involuntary unemployment includes workers fired due to an economic crisis, industrial decline, company bankruptcy, or organizational restructuring.

Classical unemployment

Classical or real-wage unemployment occurs when real wages for a job are set above the market-clearing level, causing the number of job-seekers to exceed the number of vacancies.

Most economists have argued that unemployment increases the more the government intervenes into the economy to try to improve the conditions of those without jobs. For example, minimum wage laws raise the cost of laborers with few skills to above the market equilibrium, resulting in people who wish to work at the going rate but cannot as wage enforced is greater than their value as workers becoming unemployed. Laws restricting layoffs made businesses less likely to hire in the first place, as hiring becomes more risky, leaving many young people unemployed and unable to find work.

However, this argument is criticized for ignoring numerous external factors and overly simplifying the relationship between wage rates and unemployment — in other words, that other factors may also affect unemployment. Some, such as Murray Rothbard, suggest that even social taboos can prevent wages from falling to the market clearing level. It is noted that there can be unemployment when job market is in equilibrium. For example, the salary of appliance repairman in a city is $3,000. At this salary, the appliance stores of city want to hire 100 repairmen. But there are 300 repairmen looking for jobs within the city. So there are 200 repairmen looking for jobs are unemployed. At this time, job market is not in equilibrium. But six months later, the salary of appliance repairman in this city drop to $1,000. At this salary, the appliance stores of city want to hire 200 repairmen. There are 200 repairman want to accept jobs. For the rest 100 repairmen, they no longer want to work for this kind of job because the salary is too low. By this time, job market reaches equilibrium. But there are still 100 repairmen unemployed because they no longer want to work for this kind of job.

In Out of Work: Unemployment and Government in the Twentieth-Century America, economists Richard Vedder and Lowell Gallaway argue that the empirical record of wages rates, productivity, and unemployment in American validates the classical unemployment theory. Their data shows a strong correlation between the adjusted real wage and unemployment in the United States from 1900 to 1990. However, they maintain that their data does not take into account exogenous events.

Cyclical unemployment

Cyclical or Keynesian unemployment, also known as deficient-demand unemployment, occurs when there is not enough aggregate demand in the economy to provide jobs for everyone who wants to work. Demand for most goods and services falls, less production is needed and consequently fewer workers are needed, wages are sticky and do not fall to meet the equilibrium level, and mass unemployment results. Its name is derived from the frequent shifts in the business cycle although unemployment can also be persistent as occurred during the Great Depression of the 1930s. With cyclical unemployment, the number of unemployed workers exceeds the number of job vacancies, so that even if full employments were attained and all open jobs were filled, some workers would still remain unemployed. Some associate cyclical unemployment with frictional unemployment because the factors that cause the friction are partially caused by cyclical variables. For example, a surprise decrease in the money supply may shock rational economic factors and suddenly inhibit aggregate demand.

Classical economists reject the conception of cyclical unemployment and alternatively suggest that the invisible hand of free markets will respond quickly to unemployment and underutilization of resources by a fall in wages followed by a rise in employment. Similarly, Hayek and others from the Austrian school of economics argue that if governments intervene through monetary policy to lower interest rates this will exacerbate unemployment by preventing the market from responding effectively.

Keynesian economists on the other hand see the lack of demand for jobs as potentially resolvable by government intervention. One suggested interventions involves deficit spending to boost employment and demand. Another intervention involves an expansionary monetary policy that increases the demand of money which should reduce interest rates which should lead to an increase in non-governmental spending. ^{The IS-LM Model is used to analyse the effect of demand shocks on the economy.}

Involuntary unemployment

In The General Theory, Keynes argued that neo-classical economic theory did not apply during recessions because of excessive savings and weak private investment in an economy. In consequence, people could be thrown out of work involuntarily and not be able to find acceptable new employment.

This conflict between the neoclassical and Keynesian theories has had strong influence on government policy. The tendency for government is to curtail and eliminate unemployment through increases in benefits and government jobs, and to encourage the job-seeker to both consider new careers and relocation to another city.

Involuntary unemployment does not exist in agrarian societies nor is it formally recognized to exist in underdeveloped but urban societies, such as the mega-cities of Africa and of India/Pakistan. In such societies, a suddenly unemployed person must meet their survival needs either by getting a new job at any price, becoming an entrepreneur, or joining the underground economy of the hustler.

Structural unemployment

"Driver looking for work" Unemployed German laborer in 1949

Structural unemployment occurs when a labour market is unable to provide jobs for everyone who wants one because there is a mismatch between the skills of the unemployed workers and the skills needed for the available jobs. Structural unemployment is hard to separate empirically from frictional unemployment, except to say that it lasts longer. As with frictional unemployment, simple demand-side stimulus will not work to easily abolish this type of unemployment.

Structural unemployment may also be encouraged to rise by persistent cyclical unemployment: if an economy suffers from long-lasting low aggregate demand, it means that many of the unemployed become disheartened, while their skills (including job-searching skills) become "rusty" and obsolete. Problems with debt may lead to homelessness and a fall into the vicious circle of poverty. This means that they may not fit the job vacancies that are created when the economy recovers. Some economists see this scenario as occurring under British Prime Minister Margaret Thatcher during the 1970s and 1980s. The implication is that sustained high demand may lower structural unemployment. This theory of persistence in structural unemployment has been referred to as an example of path dependence or "hysteresis"._{Okun's Law interprets unemployment as a function of growth in GDP}

Frictional unemployment

Frictional unemployment is the time period between jobs when a worker is searching for, or transitioning from one job to another. It is sometimes called search unemployment and can be voluntary based on the circumstances of the unemployed individual. Frictional unemployment is always present in an economy, so the level of involuntary unemployment is properly the unemployment rate minus the rate of frictional unemployment, which means that increases or decreases in unemployment are normally under-represented in the simple statistics.

Frictional unemployment exists because both jobs and workers are heterogeneous, and a mismatch can result between the characteristics of supply and demand. Such a mismatch can be related to skills, payment, work-time, location, seasonal industries, attitude, taste, and a multitude of other factors. New entrants (such as graduating students) and re-entrants (such as former homemakers) can also suffer a spell of frictional unemployment. Workers as well as employers accept a certain level of imperfection, risk or compromise, but usually not right away; they will invest some time and effort to find a better match. This is in fact beneficial to the economy since it results in a better allocation of resources. However, if the search takes too long and mismatches are too frequent, the economy suffers, since some work will not get done. Therefore, governments will seek ways to reduce unnecessary frictional unemployment through multiple means including providing education, advice, training, and assistance such as daycare centers.

The frictions in the labour market are sometimes illustrated graphically with a Beveridge curve, a downward-sloping, convex curve that shows a correlation between the unemployment rate on one axis and the vacancy rate on the other. Changes in the supply of or demand for labour cause movements along this curve. An increase (decrease) in labour market frictions will shift the curve outwards (inwards).

Hidden unemployment

Hidden, or covered, unemployment is the unemployment of potential workers that is not reflected in official unemployment statistics, due to the way the statistics are collected. In many countries only those who have no work but are actively looking for work (and/or qualifying for social security benefits) are counted as unemployed. Those who have given up looking for work (and sometimes those who are on Government "retraining" programs) are not officially counted among the unemployed, even though they are not employed. The same applies to those who have taken early retirement to avoid being laid off, but would prefer to be working. The statistic also does not count the "underemployed" — those working fewer hours than they would prefer or in a job that doesn't make good use of their capabilities. In addition, those who are of working age but are currently in full-time education are usually not considered unemployed in government statistics. Official statistics often underestimate unemployment rates because of hidden unemployment.

Long-term unemployment

This is normally defined, for instance in European Union statistics, as unemployment lasting for longer than one year. It is an important indicator of social exclusion. The United States Bureau of Labor Statistics (BLS) reports this as 27 weeks or longer.

Effects

Costs

Individual

Unemployed individuals are unable to earn money to meet financial obligations. Failure to pay mortgage payments or to pay rent may lead to homelessness through foreclosure or eviction. Across the United States the growing ranks of people made homeless in the foreclosure crisis are generating tent cities. Unemployment increases susceptibility to malnutrition, illness, mental stress, and loss of self-esteem, leading to depression. According to a study published in Social Indicator Research, even those who tend to be optimistic find it difficult to look on the bright side of things when unemployed. Using interviews and data from German participants aged 16 to 94 – including individuals coping with the stresses of real life and not just a volunteering student population – the researchers determined that even optimists struggled with being unemployed.

Dr. M. Brenner conducted a study in 1979 on the "Influence of the Social Environment on Psychology." Brenner found that for every 10% increase in the number of unemployed there is an increase of 1.2% in total mortality, a 1.7% increase in cardiovascular disease, 1.3% more cirrhosis cases, 1.7% more suicides, 4.0% more arrests, and 0.8% more assaults reported to the police. A more recent study by Christopher Ruhm on the effect of recessions on health found that several measures of health actually improve during recessions. As for the impact of an economic downturn on crime, during the Great Depression the crime rate did not decrease. The unemployed in the U.S. often use welfare programs such as Food Stamps or accumulating debt because unemployment insurance in the U.S. generally does not replace a majority of the income one received on the job (and one cannot receive such aid indefinitely). _{Unemployed men outside a soup kitchen in Chicago, 1931}

Social

An economy with high unemployment is not using all of the resources, specifically labour, available to it. Since it is operating below its production possibility frontier, it could have higher output if all the workforce were usefully employed. However, there is a trade-off between economic efficiency and unemployment: if the frictionally unemployed accepted the first job they were offered, they would be likely to be operating at below their skill level, reducing the economy's efficiency.

During a long period of unemployment, workers can lose their skills, causing a loss of human capital. Being unemployed can also reduce the life expectancy of workers by about 7 years.

High unemployment can encourage xenophobia and protectionism as workers fear that foreigners are stealing their jobs. Efforts to preserve existing jobs of domestic and native workers include legal barriers against "outsiders" who want jobs, obstacles to immigration, and/or tariffs and similar trade barriers against foreign competitors.

High unemployment can also cause social problems such as crime; if people have less disposable income than before, it is very likely that crime levels within the economy will increase.

 _{Demonstration against unemployment in Kerala, India}

Socio-political

High levels of unemployment can be causes of civil unrest, in some cases leading to revolution, and particularly totalitarianism. The fall of the Weimar Republic in 1933 and Adolf Hitler's rise to power, which culminated in World War II and the deaths of tens of millions and the destruction of much of the physical capital of Europe, is attributed to the poor economic conditions in Germany at the time, notably a high unemployment rate of above 20%; see Great Depression in Central Europe for details.

Note that the hyperinflation in the Weimar Republic is not directly blamed for the Nazi rise – the Inflation in the Weimar Republic occurred primarily in the period 1921–23, which was contemporary with Hitler's Beer Hall Putsch of 1923, and is blamed for damaging the credibility of democratic institutions, but the Nazis did not assume government until 1933, ten years after the hyperinflation but in the midst of high unemployment.

Rising unemployment has traditionally been regarded by the public and media in any country as a key guarantor of electoral defeat for any government which oversees it. This was very much the consensus in the United Kingdom until 1983, when Margaret Thatcher's Conservative government won a landslide in the general election, despite overseeing a rise in unemployment from 1,500,000 to 3,200,000 since its election four years earlier.

 _{Unemployment rate in Germany in 2003 by states.}

Benefits

The primary benefit of unemployment is that people are available for hire, without being headhunted away from their existing employers. This permits new and old businesses to take on staff.

Unemployment is argued[citation needed] to be "beneficial" to the people who are not unemployed in the sense that it averts inflation, which itself has damaging effects, by providing (in Marxian terms) a reserve army of labour, that keeps wages in check. However the direct connection between full local employment and local inflation has been disputed by some due to the recent increase in international trade that supplies low-priced goods even while local employment rates rise to full employment.

Full employment cannot be achieved because workers would shirk if they were not threatened with the possibility of unemployment. The curve for the no-shirking condition (labelled NSC) goes to infinity at full employment as a result. The inflation-fighting benefit to the entire economy arising from a presumed optimum level of unemployment has been studied extensively. The Shapiro-Stiglitz model suggests that wages are not bid down sufficiently to ever reach 0% unemployment. This occurs because employers know that when wages decrease, workers will shirk and expend less effort. Employers avoid shirking by preventing wages from decreasing so low that workers give up and become unproductive. These higher wages perpetuate unemployment while the threat of unemployment reduces shirking.

_{In the Shapiro-Stiglitz model of efficiency wages, workers are paid at a level that dissuades shirking. This prevents wages from dropping to market clearing levels.}

Decline in work hours

As a result of productivity the work week declined considerably over the 19th century. By the 1920s in the U.S. the average work week was 49 hours, but the work week was reduced to 40 hours (after which overtime premium was applied) as part of the National Industrial Recovery Act of 1933. At the time of the Great Depression of the 1930s it was understood that with the enormous productivity gains due to electrification, mass production and agricultural mechanization, there was no need for a large number of previously employed workers.

Controlling or reducing unemployment

Societies try a number of different measures to get as many people as possible into work, and various societies have experienced close to full employment for extended periods, particularly during the Post-World War II economic expansion. The United Kingdom in the 1950s and 60s averaged 1.6% unemployment, while in Australia the 1945 White Paper on Full Employment in Australia established a government policy of full employment, which policy lasted until the 1970s when the government ran out of money.

However, mainstream economic discussions of full employment since the 1970s suggest that attempts to reduce the level of unemployment below the natural rate of unemployment will fail, resulting only in less output and more inflation.

Demand side solutions

Many countries aid the unemployed through social welfare programs. These unemployment benefits include unemployment insurance, unemployment compensation, welfare and subsidies to aid in retraining. The main goal of these programs is to alleviate short-term hardships and, more importantly, to allow workers more time to search for a job.

A direct demand-side solution to unemployment is government-funded employment of the able-bodied poor. This was notably implemented in Britain from the 17th century until 1948 in the institution of the workhouse, which provided jobs for the unemployed with harsh conditions and poor wages to dissuade their use. A modern alternative is a job guarantee, where the government guarantees work at a living wage. Temporary measures can include public works programs such as the Works Progress Administration. Government-funded employment is not widely advocated as a solution to unemployment, except in times of crisis; this is attributed to the public sector jobs' existence depending directly on the tax receipts from private sector employment.

In the U.S. the unemployment insurance allowance one receives is based solely on previous income (not time worked, family size, etc.) and usually compensates for one-third of one's previous income. To qualify, one must reside in their respective state for at least a year and, of course, work. The system was established by the Social Security Act of 1935. Although 90% of citizens are covered by unemployment insurance, less than 40% apply for and receive benefits. However, the number applying for and receiving benefits increases during recessions. In cases of highly seasonal industries the system provides income to workers during the off seasons, thus encouraging them to stay attached to the industry.

According to classical economic theory, markets reach equilibrium where supply equals demand; everyone who wants to sell at the market price can. Those who do not want to sell at this price do not; in the labour market this is classical unemployment. Increases in the demand for labour will move the economy along the demand curve, increasing wages and employment. The demand for labour in an economy is derived from the demand for goods and services. As such, if the demand for goods and services in the economy increases, the demand for labour will increase, increasing employment and wages.

Monetary policy and fiscal policy can both be used to increase short-term growth in the economy, increasing the demand for labour and decreasing unemployment.

_{Government unemployment office with job listings, Berlin, Germany.}

Supply-side solutions

However, the labour market is not 100% efficient: It does not clear, though it may be more efficient than bureaucracy. Some argue that minimum wages and union activity keep wages from falling, which means too many people want to sell their labour at the going price but cannot. This assumes perfect competition exists in the labour market, specifically that no single entity is large enough to affect wage levels. Advocates of supply-side policies believe those policies can solve this by making the labour market more flexible. These include removing the minimum wage and reducing the power of unions. Supply-siders argue the reforms increase long-term growth. This increased supply of goods and services requires more workers, increasing employment. It is argued that supply-side policies, which include cutting taxes on businesses and reducing regulation, create jobs and reduce unemployment. Other supply-side policies include education to make workers more attractive to employers.

PRODUCTION FUNCTION

 by Anurag Gupta CSE

           History:

Production function has been used as an important tool of economic analysis in the neoclassical tradition. It is generally believed that Philip Wick steed (1894) was the first economist to algebraically formulate the relationship between output and inputs as

P=  f (x1, x2, x3..... xm) .

Although there are some evidences suggesting that Johann vonThünen first formulated it in the 1840’s (Humphrey, 1997).

It is relevant to note that among others there are two leading concepts of efficiency relating to a production system: the one often called the ‘technical efficiency’ and the other called the ‘allocate efficiency’ (see Libenstein et al., 1988). The formulation of production function assumes that the engineering and managerial problems of technical efficiency have already been addressed and solved, so that analysis can focus on the problems of allocate efficiency. That is why a production function is(correctly) defined as a relationship between the maximal technically feasible output and the inputs needed to produce that output (Shephard, 1970). However, in many theoretical and most empirical studies it is loosely defined as a technical relationship between output and inputs, and the assumption that such output is maximal (and inputs minimal) is often tacit. Further, although the relationship of output with inputs is fundamentally physical, production function often uses their monetary values. The production process uses several types of inputs that cannot be aggregated in physical units. It also produces several types of output (joint production) measured in different physical units. There is an extreme view that (in a sense) all production processes produce multiple outputs(Faber, et al., 1998). One of the ways to deal with the multiple output case is to aggregate different products by assigning price weights to them. In so doing, one abstracts away from essential and inherent aspects of physical production processes, including error, entropy or waste. Moreover, production functions do not ordinarily model the business processes, whereby ignoring the role of management, of sunk cost investments and the relation of fixed overhead to variable costs (wikipedia-a).It has been noted that although the notion of production function generally assumes that technical efficiency has been achieved, this is not true in reality. Some economists and operations research workers (Farrel, 1957; Charnes et al., 1978; Bankeret al., 1984; Lovell and Schmidt, 1988; Seiford and Thrall, 1990; Emrouznejad, 2001,etc) addressed this problem by what is known as the ‘Data Envelopment Analysis’ orDEA. The advantages of DEA are: first that here one need not specify a mathematical form for the production function explicitly; it is capable of handling multiple inputs and outputs and being used with any input/output measurement; and efficiency at technical/managerial level is not presumed. It has been found useful for investigating into the hidden relationships and causes of inefficiency. Technically, it uses linear programming as a method of analysis. We do not intend to pursue this approach here.

 

2Starting in the early 1950’s until the late 1970’s production function attracted many economists. During the said period a number of specifications or algebraic forms relating inputs to output were proposed, thoroughly analyzed and used for deriving various conclusions. Especially after the end of the ‘capital controversy’, search for new specification of production functions slowed down considerably. Our objective in this paper is to briefly describe that line of development. In the schema of Ragnar Frisch(1965), we will first concentrate on "single-ware" or single-output production function. Then we would move to "multi-ware" or multi-output production function. Finally, we would address the pros and cons of the aggregate production function.

Introduction

Production Function: A production function is essentially the mathematical representation between a firm's input and output. Specifically, it describes how much capital and labor is necessary to produce a certain level of goods and services. Where labor may be defined as a firm's employees, capital is all other production factors like buildings, machinery, tools and infrastructure. Capital, as opposed to its definition in finance, is not money. Instead, money is buys both capital and labor when producing a good.

Production function, can also be defined, as a function that specifies the output of a firm, an industry, or an entire economy for all combinations of  inputs. This function is an assumed technological relationship, based on the current state of engineering knowledge; it does not represent the result of economic choices, but rather is an externally given entity that influences economic decision-making. Almost all economic theories presuppose a production function, either on the firm level or the aggregate level. In this sense, the production function is one of the key concepts of mainstream neoclassical theories. Some non-mainstream economists, however, reject the very concept of an aggregate production function.

Also, A meta-production function (sometimes meta-production function) compares the practice of the existing entities converting inputs into output to determine the most efficient practice production function of the existing entities, whether the most efficient feasible practice production or the most efficient actual practice production. In either case, the maximum output of a technologically-determined production process is a mathematical function of one or more inputs. Put another way, given the set of all technically feasible combinations of output and inputs, only the combinations encompassing a maximum output for a specified set of inputs would constitute the production function. Alternatively, a production function can be defined as the specification of the minimum input requirements needed to produce designated quantities of output, given available technology. It is usually presumed that unique production functions can be constructed for every production technology.

Returns to Scale: Production functions help to study the effect of increasing inputs on outputs. This effect is known as returns to scale. If the amount of inputs increases results in an even greater amount of outputs, the firm exhibits increasing returns to scale. If an increase in inputs results in a proportional increase in outputs, it exhibits constant returns to scale. Similarly, if increasing inputs leads to a disproportionately smaller increase in outputs, the firms exhibit decreasing returns to scale.

The production function (and indeed all representations of technology) is a purely technical relationship that is void of economic content.  Since economists are usually interested in studying economic phenomena, the technical aspects of production are interesting to economists only insofar as they impinge upon the behavior of economic agents.

Because the economist has no inherent interest in the production function, if it is possible to portray and to predict economic behavior accurately without direct examination of the production function, so much the better.  This principle, which sets the tone for much of the following discussion, underlies the intense interest that recent developments in duality have aroused.

Types of Production Function:

1. Fixed proportion production function.

2. Variable proportion production function.

Fixed proportion production function:

A fixed-proportion production function arises when there is a specific technique when producing a good. Given a specific technique, both capital and labor must be increased in fixed proportions. Thus, if a good always requires one unit of labor and two units of capital for production, two units of the good require two units of labor and four units of capital. In this context, if you have two units of labor and two units of capital, only one unit of output would be produced.

These two types are based on the technical coefficient of production. The technical co-efficient is the amount of input required to produce a unit of output. For example, if 50 workers are required to produce 200 units of output, then 0.25 is the technical co-efficient of labor for production. When 0.25 units of labor are required to produce every unit of output, it is called fixed proportion production function. Here, doubling of quantities of capital and labor in a required ratio will double the output. Fixed proportion production function can be illustrated with the help of isoquants. In this type of production function, the two factors of production, say labor and capital, should be used in a fixed proportion. The isoquants of such function are right angled as shown in the following diagram.

                                      

Variable proportion production function:

A Variable Input or factor of production is defined as one the quantity of which may be changed in the short run as the level output change.

When the technical co-efficient to produce different units of output is varying or changing, it is called as the variable proportions production function. In such a type of production function, given amount of output can be produced with several alternative combinations of labor and capital. Many commodities in real world are produced with variable proportion production function. For example, certain amount of wheat may be produced using more labor and less capital in India and more capital and less labor in USA. Variable proportion production function is illustrated in the following diagram.

The short run analysis of production function is done with one input variable (L) and the other input constant (K). The variation in the output resulting from different amounts labour applied to a fixed amount of capital is explained with the help of Law of Diminishing Returns or Law of Variable Proportions.

The long run analysis of production function is done with both the inputs (L,K) variable. The variation in the output resulting from different amounts of labor and capital employed is explained with the help of Law of Returns to Scale.

 

Criticisms of production functions:

There are two major criticisms of the standard form of the production function.

On the concept of capital, During the 1950s, '60s, and '70s there was a lively debate about the theoretical soundness of production functions. Although the criticism was directed primarily at aggregate production functions, microeconomic production functions were also put under scrutiny. The debate began in 1953 when Joan Robinson criticized the way the factor input capital was measured and how the notion of factor proportions had distracted economists. According to the argument, it is impossible to conceive of capital in such a way that its quantity is independent of the rates of interest and wages. The problem is that this independence is a precondition of constructing an isoquant. Further, the slope of the isoquant helps determine relative factor prices, but the curve cannot be constructed (and its slope measured) unless the prices are known beforehand.

On the empirical relevance, As a result of the criticism on their weak theoretical grounds, it has been claimed that empirical results firmly support the use of neoclassical well behaved aggregate production functions. Nevertheless, Anwar Shaikh has demonstrated that they also have no empirical relevance, as long as alleged good fit outcomes from an accounting identity, not from any underlying laws of production/distribution.

Natural resources: Often natural resources are omitted from production functions. When Solow and Stiglitz sought to make the production function more realistic by adding in natural resources, they did it in a manner that economist Georgescu-Roegen criticized as a "conjuring trick" that failed to address the laws of thermodynamics, since their variant allows capital and labor to be infinitely substituted for natural resources. Neither Solow nor Stiglitz addressed his criticism, despite an invitation to do so in the September 1997 issue of the journal Ecological Economics.

 

Cobb–Douglas production function :

In economics, the Cobb–Douglas functional form of production functions is widely used to represent the relationship of output and two inputs. Similar functions were originally used by Knut Wicksell (1851–1926), while the Cobb-Douglas form was developed and tested against statistical evidence by Charles Cobb and Paul Douglas during 1900–1947.

Formulation:

 

In its most standard form for production of a single good with two factors, the function is

                                                          Y=AL^ α K^ β

Where,

    Y = total production (the monetary value of all goods produced in a year)

    L = labor input

    K = capital input

    A = total factor productivity

    α and β are the output elasticity's of labor and capital, respectively. These values are constants determined by available technology.

Output elasticity measures the responsiveness of output to a change in levels of either labor or capital used in production, ceteris paribus. For example if α = 0.15, a 1% increase in labor would lead to approximately a 0.15% increase in output.

Further, if:

             α + β = 1, the production function has constant returns to scale: Doubling capital K and labor L will also double output Y. If

             α + β < 1, returns to scale are decreasing, and if

             α + β > 1, returns to scale are increasing. Assuming perfect competition and α + β = 1,  α and β can be shown to be labor and capital's share of output.

Cobb and Douglas were influenced by statistical evidence that appeared to show that labor and capital shares of total output were constant over time in developed countries; they explained this by statistical fitting least-squares regression of their production function. There is now doubt over whether constancy over time exists.

 

 Distinguish  between a short-run and a long-run production .

 Production involves transformation of inputs into outputs. The output is a function of input. The functional relationship between physical inputs and physical output of a firm is called production function. The word 'function' in mathematics means the precise relationship that exists between one dependent variable and a number (or one) of independent variables.

The production function states the maximum quantity of output that can be produced from any given quantities of various inputs during a given period of time. In brief, the production function is a catalogue of different output possibilities. Alternatively, it states the minimum quantity of inputs necessary to produce a given quantity of output. Algebraically, a production function can be stated as :

                                     Q = f (a, b, c............ n)

The above production function tells as the quantity of the output 'Q' which is produced by the given quantities of inputs of a, b, c....... n. Thus production function expresses the technological relationship between the quantity of output and the quantities of the various inputs used for the production. If the state of technology changes, the production function also changes. If a carpenter produces wooden tables in a day, its production function consists of maximum number of tables that can be produced from a given quantities of various inputs such as wood, varnish, labour time, machine time and floor space. It is flow of inputs resulting in a How of output during a specified period of time.

I. It is a technical relation:

The engineer sees that the various combinations of inputs are applied and the output resulting from them by using a particular process of production. There are many processes of production and for each process there is a relationship between various combinations of inputs and resulting output.

2- It has economic importance:

Production function has got an economic importance for the entrepreneurs. It helps the entrepreneurs to minimize the output form a given combination of inputs.

3. Production functions differ from firm to firm:

Each firm has its own production function. This production function is determined by the state of technology. If the state of technology changes the old production function is disturbed.

·       Assumptions of production function:

1. It is associated with specified period of time.
2. The state of technology is constant during the period of time.
3. The producer is expected to use the best and the most efficient technique.
4. The factors of production are divisible.

Production function is stated with reference to a particular period of time. In economics we are concerned with two types of production function :

Ø The production function when the quantities of some inputs are constant and the quantity of one input is varied. This type of input-output relationship forms the subject-matter of the law of variable proportion. Secondly the productions function with all factors variable. This type of input-output relationship forms the subject-matter of the law of returns to scale.

Ø AND  In case of short-run production function (variable proportion) some factors held constant and other factors are combined with varied proportion. The ratio of variable factor to that of the fixed factor goes on increasing on the quantity of the variable factor is increased. When all factors are increased in the same proportion the increase in output so obtained represents returns to scale. In the long run all factors are varied.

Conclusion

Ø In conclusion, it should be emphasized that in this study an attempt was

made to explain the short-run fluctuations in the number of workers employed and the number of hours paid-for per worker and to explain how the number of workers employed, the number of hours paid-for per worker, and the number of hours worked per worker are related to each other in the short run, but that no attempt was made to develop a model which was capable of predicfing these variables.

Ø In order to use the model of the short-run demand for workers developed in this study for prediction purposes, for example, it would be necessary to know the expected future changes in output in advance, and at least for those industries in which expectations appear to be quite accurate (and not based merely on past output behavior)this would require knowledge of the industry which an economic forecaster (as opposed to an individual manager in the industry) does not have at his disposal. Also, in this study an effort was made to use as disaggregate and homogeneous a body of data as possible to lessen the problems of aggregating vastly dissimilar firms, but to forecast aggregate employment from the three-digit industry level would be a tremendous task, even if all of the necessary data were available. For forecasting aggregate employment more aggregated data would have to be used.

Ø Nevertheless, if the model developed in this study can be taken to be a

valid representation of the structure of the employment sector of the              economy with respect to short-run fluctuations in the number of workers    employed and the number of hours paid-for per worker, then the information contained in this model should be of considerable use to someone attempting to develop an aggregate forecasting model of the employment sector of the economy. It was seen in $ 8.4, for example, that the model developed in this study provides an explanation of the relationship between seasonally adjusted output and seasonally adjusted output per paid-for man hour which has been observed by Hultgren and others during economy-wide contractions and expansions.