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CobbDouglasProduction Lagrangian Spreadsheet
CobbDouglasProduction Lagrangian Spreadsheet
© 1999 P. LeBel
Production functions are central to the determination of the efficient allocation of resources. At the
individual firm level, production functions enable a decision-maker to determine the optimal combination
of inputs that should be used to produce a given level of output at the lowest cost. When taken together
with a firm's profit-maximizing output decision, production functions enable firm's to achieve both technical
(or least cost) and allocative (optimal output) efficiency. In turn, technical and allocative efficiency are
essential conditions for competitive markets to achieve an economically efficient allocation of resources.
Of the many types of production functions, one of the most widespread functions has been the Cobb-Douglas
production function, after Charles W. Cobb and Paul H. Douglas, "A Theory of Production", American
Economic Review, XVIIII (Supplement, 1938), pp. 139-156. While the Cobb-Douglas production
function is limited to a unitary elasticity of substitution, it does provide for direct estimates of the optimal
expenditure proportions on production inputs, given a budget constraint and relative input prices.
Table 1
Year GDP Labor Capital
1958 16,607.70 275.50 17,803.70
1959 17,511.30 274.40 18,096.80
1960 20,171.20 269.70 18,271.80
1961 20,932.90 267.00 19,167.30
1962 20,406.00 267.80 19,647.60
1963 20,831.60 275.00 20,803.50
1964 24,806.30 283.00 22,076.60
1965 26,465.80 300.70 23,445.20
1966 27,403.00 307.50 24,939.00
1967 28,628.70 303.70 26,713.70
1968 29,904.50 304.70 29,957.80
1969 27,508.20 298.60 31,585.90
1970 29,035.50 295.50 33,474.50
1971 29,281.50 299.00 34,821.80
1972 31,535.80 288.10 41,794.30
Table 2
Ln GDP Ln Labor Ln Capital
1958 9.7176 5.6186 9.7872
1959 9.7706 5.6146 9.8035
1960 9.9120 5.5973 9.8131
1961 9.9491 5.5872 9.8610
1962 9.9236 5.5902 9.8857
1963 9.9442 5.6168 9.9429
1964 10.1189 5.6454 10.0023
1965 10.1836 5.7061 10.0624
1966 10.2184 5.7285 10.1242
1967 10.2622 5.7160 10.1929
1968 10.3058 5.7193 10.3075
1969 10.2222 5.6991 10.3605
1970 10.2763 5.6887 10.4185
1971 10.2847 5.7004 10.4580
1972 10.3589 5.6633 10.6405
C. Then, using ordinary least squares regression, estimate the coefficients of X2 and X3, with Q as
the dependent variable. Output statistics will include the following:
Table 3
SUMMARY OUTPUT
Page 1
Ln GDP
Regression Statistics
Multiple R 0.9429
R Square 0.8890
Adjusted R Square 0.8705
Standard Error 0.0748
Observations 15
ANOVA
df SS MS F Significance F
Regression 2 0.5380 0.2690 48.0688 0.0000
Residual 12 0.0672 0.0056
Total 14 0.6052
CoefficientsStandard Error t Stat P-value Lower 95%Upper 95%Lower 95.0%
Upper 95.0%
Intercept -3.3385 2.4495 -1.3629 0.1979 -8.6755 1.9986 -8.6755 1.9986
Ln Labor 1.4988 0.5398 2.7765 0.0168 0.3226 2.6749 0.3226 2.6749
Ln Capital 0.4899 0.1020 4.8005 0.0004 0.2675 0.7122 0.2675 0.7122
Ln A Ln X2 Ln X3
Ln Q = -3.3385 1.4988 0.4899
2.7765 4.8005 (t)
R^2 = 0.8890
R^2 (adj.) = 0.8705 = 1 - (1-R^2)*(N-1)/(N-k)
df = 14
F = 48.069
E. Taking the antilogarithm of the intercept and placing the regession coefficients as exponents
in the original function yields the estimated form of the Cobb-Douglas production function:
1.4988 0.4899
Q= 0.035 X2 X3
F. Testing for the presence or absence of economies of scale involves simple addition
of the input exponents (or output elasticities) to see if they are less than, equal to, or greater than one:
1.4988 0.4899
Example: Q= 0.035 X2 X3
100 100 336.80
and by doubling inputs: 200 200 1336.64 = 296.86%
G. Deriving the optimal input combination requires information on the output elasticities, the state
of technology (or the A parameter) the price of each input, and the level of income, all of which
are reformulated as a Lagrangian constrained optimization problem.
Page 2
Given: Income $200.00 $200.00 Q X2 X3
Pr X2 $10.00 $10.00 12.13 4.00 16.00 Base
Pr X3 $10.00 $10.00 12.13 4.00 16.00 Simulation
Relative Change: 0.0% 0.00% 0.00%
Before we derive the optimal input combination, we can first portray the production surface as:
Table 4
X
1 2 3 4 5 6 7 8
1 1.52 2.64 3.65 4.59 5.49 6.36 7.19 8.00
2 1.48 2.57 3.55 4.47 5.35 6.19 7.00 7.79
3 1.43 2.49 3.45 4.34 5.19 6.00 6.79 7.55
Y 4 1.38 2.40 3.32 4.18 5.00 5.79 6.54 7.28
5 1.32 2.30 3.18 4.00 4.78 5.53 6.26 6.96
6 1.25 2.17 3.00 3.78 4.51 5.22 5.91 6.58
7 1.15 2.00 2.77 3.48 4.16 4.82 5.45 6.06
8 1.00 1.74 2.41 3.03 3.62 4.19 4.74 5.28
Figure 1
8.00
6.00
4.00
2.00
0.00
8 7 6 5 4 3 2 1
0.2000 0.8000
1 Max L = 1.000 (X
2 X3 ) + l (10.00 X
2 + 10.00 X
3
-200.00)
2 Solving for optimal values of each input, X2 and X3, requires taking the first
partial derivative of the Lagrangian function for each variable and setting it equal to zero:
-0.8000 0.8000
2.a dL/dX2 = 0.2000 X X3 + l 10.00 =0
2
Page 3
0.2000 -0.2000
2.b dL/dX3 = 0.8000 X X3 + l 10.00 =0
2
-0.8000 0.8000
3.a -l = 0.02 (X2 X3 )
0.2000 -0.2000
3.b -l = 0.0800 (X2 X3 )
5 Next, take the expressions in equation four and multiply each by a simplifying constant to
eliminate one unknown:
Thus:
5.a 0.02 X3 = 0.0800 X2 and:
5.b X3 = 4.00 X2
Substituting this optimal input ratio into the budget constraint yields:
6.a and the optimal quantity of X2 = 4.00 which when substituted into the budget constraint yields:
7 From the optimal input quantities we derive the optimal level of input expenditures as:
Page 4
8 We can also compare these expenditures in relation to the proportional values of the output elasticities:
dQ/dX2 = = X X3 =
9.a 0.6063 (0.20)x 2 (0.20)x (4.00)x (16.00)
dQ/dX3 = X X3 =
9.b 0.6063 = (0.80)x 2 (0.80)x (4.00)x (16.00)
10 Then we compute the ratio of each marginal product, or partial derivative, to its corresponding input price:
X2 10
X3 10 Q.E.D.
Figure 2
Page 5
0
0.00 1.00 2.00 3.00 4.00 5.00 6.00 7.00 8.00 9.00 10.0 11.0 12.0 13.0 14.0 15.0 16.0 17.0 18.0 19.0 20.0
5
0
0.00 1.00 2.00 3.00 4.00 5.00 6.00 7.00 8.00 9.00 10.0 11.0 12.0 13.0 14.0 15.0 16.0 17.0 18.0 19.0 20.0
0 0 0 0 0 0 0 0 0 0 0
Base Budget Base Q Sim Q
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