Production FunctionsShephard (1970) acknowledges the definition of a production function being the relationship between inputs and outputs of a firm to produce the given output. In economic theory, it is often a representation of the mathematical relationship between the inputs and outputs, to reach a certain amount of outputs through production.There are several production functions models within neoclassical economists, and one of the major ones was created by Cobb-Douglas (1947), who came up with a production function where the different inputs can have a degree of substitution, but only within the same amount, such , 5 % of labor for 5 % of capital.
Another known model is the CES production function, or Constant Elasticity of Substitution, developed by Arrow, Chenery, Minhas, and Solow (1961). The CES allows for a flexible substitution between labor and capital, hence, the function is changing constantly in outputs, because of the flexibility of inputs. The only requirement, is that the change is to remain the same on the isoquant.Using these models within growth theories, or in other words, to use them at the macroeconomic level, escalated the conflict within schools of economics. Humphrey (1997) explains that the development came through the case of Cobb-Douglas ( 1947) where neoclassical economists emphasised that the production function showed empirical evidence of being capable of transferring its theory from micro to macro level. Neoclassical Growth Theory Neoclassical growth theory is a theory that explains how a stable growth rate can be established with the use of labor , capital, and technology.
It implies that using a different amount of either capital or labor in the production, economic equilibrium can be reached. Furthermore, it sees technology as a an important factor in economic growth, and that the economy is dependent on technology to develop itself further. Production Function is an essential part of the growth theory, as it fundamentals is through explaining the accumulation of capital, and how citizens use this, is important for economic growth. The last ingredient of the variables is technology, and is seen as a factor that is able to increase the output through increasing the efficiency of the labor used. Solow Model In the long run, the Solow model implies that the most important factor for economic growth is technological advancement.
It implies that economic growth, cannot be achieved without technological development. According to the model, savings and a growth in the population can only change the real income per capita in countries. In a simplified conclusion, Solow and Swan (1956) provide research that the neoclassical production function can allow labor and capital to be substituted by each other, but both must be present at the same time.
David (2006) expands that through the Solow and Swan model developing countries should theoretically have a faster economic growth, and eventually reach the same level as developed countries in the long run . Another neoclassical argument is that developing countries will eventually catch up technology wise, and in that case, the only factor that will make the economic growth different by country, is the growth of the population. Endogenous growth theoryOther modern neoclassical economic approaches, include endogenous growth theory, which was heavily influenced by Paul Romer (1994), where the focus was shifted on enhancing productivity through education, research, and investing in human capital. Another similar approach, also part of the endogenous growth theory, is the Uzawa(1965)-Lucas (1988) model, which emphasises the importance of human capital, because their research supports the idea that human capital is the factor that can improve technology within a country the most. Profit maximization Marshal (1890) can be credited for developing the basic profit maximization theory.
The basic assumption is that the marginal cost, is set to be the same as the marginal revenue. From a mathematical point of view, it gives the maximum amount of profit, as long as one assumes that revenue subtracted by the total costs, is the profit. The theory is supposed to describe the average firm, and that these firms are affected by both supply and demand.
In conclusion, it also assumes that the main goal of any firm is maximum amount of profits obtainable. Keen (2005) He highlights through simulation that the amount of firms in an industry, and the amount of competition, and consumer purchasing power, which is all assumptions for the neoclassical profit maximizing models, is false. He agrees only that the models are realistic if one is looking at a firm operating in a monopoly, arguing that this is the only time where MC is equal to MR maximizes profit. In conclusion, his main argument is that in the “competetive market”, the real profit maximization is when MR is higher than the marginal cost.
Price and output of a firm in a perfect competetive market, will be the same as a monopoly, according to neoclassical microeceonomic theory.