More applications of Production Functions Attribution of Surplus

(i) Value
Capital
Labour Raw
material Value added
Land
Entrepreneurship

Value Value of output Values of raw-

(consumer’s
-
added or = material inputs
surplus marginal valuation)

4
Sum of value added
∑ VAi by the 4 factors of
production
i=1
 V = Fα Iβ Hγ

F = Fertilizer
I = Irrigation
H = High yielding variety seeds

L+ β + γ= 1

ii. Wage / Bonus Negotiations

V = Kα Lβ
Total factor productivity (TFP)
Why TFP?
1. Inability to distinguish between price and productivity
components of profit.
2. Executives striving for price increase than productivity
increase
3. In case of losses, inability to know how much is due to price
subsidy and how much due to inefficiency
4. Total benefit= incomes to various factors=
rent + wages + interest + profit.
Profit criterion ignores the rest.
Eg: A Hongkong enterprise making profit by locating its plant in
china.
TFP index= index of net output
Index of Total Factor input

Example: α = .3 β= .7 Factor share

Labour Capital net output

1960 1000 men 100 Cr. 10 Cr.

1965 1250 125 Cr. 13Cr.
(25%) (25%)

Price increase 20% (2CR.)

Year Index of Index of Index of Index of Index of
Net out capital Labour Total TFP
put Factor
input
1960 100 100 100 100 100
1965 130 125 125 125 104
1 2 3 4 5 6

(3)*.7+(4)*.3 (2)/(5)

TFP has increased by 4% (100 to 104)

Profit has increased from 7 Cr. To (13 x.7+2) =11.1 Cr
% increase 11.1 x 100 =58%
7
Merits of TFP
1. Eliminates effects of price changes by taking inputs and outputs
at constant prices.
2. Relates only to that portion of the goods produced by firm itself
(excludes purchases)
3. Dynamic (i.e. measures changes in output)

Uses:
1. CEGB (U.K) (former Public utility in U.K) used TFP in presenting its
performance to the public.
2. Prof Bakul Dholakia of IIM-A has researched and found that
though Public Enterprises in India accumulated losses , they were
having positive Total Factor Productivity to their credit and this
was higher than that of Private sector enterprises
Chang-Tai Hsieh and Peter J Klenow “Misallocation and manufacturing TFP in
China and India” The Quarterly Journal of Economics , Vol. CXXIV, Nov
2009, Issue 4. Pp 1403-1448

This study finds that in spite of reforms in early 1990s, there is

evidence of rising misallocation of Capital (K) and Labour (L) in India from 1991
to 1994. This is in contrast to China where also there was misallocation,
compared to US, but this misallocation for China decreased over the years,
whereas for India it increased. US was the bench mark, and the authors found
that if India and China reached the US level, TFP gains would be around 30 to
50% for China and 40 to 60% for India. The misallocation of K and L is judged
by the dispersion, i.e. difference of Marginal Product of K and L , across
plants. This is in the context of largely privately owned plants in India (87.7% in
1998 to 92.4% in 2005) and in China the private ownership increasing from a
low of 16% in 1998 to 62.5% in 2005.