Comments on A suggestion for complicating the simple aggregate production function (bleg)TypePad2012-12-30T16:33:44ZStephen Gordonhttp://worthwhile.typepad.com/worthwhile_canadian_initi/tag:typepad.com,2003:http://worthwhile.typepad.com/worthwhile_canadian_initi/2013/01/a-suggestion-for-complicating-the-simple-aggregate-production-function/comments/atom.xml/2slugbaits commented on 'A suggestion for complicating the simple aggregate production function (bleg)'tag:typepad.com,2003:6a00d83451688169e2017c357657f6970b2013-01-08T22:19:07Z2013-01-08T22:19:07Z2slugbaitsI'm not a professional economist (not even close), but doesn't the function F(C,I,K,L)=0 confuse stock and flow variables? C &...<p>I'm not a professional economist (not even close), but doesn't the function F(C,I,K,L)=0 confuse stock and flow variables? C & I are income and are therefore flow variables. K & L are stock variables and should be regarded as wealth or an endowment position. So doesn't the equation H(C,I) = F(K,L) equate flows and stocks? For example, when you say:</p>
<p><i>We don't assume a straight line PPF between two different consumption goods. Why should we assume a straight line PPF between consumption goods and capital goods?</i></p>
<p>you have me confused. Isn't the PPF derived from F(K,L) and doesn't H(C,I) represent the budget line? The language you're using here (i.e., referring to consumption "goods" and capital "goods") slides into thinking of C &I as physical stocks of things. Shouldn't C & I be interpreted as utility flows from C & I rather than as physical goods?</p>
<p>To be honest, I'm not sure what lesson you're trying to teach your students. Is the goal here to show that C & I are constrained by the PPF F(K,L)? Or is the goal to derive the locus of C & I equilibrium points subject to the prices of K & L? Are you trying to show something like the old four-quadrant Keynesian curves relating wages, the production function and IS-LM? I guess I'm not sure where this is headed. It's interesting, but I just don't see the takeaway.</p>
<p>Thanks. </p>Alex Godofsky commented on 'A suggestion for complicating the simple aggregate production function (bleg)'tag:typepad.com,2003:6a00d83451688169e2017d3f95e0fb970c2013-01-07T15:36:27Z2013-01-07T15:36:27ZAlex GodofskyFrank: If you just know K & L, you should be able to solve for both I & C, whereas:...<p>Frank:</p>
<blockquote>If you just know K & L, you should be able to solve for both I & C, whereas:
<p>(equation elided)</p>
<p>Presumably, I is an independent variable from both K and L which means that to find C you must know I, K, and L.</blockquote></p>
<p>Yes, that's the point. Just knowing K and L doesn't tell you both I and C; as you noted, there is a question of allocation between investment and consumption. The problem is that you're trying to express that allocation as "% of each factor allocated to consumption", but that doesn't actually capture all of the possible systems. A given production process may produce both consumption goods and investment goods, and it may be impossible to decide which fraction of that process's inputs are allocated towards the consumption goods.</p>
<p>Example: you have a grain farm. Inputs are land (K) and labor (L). It produces two qualities of grain. High-quality grain is sold to humans as food (C). Low-quality grain is fed to cows (I). How do you decide what fraction of L is allocated to C?</p>
<p>Note that I'm not claiming you can't come up with some halfway-reasonable algorithm for this specific example; the point is that the question is extremely unclear and plausibly unanswerable for some example, so we shouldn't even attempt it. The behavior you are trying to capture is already sufficiently explained by making I an independent variable.</p>Frank Restly commented on 'A suggestion for complicating the simple aggregate production function (bleg)'tag:typepad.com,2003:6a00d83451688169e2017d3f91cac6970c2013-01-07T05:30:06Z2013-01-07T05:30:06ZFrank RestlyAlex, Even if you ignore allocation of resources between consumption and production goods I = F1 (K,L) C = F2...<p>Alex,</p>
<p>Even if you ignore allocation of resources between consumption and production goods</p>
<p>I = F1 (K,L)<br />
C = F2 (K,L)</p>
<p>If you just know K & L, you should be able to solve for both I & C, whereas:</p>
<p>C = G(I, K, L)</p>
<p>Presumably, I is an independent variable from both K and L which means that to find C you must know I, K, and L.</p>Nick Rowe commented on 'A suggestion for complicating the simple aggregate production function (bleg)'tag:typepad.com,2003:6a00d83451688169e2017d3f8655ac970c2013-01-05T18:45:55Z2013-01-06T19:34:23ZNick Rowehttp://profile.typepad.com/1227288949s8794Kathleen: I always get concave and convex muddled. Yep. PPF should bow out.<p>Kathleen: I always get concave and convex muddled. Yep. PPF should bow out. </p>Kathleen commented on 'A suggestion for complicating the simple aggregate production function (bleg)'tag:typepad.com,2003:6a00d83451688169e2017ee6fabbe0970d2013-01-05T18:41:27Z2013-01-05T18:41:27ZKathleenDo you really mean for the PPF to be convex? Normally they are concave to the origin. I understood that...<p>Do you really mean for the PPF to be convex? Normally they are concave to the origin. I understood that to mean the PPF would bow outwards.</p>Alex Godofsky commented on 'A suggestion for complicating the simple aggregate production function (bleg)'tag:typepad.com,2003:6a00d83451688169e2017d3f8642e4970c2013-01-05T18:33:31Z2013-01-05T18:33:31ZAlex GodofskyFrank: Your equations are still vulnerable to identifying what %L and %K are, and implicitly assume resources are only ever...<p>Frank:</p>
<p>Your equations are still vulnerable to identifying what %L and %K are, and implicitly assume resources are only ever allocated towards one thing at a time (what if a given production process produces C but also I as a byproduct?). But it's also unnecessary. If you start with your first equation:</p>
<blockquote>I = F1(%K, %L, K, L)</blockquote>
<p>Imagine we know I, K, and L, but not %K or %L. This gives us a curve in %K and %L of feasible points. Apply that curve to the equation:</p>
<blockquote>C = F2 (1 - %K, 1 - %L, K, L)</blockquote>
<p>Where we already know K and L, and that gives us a surface of points in C, %K, and %L. You can maximize C on this surface because %K and %L are constrained between 0 and 1.</p>
<p>But what we've just done with this process is develop a (possibly non-algebraic) equation of the form:</p>
<p>C = G(I, K, L)</p>
<p>So we didn't gain anything from introducing %K and %L as variables, and possibly lost something because we aren't sure they correspond to real things.</p>Nick Rowe commented on 'A suggestion for complicating the simple aggregate production function (bleg)'tag:typepad.com,2003:6a00d83451688169e2017ee6f57519970d2013-01-05T03:24:36Z2013-01-06T19:34:23ZNick Rowehttp://profile.typepad.com/1227288949s8794Peter N. Agreed. You need to add preferences. It's the utility of future consumption that matters. That is understood. This...<p>Peter N. Agreed. You need to add preferences. It's the utility of future consumption that matters. That is understood. This is the part where preferences get brought in: "To complete the model we need to add a labour supply function and a savings function. One simple savings function would be a consumption-Euler equation where r is an increasing function of the growth rate in consumption, and so is an increasing function of I/C."</p>
<p>JF: good find. <a href="http://ideas.repec.org/p/ide/wpaper/2865.html" rel="nofollow">it's here, for those interested</a></p>
<p>The technology they assume is (in my notation) C=F(I,K,L). They show how it is a general case of a two sector model that includes the C+I=F(K,L) and adjustment cost model as special cases.</p>
<p>Simon: thanks. I must borrow a copy of Varian.</p>Peter N commented on 'A suggestion for complicating the simple aggregate production function (bleg)'tag:typepad.com,2003:6a00d83451688169e2017d3f80bdfe970c2013-01-05T02:41:22Z2013-01-05T02:41:22ZPeter NI think calculating everything in the consumption good hides certain aspects of the problem and, in a way, assumes what...<p>I think calculating everything in the consumption good hides certain aspects of the problem and, in a way, assumes what you seek to prove. An investment is made based on the expected price (or marginal utility, if you prefer) of the consumption good (assuming this is what is being directly produced). The money/utilities involved can't be assumed to track the consumption good.</p>
<p>I don't borrow 100,000 bolts, I borrow money equal to the current price of bolts. Whether I can repay the loan by producing 100,000 bolts depends on the price of bolts when I produce and sell them. I can't just hand my creditor 100,000 bolts and be quit.</p>
<p>This colors the result of your robot models, where the value of human labor in widgets is found to be stable. But if widgets lose 99% of their value, human employment in widget production will cease.</p>
<p>At one time, screw making was a skilled profession. Screws were hand filed from bronze or brass casting or rods. The first automated screw factory produced 30,000 screws a day with 30 employees. That was it for hand filed screws. Nobody with mechanical skill would work for what a day's hand production (maybe 50 screws) would sell for.</p>JF commented on 'A suggestion for complicating the simple aggregate production function (bleg)'tag:typepad.com,2003:6a00d83451688169e2017d3f8086b4970c2013-01-05T02:08:33Z2013-01-05T02:08:33ZJFProf. Rowe, You could try looking into Frank Portier and Paul Beaudry's paper When Can Changes in Expectations Cause Business...<p>Prof. Rowe,</p>
<p>You could try looking into Frank Portier and Paul Beaudry's paper When Can Changes in Expectations Cause Business Cycle Fluctuations in Neo-Classical Settings, they have specific examples that could rationalize <br />
H(C,I) = F(K,L)</p>Frank Restly commented on 'A suggestion for complicating the simple aggregate production function (bleg)'tag:typepad.com,2003:6a00d83451688169e2017ee6f3b74f970d2013-01-04T22:37:03Z2013-01-04T22:37:03ZFrank RestlyAlex, One last try: I = F1 (%K, %L, K, L) C = F2 (1 - %K, 1 - %L,...<p>Alex,</p>
<p>One last try:</p>
<p>I = F1 (%K, %L, K, L)<br />
C = F2 (1 - %K, 1 - %L, K, L)</p>
<p>I just don't think you can get there with one equation to describe both C & I unless Nick is assuming some constraint or resource limitation not obvious in the equation.<br />
</p>Simon Van Norden commented on 'A suggestion for complicating the simple aggregate production function (bleg)'tag:typepad.com,2003:6a00d83451688169e2017d3f7ef58e970c2013-01-04T21:36:29Z2013-01-04T21:36:32ZSimon Van Nordenhttp://profile.typepad.com/vannordenNick: in Varian's notation, y is just the netput *vector* (call it q if you find that less confusing.) Of...<p>Nick: in Varian's notation, y is just the netput *vector* (call it q if you find that less confusing.) Of course, it will contain all the components of GDP (ie. output) that you want as well as all the factors of production.</p>ivansml commented on 'A suggestion for complicating the simple aggregate production function (bleg)'tag:typepad.com,2003:6a00d83451688169e2017ee6f35998970d2013-01-04T21:32:00Z2013-01-04T21:32:00ZivansmlNick: "But I think that would give a straight line PPF between C and I, unless you assumed decreasing returns...<p>Nick: "But I think that would give a straight line PPF between C and I, unless you assumed decreasing returns to scale."</p>
<p>It doesn't have to, e.g. have H(C,I) = (C^a + I^a)^(1/a), for a>=1, which has constant returns (and PPF is line for a=1, circle for a=2, square for a=infinity, etc.). Anyway, I think that once you write your technology as H(C,I)=F(K,L), you're implicitly already assuming this kind of intermediate good story. </p>Alex Godofsky commented on 'A suggestion for complicating the simple aggregate production function (bleg)'tag:typepad.com,2003:6a00d83451688169e2017d3f7ea28c970c2013-01-04T20:38:23Z2013-01-04T20:38:23ZAlex GodofskyFrank: Frank: but now your model doesn't give us double the investment and consumption if we double the labor and...<p>Frank:</p>
<p>Frank: but now your model doesn't give us double the investment and consumption if we double the labor and capital inputs, and it doesn't understand what happens if we increase the total capital stock without adding more labor.</p>
<p>It's also possible that we can't disentangle what fraction of labor is "allocated to investment" and what fraction is "allocated to consumption". Some activities may be allocated to both more-or-less simultaneously. Thus Nick's most general possible formulation of F(C,I,K,L)=0.</p>Neal commented on 'A suggestion for complicating the simple aggregate production function (bleg)'tag:typepad.com,2003:6a00d83451688169e2017ee6f2f67d970d2013-01-04T20:20:43Z2013-01-04T20:20:43ZNealhttp://contraryneal.blogspot.comThanks - I just stole the picture from Garrison's book. (My equation was linear: Y = C + I.) LaTeX...<p>Thanks - I just stole the picture from Garrison's book. (My equation was linear: Y = C + I.)</p>
<p>LaTeX for casual use is unsophisticated: _ for subscripts, \frac{}{} for fractions, and the occasional \partial for partial derivatives. I always use http://en.wikipedia.org/wiki/Help:Displaying_a_formula</p>
<p>I need to think more about the math in the model.</p>Frank Restly commented on 'A suggestion for complicating the simple aggregate production function (bleg)'tag:typepad.com,2003:6a00d83451688169e2017c354f9114970b2013-01-04T20:13:01Z2013-01-04T20:13:01ZFrank RestlyAlex, You are correct. %K = Capital goods dedicated to production of capital goods I = F1 (%K, %L) C...<p>Alex,</p>
<p>You are correct.</p>
<p>%K = Capital goods dedicated to production of capital goods</p>
<p>I = F1 (%K, %L)<br />
C = F2 (1 - %K, 1 - %L)</p>Alex Godofsky commented on 'A suggestion for complicating the simple aggregate production function (bleg)'tag:typepad.com,2003:6a00d83451688169e2017d3f7e3eb5970c2013-01-04T19:30:47Z2013-01-04T19:30:47ZAlex GodofskyFrank: in your model the division of output between I and C is solely a function of the allocation of...<p>Frank: in your model the division of output between I and C is solely a function of the allocation of labor, but we can also vary the composition of output by changing the allocation of capital.</p>Frank Restly commented on 'A suggestion for complicating the simple aggregate production function (bleg)'tag:typepad.com,2003:6a00d83451688169e2017ee6f2516d970d2013-01-04T18:32:38Z2013-01-04T18:32:38ZFrank RestlyNick, What is the contraint that holds F(C,I,K,L) = 0 or C = F(I,K,L)? If labor then why not just...<p>Nick,</p>
<p>What is the contraint that holds F(C,I,K,L) = 0 or C = F(I,K,L)? <br />
If labor then why not just say:</p>
<p>%L = Labor force dedicated to production of capital goods</p>
<p>I = F1 (K, %L)<br />
C = F2 (K, 1 - %L)</p>Nick Rowe commented on 'A suggestion for complicating the simple aggregate production function (bleg)'tag:typepad.com,2003:6a00d83451688169e2017c354ed7f9970b2013-01-04T18:12:36Z2013-01-04T21:56:31ZNick Rowehttp://profile.typepad.com/1227288949s8794Ivansml: "I understood your model like this: first, capital and labor are used to produce intermediate good, with standard production...<p>Ivansml: "I understood your model like this: first, capital and labor are used to produce intermediate good, with standard production function Y = F(K,L); then, intermediate good is used to produce consumption and investment goods, with the tradeoff captured in H(C,I)=Y constraint. This seems somewhat restricting (e.g. it would be impossible for such model to capture investment adjustment costs which depend both on I and K)."</p>
<p>Interesting interpretation. But I think that would give a straight line PPF between C and I, unless you assumed decreasing returns to scale.</p>
<p>Ken: "Conceptually, the model should be F(I, K, L) with a constraint that wL>=C."</p>
<p>Why would you want to impose wL >= C? (Or maybe you meant C>=wL? But even then, why assume all wage income gets consumed? Some of us workers save and invest and become capitalists too?)</p>
<p>Thanks Bob.</p>
<p>Simon: But what would Varian mean by "a given value of y"? What is y? Income? The way I'm looking at it is that income (measured in units of the consumption good) is (Pk.I + C). But you don't need to define income.</p>
<p>All: I'm starting to think that perhaps C = F(I,K,L) isn't so bad after all. [Or, if you include depreciation at rate d, where I is net investment, C= F(I+dK,K,L).] And if you impose CRS that becomes C/L=F(I/L, K/L). Which should give a simple enough steady state for things like the Solow Growth Model.</p>Simon Van Norden commented on 'A suggestion for complicating the simple aggregate production function (bleg)'tag:typepad.com,2003:6a00d83451688169e2017d3f7ce4aa970c2013-01-04T15:49:49Z2013-01-04T15:49:53ZSimon Van Nordenhttp://profile.typepad.com/vannordenGlancing through my (1977...okay, I'm old) copy of Varian, his notation is something along the lines of define vector y...<p>Glancing through my (1977...okay, I'm old) copy of Varian, his notation is something along the lines of <br />
define vector y = [C,I,K,L]<br />
define set Y as the set of all feasable points in R4 for a given value of y.<br />
This is the first thing Varian does (pages 1-5.) Have a look.</p>Bob Murphy commented on 'A suggestion for complicating the simple aggregate production function (bleg)'tag:typepad.com,2003:6a00d83451688169e2017ee6f14d91970d2013-01-04T15:47:31Z2013-01-04T15:47:31ZBob Murphyhttp://consultingbyrpm.comHmm I must have screwed up the formatting in my hyperlink, above. What I was trying to say was: However,...<p>Hmm I must have screwed up the formatting in my hyperlink, above. What I was trying to say was:</p>
<p>However, what people can see right away is <a href="http://consultingbyrpm.com/uploads/Dissertation.pdf" rel="nofollow">my dissertation</a>. In the mathematical appendix I came up with a formal result where r=MPK is the special case, of a more general equilibrium relationship. So that's a good summary of the way I was approaching this issue.</p>Bob Murphy commented on 'A suggestion for complicating the simple aggregate production function (bleg)'tag:typepad.com,2003:6a00d83451688169e2017d3f7cdd40970c2013-01-04T15:45:36Z2013-01-04T15:45:36ZBob Murphyhttp://consultingbyrpm.comNick I will try to look at this over the weekend... The paper I sent you was published here, but...<p>Nick I will try to look at this over the weekend...</p>
<p>The paper I sent you was published <a href="http://journals.cambridge.org/action/displayAbstract?fromPage=online&aid=5805816" rel="nofollow">here</a>, but I don't think it's online for free.</p>
<p>However, what people can see right away is my Ken Houghton commented on 'A suggestion for complicating the simple aggregate production function (bleg)'tag:typepad.com,2003:6a00d83451688169e2017d3f7cda2e970c2013-01-04T15:43:48Z2013-01-04T15:43:48ZKen Houghtonhttp://www.angrybearblog.comIf you were getting CRS for Consumption Goods, economic shifts from Manufacturing to Services would make more sense--but the shift...<p>If you were getting CRS for Consumption Goods, economic shifts from Manufacturing to Services would make more sense--but the shift from Ag to Mfg wouldn't.</p>
<p>Conceptually, the model should be F(I, K, L) with a constraint that wL>=C. But that could be even harder to teach.</p>ivansml commented on 'A suggestion for complicating the simple aggregate production function (bleg)'tag:typepad.com,2003:6a00d83451688169e2017d3f7cd09e970c2013-01-04T15:39:05Z2013-01-04T15:39:05ZivansmlI understood your model like this: first, capital and labor are used to produce intermediate good, with standard production function...<p>I understood your model like this: first, capital and labor are used to produce intermediate good, with standard production function Y = F(K,L); then, intermediate good is used to produce consumption and investment goods, with the tradeoff captured in H(C,I)=Y constraint. This seems somewhat restricting (e.g. it would be impossible for such model to capture investment adjustment costs which depend both on I and K).</p>
<p>Mas-Colell et al. textbook discusses this in section 20.C. For a two-sector growth model, they describe technology with "transformation" function C <= G(K,L,K'), where K' is capital next-period and G() is a maximum amount of consumption given K,L and K' (this is in discrete time). Similar formulation is often used when the model is solved in recursive form (so K' becomes control variable in the Bellman equation). Also, K and K' could be in principle vectors of disaggregated capital goods. </p>Nick Rowe commented on 'A suggestion for complicating the simple aggregate production function (bleg)'tag:typepad.com,2003:6a00d83451688169e2017c354d84af970b2013-01-04T14:57:03Z2013-01-04T15:07:16ZNick Rowehttp://profile.typepad.com/1227288949s8794Neal: I just skimmed your post. Good to see you have the same curved PPF between C and I. Here's...<p>Neal: I just skimmed <a href="http://contraryneal.blogspot.ca/2013/01/the-loanable-funds-market.html" rel="nofollow">your post.</a> Good to see you have the same curved PPF between C and I.</p>
<p>Here's what's at the back of my mind:<br />
There's a technology for producing consumption goods C=c(Kc,Lc), and a technology for producing investment goods I=i(Ki,Li), and Kc+Ki=K and Lc+Li=L, so F(C,I,K,L)=0 is the envelope thingy.</p>
<p>If c() and i() are identical functions, with constant returns to scale we can write is as C+I=F(K,L). I'm OK with constant returns to scale, but I'm not OK with assuming c() and i() are identical functions, and so I'm not OK with assuming the PPF between I and C is a straight line.</p>Nick Rowe commented on 'A suggestion for complicating the simple aggregate production function (bleg)'tag:typepad.com,2003:6a00d83451688169e2017c354d7038970b2013-01-04T14:46:20Z2013-01-04T15:07:16ZNick Rowehttp://profile.typepad.com/1227288949s8794Contraryneal: I learned LaTeX once, but forgot it. I'm as scared of learning new computer programs as I am of...<p>Contraryneal: I learned LaTeX once, but forgot it. I'm as scared of learning new computer programs as I am of math!</p>Contraryneal.blogspot.com commented on 'A suggestion for complicating the simple aggregate production function (bleg)'tag:typepad.com,2003:6a00d83451688169e2017ee6f0a9e6970d2013-01-04T14:24:32Z2013-01-04T14:24:36ZContraryneal.blogspot.comhttp://profile.typepad.com/contrarynealblogspotcomBefore I jump into the math - have you ever considered using MathJax? http://www.mathjax.org/ Basically, it lets you typeset LaTeX...<p>Before I jump into the math - have you ever considered using MathJax? http://www.mathjax.org/ Basically, it lets you typeset LaTeX in your webpage by adding a line to your site's header.</p>Nick Rowe commented on 'A suggestion for complicating the simple aggregate production function (bleg)'tag:typepad.com,2003:6a00d83451688169e2017ee6f049bd970d2013-01-04T13:30:04Z2013-01-04T15:07:16ZNick Rowehttp://profile.typepad.com/1227288949s8794Simon: so the upper year undergrad and grad students would be fine with F(C,I,K,L)=0 ? I could just write it...<p>Simon: so the upper year undergrad and grad students would be fine with F(C,I,K,L)=0 ? </p>
<p>I could just write it as C=F(I,K,L), which is equivalent, but a little more inutuitive.</p>
<p>(It's the investment demand curve you get from C+I=F(K,L) that really bugs me, and bolting on that adjustment costs story as an afterthought to make Id slope down is such a fudge.)</p>Simon Van Norden commented on 'A suggestion for complicating the simple aggregate production function (bleg)'tag:typepad.com,2003:6a00d83451688169e2017d3f7bc91f970c2013-01-04T13:17:11Z2013-01-04T13:17:18ZSimon Van Nordenhttp://profile.typepad.com/vannorden"Macroeconomists like to aggregate things." Any standard micro textbook will work you through production functions with "netput" vectors (Varian is...<p>"Macroeconomists like to aggregate things."<br />
<br />
Any standard micro textbook will work you through production functions with "netput" vectors (Varian is the classic reference for our generation.) <br />
However, you should note that those who work seriously with data and production functions tend to use a KLEM or KLEMS framework ([K]apital, [L]abour, [E]nergy, [M]aterials and [S]ervices) because they think this better captures important features of the real economy. </p>