NEC PRODUCTION AND DISTRIBUTION THEORY Three main manners of interpretation of capital/profit and labor/wage in NCE 1. Psychological interpretation a) Capital as effect of „waiting”, of postponing (shifting in time) instaneous consumption of goods/income. Profit as the reward for „waiting” b) Profit as the reward resulting from the difference between the value (utility) of current (present) and future goods c) Supply of labor (by households and individuals) and wages as categories related to the utility and disutility of labor 1

Manners of interpretation of capital/profit and labor/wage in NEC Capital and profit as categories occuring in the so called economic dynamics Statics Resources of capital and labor are given with regard to quantity and qualitative features, production technologies and production costs are fixed (do not change) 1. Prices of final goods are fixed 2. There occur no profits: zero profit hypothesis Dynamics: all above mentioned conditions/constraints are subject to change. In particular, there appear new technologies 2

Manners of interpretation of capital/profit and labor/wage in NEC Capital and profit as catergories occuring in the so called economic dynamics (cont.) 1. Profit (rate of interest) as the reward for economic risk a) Risk as immanent feature of physical capital formation and modernization process b) Profit as the function of time of (physical) investment duration c) Diversification of rate of profit as resulting from risk diversification 3

Manners of interpretation of capital/profit and labor/wage in NEC Capital and profit as categories occuring in the so called economic dynamics – cont. 2. Profit as the reward for innovations (J.A.Schumpeter) a) Equilibrium /statics: no profits, no entrepreneurs, manufacturing based on routine methods b) Evolution/development: there appear innovations and enterpreneurs (enterpreneur=innovator) c) Origin of profit: difference between social marginal costs (=market price) and individual (in a given enterprise) marginal costs (of production, distribution) d) Imitation (diffusion) of innovation, gradual disappearence of profits and the return to statics 4

Manners of interpretation of capital/profit and labor/wage in NEC NEC production and distrtibution theory 1. Theory of marginal productivity of production factors (MPT) and marginal distribution theory (MDT) as the main foundation of neoclassical microeconomics 2. Law of diminishing marginal productivity (LDMP) (law of diminishing returns on production factors) a) Universal nature of MPT/MDP b) Productive and value-generating character of all production factors c) Marginal product of a given production factor (MP) as the measure of (1) its share (contribution to) in the value of manujfactured (extracted) goods, (2) foundation of its reward and (3) base for its market price 5

Manners of interpretation of capital/profit and labor/wage in NEC NEC production funkction - PF as basic model of neoclassical production and distribution theory 1. Definition: general and neoclassical General: quantitative manner of defining the relation between the product and inputs of production factors which are required for its manufacturing (extracting) The very nature of that relation is determined by the technology, understood here as the so called abstractive technology Abstractive technology: set of technical characteristics (features) of production function: 1. Capital intensity of technology 2. Scope of substitution between production factors (in particular: labor for capital and vice versa) 3. Technologically determined economies of scale 6

Manners of interpretation of capital/profit and labor/wage in NEC NEC production function – PF as basic model of... Definition and features of NEC PF P = F(x 1,x 2,…x n ) x 1,x 2,…x n homogenous production factors P = F(x 1,x 2,…x n )  0 product can not be negative P = F(K,0) = F(0,L) = F(0,0) = 0 (complementarity of production factors; K – capital, L – labor) MP K = f ' K (P); MP L = f ' L (P)– marginal product of K and L MP K  0; MP L  0 ; marginal products have to be positive (economic sense: rationality of economic behavior) f’’ K (P)<0, f’’ L (P)<0 ; Law of DMP 7

Manners of interpretation of capital/profit and labor/wage in NEC NEC production function – PF as basic model of... a) Substituability of L and K, notion of capital vintage and vintage PF, and the interpretation of technical/technological progress (change) in the NEC production theory 1. Full s ubstituability (ex ante and ex post): labor can be fully substituted for capital and vice versa, the so called disembodied technological progress, residual and exogenous (with regard to economy) character of technological progress 2. Limited s ubstituability (takes place only ex ante, labor is not substituted for capital, and vice versa, ex post); there occur capital vintages and, subsequently, the vintage production factor, technological progress can be both embodied (within a given capital vintage) and disembodied; there appears the problem of the so called life time of (physical) capital 3. No substituability (K/L relation is fixed/rigid both ex post and ex ante) 4. „Cambridge contra Cambridge” controverse (NEC versus PKE) 8

Manners of interpretation of capital/profit and labor/wage in NEC Basic analytical forms of NCE PFs Main criteria for distinguishing types of PFs 1. Technological economies of scale : interdependence between the quantitative increase of product and the increase of inputs of production factors P = F(aK, aL); F= a r F(K,L); r – level of scale economies r= 1 costant; r>1 increasing; r<1 decreasing Economies of scale = grade of homogenousness of PF 2. Elasticity of substitution (L for K or vice versa) : relation between marginal rate of substitution of L for K (or K for L) and capital intensity of technology (K/L) 9

Manners of interpretation of capital/profit and labor/wage in NEC Basic analytical forms of NCE PFs Main criteria for distinguishing types of PFs 2. Elasticity of substitution of L for K MRS K/L = ðK/ ðL, p>0, k = K/L MRS K/L = p k δ δ>0 elasticity of substitution of L for K Economic sense of elasticity of substitution: Ratio of relative change in MRS K/L to relative change in K/L δ = d(MRS K/L )/ MRS K/L : dk/k 10

Manners of interpretation of capital/profit and labor/wage in NEC General features of NEC distribution theory (MDT) 1. Strictly related to MPT 2. Technical character: shares of production factors in (manufactured/extracted) product are determined by;  Changes in the quantity of production factors (and, implicitly, their marginal productivity)  Possibilities of technologically determined susbstitution betweeb production factors 3. Social and institutional condtions do not affect the shares of production factors  In the equlibrium, prices of goods are equal to their marginal production (distribution etc.) costs > zero profit hypothesis 11

Manners of interpretation of capital/profit and labor/wage in NEC Let’s assume, there is the macroeconomic NEC PF P= f(K,L) If it is homogenous of grade 1 (constant economies to scale), it is equivalent to the function y = f(k); Where: y=P/L (labor productivity k=K/L (technical equipment of labor, capital intensity of technology) 12

Manners of interpretation of capital/profit and labor/wage in NEC Conclusions from the model 1. Wage rate changes directly (proportionally) to changes in K/L ratio which means that in the process of capital accumulation (economic growth) the reward of laboreres grow 2. Rate of interest (profit) changes inversely to changes in K/L ratio. In the process of capital accumulation, the unit reward of capital diminishes. It does not necessarily means that the share of capital in social product falls. The tendency of capital share to diminish may be effectively compensated by the substitution of labor for capital, as well as by technological progress (given specific features of that substitution and progress). 3. Fair distribution is when the production factors are rewarded accordingly to their marginal products 4. Fair distribution is taking place when the conditions of perfect competition are fulfilled. 13

Manners of interpretation of capital/profit and labor/wage in NEC 14

Manners of interpretation of capital/profit and labor/wage in NEC Analytical forms of PF COBB-DOUGLASA PF 1. Constant economies to scale 2. Constant and equal to 1 elasticity of substitution 3. Constant elasticities of product with respect to K and L P = F(aK, aL) F= aF(K,L) r=1 MRS K/L = p k δ δ=1 15

Manners of interpretation of capital/profit and labor/wage in NEC 1. Marginal product of capital is proportional to its average product 2. Marginal product of labor is proportional to its average product 16

Manners of interpretation of capital/profit and labor/wage in NEC 1. Q K and Q L - respectively, product generated by capital and labor, whereas Q K /P oraz Q L /P stand for the shares of capital and labor in the social product 2. Conclusion: in the Cobb-Douglas PF the elasticities of product with respect to capital and labor are equal their shares in the social product and remain constant 3. Cobb-Douglas PF may take a generalized form in which it is subject to any positive economies of scale (E P/K + E P/L = r #1; r>0) 17

Manners of interpretation of capital/profit and labor/wage in NEC Assumption which is underlying the Cobb –Douglas PF (elasticity of substitution constant abd equal to 1) may be generalized If we assume that the elasticity of substitution (δ) is constant but not necessarily equal to 1, we receive a more general class of production functions. These are the CES (Constant Elasticity of Substitution) PFs What is the conomic sense of δ : it is the ratio of relative change in MRS K/L (marginal rate of substitution of L for K) to relative change in K/L (capital intensity) δ = d(MRS K/L )/ MRS K/L : dk/k 18

Manners of interpretation of capital/profit and labor/wage in NEC Marginal rate of substitution of labor for capital (MRS) may be expressed as the relation of marginal labor product (MPL) to marginal capital product (MPK). For macroeconomic production function, it is the relation of unit wage (w) to unit reward of capital (r) 19

Manners of interpretation of capital/profit and labor/wage in NEC Thus, in macroeconomic approoach, the elasticity of substitution measures how the relation of unit rewards or prices of production factors changes when the relative „saturation” of economy with capital (as described by the K/L ratio) increases or decreases. 1. δ = 1; shares of labor and capital in the social product remain constant (Cobb-Douglas PF) 2. δ>1; share of labor increases, share of capital decreases (CES PFs) 3. δ<1; share of labor decreases, share of capital increases (CES PFs); 4. Elasticities of product with respect to K and L are no more constant (fixed) in the CES PFs Cobb-Douglas PF is a special case of CES PFs Variable Elasticity of Substitution (VES) PFs 20