| Sumario: | Firms determine their demands for factors of production by finding the combination of factor inputs that will maximize profits or minimize costs, subject to a technological constraint , the production function. Because the production function is common to decisions for all factors, the factor demands must be interrelated; each factor demand function contains parameters from the underlying production function which also appear in other demand functions. Yet factor demand equations are commonly estimated independently, with the consequence that production function parameters implied by the different equation estimates may well be inconsistent. If the demand functions are to be included in a complete model of an economy, it is certainly desirable, if not essential, that they be consistent, i.e., that they imply a single set of parameters for the underlying production function. The production function estimated indirectly through the labor and investment demand relations will have a prominent role of its own in the complete model. It will be used to determine potential or full employment gross national product (GNP), while actual GNP will be determined by effective demand.
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