Change in total Factor Productivity

[johntavv]

1. I have seen a question that states the assumption of constant returns to scale implies that %∆TFP is zero, so that equal % changes in labour and capital will produce the same % change in real output.
2. I have also seen that the ∆TFP is the Solow residual.
Why do we assume %∆TFP=0 for 1. but for 2. the ∆TFP is not zero?

 

[S2000magician]

The assumption of constant returns to scale does not imply that %∆TFP = 0.
What it means is that if %∆TFP = 0, and %∆K = %∆L, then %∆Y = %∆K = %∆L.
I wrote an article about this stuff that may be helpful: http: //financialexamhelp123.com/cobb-douglas-production-function/

 

[johntavv]

Thanks magician, do you mind please sharing the link on the article you wrote?

 

[Galli]

^^
Isn’t this forumla more correct?
if, %∆K = %∆L, then %∆Y = %∆K + %∆L.

 

[S2000magician]

johntavv wrote:Thanks magician, do you mind please sharing the link on the article you wrote?

Sorry about that.
It’s there now.

 

[S2000magician]

Galli wrote:^
Isn’t this forumla more correct?
if, %∆K = %∆L, then %∆Y = %∆K + %∆L.

Only if α =1 and β =1. But then α + β = 2 > 1, so you have increasing returns to scale, not constant returns to scale.
We’re told that we have constant returns to scale: α + β = 1.
The proper formula is:
%ΔY = %ΔA +α(%ΔK) + β(%ΔL).

 

[Galli]

^, gotcha. Thanks!

 

[S2000magician]

Bitte.

 

[daharmattan1]

There was an error in Schweser 2013 prep material that got a lot of people confused about this. Smagician’s article is on point