TECHNOLOGICAL CHANGE EFFECT ON PRODUCTION FUNCTION
Technological change has been defined broadly as “the process
by which economies change over time in respect of the products and services
they produce and the processes used to produce them" and more specifically
as alteration in physical processes, materials, machinery or equipment, which
has impact on the way work is performed or on the efficiency or effectiveness
of the enterprise. Technological change may involve a change in the output, raw
materials, work organisation or management techniques but in all cases it would
affect the relationship between labour, capital and other factors of
production.
PRODUCTION FUNCTIONS AND TECHNOLOGICAL
CHANGE
'A production function attempts to specify the output of a
production process (as a function of the various factors of production e.g.,
labour, capital, technology, management or organisation and land). It may be possible
to explicitly state the nature of this function based on econometric studies
but that is not our interest at present. We would like to understand the role
of technology in the production process and for that purpose we would like to
begin with the isoquant approach. An isoquant specifies a range of alternative
combinations of two factors of production, say labour and capital, which can be
used to produce a given quantity of the output and is based on the
assumption that the other factors of production e.g. the state of knowledge of
technology is constant.
Figure 1 : Isoquants and factor substitution
In Figure 3.1 above AB is an isoquant representing various
combinations of labour and capital that could be used to produce a specific
quantity of the product. If we want to produce a higher quantity of the product,
another isoquant can be drawn to represent the various combinations of labour
and capital that could be used for the same. Here CD represents such an
isoquant and, as is expected, is above AB since the marginal product of both
labour and capital is assumed to be positive in the ranges shown. Similarly, EF
is another isoquant and because it lies below AB, it represents an output level
lower than that of AB.
All of these isoquants are drawn for the same level of
technology and for the given level of technology, an isoquant represents the
possible substitution of labour by capital or vice-versa. In this approach,
therefore, if the relative prices of labour and capital are known, one can find
an optimum mix of labour and capital to minimise the total cost of production.
The textbook expositions usually represent isoquants as smooth curves as shown
in Figure 3.1 above, which would imply, at least in theory, that even
small changes in factor prices would induce factor substitution to restore
optimal conditions. Thus, a change in factor prices would result in a
movement along the isoquant AB-e.g. From X to X' in Figure 3.1, whereas a
change in technology would result in a shift in the isoquant, e.g. from AB to
A'B' as shown in Figure 3.2 below:
Figure 2 : Isoquants and Change in Technology
A closer look at Figure 3.2 would reveal that the technology
used to get the isoquant A'B' is superior to that used before the change in
technology. However, the corresponding shift in the optimal point from X to Y
is, more difficult to interpret. Given the relative factor prices, point X
minimises the total cost of production with the existing technology (relevant
for the isoquant AB) whereas point Y minimises the total cost of production
with the improved technology (relevant for the isoquant A’B’). The difficulty
in conceptualising smooth production functions and consequently smooth isoquants
- now gets clear. For example, it is not at all obvious from Figure 3.2 above
whether the improved technology is labour-augmenting or capital augmenting.
Suppose the factor prices were such that the optimum was at P on
AB in Figure 3.2. It would appear that the shift in the optimal point from P to
Q as a consequence of the change in technology has been mostly of the labour augmenting
type since the labour efficiency has improved much more than the capital
efficiency. On the other hand, if the factor prices were such that point R on
AB was the optimal point and it shifted from S to S as the technology changed,
it would appear that the change in technology has mostly been of the capital-augmenting
type. In other words, the change in technology can manifest itself as either
labour- or capital-augmenting type depending upon the factor prices.
A smooth isoquant also implies that there are many
(theoretically infinite) combinations of labour and capital at any given
level-of technology and so any change in factor prices is immediately reflected
in a new optimal mix of labour and capital. This is not generally borne out in
practice. In practice, we find that the mix of labour and capital is relatively
insensitive to short-term changes in factor prices and is quite well defined
for a given level of technology. Similarly, a change in technology is usually
associated with a different mix of labour and capital. For example,
manufacturing of sugar and khandsari require different mix of capital. It
should be pointed out that these mixes of labour and capital are determined
more by long-term changes (and expectations of changes) in factor prices than
by short-term fluctuations. A smooth production function is incapable of
explaining these realities. If we change our assumption that the amount of labour
and capital can be mixed in an infinite number of alternative proportions (as
indicated by an isoquant of the type 'shown in Figure 3.2 above) and assume the
other extreme possibility, i.e., that the proportion of labour and capital is predetermined at a given level of technology
and is totally immune to any changes in factor prices, we can then show the
effect of changes in labour, capital and technology on the same graph as shown
in Figure 3.3 below. Each point on the production function represents one
process of producing the product and associated with each of these processes is
a certain technological knowledge specific to that process. Figure 3.3, for
example, shows that there are two different processes available to produce the
product under discussion represented' by points A and B -one being labour
intensive (viz. B) and the other capital intensive(viz. A).
Figure 3 : Production Function with no Factor Substitution
Given different factor prices, each of these processes can be economically
viable in different economies. In developed countries, for exmaple, labour is
relatively more expensive and hence, capital, intensive technologies are preferred.
The line AB is still similar to an isoquant as the combinations of labour and
capital represented by points A and B would produce the same quantity of output.
Much of the technological change is based on the accumulation of technological
knowledge about specific processes. So a change in technology is quite often
reflected by a shift in the production function from AB to A'B ambiguous
whereas the shift from A to A' is associated with a change in technological
knowledge specific to the capital intensive process above. This gives rise to a
further reduction in the use of units of labour required to produce the same
number of units of output. It has been established in many empirical studies
that a choice of technology does exist in the manufacture of many products,
although the number of such alternatives may not be as high as perhaps suggested
by continuous production functions. Also, the change in technology in terms of
both the development of new knowledge as well as its application appears to be
induced by long-term movements of factor prices and not so much by short-term
fluctuations.
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