On Optimal Returns to a Factor

Abstract

In a recent note Latham and Peel (1974) showed, in the context of a model in which labour adjustments are costly and the capital stock is fixed, that any positive value of the returns to labour parameter is compatible with present value maximization. The use of a Cobb-Douglas production function in that paper meant that the presence of increasing, constant or decreasing returns to labour was datum. More recently Gaudet (1977) shows how production in the increasing returns range of the production function may be compatible with competitive equilibrium in a model in which there are two factors of production, labour and capital, and there are costs incurred in adjusting the capital stock. However, Gaudet used a Cobb-Douglas production function with diminishing returns to each factor of production.The purpose of this note is to show that a firm operating in perfectly competitive markets but facing costs of adjustment to its sole variable input (labour) may well prefer to operate in a region of the production function in which the output elasticity of labour is greater than unity (i.e. increasing returns to labour).