Production function

Capital has five characteristics.

  1. It is productive.
  2. It is produced (investment requires opportunity cost of more consumption today)
  3. Its use is limited (rivalry)
  4. It can earn a return.
  5. It wears out (depreciates).

Production function

Assumptions - 

  • constant returns to scale (i.e. F(zK,zL)=zF(K,L)
  • diminishing marginal product (where MPK=f(k+1)-f(k)

Equation

Cobb-Douglas production function where

  • F(K,L)=AK^αL^(1-α)
    • y=Ak^α 
    • in the data α = 1/3
    • MPK=αAK^(α-1)L^(1-α)