Production with Uncertain Technology: Some Economic and Econometric Implications

Abstract

TRADITIONAL PRODUCTION THEORY assumes that the relevant decision maker knows the parameters of his production function with certainty, except perhaps for an independent additive or multiplicative error.2 This assumption of no technological uncertainty can be appropriate only in those industries in which the production process is a well-understood physical transformation and in which there is little room for individual discretionary behavior. Although these conditions may be approximately satisfied in some manufacturing and utility industries, they are not universally valid in manufacturing and are an incorrect description of the service industries that now employ more than half the nation's workers. In particular, there is substantial technological uncertainty about government activities in areas such as education and health in which economists would like to offer advice about scale and input mix on the basis of estimated production functions. The purpose of this paper is to study some of the implications of dropping the assumption of perfect technological knowledge. Section 2 derives the optimal input mix for a Cobb-Douglas production function with uncertain coefficients and investigates the effect of production uncertainty on factor incomes. Section 3 discusses the appropriateness of several standard econometric estimation methods in the context of this more general model. An illustrative application to a problem of public expenditure planning is presented in Section 4. The paper concludes with a brief summary.

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