Production function for the industrial sector of Indonesia

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Virginia Polytechnic Institute and State University


The primary purpose of this thesis is to quantitatively analyze the production features of the Indonesian manufacturing sector. In particular, using concepts from traditional neoclassical theory of the firm, attention is focused on such aspects as returns to scale and the elasticity of factor substitution. Some empirical knowledge of these features of a production activity is important because of the crucial role they play in many theories of, for instance, growth and development economics, international trade and public economics.

In order to measure returns to scale and elasticities of substitution, the approach adopted was that of production function analysis, using econometric techniques. Cross-sectional Indonesian data for 1983 were fitted to both Cobb-Douglas and CES-type production functions, and the unit of observation is the establishment. Ordinary least squares method was applied in estimating the regression models.

Chapter One is an introductory exposition. It describes the aim and the purpose of the study, while Chapter Two gives a general description of the manufacturing sector as a component of the national economy.

Chapters Three and Four are the main substance of the thesis. In Chapter Three, a theoretical discussion of production functions and common problems usually encountered on the estimation of neoclassical aggregate production functions are given. The chapter is concluded with the discussion and definitions of the data used for the study. Two specifications for the tests of returns to scale and one specification for the tests of elasticity of substitution were formulated in chapter four. And 20 industries were tested for each specification. The results indicate that the majority of these industries show constant returns to scale. Moreover, most of them show elasticity of factor substitution greater than one.