Academic journal article IUP Journal of Applied Economics

Factor Substitution and Price Elasticity of Demand in Haryana Manufacturing Industries

Academic journal article IUP Journal of Applied Economics

Factor Substitution and Price Elasticity of Demand in Haryana Manufacturing Industries

Article excerpt

In this paper an attempt has been made to analyze the substitution possibilities in Haryana manufacturing industries. The study derives its rationale primarily from the fact that the growth of manufacturing sector in Haryana is the need of the hour, as the agriculture growth appears to have already reached a plateau after enjoying a period of high growth in the wake of Green Revolution. The major objective of the study is to examine trends in substitution possibilities during the pre -and post-liberalization periods. The study relies mainly on data generated by Annual Survey of Industries and covers the period from 1981-82 to 2007-08. In the year 1991, economic policy underwent substantial changes and the year is treated as a watershed for dividing the entire policy regime into two phases. The results suggest limited substitution possibilities between labor and capital, and labor and energy, while strong substitution possibilities are suggested between capital and energy. The results suggest that the hypothesis of uniform elasticity of substitution for every pair of inputs over the two policy regimes holds only partially good. While the hypothesis is accepted for substitution elasticity between capital and energy, it is rejected for labor and capital as well as for labor and energy.

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Empirical estimates of elasticity of substitution are not only of theoretical interest, but they may also provide useful guidelines for the economic policies. The importance of elasticity of substitution between labor and capital in growth models and international trade is wellrecognized. Similarly, the significance of price elasticity of demand for policy purposes is wellknown and requires no elaboration. This paper is devoted to the analysis and measurement of substitution possibilities in Haryana manufacturing industries. The analysis has been carried out in both pre- and postliberalization periods.

The paper is organized as follows: It discusses the methodology used that includes characterization of production technology and measurement of variables. Subsequently, the parameter estimates of translog cost function and Allen's partial elasticities of substitution in the pre- and post-liberalization periods for Haryana manufacturing industries are presented. Then it presents the estimates of own and cross-elasticities of demand in pre- and post-liberalization periods for the Haryana manufacturing industries at aggregate level, and finally, the conclusion is offered with policy implications.


Methodology in this paper basically includes characterization of the production technology and measurement of variables.

Characterization of Production Technology and Factor Demand

In this paper, we follow the econometric approach for measurement and analysis of substitution possibilities. This approach involves the specification of production/cost function and its subsequent estimation. As a matter of fact, under certain conditions of duality theory, production function and cost function are just two equivalent ways of characterizing the technology of a production unit. Here, we prefer the cost function approach to the production function approach because of certain econometric and analytical advantages.

A cost function expresses the total cost as a function of output and input prices. In the estimation of a production function, the econometric assumption of exogenous regressand does not appear to hold good, because generally managerial decisions in industries are concerned primarily with determination of optimal input levels. While in the estimation of a cost function since all industries are to compete with each other for their inputs, input prices can be regarded as exogenous variables. On analytical grounds as well, cost function is more convenient for analyzing factor substitution, scale economies and technical change. …

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