Role of real money balances in the production function: A case study of manufacturing industries of Pakistan over the the period 1973-1987

Abstract

ABSTRACT The primary objective of this dissertation is to examine and test the behavior of firms lor holding their money balances in the context of role of real money balances in the production function. The model developed treats money as a factor input in a Neo-classical production function along with labor and capital. For the developoment of the model various relevant theoritical and empirical issues of the literature has been discussed and examined. Production factor approach has been selected in which money has been introduced as a factor input in the production function. The use of duality theorems demanstrates that comparable information about the firm'/; productive technology can be obtained from either the cost function or the production function. Instead of production function, a Translog cost function has been used, which is dual to its associated production function. Cost share equations have been derived for each of the three inputs. This system of cost share equations is then used to evaluate the role of real money balances as a productive input. Aggregate data of manufacturing industries -,t Pakistan from 1973 v`IIIto 1987 are used to examine the model. The estimated results indicate that 1. All factor inputs (labor, capital, and real money balances are important factor inputs in the production and cannot be omitted from the production function. 2. The main deteminants of real money balances are the opportunity cost of holding money, relative prices of labor and capital, the level of output, and the technological changes in the production process. 3. All the coefficients of cost share equations are different from zero. 4. All factor inputs (labor, capital, and real money balances) are not separable from each other in the production function. 5. Real money balances are substitudes for capital, and complements to labor, while labor and capital are substitutes to each other in the production process. 6. Real money balances are more sensitive to the price of capital than the price of labor, while labor is more sensitive to the price of money, than the price of capital. IX