Will someone please answer this - I have seen it in prior years but no one seems to be able to answer it…
When “contstant return to scale” applies in the cobb-dougles production function, I know that B = 1-a. Great.
My question is, does TFP = 0 ??? Schweser says so on practice tests but CFAI seems to not say that.
do not think that is implied when they say constant returns to scale.
It means that b = 1-a.
Where specifically does Schweser say that?
I believe it says change in TFP = 0.
Clark is right. TFP is constant (at 2%, 1%, whatever).
constant returns to scale does not mean that change in TFP should be 0.
CPK (or CP) is right. Constant return to scale does not say anything about TFP OR change in TFP. Change in TFP can be 100% and you can still have constant returns to scale. It just means that capital and labor can substitute for one another.
schweser book 2 page 137
“constant returns to scale assumes %change in TFP = 0”
compare against text book:
production function exhibits constant returns to scale (i.e., a given percentage increase in capital stock and labor input results in an equal percentage increase in output), we can substitute β = (1 − α)
no mention of TFP or change in TFP here.
This:
doesn’t justify:
I just assumed when in the text it meant change in inputs by an amount moves other inputs in a constant proportion. In other words, if labor input goes up a lot vs goes up a little, everything else changes in same proportion.
Constant return to scale means if both labor and capital increase 10%, growth will increase 10%.
If TFP is changing too then this will no longer apply
Well - since the CFAI did not say anything about TFP = 0, I will not set TFP = 0 on the exam.
Who is with me?!!!
Schwes - you anger me.
Your right, it says that. From Schweser Vol 1, Mock 2 answer guide: "Constant returns to scale assumes that the percentage change in total factor productivity is zero, so that if labor and capital increase by a given percentage, economic output will increase by the same amount. "
Clark, are you saying that Schweser is correct on this? If so, why wouldn’t we set ΔTFP to 0 in our calculations then? And why doesn’t CFAI mention this?
Clarification would be great on this.
IT is true that for constant return to scale to hold, % change in TFP = 0.
I really dont feel like showing the math behind it. 
CFAI mentions CRTS means the a & (1-a) relationships hold.
Otherwise for a given amount of input, output will vary.
TFP =0
a given change in K and L will imply the exact same change in growth.
watch out it is not TFP = 0, it is % change in TFP = 0
TFP doesnt have to be zero. Just has to be constant (growth or delta = 0). It just makes (a) and (1-a) hold. If you had increasing returns to scale, you would not be able to use (a) and (1-a) to estimate output
could also mean that % change (increase) in L = % change (increase) in K
Then why, when CFA materials ask us to solve using the Cobb-Douglas and assume returns to scale, do they not want us to set %change in TFP to zero? (e.g. Reading 19, EOC question 2A)