Derived Demand for Factors in the Large-scale Manufacturing Sector of Pakistan

Factor demand is essentially a derived demand because a profit-maximizing firm’s demand for factors is derived from the demand for the final product which it produces. Since the firm’s optimal choice of a bundle of factors depends on the cost-minimization strategy for a given level of output, the derived demand for factors depends on the level of output, the substitution possibilities among factors in production allowed by the production technology, and the relative prices of all factors. Knowledge of the substitution possibilities among factors in production is particularly important if one is interested in deriving implications for policy which influence the relative price of factors. More generally, if substitution possibilities among factors in production are limited then adjustment by industry to higher factor prices will be somewhat difficult, and significant changes in the underlying technological structure may be required. Most of the earlier work on the estimates of elasticities of substitution for Pakistan’s manufacturing sector are restricted to two factors [see Battese and Malik (1988), Kazi et al. (1976); Kemal (1981) and Naqvi et al. (1983)]. These studies either use Cobb-Douglas (CD) Constant Elasticity of Substitution (CES) or Variable Elasticity of Substitution (yES) approaches. These technologies have some wellknown limitations.’ In a recent study using ‘nested’ CES production function Khan (1989) added energy as a third factor of production to estimate the elasticity of substitution.