Abstract

http://ssrn.com/abstract=892142
 
 

References (69)



 
 

Citations (5)



 


 



Using Firm Optimization to Evaluate and Estimate Returns to Scale


Yuriy Gorodnichenko


University of California, Berkeley - Department of Economics; National Bureau of Economic Research (NBER); Institute for the Study of Labor (IZA)

February 21, 2006


Abstract:     
This paper shows that because of data limitations available estimates of returns to scale at the firm level are for the revenue function, not production function. Given this observation, the paper argues that, under weak assumptions, micro-level estimates of returns to scale are often inconsistent with profit maximization or imply implausibly large profits. The puzzle arises because popular estimators ignore heterogeneity and endogeneity in factor/product prices, assume perfect elasticity of factor supply curves or neglect the restrictions imposed by profit maximization (cost minimization) so that estimators are inconsistent or poorly identified. The paper argues that simple structural estimators can address these problems. Specifically, the paper proposes a full-information estimator that models the cost and the revenue functions simultaneously and accounts for unobserved heterogeneity in productivity and factor prices symmetrically. The strength of the proposed estimator is illustrated by Monte Carlo simulations and an empirical application. Finally, the paper discusses a number of implications of estimating revenue functions rather than production functions and demonstrates that the profit share in revenue is a robust non-parametric economic diagnostic for estimates of returns to scale.

Number of Pages in PDF File: 60

Keywords: production function, identification, returns to scale, covariance structures

JEL Classification: C23, C33, D24

working papers series


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Date posted: March 21, 2006  

Suggested Citation

Gorodnichenko, Yuriy, Using Firm Optimization to Evaluate and Estimate Returns to Scale (February 21, 2006). Available at SSRN: http://ssrn.com/abstract=892142 or http://dx.doi.org/10.2139/ssrn.892142

Contact Information

Yuriy Gorodnichenko (Contact Author)
University of California, Berkeley - Department of Economics ( email )
549 Evans Hall #3880
Berkeley, CA 94720-3880
United States
HOME PAGE: http://www.econ.berkeley.edu/~ygorodni/index.htm
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Institute for the Study of Labor (IZA)
P.O. Box 7240
Bonn, D-53072
Germany
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