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Using firm optimization to evaluate and estimate returns to scale," (previous title: "Estimating Returns to Scale: Critique of Popular Estimators and New Solutions to Old Problems"), working paper available at http://www-personal.umich.edu/~ygorodni/ Gril

By Yuriy Gorodnichenko, Robert Chirinko, Olivier Coibion, Erwin Diewert and Juan Carlos

Abstract

At the firm level, revenue and costs are well measured but prices and quantities are not. This paper shows that because of these data limitations 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 propose

Topics: Production functions estimated on establishment level data provide essential insights into
Year: 2006
OAI identifier: oai:CiteSeerX.psu:10.1.1.187.1005
Provided by: CiteSeerX
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