Estimation Techniques for the Elasticity of Substitution and Other Production Parameters

Publisher Summary This chapter describes a general analytic framework in which estimators of the elasticity of capital-labor substitution and other production parameters can be examined for specification bias. Econometric methods are devised for testing the production model against specific alternatives of interest. In particular, tests are developed for the following sources of possible bias in the usual cross-section estimates of industry production functions: (1) nonconstant returns to scale and nonhomotheticity in production, (2) inclusion of productive factors other than capital and labor, particularly raw materials, (3) variations in output prices faced by firms, and (4) nonconstancy of the elasticity of substitution. The chapter discusses a useful reformulation of production possibilities in terms of cost functions and describes the elasticity of substitution. It also discusses the assumptions underlying the usual estimation procedures and evidence in the literature concerning their validity.