Using firm optimization to evaluate and estimate returns to scale

Arbeitspapier

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 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.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: IZA Discussion Papers ; No. 3368

Classification and Topics

• Classification: Wirtschaft ; Single Equation Models; Single Variables: Panel Data Models; Spatio-temporal Models
• Subject: Production function ; identification ; returns to scale ; covariance structures ; Unternehmen ; Gewinn ; Kosten ; Skalenertrag ; Produktivität ; Betriebswirtschaftliche Produktionsfunktion ; Theorie

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Gorodnichenko, Yuriy
• Event: Veröffentlichung
• (who): Institute for the Study of Labor (IZA)
• (where): Bonn
• (when): 2008

Further information

• Handle: http://hdl.handle.net/10419/35168
• Last update: 10.03.2025, 11:43 AM CET