Journal of Econometrics 13 (1980) 101-115.

0 North-Holland Publishing Company

ON THE ESTIMATION OF
A FLEXIBLE FRONTIER PRODUCTION MODEL

William H. GREENE
Cornell University, Ithaca, NY 14853, USA

1. Introduction

This paper will describe a method of estimating the frontier production

model using the translog functional form. Efficient estimation of flexible
functional forms generally entails the use of a set of factor demand equations
and a multivariate estimator. The received frontier models have dealt with
relatively simple (e.g., Cobb-Douglas) technologies, and have, with the
exception noted below, been estimated using single equation techniques.
Hence, in order to achieve the greater level of generality afforded by the
flexible functional forms, some modification of the familiar frontier estimators
is required.
Additional information can be obtained by estimating the frontier function
in this framework. In their recent study, Schmidt and Love11 (1977) showed
how the factor demands implied by a Cobb-Douglas model could be used to
study allocative inefficiency. Previous empirical results have, because they
have dealt only with either direct or indirect estimation of the production
function, provided evidence only on technical inefficiency. The use of a set of
demand equations and a flexible functional form allows the simultaneous
estimation of both types of inefficiency in the setting of a general model of
production.
Numerous flexible functional forms have been proposed, among them the
generalized quadratic, translog, generalized Leontief, and generalized Cobb-
Douglas. By far the most widely used has been the translog function. We will
concentrate on the translog production [Berndt and Christensen (1973)] and
cost [Christensen and Greene (1976)] functions in this study. Most of the
flexible functional forms and their associated demand functions are, like the
translog, linear in their parameters. Hence, the extension to other functional
forms will, in many cases, be direct. In addition, we will consider the one
sided Gamma distributed disturbance for the frontier function. [See Greene
(1980).] But, an alternative, the stochastic frontier specification proposed by
Aigner, Lovell, and Schmidt [ALS (1977)] is easily accommodated, as will be
102 W.H. Greene, Estimation ofuflexihle,frontier production model

shown. The maximum likelihood estimator described uses an extension of the

results presented by Joreskog (1973) for estimation of a general linear
structural model. The underlying rationale of the frontier model and the
various aspects of an appropriate stochastic structure are discussed elsewhere
[e.g., Aigner and Chu (1968), Aigner, Love11 and Schmidt (1977) Greene
(1980) Schmidt and Love11 (1977, 1978), etc.] and will not be reviewed here.

2. Functional form and stochastic specification

The translog production function may be written

logq=y,+y’logz+ ~logz’rlogz-E,,

where q is output, z is a vector of M inputs, logz is a vector each of whose

elements is the logarithm of the corresponding element in z, yO, y, and r are
1 x 1, M x 1, and M x M parameter matrices, and cp is a random disturbance.
The translog production function places no constraints on substitution
among inputs and does not assume separability. [Additional discussion of
the characteristics of this production function may be found in Berndt and
Christensen (1973).]
The disturbance, cp, captures the effects of technical inefficiency. Following
Greene (1980) we will assume that sp is positive. Thus, all observations lie
below the frontier defined by the systematic part of the right-hand side of (1).
Alternatively, E,, could be formulated as the sum of a symmetric component
representing the effect of factors outside the control of the firm and a one
sided component representing technical inefficiency, as proposed by ALS. In
this case, cP is not one sided, but is asymmetric.
One could, in principle, estimate the parameters in (1) using ordinary least
squares or instrumental variables. Of course, this neglects the nature of the
disturbance, so a maximum likelihood technique could be employed.
However, as the number of inputs increases, the number of parameters
becomes quite large. If the model contains more than two inputs,
multicollinearity will likely be severe. Thus, single equation estimates will
likely be imprecise.
Berndt and Christensen (1973) have shown how this problem can be
overcome in the standard setting by the use of a set of factor demand
equations. The resulting system of equations can be used with the Zellner
estimator to obtain more precise estimates of the parameters. Assuming that
factors are paid their marginal products and that production is characterized
 W.H. Greene, Estimation of uflexiblefrontier production model 103

by constant returns to scale, the set of factor cost shares is given by

alog62
-=s=y+r10gz+w,,
alOgz

where wP is a disturbance vector.

A number of restrictions are required for estimation of (2). First, an
identifying restriction, symmetry of r, r = r’ is necessary. Constant returns to
scale implies y’i = 1, XT = 0’ and Ti = 0, where i = (1, 1, . . ., 1)‘. The (A4 - 1) = N
independent share equations provide a set of linear equations which, with the
cross equation restrictions implied by the symmetry of r, can provide efficient
estimates. [For further discussion of additional restrictions on, and
estimation of, the translog function, see Berndt and Christensen (1973).]
Alternatively, (1) and (2) can be estimated jointly, as we shall propose here.
(Note that in either case, one of the share equations is dropped in order to
obtain a non-singular equation system.)
Inasmuch as w represents the deviation of the observed cost shares from
the theoretical optimum, it is appropriate to interpret w as the effect of
allocative inefficiency. In their study, Schmidt and Love11 [SL (1977)]
represented allocative inefficiency using the input ratios, i.e., log (zi/zl )
= ‘optimum’ + wi, using zi as the numeraire. Of course, the two formulations
are equally i,nformative. The question arises, though, in either formulation,
whether w captures only the effects of allocative inefficiency. This is clearly
the case if production is homothetic as the input ratios and factor cost shares
are independent of output. Thus, allocative inefficiency can be represented in
this manner in SL’s Cobb-Douglas case and in the present case in which
linear homogeneity has been assumed. On the other hand, if the production
structure is not homothetic, the factor shares and input ratios are not
independent of the level of output. Hence, in this case, it is not clear that
allocative inefficiency can be represented in this fashion.
In what follows, we will model E and w as stochastically independent
effects. Whether or not this is reasonable is considered in Schmidt and Love11
(1978). They point out that given certain dynamic considerations, a model
which assumes independence may well be appropriate. At this stage, the
answer seems unclear. In practical terms, Schmidt and Love11 (1978) find that
dispensing with the assumption has almost no effect on their estimates of the
frontier. But, as they amply demonstrate, this generalization dramatically
complicates the problem.
The translog function is the only one of the flexible functional forms which
is readily used for direct estimation of the production function. The various
flexible models have been most useful in the indirect estimation of
production structures through the use of cost functions. In certain settings,
104 W.H. Greene, Estimution of u flrxihle/rontirr production model

the neoclassical cost function provides a preferable alternative to the

production function for studying the structure of production. The cost
function methodology assumes that prices and output are exogenous, while,
as before, the input demands and total cost are endogenous. The behavioral
assumption underlying the formulation is that producers minimize the costs
of production subject to output, prices, and the production function. The
model has been most frequently applied to regulated industries in which
output prices are set by regulatory agencies rather than the firms themselves.
[See e.g., Nerlove (1963).]
The translog cost function is

log c = 6, + 6, log q + d’log p + l/2 6,,(log q)2

+ l/2 log p’ A log p + a;, log p + I-:,, (3)

where p is the vector of input prices and C is total cost. Linear homogeneity
in prices requires 6’i= 1, A’i=O, and db,i =O. Symmetry, A = A’ is required for
identification. This cost function corresponds to a non-homothetic
production structure and places no constraints on elasticities of substitution.
It provides an extremely versatile framework which can be used to study
substitution effects [Berndt and Wood (1975)], scale effects [Christensen and
Greene (1976)], and technological change [Berndt and Khaled (1977)].
The set of factor cost share equations is derived using Shephard’s (1953)
Lemma.

a1og c
-=S=d+Alogp+6,,logq+w,. (4)
i3logp

As before, one of the cost share equations is dropped in estimation. Note

that unless constant returns to scale is assumed, (6, = 1, 6,, =O, 6,, =O), the
share equations do not provide a full set of parameter estimates. [See
Christensen and Greene (1976) for details on joint estimation of (3) and (4).]
Unfortunately, the interpretation of the disturbances in the cost model is
less clear than it was on the production side. First, assume that firms are
allocatively efficient. Then E, represents the cost of technical efficiency and is
always positive. Thus, the systematic part of (3) gives the cost frontier.
However, unless production is homogeneous, the relationship between E, and
cp is unclear. If production is homogeneous of degree r, then E, =GJY. If
production is not homogeneous, the relationship between cP and E, still
depends on the degree of returns to scale, but not in any obvious manner.
But producers can be allocatively inefficient as well. It is clear from (4)
that w, only represents purely allocative effects when production is
homothetic (i.e., a,, --0). But, even if production is homothetic, c, represents
 W.H. Greene, Estimation ofajlexible,frontier production model 105

the total costs of inefficiency, and is thus affected by both types. The problem
is that w, enters E, in a very complicated manner. Regardless of the sign of
w,, its contribution of E, is positive. Take the case analyzed by Schmidt and
Love11 (1977) as an example. Using a Cobb-Douglas production function of
degree of homogeneity r, and using demands xi/x1 =hi(p)ewi, they find (in
our notation)

~c=~p/r+ i (yi/‘)Wi+lOg yl+ 2 Yi’e-“’ .

i=2 ( i=2 >

Even for this simple production model, direct statistical treatment of E,

appears intractible (with or without independence of E and w).
Thus, the cost function disturbance has two components. The exact
statistical relationship between E, and w, appears unclear, particularly in view
of the positive sign of wis contribution to E,. As a first step, at least in a
model in which monotheticity is assumed, one might treat them as
independent, but clearly this is a simplifying assumption at best. Given the
usefulness of the cost function methodology, this seems to be a promising
area for future research. We will consider estimation of systems (l)-(2) and
(3)(4). In both, E and w are assumed to be independent. As discussed above,
particularly in the cost function case, a number of caveats apply.

3. Likelihood function and estimation

We assume, then, that the frontier function of interest is (l), (3), or some
other function linear in its parameters (perhaps after suitable
transformation). Following Greene (1980) assume that the disturbance
follows the two parameter Gamma probability law,

where P(P) is the Gamma function evaluated at P. This disturbance has

mean P/A and variance P/i2 and is always positive. Further properties of the
Gamma density and the implied likelihood function and maximum likelihood
estimator are derived in the earlier paper. The disturbance vector on the
share equations is assumed to be joint normally distributed with zero mean
and non-singular covariance matrix, 52. Thus,

[The assumption of non-singular 52 implies that the redundant share

106 W.H. Greene, Estimation of uflexiblefrontier production model

equation has been dropped at the outset. See Berndt and Christensen (1973).
With the independence assumption, the joint density of E and w is the
product
f(s w)=~pap+l exp{ -(1/2w’Q-‘w-t-&)}
3
(27r)V(P$4”2 .

To form the likelihood function, it is convenient to rewrite the frontier

function and the share equations. Let the frontier function for the tth
observation be

Y*=R’X,+E fr t=l,...,T,

where x is the full vector of K regressors. The case of positive disturbance

(cost function) is assumed for convenience. All necessary prior restrictions are
imposed on 71, so that all elements of n are unconstrained. [See (5).] The N
independent share equations can now be written

s,= nx, + w,, t=l,...,T,

where S, is the (N x 1) vector of observations on the factor shares for the tth
observation. Note that the N xK parameter matrix II contains a substantial
number of zeroes, as none of the quadratic terms in (1) or (3) appear in the
share equations. There will also be a number of equality restrictions on 17
due to the symmetry of the second order terms [rij=rji in (I), and A,,= dji in
(3).] But, every non-zero element in f7 is equal to some element in Z. Now,
let

W = (l/T) % (S, - nx,)(S, - 0=x,)’

1=1

be the N x N sample estimate of Q based on a random sample, w, (t

= 1,. ., T). The log likelihood, apart from an irrelevant constant, is

Ye= -T(lnT(P)-PIni)-T/2[ln1Q1+tr(K1W)]

+(P-l)Cln(4.1- 7r’X,)4&4Xf).
I t

The problem of maximizing 9 with respect to I, P, rc, 17, and Q (subject

to all of the necessary restrictions in n) is simplified by concentrating over
s2. At the maximum of 2, we have

d_Y
n-T"-l(R-W).C-'=@
 W.H. Greene, Estimation of afleviblefrontier production model 107

This implies that, given ll (i.e., z), W is the MLE of 52. Substituting this
result in 9, and discarding a constant, we obtain the concentrated log
likelihood function

5?*=-T(lnT(P)--PIni)-T/2lnIWI

+ (P - 1) C In (y, - II’X,) - /zC (y, - 7r’xf),

t f

which is to be maximized with respect to I.,P, 71, and ll subject to all of the
constraints relating ll and II.
The likelihood equations, which are given in the appendix, provide a set of
non-linear equations which can be solved iteratively to obtain estimates of
the unknown parameters. The second derivatives are straightforward, and
Newton’s method can be employed to obtain the estimates. These are also
given in the appendix at the end of the paper.
We now consider imposing the equality constraints in 71 on the estimation
procedure. First, let

and note that p is the full set of (K +2) unconstrained parameters in the
model. Let

where 6, is obtained by stacking the row of I1 in an NK x 1 vector, be the full

set of (N + 1 )K + 2 constrained parameters in the model.
Define the ((N+l)K+2)x (Kf2) matrix C by

Cij=l if fii=pj,

=0 if bi#pj or pi=O.

Then
p=c/l.

To obtain ?_Y*/ap, simply arrange the elements of a_%‘*/aa. [See eq. (A.2).]
108 W.H. Greene, Estimation of a flexible frontier production model

in a ((N + l)K +2) x 1 vector. (The last NK elements are a_Y*/ZZl arranged
by rows.) Then,

The derivatives of _5?* with respect to p are simple sums of the elements in
aZ’*/afi. Finally, the asymptotic second derivatives

a22*
plim ---z=~@C=H,
a~+~

where @ = a2Y*/ajIap’. [See eq. (A.6).]

The iteration procedure is simply

where at each iteration.

s,s, = c&s,.

We have found that good starting values for 72 are provided by the
multivariate normal regression using the share equations and the frontier
function. To obtain starting values for I and P, a set of estimates of the
disturbances E, is first obtained by moving the intercept of the estimated
frontier until all residuals are positive (or negative) - save one. Then, the
sample mean and variance of these modified residuals provide moment
estimators for P and II. The Gamma function and its derivatives are
approximated using a Gauss-Laguerre polynomial approximation. At
convergence, -H- ’ provides the estimated asymptotic covariance matrix for
the parameter estimates.

4. An application

In a well known paper, Berndt and Wood (1975) estimate a translog cost
function using annual time series data (1947-1971) for the U.S.
manufacturing sector. To illustrate the techniques described above, we have
reestimated their model employing the translog production function (1).
The production function for U.S. manufacturing is modelled as a four
input process, these being capital (K), labor (L), energy (E), and materials
(M). Berndt and Wood assume constant returns to scale in their study, but
place no restrictions on the Allen partial elasticities of substitution. In a
more recent study using these same data, Berndt and Khaled (1977) have
 W.H. Greene, Estimation of a flexible frontier production model 109

relaxed the constant returns assumption. However, at this level of

aggregation the technical concept of economies of scale seems ambiguous
enough to make the initial Berndt and Wood specification preferable, and we
have maintained it here.
This restriction which is necessary for estimation of (1) and (2) may not be
palatable in some settings, however, for an aggregate production function it
is probably reasonable. (We note, in passing, that one of the primary virtues
of the cost function approach, when it is justifiable, is that it allows much
more general specifications of scale effects than are generally tractable on the
production side.) The specific model estimated is a translog production
function with Hicks neutral technical change,

hh?/w = Yo + YK log (WW-t YL 1% w/w +YElog ww

+tYdog ww)2 @gWWY
+3YLL
+ +YEE(log(E/M )I2
+ YKLlog KIM) 1%W/M) + YKElog WM) log ww
+YLElog w/f4 1%ww +y7.t. (5)

The constant returns to scale and symmetry restrictions are imposed

directly. The variable t is time, in years 1, 2,. . ., 25, and yT is the rate of
technical change. Berndt and Wood did not estimate the rate of technical
change, as they only estimated the three independent cost share equations.
For the above production model,

s, = YK + yge log (K/M) + YKL log cLIM) + Yhti log tEIM)? (6a)
(6b)

SE=yE+y,,log(K/~)+yL,log(L/M)+yE,log(E/M)' (64

Note that if only the share equations are estimated, the model in (5) cannot
be distinguished from one in which technical change is assumed to be zero.
The remaining parameters (yM, yKN, yLM, yEM, yMM) are deduced from direct
estimates and from the restrictions.
The cost data, cost shares, and price data are given in Berndt and Wood
(1975), and the output and input data are found in Berndt and Khaled
(1977). Table 1 presents two sets of estimates of the free parameters in the
model. The first is the result of treating (5)(6) as a four equation
multivariate normal regression model.
These estimates were used as the starting values for the frontier estimates
which appear in the second column.
 Table 1
Parameter estimates for translog production function (asymptotic t-
ratios in parentheses).a

Multivariate normal Full frontier

1.1470 (33.25) 1.4972 (12.27)

0.0886 (3.75) 0.1090 (4.35)
0.2364 (8.27) 0.2324 (8.43)
0.1265 (8.99) 0.1341 (9.19)
-0.0126 (- 1.16) -0.0055 ( - 0.48)
- 0.0873 ( - 5.45) -0.0901 (- 5.58)
0.003 1 (0.40) 0.0046 (0.56)
0.0041 (0.53) 0.0037 (0.47)
0.0025 (4.12) 0.0024 (4.31)
0.0182 (6.67) 0.0183 (6.71)
0.0074 (16.10) 0.0069 (14.94)
111.89 (4.18)
2.56 (2.06)

“Asymptotic t-ratios are computed as the ratio of the estimated

coefficient to the square root of the corresponding diagonal element of
the estimated asymptotic covariance matrix. They are asymptotically
distributed as standard normal.

Table 2
Distribution of residuals

Disturbance distribution estinmres

EmpirIcal mean u 0.0258
Empirical variance c1mc, (c,-4z I
0.0003
Minimum (negative) min (el,...,rT) 0.00179
Maximum (negative) max (e,, .. e?) 0.05560
Expected value P/i: 0.0219
Variance B/i’ 0.000187
EstimatcJd disturhmcrs

1947 0.0288 1960 0.0155

1948 0.0253 1961 0.0192
1949 0.0213 1962 0.0244
1950 0.0162 1963 0.0217
1951 0.0120 1964 0.0334
1952 0.0092 1965 0.0368
1953 0.0561 1966 0.0404
1954 0.0037 1967 0.0425
1955 0.0018 1968 0.0456
1956 0.0033 1969 0.0501
1957 0.0054 1970 0.0556
1958 0.0074 1971 0.0529
1959 0.01 I 1
 Estimation
W.H. Greene, of (I ,flexible,frrontier production model 111

The differences in the estimated elasticities of substitution obtained using

the frontier function differ only marginally from those found by Berndt and
Wood. Our estimate of the rate of technical change in U.S. manufacturing is
0.69% per year. The Berndt and Khaled study, which employs a different
functional form and a more involved model, presents many results on returns
to scale and technical change, and it is difficult to extract a single figure for
comparison. However, in the case in which they assume constant returns to
scale and Hicks neutral technical change, they obtain an estimate of 0.72 IX.
Table 2 presents the maximum likehood estimates of the moments off(s)
and the estimated disturbances for these data. The mean inefficiency is
roughly 2.2’/& and the standard deviation of the theoretical distribution is
roughly 1.4”/,. Thus, an average efficiency of about 97.8 7” is implied. The
individual estimated disturbances are presented also in table 2.
The residuals from the cost share equations do not contain any obvious
patterns except that the residuals on the capital and material equations
always have opposite signs. The means of the four sets of residuals are quite
small, and not significantly different from zero. No systematic allocative
inefficiency is indicated in these data.
In their study, Schmidt and Love11 found that the mean residuals on their
demand equations were quite large and significantly different from zero. The
model described here can also be easily modified to allow a non-zero mean
of the allocative efficiency effects by simply relaxing the constraints that force
the intercepts in the share equations to equal the first-order terms in the
frontier. Define, for example, ak to be the non-zero mean of the disturbance
in (6a). Now, define yt = yk + ak and wz = wk - Q, then, the model is exactly as
before, i.e., with a zero mean disturbance. The estimate of yk from (5) can be
subtracted from that of 7: from (6a) obtain the estimate of Q.
Computationally, this modification entails simply adding c+ to the sets of
parameters in p and j? and constructing the matrix C accordingly.

5. Conclusions

The preceding has presented an estimator for frontier production models

using a flexible functional form such as the translog or generalized quadratic
among several. These recently developed functional forms allow much more
general specifications of technology than the Cobb-Douglas model, and
should provide an attractive framework for estimating frontier models as
well. The estimator described relies heavily upon the linearity of the
production (or cost) function and the set of demand equations, but
modification to accommodate non-linear models, while tedious, is certainly
feasible.
The use of a set of demand or share equations brings a great amount of
112 W.H. Greene, Estimation of a flexible frontier productiorl model

information to bear upon the problem, and can provide estimates far more
efficient than those obtained by single equation methods. For example, for
the single equation (least squares and maximum likelihood) estimators of
eq. (5) only the estimated intercept is larger than its estimated standard
error.
We have derived results for a one sided disturbance, or full frontier model.
However, the modification of the methodology required for the composite
error term of Aigner, Lovell, and Schmidt (1977) would simply be the
replacement of the first three equations in (A.2) with their equations (llb(13)
and the elements in the upper-left block of (A.7) with their (A.lb(A.6).

Appendix

The concentrated log likelihood function is

L*= -T(lnP(P)--PlnI)-(T/2)ln(Wj

+(P-l)Cln(L’r-~‘x,)-~C(y,-~‘x,), (A.11
t t

where

W=(l,T)i
f=l
(S,-x,)(S,-x,)‘.

The likelihood equations are

d2?* TP
-=l_-c (yt-7c’x,)=O,
dl f

?i_!Z*
~=T(lni-r’(P)/P(P))+~ln(~z-z’~,)=O,
/ f
(A.9
~~=~~x,+(P-I)~x,,(Br-n’x,)=O.
* f

a_Y*
p= -TW-‘(Z7M,,-M,,)=[O],
an

where
 W.H. Greene, Estimation of a flexible frontier production model 113

With respect to the parameters in the frontier function,

=
II 22

2
1 T(P)T”(P) - (r’(P)y
(r(p))2 I
. (A.3)

For elements in the share equations,

a29*
= -T(W,‘Mxxj, -(Wm’v)il(WplVj~)
anij
an,,
-w,‘(v’w-‘V),,), (A.4)

where

V=llM,,-M,,.

For purpose of estimation and for forming asymptotic standard errors, it is

convenient to rearrange the elements in 17, row by row, in a vector 8. Thus,

r;lij=e,i_l,,+j.
(A.5)

This allows the convenient arrangement of the elements in (A.4) into an NK

x NK matrix, a2L?*/d0 a&. Absent the constraints, d21P*/d0 a$ = [IO]. The
elements (A.3) may be replaced with their exact expectations, and those of
114 W.H. Greene, Estimution of‘ a ,flr.xihle,frontier production model

(?26a*/P0?O’ with T times plim ((1/T);12T*/~08W) to obtain

i 0

I
Y(P) I
(A.6)
IL
A2M /
p-l- p-2 x-x 1

d-m ---------__--_-
I

where X is the vector of sample means, and y(P) = (TT” - f ‘2)/r2.’

Imposition of the constraints linking T-C
and n is discussed in the text.

‘See Jiireskog (1973) for derivatives with respect to I7 and for the result in the lower right
block of the matrix in (A.6).

References

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Economic Review 58, 826839.
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production models, Journal of Econometrics 5, no. 1, 21-38.
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equipment, structures and labor in U.S. manufacturing 1929 lY6X. Journal of Econometrics
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gains in U.S. manufacturing, 194771971, Discussion Paper no. 77.~23 (Department of
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stochastic production and cost frontiers, Econometrics Workshop Paper no. 7702 (Michigan
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