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Estimation of a Cobb-Douglas Production Function

! Least squares regression of log output (value added) on a

constant and the logarithm of labor and capital produce

parameter estimates of a Cobb-Douglas production function.

! The following Table provides the results of our estimating a

Cobb-Douglas production function:

lnY t

= b

0

+ b

1

lnL

+ b

lnK

t2t

+ e

t

(t =1, 2,

,27)

Estimated Cobb-Douglas Production Function

No. of

Obs.=27

s

u

=

0.1884

R 2 =

0.9435

eNe =

0.85163

0.9388

Variable

Coefficient

Std. Error

T-Ratio

Intercept

1.1706

0.3268

3.5823

LN(Lab)

0.6030

0.1260

4.7875

LN(K)

0.3757

0.0853

4.4022

Estimated Covariance Matrix

Intercept

0.10680

LN(Lab)

-0.01984

0.01586

LN(K)

0.00189

-0.00961

0.00728

! For testing the hypothesis that the j th coefficient is equal to a

particular value,

0

b j

, the matrix R has a single row, r with a 1

in the j th position. Thus R(XNX) -1 RN is the j th diagonal element of the inverse matrix. The resulting F-Statistic is:

F

1,T-K

= (b

jS

- O
2
b
)
j

Est.Var(b

jS

)

which is the square of the t-statistic with (T-K) degrees of freedom.

! Lets test the null hypothesis that the output elasticity of labor

equals 1, H 0 :

b

1

= 1

.

! The following F-Statistic is obtained:

F 1,2 = (0.6030 - 1) 2 /(0.0156) = 9.937. The 5% critical value is 4.26 . We therefore reject the null hypothesis.

! For testing a single linear restriction of the for H 0: r*b = q the

F-statistic is:

F 1,T-K

=

(

r*

b

- q

)

2

r*

S

b

S

r* ¢

=

 Ê Á Â ( * ) ˆ 2 r j b jS - q ˜ Ë j ¯ K K ÂÂ j 1 = k 1 = r r Est.Cov. j k * * ( b jS b kS )

where r* is (1 x K) and r j * is the j th coefficient and

S

b

S

the

variance covariance matrix of least squares parameters.

! The hypothesis of constant returns to scale is equivalent to the null hypothesis that the sum of labor and capital coefficients equals 1.

! From the above results, we have:

F

1,24

=

(

0.6030 + 0.3757 - 1

) 2

=

0.1157

(0.01586 + 0.00728 + 2(-0.00961)

This is substantially less than the critical F-value of 4.26 . We would not reject the null hypothesis. That is, the data are consistent with the hypothesis of constant returns to scale.

Estimation of the Translog Production Function

! A generalization of the Cobb-Douglas estimated above is the translog model which can be represented by the following:

lnY

b

t

4

=

b

0

+

(

1 / 2 ln

b

2

1

lnL

t

K

t

)

+

+

b

b

5

2

lnK

t t

(

lnL

t

+

b

3

lnK

t

(

)

1 / 2 ln

+

e

t

2

L

t

)

+

(t =1, 2,

,27)

! This model differs from the Cobb-Douglas model in that it relaxes the assumption of unitary elasticity of substitution. Note the Cobb-Douglas model is obtained by the restriction:

bbb=== 0

345

! The F-statistic for the hypothesis of a Cobb-Douglas model can be obtained using the general F-statistic we reviewed in class when we have multiple linear restrictions on the parameters using the formula:

F J, T-K

=

(R

b

S

-

b

O

) [R(

¢

X

'

X

)

-

1

R ']

-

1

(R

b

S

-

b

O

)

J s

2

u

! Alternatively, we recognize that the above Cobb-Douglas production function represents a restricted regression that imposes that above parameter restrictions. It can be shown

that the above F-statistic can be calculated via the following:

F J, T - K

=

e

R

¢

e

R

- e

S

¢ e

S

J s

2

u

where e R Ne R is the sum of squared errors from the restricted

regression which in our example is the Cobb-Douglas

production function.

! The following table provides the results of estimating the

translog production function regression model:

 Estimated Translog Production Function R 2 = 0.9549 No. of s u = Adj. R 2 = Obs.=27 0.1799 eNe = 0.9441 0.67993 Variable Coefficient Std. Error T-Ratio Intercept 0.9442 2.9108 0.3244 LN(L) 3.6136 1.5481 2.3343 LN(K) -1.8931 1.0163 -1.8628 ½LN 2 (L) -0.9641 0.7074 -1.3628 ½LN 2 (K) 0.0853 0.2926 0.2915 LN(L)*LN(K) 0.3124 0.4389 0.7117

! The resulting F-statistic for the null hypothesis of a Cobb-

Douglas model is:

F

3,21

=

0.85163 - 0.67993

3 (0.03238)

= 1.768

The critical value from the F table is 3.07, so we could not reject

the hypothesis of a Cobb-Douglas model.

! Note the coefficient on lnK is now negative. This does not mean that the estimated output elasticity with respect to capital has the wrong sign.

lnY

# =

lnK

b

2

+

b

4

lnK +

b

5

lnL

Inserting the coefficient estimates and mean values of lnK

and lnL (not the log of the means) of 7.4459 and 5.7637,

the above partial is 0.5425.

# Estimated variance for this linear combination of the least

squares estimates is computed as:

Est. Var

where

È

Î

b

2

w =

+

(

b

4

ln K +

b

5

ln L

˘ ˚ =

0010 ln K ln L

)

¢

w

¢S

b

S

and S

w

b

S

=

0.01259

is the full

6x6 covariance matrix of the least squares parameters.

# At the mean values, the above results imply that the

hypothesis that the marginal impact of K on output is non-

positive is rejected (t = 0.5425/0.1122).