Section 14.3

Section 14.3.1 presents estimates of a Cobb–Douglas cost function using Nerlove’s 1955 data on theU.S electric power industry. Christensen and Greene’s 1976 update of this study used 1970 data for this industry. The Christensen and Greene data are given in Table F5.2. These data have provided a standard test data set for estimating different forms of production and cost functions, including the stochastic frontier model examined in Example 17.5. It has been suggested that one explanation for the apparent finding of economies of scale in these data is that the smaller firms were inefficient for other reasons. The stochastic frontier might allow one to disentangle these effects. Use these data to fit a frontier cost function which includes a quadratic term in log output in addition to the linear term and the factor prices. Then examine the estimated Jondrow et al. residuals to see if they do indeed vary negatively with output, as suggested. (This will require either some programming on your part or specialized software. The stochastic frontier model is provided as an option in TSP and LIMDEP. Or, the likelihood function can be programmed fairly easily for RATS or GAUSS. Note, for a cost frontier as opposed to a production frontier, it is necessary to reverse the sign on the argument in the Ф function.)

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