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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 lnL lnK (t =1, 2, ...,27)
0 1 t 2 t
e
t t
+ + +
Estimated Cobb-Douglas Production Function
No. of
Obs.=27
=
u

0.1884
R
2
= 0.9435
Adj. R
2
=
0.9388
eNe =
0.85163
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, , the matrix R has a single row, r with a 1
0
j

in the j
th
position. Thus R(XNX)
-1
RNis the j
th
diagonal element
of the inverse matrix. The resulting F-Statistic is:
O 2
1,T-K jS j jS
F ( ) Est.Var( )
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
: .
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:
the
r* q
F-statistic is:
( )
( )
( )
2
*
2 j jS
1,T-K
* *
j k jS kS
1 1
r q
r* - q
F
r* r*
r r Est.Cov.
S
j
K K
j k



| `


. ,

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

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:
( )
2
1,24
0.6030 + 0.3757 - 1
F 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:
( )
( )
( )
0 1 t 2 t
t
4 5
2
lnY lnL lnK 1 / 2 ln L
2
1/ 2 ln K lnL lnK (t =1, 2, ...,27)
3 t
t t t
t
t
e


+ + + +
+ +
! 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:
3 4 5
0
! 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:
1 1
J, T-K
2
(R ) [R( ' ) R'] (R )
F
J
O O
S S
u
X X

! 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:
R R S S
J, T - K
2
e e
F
- e e
J
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
No. of
Obs.=27
=
u

0.1799
R
2
= 0.9549
Adj. R
2
=
0.9441
eNe =
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
LN
2
(L)
-0.9641 0.7074 -1.3628
LN
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:
3,21
0.85163 - 0.67993
1.768
3 (0.03238)
F
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.
# 2 4 5
lnY
lnK + l nL
lnK

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:
2 4 5
Est. Var ln K + l nL w w 0.01259
S


]
+
]
where is the full
( )
w = 0 0 1 0 ln K ln L and
S

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).