Revisiting the omitted price bias in the estimation of production functions

González, Xulia, Saul Lach and Daniel Miles

No 17079, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We revisit the bias in the estimation of production functions with firm-level data due to the lack of physical quantities on output and inputs. We show that constructing firm-specific prices from available data on firm-specific price changes, and using them to deflate revenues and expenditures, introduces a measurement error into the empirical production function. This error reflects the unobserved base year prices used in the construction of the firm-specific prices. The usual practice of ignoring them generates an omitted variable bias (OVB). Monte Carlo simulations suggest that this bias can be significant. Because of the OVB, the estimates are sensitive to the choice of base year. The OVB disappears in our simulations when firm-specific fixed effects are incorporated into the estimation of the production function.

Keywords: Production function estimation; Unobserved prices; Omitted variable bias (search for similar items in EconPapers)
JEL-codes: D22 D24 L10 L60 (search for similar items in EconPapers)
Date: 2022-04
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