Revisiting the omitted price bias in the estimation of production functions

González, Xulia, Saul Lach and Daniel Miles

No 17079, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: The lack of information on quantities presents significant challenges for estimating production functions. As shown by Klette and Griliches (1996), deflating nominal variables using aggregate price indices leads to biased estimators. In this paper we show that a similar problem arises when firm-specific prices are recovered from reported firm-specific price \emph{changes} via a recursive formula. This recursion formula depends on an initial condition given by the unobserved price level in the base year which then appears in the empirical production function as firm-specific fixed effect. The standard practice is to ignore these fixed effects by setting the firm-specific prices in the base year to a constant value common to all firms, usually unity (zero in logs). We show that this practice generates biased estimators. We examine this bias via Monte Carlo simulations and with an empirical application. Solving this problem is not straightforward, and requires further assumptions, because these fixed effects generate nonlinear measurement errors.

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: 2022-03
References: Add references at CitEc
Citations:

Downloads: (external link)
https://cepr.org/publications/DP17079 (application/pdf)

Related works:
Journal Article: Revisiting the Omitted Price Bias in the Estimation of Production Functions (2025)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:cpr:ceprdp:17079

Ordering information: This working paper can be ordered from
https://cepr.org/publications/DP17079

Access Statistics for this paper

More papers in CEPR Discussion Papers from Centre for Economic Policy Research 33 Great Sutton Street, London EC1V 0DX, UK.
Bibliographic data for series maintained by CEPR ().