Working Papers 2009– Abstracts

The Econometric Specification of Input Demand Systems Implied by Cost Function Representations

Keith R. McLaren and Xueyan Zhao

In the case of input demand systems based on specification of technology by a Translog cost function, it is common to estimate either a system of share equations alone, or to supplement them by the cost function. By adding up, one of the share equations is excluded. In this paper it is argued that a system of n-1 share equations is essentially incomplete, whereas if the n-1 share equations are supplemented by the cost function the implied error structure is inadmissible. Similarly, if the technology is specified by a normalized quadratic cost function, it is common to estimate either a system of n-1 demand equations alone, or to supplement them by the cost function. In both cases, the implied error structure is again inadmissible.

Keywords: Cost Function; Input demands; Share equations; Translog; Normalized Quadratic; Error specification.

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