July 2011

IZA DP No. 5881: On Input Market Frictions and Estimation of Factors Demand

Published as "On input market frictions and estimation of factors' demand" in Southern Economic Journal, 2014, 80 (3), 772-782. (Winner of 2015 Georgescu-Roegen Prize for best paper published in SEJ during the calendar year.)

In this paper we explore the impact of imperfectly competitive input markets on production function estimation. First order profit maximizing conditions are altered when frictions in input markets cause the elasticity of input supply to the firm to be finite. A consequence of this is that the standard econometric model used for production function estimation will be misspecified. We prove that, in all non trivial cases, finite elasticities of supply to the firm will lead to inconsistent estimates of production function parameters. Monte Carlo simulations show that the resulting bias can be economically significant.