Agricultural & Applied Economics Association

Production Function Estimation and Related Risk Considerations

Author(s): Richard E. Just and Rulon D. Pope
Source: American Journal of Agricultural Economics, Vol. 61, No. 2 (May, 1979), pp. 276-284
Published by: Oxford University Press on behalf of the Agricultural & Applied Economics Association
Stable URL: http://www.jstor.org/stable/1239732 .
Accessed: 18/09/2013 17:56

Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at .
http://www.jstor.org/page/info/about/policies/terms.jsp

.
JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of
content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms
of scholarship. For more information about JSTOR, please contact support@jstor.org.

Agricultural & Applied Economics Association and Oxford University Press are collaborating with JSTOR to
digitize, preserve and extend access to American Journal of Agricultural Economics.

http://www.jstor.org

This content downloaded from 128.135.12.127 on Wed, 18 Sep 2013 17:56:16 PM

All use subject to JSTOR Terms and Conditions
 Production Function Estimation and
Related Risk Considerations
Richard E. Just and Rulon D. Pope

Therehas been considerableinterestin estimationsof inputeffects on the probability

distributionof output.Mostempiricalandtheoreticalanalysesutilizemultiplicative
stochasticspecificationswhich are analyzedandfoundundulyrestrictive,particularly
since inputsthat marginallyreduceriskare not allowed.A moregeneralstochastic
specificationis proposed,free of these a priorirestrictions.The proposedfunctionalform
estimationis discussedanddemonstratedwith nitrogen-responsedataand common
log-linearproductionfunctions.Thoughnitrogenis risk-increasing,the marginalvariance
contributionis smallerwhen comparedto estimatesbasedupon multiplicative
specification.Finally,stochasticspecificationerroreffects are analyzed.

Key words: fertilizerresponsefunctions,productionfunctions,risk.

Increasingly, risk considerations are neces-
sary in the analysis of the agricultural sector.
Risk is affected not only by price and other
market-related phenomena but also by many
technological innovations and government
policies related to input use. For example,
much of the controversy surrounding pesticide
regulations relates to their reducing risk (see
Turpin and Maxwell). In such a case, intelli-
gent public policy formulation should consider
not only the marginal contribution of pesticide
use to the mean of output but also the marginal
reduction in variance of output. Other exam-
ples in which increased input use appears to
reduce variability are "overcapitalization,"
frost protection such as use of smudge pots,
and possibly irrigation. Consider, for example,
overcapitalization in grain harvesting. The use
of large (and fast) harvesting equipment, as
opposed to smaller (and slower) equipment,
usually leads to less variability of output (be-
cause of random weather conditions which
can destroy a ripe crop before harvest).
The problem of investigating stochastic as-
pects of production response is apparently an
old one (Fuller, Day, and Anderson). The
traditional approach in agricultural economics
to evaluating the impact of inputs on risk in
production has been to use experimental data.
This method, of course, allows the variance of
Richard E. Just is an associate professor of agricultural and re-
source economics, University of California, Berkeley, and Rulon
D. Pope is an assistant professor of agricultural economics, Uni-
versity of California, Davis.
yields to be estimated within cells. A number
of other authors (e.g., de Janvry and Fuller)
have recognized that more efficient estimation
is possible by utilizing continuous response
functions. Apparently thus far, however, no
one has given adequate attention to the effect
of inputs on risk. This is true of both empirical
and theoretical studies. As shown in this pa-
per, virtually all empirical and theoretical
studies make implicit, if not explicit, assump-
tions to the effect that inputs increase risk.
Examples of such theoretical studies are such
notable works as Stiglitz, Batra, Magnusson,
Crawford, Rothenberg and Smith, Bardhan,
and Feldstein. Examples of empirical works
include such notables as de Janvry, Wolgin,
Sadan, and Moscardi and de Janvry.
The purpose of this paper is to examine the
implications of traditional econometric pro-
duction function studies when the above is-
sues are important and, then, to demonstrate
some useful generalizations. Attention will be
focused on neoclassical log-linear production
functions. First, the restrictions associated
with popular formulations of stochastic pro-
duction functions are developed. A more gen-
eralized stochastic specification for produc-
tion function estimation is then posed, and its
generality in reflecting the risk effects of input
use is demonstrated. The functional form pro-
posed is general enough to encompass the de-
terministic implications of all the functions
used in the above studies but avoids the risk-
related restrictions they impose. A methodol-

This content downloaded from 128.135.12.127 on Wed, 18 Sep 2013 17:56:16 PM

All use subject to JSTOR Terms and Conditions
Just and Pope
ogy for estimating the generalized specifica-
tion is discussed. Finally, application of the
methodology is exemplified with the well-
knownfertilizerresponse data used in a previ-
ous study by Day.
Shortcomingsof PopularProduction
Specifications
Historically, a popular enconometric spec-
ificationin productionfunction estimationhas
been
(1) y = A( HXi
)e1i,
where y is output,X, is a factor input (X, > 0),
and Eis a stochastic disturbance with E(E) = 0,
V(E) > 0.
Considerthe marginaleffect of input use on
production variability. One finds that
V(y) = A2H X2ai V(e ),
and, hence, that
(2) aV(y) _ 2acA2 > 0,
ax, (HXi2aiV(eE)
Xi i=1
assuming a? > 0. Thus, the marginaleffect of
increasing input use must always be to in-
crease the variabilityof output when the rele-
vant a~.> 0; and oamust be positive if marginal
productivity is positive.
Pragmatically,the implicationsof using the
usual formulationin (1) are as follows. Con-
sider the evaluation of a policy which limits
the use of some input such as pesticides.
Using (1), a reductionin pesticide use would
imply by (2) a reductionin variabilityof out-
put. In reality, however, a reduction in pes-
ticide use may lead to more variable produc-
tion. Under risk aversion, the true utility loss
associated with higher risk (at the lower input
level) will be greaterthan when the risk effect
is incorrectlyestimated as a reductionin vari-
ability [as implied by (1)].' Similarly, if one
were to promote the expansion of irrigated
acreageand therebyreduce risk, the estimated
benefits (again assuming risk aversion) would
be greater than when the reduction in risk is
' Although it is well known that variance has limitations as a
measure of risk (Borch), risk is associated with variance in the
above discussion because 1/2 8V(y)/8X, = cov (y, &y/8X,) and
cov (y, &y/8Xi) determines whether a risk averter uses more or
less of the input X, than the risk-neutral producer under produc-
tion uncertainty (Horowitz).
This content downloaded from 128.135.12.127 on Wed, 18 Sep 2013 17:56:16 PM
All use subject to JSTOR Terms and Conditions
Production Functions and Risk 277
ignored or is incorrectly estimated as an in-
crease in risk as suggested by (1) and (2).
Incorrect conclusions of this type also can be
obtainedin evaluationof policies which affect
inputs that increase risk because of the lack of
flexibility in (1).
Consider, further, the marginal effect of
input use on marginalproductivityvariability.
Here one finds
ay
__oy
ax, X,
V - V (y),
ax,
242a2 ("Xi2aiV(eE) <
0,
assuming < 1 or equivalently that E(y) is
concave inaoXi. Thus, the marginaleffect of
increasing input use is always to reduce the
variabilityof the marginalproduct (unless ex-
pected productionis not concave in X).
It appears, however, that in many realistic
situations this constraint may be overly re-
strictive. For example, it seems that in some
cases the variabilityof the marginalproductiv-
ity of land increases when other inputs are
held fixed. As one farms on a more extensive
basis with the same inputs, "firefighting"abil-
ity is reduced (Radnerand Rothschild). That
is, one is more subject to adverse weather
conditions, etc., during such critical opera-
tions as harvestingand planting. On the other
hand, an input such as smudge pots in frost
protection is likely to have a decreasing mar-
ginal productivityvariabilitybecause survival
of the crop becomes more probable, and mar-
ginal productivitypresumablytends in proba-
bility towardzero with increased input use (in
the relevant range).
Of course, manyfunctionalforms other than
the Cobb-Douglashave been used economet-
rically in production-functionestimation. Ex-
amples are the transcendentalfunction (Hal-
ter, Carter, Hocking), the generalized power
production function (de Janvry), and the
translog function (Christensen, Jorgenson,
Lau). However, all of these functions includ-
ing Kmenta's approximation of the CES func-
tion are estimated in practice by specifying a
log-linear disturbance: y = f(X)e', E(E) = 0,
where f(X) represents the particular functional
278 May 1979 Amer. J. Agr. Econ.

form. And each of these cases has the same It can be affirmed readily that the signs of
shortcomings discussed above for the Cobb- neither(4) nor (5) are determineda priorieven
Douglas because when h (X) follows one of the popularproduc-
tion function forms (Cobb-Douglas,translog,
V(y) = f(X))v(e), etc.) with parametersunconstrained.For ex-
aV(y) = ample, if h(X) follows a Cobb-Douglasform
aXi 2f(X)f(X)V(e()> 0, and the ith input is associated with a negative
parameter, thenh,(X) < 0; and thus the case of
y
y
,
(X)e f)
-f2(X)V(e'),
a nsk-reducinginput is exemplified.
It is furtherinterestingto note that the popu-
aXXj-J;(X) ,V(- aX
lar specificationin (1) is simply a special case
of (3). This is apparentbecause, regardlessof
aV(y/laX-) = 2f (X)fj(X)V(e6) < 0,
axi specific functionalforms,
when f > 0, fj < 0. y = f*(X)eu = f(X) + h'112(X)E,
A Reasonable Stochastic Specification E(E*)= E(E) = 0
under Risk wheref(X) h'/(X) =f*(X)E(e'E), and E eE
- E(e":). Thus, the proposed functional form
The results of the previous section point to an can be no morerestrictivein any sense so long
important problem with the traditional as explicit specificationsadmit the possibility
stochastic specification of production func- thatf(X) = h/2(X).
tions. Namely, if any input has a positive ef-
fect on output, then a positive effect on vari- An Estimation Procedure
ability of output is also imposed. The argu-
ments of the previous section imply that the For empiricalpurposes, suppose bothf and h
effects of inputon outputshould not be tied to follow a popular log-linear form-Cobb-
the effects of input on variabilityof output a Douglas or translog (Christensen, Jorgenson,
priori. To attain this generality, it seems that Lau; Just and Pope). Thus,f(X) = h'/2(X) is a
an adequateproduction-functionspecification potential special case. Estimation with log-
should include two general functions-one linearity can be accomplished as follows.
which specifies the effects of input on the First, rewrite (3) for observation t explicitly
mean of output and another which specifies includingthe parametersoff and h as
the effects of input on the variance of output.
Such a function is given by (6) yt = f(X,, a) + E*t,
E(E*t) = 0, E(E*tE*,) = 0 for t 4 7,
(3) y = f(X) + h'2'(X)E, E(E) = 0, V(E) = 1.
where e*t = hl/2(Xt, 3)Et, E(Et) = 0, E(EtE,) = 0
for t 4 7. One can then consider (6) as a
Thus, E(y) = f(X), V(y) = h (X), so that the nonlinear, heteroscedastic regression of y on
effects on mean and varianceof output can be X. It can be shown, following the methods of
independent. (For alternatives to this spec- Malinvaud,thatnonlinearleast squares(NLS)
ification, see Just and Pope.) appliedto (6) leads to consistent estimatorsof
With the specificationin (3), one can easily a, the parametersof f, and of f(Xt, a) itself
verify that under a broad range of conditions (see Just
aV(y) - h(X) and Pope).
If one is interested only in estimation off,
(4) aOy (X) + 1 12 this may be as far as one needs to proceed.
- -
- h(X)[(X) and However, there are several importantreasons
h-2(X)hi(X)E, for carrying the estimation procedure beyond
aX, this point. An obvious reason is to learn more
about the effect of input use on risk. But even
if risk is not important, there are several
econometric shortcomings if one obtains only
the above results. First, because of hetero-
scedasticity, hypothesis testing about the im-
portance of various variables cannot generally
2h2(X) be performed. But, secondly, by taking ac-

This content downloaded from 128.135.12.127 on Wed, 18 Sep 2013 17:56:16 PM

All use subject to JSTOR Terms and Conditions
Just and Pope Production Functions and Risk 279

count of the heteroscedasticity, it is possible e*, (with the above functional form and condi-
to gain more efficiency in estimation (at least tions developed by Christensen, Jorgenson,
asymptotically). Lau; and Just and Pope).3 Hence, a weighted
To accomplish this, one can consider two NLS regressionof y, on X, in (6) with weights
additional stages of estimation. Using the h-1/2(Xt, /3)can attainasymptotic efficiency in
(consistent) estimate of a, say, &, one can estimation of a. In other words, in a third
consistently estimatef(X,, a) byf(X,, &)and, stage one would find an NLS estimate of a for
thus, e*, or h112(Xt, P3)E, can be estimated by the model
= y - f(Xt, &), y* = f'(Xt, a) + it,
.*,
under a broad range of conditions. But note where
that = Y*t yth-l'2(Xt, /),
E[(E*t)2]
= E[h(Xt, P)et2] = h(Xt, P). f'(Xt, a) = f(X,, a)h-1/2(Xt, 3).
Recallingthe work of Hildrethand Houck and It has been rigorously shown elsewhere by
others on the random coefficient regression Just and Pope that the estimator for a thus
problem(see Theil), this suggests a regression obtained is consistent, asymptotically effi-
equation based on the relationship cient, and unbiased under conditions indicat-
ed above so long as fourthmomentsof E,exist
(7) (E*,t)2= E[(E*t)2]ut when the regression equation in (7) is used
= h(Xt, P)u,,
directly.
In summary,the regressionmethod thus in-
where E(ut) = 1 by the definitionof expecta- volves the following steps:
tions. That is, /3 can be estimated by regres- An NLS of on =
(a) regression Yt f(X,, a)
sing (E*t)2 on Xt (in a nonlinear framework) or,
because *t,consistently estimates E*t, regres- exp [(In Xt)a] obtaining, say, &.
(b) An OLS regression of InlE*tj= Inly -
sing (i*t)2 on Xt leads to the same regression on In Xt obtaining, say, P3.
results asymptotically.Takinglogarithms,this f(Xt, &)l
An NLS regression of y*t = yh- 1/ (X,, )
can be leastsquares (c)
accomplishedby ordinary 1
(OLS) regressionof in on InX, because (7) =
Yt expL- (InXt)' on f(Xt, a) = exp
implies I*t,
i- - 1
1 (ln Xt)'a - (in obtaining, say, &.
(8) Inle*, = /o + -2 (In Xt)'p + u*t, 2 Xt)'

E(u*,) = 0 Production Function Estimation with

Experimental Data
where /3 = E(In ut), u*t = In ut - E(In u,),2 and The steps of estimation in (a), (b), and (c)
(9) In h(X,, p) = (In X,)'p. requiresome modificationwhen data are gen-
erated experimentally by a cross-section of
Furthermore, OLS yields a consistent es- time series where perhaps the same random
timator for / under the same conditions re- phenomena, such as weather, affect all con-
quired for consistency in the first-stage NLS temporaneous observations.4 The investiga-
problem. tion of data with time or cross-section effects
Given consistent estimation of p in the re- has been discussed extensively in the litera-
gression problem in (8), it is possible to com- ture on variance components (e.g., Hoch;
pute a nonlineargeneralized least-squareses- Wallaceand Hussain). A generalconclusionis
timator for the regression in equation (6) in
essentially the same way as proposed by Zell- variance
3 One can also note in this case that a negativeestimateof the
of will not resultas in the Hildrethand Houck treat-
ner and Hildreth and Houck. Where /3 is the e*,
ment of randomcoefficientregressionbecause of the log-linear
estimator obtained above, one obtains a con- specificationof h.
sistent estimator h(X,, 13)for the variance of 4 Alternativelyor additionally,one similarlycould considerplot
effects across years. The possibility of plot or cell-associated
randomterms, however, will not be discussed explicitly in this
2 Note that is definedto take accountof the nonzero
3o expecta- papersince they are not necessaryin the empiricalcases consid-
tion of InIE*,|.This modificationis requiredto obtainconsistency ered explicitly;furthermore,the necessarygeneralizationsfollow
in estimationof / usingthe linearregressionequationin (8). For a simplyfrom the discussionin this paper. A furthergeneralization
proof of the consistency of this approach,see Just and Pope. of the model could also be developed by consideringrandom
Kelejianuses a similarapproach. coefficientsas proposedby Hildrethand Houck and Feldstein.

This content downloaded from 128.135.12.127 on Wed, 18 Sep 2013 17:56:16 PM

All use subject to JSTOR Terms and Conditions
280 May 1979 Amer. J. Agr. Econ.

that time effects can be investigated either by cross-section of plots, however, it does not
using dummy variables representingdifferent seem reasonable to specify a plot effect be-
time periods or by using a variance compo- cause the plots were in very close proximityof
nents procedure. However, Maddala has one another (a test against this specification
shown that the variancecomponentsapproach was not possible because plot attributeswere
is an efficient way of combiningthe informa- not recorded with the data). However, it is
tion obtained from using dummy time vari- likely that time effects are importantbecause
ables with that from using least squares with- different plots are affected by the same
out dummies.Furthermore,Wallaceand Hus- weather conditions each year.
sain show that asymptotic efficiency is at- The functionalforms which are investigated
tained only with the variance components ap- are the Cobb-Douglasand the translog spec-
proach when the regressors repeat from time ifications. That is, in each case one set of
period to time period as they do with the data estimates is obtained in which bothf and h
used here. Although these results were de- follow the Cobb-Douglasform,
rived under linearity, it is clear that similar
results would hold in the model considered in (11) yti = AZtia1 + BZtij'(Eti + wt);
this paper if any dummy terms are included anotheris obtained where bothf and h follow
additively. the translog specification:
To obtain a variance components modifica-
tion of the estimation procedure outlined (12)
above, equation (3) can be augmentedby ad-
yti =
1
AZtiaI
exp
-•2 ln2Zti 1
ding an errorterm wt, as well as time and plot + BZt,1'exp -- pln2Zti
subscripts t and i, to existing variablesin the 32 (Eti + wt).
equation. The model thus becomes
Note that the above equationsare both special
(10) ytv= f(X,,,a) + h112(X,1,
P)(Eti+ wt), cases of (9).
with E(Et?)= 0, E(w,) = 0, = 48tTij, Following the estimation methodology of
the previous section, the results are presented
E(wtw,) = t,o-, E(Eti,,) = 0, E(e,•iEJ)
and where o- is in tables
1, 2, and 3 for corn and oats. In each
the variance of w, and 8ij is the Kronecker case the dependent variablesare measuredin
delta. A generalizationof the estimation pro-
bushels per acre, and the independent vari-
cedure in the previous section which attains
able is pounds of nitrogen per acre (see Day
consistency for this model is given in the ap- for the data and a furtherdescription).Table 1
pendix of this paper. contains the ordinarynonlinearleast-squares
An Application in Fertilizer Response estimates of equation (A.4).5 Table 2 contains
5 The standarderrorsreportedin parenthesesin table should
1
To demonstrate the approach of this paper, thus be interpretedwith cautionbecausedisturbancesin (A.4) are
the notable data set investigated by Day has not uniformlydistributedunder the assumptionsin (A.I) and
been selected. Briefly, his yield data were (A.2).
generated for several crops by controlled ex- Table 1. First-Stage Estimates of the Deter-
periments varying fertilization over several ministic Component of Production
fixed levels. Observationswere generated by
recording time series of data over a cross- Constant
Term
Fertilizer
section of plots. Using these data, Day at- Coefficientsa
Functional
tempts to determinethe distributionof yield at Crop Form A a, a2
each level of fertilization among the family
of Pearson-typedistributions.His dataare use- Corn Cobb-Douglas 14.759 .3053
ful for exemplifying the methodology of this (2.195) (.0445)
Corn Translog 20.916 .0634 .0806
paper because problems of multicollinearity (14.384) (.4698) (.1561)
are not encountered and because concentra- Oats 10.900 .4195
Cobb-Douglas
tion on a single input in investigating risk ef- (1.248) (.0317)
fects is possible. Oats Translog 6.194 .8804 -.1568
Because the data possess both time-series (2.597) (.2356) (.0653)
and cross-section characteristics, the method- Note: Figuresin parenthesesare standarderrors,estimatedunder
ology of the previous section is applicable. the assumptionof homoscedasticity.
Even though the data were generated with a " See equations(11) and (12) for functionalforms.

This content downloaded from 128.135.12.127 on Wed, 18 Sep 2013 17:56:16 PM

All use subject to JSTOR Terms and Conditions
Just and Pope Production Functions and Risk 281

Table 2. Second-StageEstimatesof the StochasticComponentof Production

Fertilizer Standard
ConstantTerm Coefficient&s Error

Functional 0= Po
Crop Form O 1o 21 10o - go
Corn Cobb-Douglas 74.169 80.605 .1269 11.524
(22. 107) (25.037) (.0462)
Corn Translog 178.61 193.98 -.1852 .1058 11.621
(251.48) (273.21) (.4908) (.1653)
Oats Cobb-Douglas 42.272 57.428 .1999 2.789
(12.686) (17.708) (.0395)
Oats Translog 5.879 7.489 .7846 -. 1693 3.652
(8.151) (10.499) (.3909) (.1079)
Note: Figuresin parenthesesare standarderrors,estimatedunderthe assumptionof homoscedasticityin equation(8); see equation(8)
for the interpretationof /3* and&3o.
a See equations(11) and (12) for functionalforms.

the second-stage results corresponding to LettingA = AE(e8t)and Et = e't - E(e6t), (13)

(A.2).6 Table 3 presents the nonlineargener- can be rewrittenas
alized least-squares results correspondingto
Yt = AXtaI + BXtO'Et, E(Et) = 0,
equation (A.4) with covariance matrix esti-
mated on the basis of table 2. where
Consistentwith Fuller's findings,the results (14) B = A = A[E(et)]-',
in table 2 imply that fertilizer has a positive
marginaleffect on yield variabilityin the rele- (15) f3 =
O(.
vant range. This result obviously holds for all Thus, the Cobb-Douglascase examinedin this
positive fertilizer levels in the Cobb-Douglas paper has a special case which includes the
formulations;for the translog cases, the mar- common specificationin (13). If (13), in fact,
ginal effect on corn yields is positive if the holds, one expects to find, amongotherthings,
fertilization rate is greater than 5.757 pounds a, = 3p; hence, the usual case is apparently
per acre, and the marginaleffect on the oats' not supported.7If one considers the above
yield is positive if the fertilizationrate is less
than 102.964 pounds per acre (active nutri- 7By orthogonalityof regressionresidualsto coefficient esti-
mates in the first stage, the distributionof coefficientsin the
ents). It is interestingthat, with transloggen- second stage is independentof that for the first stage. A test of
erality, the marginaleffect on yield variability equalityof coefficients(other than the constantterm)in the first
is increasingfor corn but decreasingfor oats. two stages,basedon thisfact andthe usualleast squaresstatistics,
leads to rejectionof equality at the 2.5% level. Unfortunately,
Another notable result is that the elasticity however, least squares statistics are not applicable, so limited
for variabilityis much lower in each case than confidencecan be placed in the test.
the elasticity for the mean of yield. For exam- Table 3. Third-Stage Estimates of the Deter-
ple, the a, estimates are considerably higher ministic Component of Production
than the 1, estimates in the Cobb-Douglas
cases. This result has importantimplications Constant Fertilizer
for the applicability of the usual stochastic Term Coefficientsa
Functional
specification in production-functionestima- Crop Form A a2
aI
tion, i.e., the one with log-lineardisturbances.
Consider the commonly used specification Corn Cobb-Douglas 3.2839 .3532
(droppingthe variance components specifica- (.7476) (.0885)
tion for convenience): Corn Translog .00023 8.2887 -3.1903
(.00052) (1.7738) (.6948)
(13) Yt = f(Xt)et = AXtoalet, E(8t) = 0. Oats Cobb-Douglas 6.0863 .3101
(1.0067) (.0531)
Oats Translog .9187 1.6013 -.4260
6
(.6265) (.4473) (.1442)
The standarderrorsreportedin table 2 are generatedby ordi-
nary nonlinear least squares. However, they may not apply Note: Figuresin parenthesesare standarderrors,estimatedunder
exactly even in an asymptoticsense because the disturbancesin the assumptionof homoscedasticity.
(A.3) may not be uncorrelatedor uniformlydistributed. a See equations(11) and (12) for functionalforms.

This content downloaded from 128.135.12.127 on Wed, 18 Sep 2013 17:56:16 PM

All use subject to JSTOR Terms and Conditions
282 May 1979
derivation in the translog case, it is again
found that the usual specification with a log
linear disturbance is the special case of the
specificationof this paper where P2= a, holds
in addition to the conditions in (14) and (15).
It is furtherinterestingto comparethe stan-
darderrorestimatesin tables 1 and 3 (although
they only apply asymptotically). One finds in
all cases except constant terms that standard
error estimates are larger in table 3 than in
table 1. But the estimatorin the third stage is
asymptotically efficient and thus possesses
lower standard errors (asymptotically) than
the first-stageestimator,i.e., the true standard
errorestimatesin table 1 shouldbe higherthan
those in table 3. Of course, the standarderror
estimates in table 1 are not applicable under
the generalstochastic specificationused in ob-
tainingtable 3 estimates. But, unfortunately,it
is often the case in econometric practice to
assume homoscedasticitywhen risk aspects of
a study are presumed unimportant,or infor-
mationto the contraryis not readilyapparent.
The comparison of tables I and 3 illustrates
the potentialdangerof assuminghomoscedas-
ticity if, in fact, it is not applicable. In other
words, if functionalforms such as (3) are ap-
plicable in reality, the standardpractice of as-
suminghomoscedasticitycould correspondto
the first-stageestimationof this paper. But, if
so, the associated statistics apparentlywould
be misleading and imply much more precise
estimation than is warranted.
Implications of Assuming Log
Linear Disturbances
Because the more common approachis to as- where
sume homoscedasticity with log-lineardistur-
bances (rather than additivity as in the first-
stage case of this paper), it is interesting to
Table 4. OLS Estimates under the Assumption of Homoscedastic Log-Linear Disturbances
Constant
Term
Functional
Crop Form In A
Corn Cobb-Douglas 2.5667
(.1310)a
Corn Translog 2.8830
(.6417)
Oats Cobb-Douglas 2.4897
(.1337)
Oats Translog 1.8026
(.4557)
a
Figuresin parenthesesare standarderrors.
This content downloaded from 128.135.12.127 on Wed, 18 Sep 2013 17:56:16 PM
All use subject to JSTOR Terms and Conditions
Amer. J. Agr. Econ.
pursue further the misspecificationproblems
associated with log linearity [if (3), in fact,
holds]. To investigate this problem, the re-
gression results in table 4 have been derived
under the usual assumption of log linearity.
Comparingwith table 1, the resemblance of
statistics, aside from those pertaining to the
constantterm, is remarkable.This is true with
respect to standarderror estimates as well as
coefficient estimates. Furthermore,the differ-
ence in constant term estimates is explained
by the fact that only those in table 4 are esti-
mated in logarithmic terms (see Zellner,
Kmenta, Dreze for a discussion of related
problems). Thus, the methodologyassociated
with table 4 apparentlyis subject to the same
criticism made of the homoscedasticity as-
sumption above in comparingtables I and 3.
That is, use of the common but simple ap-
proach of log linearity in disturbances (with
homoscedasticity) when, in fact, (3) is appli-
cable, apparently can lead to much smaller
standard error estimates than are justified
(asymptotically). This is true because the
table 3 estimates are asymptotically efficient
and their standard errors are much larger.
Thus, any hypothesistesting based on tables I
and 4 could be very misleading.
It appears, however, that there are even
more serious problemsof bias associated with
log linearstochasticspecificationwhen, in fact,
(3) is applicable. In logarithmic terms, and
assuminglog linearityoff, the specificationin
(3) becomes
(16) In y, = Inf(X,, a) + u,
= (In X,)'a + ut,
u, = In I + Eth(X, 18)
1 f(X, 3a)
Fertilizer
Coefficients
a, a2 R"
.3246 .219
(.0413)
.0961 .0785 .220
(.4556) (.1560)
.3855 .308
(.0390)
.8286 -.1354 .316
(.2838) (.0859)
Just and Pope
Thus, where X = (In X, . . . , In XT)' and V =
(u, ... ., u)', the OLS estimate a* in (16) has
expectation
E(a*) = a + (X'X)-'X'E(V) 4 a
since E(V) < 0 by Jensen's inequality and
concavity of u, in et,
E[ut(Et)] = 0.
< utE(Et)
Of course, OLS also is inconsistent because
the magnitudeof bias does not generally de-
pend on T (see Kmenta for a similar discus-
sion). Taking expectations of a Taylor-series
expansion of ut,
E(ut) ?1 E(Et2)h2(Xt, P3)
2 f2(Xt, a)
1 E(Et4)h4(Xt, 3)
4 f4(Xt, a)
it also is evident that the bias is necessarily
small only when instability in production is
small (relative to expected production). One
must then question the use of log linear esti-
mates of f if the argumentsin the first part of References
this paper hold.
Conclusionsand Summary
As arguedin the first part of this paper, tradi-
tional production-functionformulations are
uninformativewith respect to risk. The flexi-
bility given by (3), however, is within tradi-
tional neoclassical orthodoxywith respect tof
(as far as mean response) but appearssuperior
for risk analysis. For firm decision problems
and public policy, it seems the generalization
suggested by (3) potentially offers greater
flexibility in describing stochastic technolog-
ical processes and related behavior.
In summary, the major conclusions of this
paper are as follows:
(a) Traditionalproduction-functionformu-
lations are very restrictive and, in particular,
imply that changes in inputs are directly re-
lated to changes in the variance of output.
(b) This restriction contradicts other re-
search findings.
(c) Hence, traditionalproduction-function
estimates may be of little use in evaluating
policies-particularly those which can have a
risk-reducingeffect on output.
(d) A simple reasonable production-
function specificationmust apparentlycontain
at least two components-one explaining the
This content downloaded from 128.135.12.127 on Wed, 18 Sep 2013 17:56:16 PM
All use subject to JSTOR Terms and Conditions
Production Functions and Risk 283
effect of input on expected outputand another
explainingthe effects of input on variabilityof
output.
(e) Such a productionfunction is given by
(3), and a three-step NLS procedure (with or
without variance components) is proposed.
Use of a maximum likelihood procedure
(without variance components) to attain
efficiency in estimatingh(-) is also discussed.
(f) An application indicates that fertilizer
has a variance-increasingeffect on yield; but
the marginal variance contribution is much
smaller than the standard log-linear distur-
bance approachwould indicate.
(g) Empirical results indicate that estima-
tion assuming the homoscedastic log-linear
disturbance case can lead to standard error
estimates that are misleading and indicate
muchgreaterprecisionin estimationthanis, in
fact, obtained.
[Received June 1977; revision accepted
October 1978.]
Anderson,Jock. "Sparse Data, ClimaticVariability,and
Yield Uncertaintyin Response Analysis." Amer. J.
Agr. Econ. 55(1973):77-82.
Bardhan,P. "Variationsin Formsof Tenancyin a Peasant
Economy." J. Devel. Econ. 4(1977):105-18.
Batra,R. "Resource Allocationin a GeneralEquilibrium
Model of ProductionUnder Uncertainty."J. Econ.
Theory8(1974):50-63.
Borch, K. "A Note on Uncertainty and Indifference
Curves." Rev. Econ. Stud. 36(1969):1-4.
Christensen, L. R., D. W. Jorgenson, and L. J. Lau.
"Transcendental Logarithmic Production Fron-
tiers." Rev. Econ. Statist. 55(1973):28-45.
Crawford,R. "Implicationsof Learningfor Economic
Models of Uncertainty." Int. Econ. Rev.
14(1973):587-600.
Day, Richard. "ProbabilityDistributionsof Field Crop
Yields." J. Farm Econ. 47(1965):713-41.
de Janvry, Alain. "The GeneralizedPower Production
Function." Amer. J. Agr. Econ. 54(1972):234-37.
Feldstein, M. "ProductionUncertainty with Uncertain
Technology: Some Economic and EconometricIm-
plications." Int. Econ. Rev. 12(1971):27-36.
Fuller, Wayne. "Stochastic FertilizerProductionFunc-
tions for Continuous Corn." J. Farm Econ.
47(1965): 105-19.
Halter,A. N., H. O. Carter,andJ. G. Hocking. "A Note
on the TranscendentalProduction Function." J.
Farm Econ. 39(1957):966-74.
Hildreth,C., andJ. Houck. "Some Estimatesfor a Linear
Model with RandomCoefficients."J. Amer. Statist.
Assoc. 63(1968):584-95.
Hoch, Irving. "Estimation of ProductionFunction Pa-
284 May 1979
rameters Combining Time Series and Cross-Section
Data." Econometrica 30(1962):34-53.
Horowitz, I. Decision Making and the Theory of the Firm.
San Francisco: Holt, Rinehart & Winston, 1970.
Just, Richard E., and Rulon Pope. "Stochastic Represen-
tation of Production Functions and Econometric Im-
plications." J. Econometrics 7(1978):67-86.
Kelejian, H. "The Estimation of Cobb-Douglas Type
Functions with Multiplicative and Additive Errors: A
Further Analysis." Int. Econ. Rev. 13(1972): 179-82.
Kmenta, J. Elements of Econometrics. New York: Mac-
millan Co., 1971.
Maddala, G. "The Use of Variance Components Models
in Pooling Cross-Section and Time-Series Data."
Econometrica 39(1971):939-53.
Magnusson, Gudmunder. Production Under Risk: A The-
oretical Study. Uppsala: Almqvist and Wiksells,
1969.
Malinvaud, E. "The Consistency of Nonlinear Regres-
sions." Annals of Math. Statist. 41(1970):956-69.
Moscardi, Edgardo, and Alain de Janvry. "Attitudes To-
ward Risk among Peasants: An Econometric Ap-
proach." Amer. J. Agr. Econ. 59(1977):710-16.
Radner, Roy, and Michael Rothschild. Notes on the Allo-
cation of Effort. Center for Research in Management
Sciences Tech. Rep. No. OW-1, University of Cali-
fornia, Berkeley, 1974.
Rothenberg, T. J., and K. Smith. "The Effect of Uncer-
tainty on Resource Allocation in a General Equilib-
rium Model." Quart. J. Econ. 85(1971):440-59.
Sadan, Ezra. "The Investment Behavior of a Farm Firm
Operating under Risk." Amer. J. Agr. Econ.
52(1970):494-504.
Stiglitz, Joseph E. "Incentives and Risk Sharing in
Sharecropping." Rev. Econ. Stud. 41(1974):219-55.
Theil, Henri. Principles of Econometrics. New York:
John Wiley & Sons, 1971.
Turpin, F., and J. Maxwell. "Decision-Making Related to
Use of Soil Insecticides by Indiana Corn Farmers."
J. Econ. Entomol. 69(1976):359-62.
Wallace, T. D., and Ashiq Hussain. "The Use of Error
Components Models in Combining Cross-Section
with Time-Series Data." Econometrica 37(1969):
55-72.
Wolgin, J. M. "Resource Allocation and Risk: A Case
Study of Smallholder Agriculture in Kenya." Amer.
J. Agr. Econ. 57(1975):622-30.
Zellner, Arnold. "An Efficient Method of Estimating
Seemingly Unrelated Regressions and Tests for
Aggregation Bias." J. Amer. Statist. Assoc.
57(1962):348-68.
Zellner, A., J. Kmenta, and J. Dreze. "Specification and
Estimation of Cobb-Douglas Production Function
Models." Econometrica 34(1966):784-95.
Appendix
Generalized Estimation
Consider multistage estimation of the error components
version of the production function model specified by
This content downloaded from 128.135.12.127 on Wed, 18 Sep 2013 17:56:16 PM
All use subject to JSTOR Terms and Conditions
Amer. J. Agr. Econ.
(10). In this case, a first-stage regression, such as sug-
gested by (6), is still possible and consistency for a is
obtained where E*t, is defined by
E*ti= hV2(XA,./)(E,i +
•,).
However, one finds in place of (7) a regression equation of
the form
= 0.
(A. I) (e*,)2 = h(X,i, 13)(1I+ o-) + uii. E(uti)
because E[(E*,=)2] = + o-), where t = 1 ..., T,
h(X,, p/)(1
and i = 1, N. Furthermore, since E*tiE*,,, i / j, no
longer has ....
a zero expectation [as with E,ET,t 7, corre-
*
sponding to (7)], one must also consider
(A.2) E*,iEtj = h12(Xt, P)h"2(X,t. P)o-
+ ut;, E(u,3) = 0,
for i 4 j since E(E*, , E*,j) = h12(X,., p)h•'2(X,3j,P)o, where
= = - 1; andj = 1,
t 1, . , T; i 1, . . . j N. It is still
the case, however, that E(E*te*) = 0 if t..../ 7 so only the
relationships in (A.1) and (A.2) must be considered.
Comparing with the earlier derivation and, in particular
equation (8), it is no longer possible even with log-linear
functions to combine (A.I) and (A.2) into a linear
second-stage equation replacing (8) because E*,tE*,Jcan
possibly be negative; thus, its logarithm does not exist. An
alternative second-stage regression equation would com-
bine equations (A.I) and (A.2) directly:
(A.3) E*,iE*,. =
+ [-•P3*o
(I - 8i,)/o]h'"(X,,, p) + 1u,t,
p)h1'2(X,t,
wheret = 1..., T; i = 1, ... j;andj = 1, . . . N;p, =
I + o-, /o = 8j is the Kronecker delta, and the E*t, are
replaced by --,their first-stage estimates. Also, for identifica-
tion purposes, any multiplicative constant term in h must
be combined with P/"* and 1o. The addition of variance
components in estimation thus suggests nonlinear estima-
tion in the second stage if asymptotic efficiency is to be
obtained in the third stage. That is, one cannot choose to
disregard the observations generated by (A.2) and still
identify o-;8when (A.2) is used, the log-linear representa-
tion cannot be used because E*,iE*,j is possibly negative. It
can be shown following Just and Pope that NLS estimates
of (A.2) are consistent under the general specification in
(9) so long as X satisfies conditions for consistency in the
first stage and eE, has bounded fourth moments.
Thus, a third-stage, nonlinear, generalized least-squares
regression of y,v on X,;, using the equation
(A.4) yti = fl(X,, a) + E*,i,
is possible where the covariance matrix is estimated by
predicted values from the second-stage regressions corre-
sponding to (A.3). It can be shown that the a estimator
thus obtained is consistent and asymptotically efficient
along the same lines as in the case considered by Just and
Pope without error components.
' This is true so
long as h contains a multiplicative constant term
(so that homoscedasticity is a special case), in which case the
estimate of po would be an estimate of the multiplicative constant
times 1 + o-.