Answer to Question #262245 in Economics for abc

Question

Consider the Cobb–Douglas production function

Y = β1Lβ2Kβ3 (1)

where Y = output, L = labor input, and K = capital input. Dividing (1) through by

K, we get

(Y/K) = β1(L/K)β2Kβ2+β3−1 (2)

Taking the natural log of (2) and adding the error term, we obtain

ln (Y/K) = β0 + β2 ln (L/K) + (β2 + β3 − 1) ln K + ui

where β0 = ln β1.

a. Suppose you had data to run the regression (3). How would you test the hypothe-

sis that there are constant returns to scale, i.e., (β2 + β3) = 1?

b. If there are constant returns to scale, how would you interpret regression (3)?

c. Does it make any difference whether we divide (1) by L rather than by K?

Answer 1

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