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Reassessing aggregate returns to scale with standard theory and measurement

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  • Harold L. Cole
  • Lee E. Ohanian

Abstract

Constant returns to scale is a central construct of neoclassical theory. Previous studies argued that one must adopt a specification of the production function with substantial unobserved service variation to reconcile constant returns with the data. Some economists have argued that this finding has not resolved the size of returns to scale, since factor service variation is unobserved, and there is no generally accepted theory to guide specification of this alternative framework. In this paper we show that the stochastic version of the neoclassical growth model delivers an orthogonality condition which can be used to estimate returns to scale. Rather than the standard finding of increasing returns, we show that standard theory and conventional measures of output and inputs yield estimates of constant returns to scale at the aggregate level. Our estimates also suggest that factor service variation is not an important determinant of output fluctuations.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Minneapolis in its series Working Papers with number 566.

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Date of creation: 1996
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Handle: RePEc:fip:fedmwp:566

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Keywords: Production (Economic theory);

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Cited by:
  1. Harold L. Cole & Lee E. Ohanian, 1999. "Aggregate returns to scale: why measurement is imprecise," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Sum, pages 19-28.

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