Estimation of Technical Change and Price Elasticities : A Categorical Time-Varying Coefficient Approach

In this paper we propose a categorical time-varying coefficient translog cost function to estimate technical change and productivity. The primary feature of this model is that each of its coefficients is expressed as a nonparametric function of a categorical time variable, thereby allowing each time period to have its own set of coefficients and thus its own cost function. Our application of this model to a panel of 80 electricity firms in the U.S. over the period 1986-1998 reveals that this model offers two major advantages over the traditional time trend representation of technical change: (1) it is capable of producing estimates of productivity growth that closely track those obtained using the Tornqvist approximation to the Divisia index; and (2) it can solve a well-known problem commonly referred to as the problem of trending elasticities