A Flexible Approach to Estimating Production Functions When Output Prices are Unobserved∗

There exists significant price dispersion in many industries. As a consequence the value of output is not necessarily a good measure of the quantity of output. Estimation of production functions for these types of goods is thus challenging since quantities and prices of output are typically not separately observed by the econometrician. This paper provides a new flexible approach for estimating production functions which treats quantity and prices for output as latent variables. To illustrate the usefulness of the techniques we consider two applications. The first application focuses on estimating production functions for housing. The empirical analysis is based on a comprehensive database of recently built properties in Allegheny County, Pennsylvania. The second application focuses on the car repair service industry based on a unique survey conducted by the leading magazine that covers this industry. We find that the new methods proposed in this paper work well in these applications and provide reasonable estimates for the underlying production functions. JEL classification: C51, L11, R12