Estimation of technical change and price elasticities: a categorical time-varying coefficient approach

We propose a categorical time-varying coefficient translog cost function, where each coefficient is expressed as a nonparametric function of a categorical time variable, thereby allowing each time period to have its own set of coefficients. Our application to U.S. electricity firms 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.