Empirical Economics (2003) 28:753765 DOI 10.

1007/s00181-003-0157-5

Estimating multiproduct costs when some outputs are not produced

Quinn Weninger
Department of Economics, Iowa State University, 260 Heady Hall, Ames, IA 50011-1070, USA (e-mail: weninger@iastate.edu) First version received: March 2002/Final version received: September 2002

Abstract. Pooling diversied and specialized rm data to analyze multiproduct cost technologies raises two issues in applied research: (1) a functional form must be specied that accommodates zero outputs, and (2) assumptions must be made regarding the structure of the multiproduct technology when some outputs are not produced. This article introduces a methodology to estimate the translog multiproduct cost function in the presence of zero outputs. The method adds exibility to allow for and test competing structural assumptions. The added exibility can improve measurement of the global properties of multiproduct cost structures. An application to a cross section of U.S. railway rms demonstrates this key advantage. Key words: Translog multiproduct cost function JEL classication: C3, D2 1. Introduction Economies of scale and scope, among other characteristics of multiproduct technologies, have important implications for policy design and industry regulation. Empirical analysis of multiproduct costs has been the focus of numerous studies in a wide range of industries, and estimation is often carried out using observations on both diversied (multiproduct) and specialized rms.1 Specialized rms provide cost information when some outputs are not
This manuscript has beneted from discussions with Christopher Barrett, Wallace Human, Giancarlo Moschini, and Joseph Herriges. The usual disclaimer applies. 1 Examples are found in the banking industry (Pulley and Braunstein 1992), the health industry (Cowing and Holtmann 1983; Vita 1990), public utilities (Garcia and Thomas 2001; Kim, 1987), telecommunications (Ro ller 1990 ), railways (Caves et al. 1980), agriculture (Moschini 1988), and natural resource industries (Toft and Bjrndal 1997).

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produced and may improve estimation of the global properties of multiproduct technologies. For example, zero or at least small output quantities are required to obtain reliable estimates of economies of scope. The presence of zero outputs complicates the selection of a exible functional form. The otherwise popular transcendental logarithmic (translog) function, introduced by Christensen et al. (1973), cannot be implemented directly in the presence of zeros because the natural logarithm of zero is not nite. This has led to the development of exible functional forms that are analytic at zero. Caves, Christensen, and Tretheway (1980) introduced the Generalized Translog Multioutput Cost Function (GTMCF) which utilizes the Box-Cox transformation for outputs and the logarithmic transformation for input prices. The Box-Cox transformation is analytic at zero and may have a certain appeal because of its limiting relationship to the natural logarithm. Ro ller (1990) introduced a proper quadratic cost function, which was extended by Pulley and Braunstein (1992) to study non-separable production technologies in the US banking industry. This function, referred to as the Composite cost function, combines a quadratic structure for outputs with a log-quadratic structure for input prices. The quadratic structure for outputs readily accommodates zeros and may be better-suited for measuring global properties such as economies of scope (Baumol et al. 1982). Another alternative is the generalized hybrid Diewert multiproduct cost function (GHDF for short) which utilizes the square root metric for function arguments allowing direct implementation when zeros are present (see Hall 1973). Yet another approach often used in applied research is to insert a small positive value in place of zeros, and then t the translog function to the modied data. This method, hereafter referred to as the small value translog function (SVTF), has produced erratic measures of economies of scope in banking (see Berger et al. 1999; Pulley and Humphrey 1993), but remains popular likely due to its simplicity.2 A second issue that arises when data include diversied and specialized rms is the maintained hypotheses for the underlying structure of the multiproduct technology. It is common practice to specify a shared empirical multiproduct cost function and pool diversied and specialized rm data during estimation. The analysis is thus carried out under the maintained hypothesis that diversied and specialized costs have common structural properties (this structural restriction is formalized below). This maintained hypothesis is restrictive and may not be supported by empirical data. For example, suppose the multiproduct technology exhibits economies of scope due to cost complementarity, i.e., the marginal cost of producing a given output is reduced under diversied production. Cost complementarity can cause the multiproduct cost surface to have a dierent shape than the single output cost surface, in which case, pooling data and estimating the parameters of a shared empirical function can bias the measurement of the underlying technology. This article reconsiders the problem of estimating multiproduct costs when some outputs are not produced. The main contribution is an empirical methodology that (1) facilitates estimation of the translog multiproduct cost
2 Space limitations do not permit an exhaustive survey of empirical models used to analyze multiproduct costs. See Wheelock and Wilson (2001) and a survey of banking studies in Berger et al. (1999).

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function in the presence of zero-valued outputs, and (2) provides a setting to relax and test the assumption that diversied and specialized costs share common structural properties. An application to US rail data illustrates the second feature. The analysis nds that estimating the economically relevant information that exhaustively characterized cost minimizing behavior requires relaxing the assumption of a common cost structure for diversied and specialized rail producers. The proposed methodology is referred to as the zero-output translog multiproduct cost function, or Z-log cost function for short. The Z-log cost function has the desirable properties that exible functional forms should possess (Fuss et al. 1978). It is linear in parameters, parsimonious3 and exible under the maintained hypotheses for the structure of multiproduct and specialized costs, and delivers the advantages of the translog functional form (see Wales 1977, for a discussion). For example, economic eects of interest such as returns to scale are tractable functions of parameters and data. Results from a Monte Carlo simulation experiment nd that the Z-log function provides low bias estimates of a known multiproduct cost structure where some outputs are not produced. Estimation bias under the Z-log is considerably less than under the commonly used SVTF and GTMCF. The next section introduces a multiproduct cost minimization problem with diversied and specialized rms. Commonly used empirical functions, the GTMCF, SVTF, GHDF, and Composite function are presented along with the Z-log multiproduct cost function. Section 3 reports results from a Monte Carlo simulation experiment. An analysis and test of common structure for specialized and diversied US rail producers under the Z-log function appears in Sect. 4. Sections 5 presents concluding remarks and extensions. 2. Multiproduct costs with diversied and specialized rms Let y 2 <m denote an m-dimensional vector of outputs produced from an n-dimensional input vector x 2 <n . Outputs are determined exogenously. Inputs are purchased competitively at price w 2 <n . Let m 2 and suppose that all inputs are essential in production. The model is easily generalized. Data contain observations on K rms that produce at least one of the outputs in a given period. The rst K M rms produce strictly positive quantities of both outputs; these are the multiproduct rms. The remaining K S specialized rms produce positive quantities of y1 only. The objective of all rms is to minimize production P cost. Multiproduct costs are given by x2 ; . . . xn can produce y1 ; y2 g and single C M y1 ; y2 ; w minx f n i1 wi xi : x1 ; P output costs are C S y1 ; w minx f n i1 wi xi : x1 ; x2 ; . . . xn can produce y1 g. C M y1 ; y2 ; w and C S y1 ; w are positive real valued functions, are nondecreasing, twice continuously dierentiable, concave and linear homogeneous in input prices. The empirical analysis seeks to measure the economic eects that exhaustively characterize rm behavior. To obtain unbiased measures of these eects, structural restrictions that are not supported empirically should
In contrast, the GHDF is nonlinear in parameters and contains an excessive number of parameters, factors that limit its usefulness empirically (Fuss et al. 1978).
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be avoided. Rather, the behavioral relationships under study marginal cost, conditional input demands, substitution elasticities, and returns to scale should be estimated from data. An important structural restriction in the current setting is whether the multiproduct cost function is identical to the specialized cost function at the limiting value y2 0; C M y1 ; 0; w  C S y1 ; w: C.1 Hereafter, the above structural restriction will be referred to as condition C.1.4 Condition C.1 may be adopted as a maintained hypothesis, or investigated as part of the empirical analysis. Specifying a common parametric function and pooling data from diversied and specialized producers imposes C.1 a priori. The implied structural restriction may not be supported by empirical data. For example, the preferred technology for multi- and single-output rms may exhibit dierent input-input, input-output and output-output transformation relationships. Alternatively, suppose the K M diversied rms and K S specialized rms coexist in a competitive industry equilibrium.5 The conditions that characterize multiproduct industry equilibrium are that multiproduct rms minimize ray-average costs, all rms earn zero prots, and that prices equal marginal costs (Baumol et al. 1982; MacDonald and Slivinsky 1987). If data are generated under a multiproduct competitive market equilibrium, the structural restriction oC M y1 ; y2 ; w=oy1 oC S y1 ; w=oy1 is implied, where all outputs are equilibrium quantities. Condition C.1 implies, however, that all input-input and input-output transformation relationships are identical for diversied and specialized rms, which is clearly more restrictive.6 2.1. Flexible multiproduct cost functions For notational convenience denote the cost function arguments as z z1 ; z2 . . . zn2 y1 ; y2 ; w1 . . . wn . The rst two elements of z are outputs and the third through n 2nd elements are input prices. The standard translog cost function is a quadratic function of the logarithm of z, P PP aij lnzi lnzj ; aij aji ; 1 ln C z a0 ai lnzi 1=2
i i j

where a0 ; ai ; aij are unknown parameters. The log-quadratic structure for input prices allows linear in input prices to be imposed with the P P homogeneity 2 n2 parameter restrictions n i3 ai 1, and j3 aij 0, for all i. Application of Shepherds lemma obtains factor input cost shares P wi xi z ai aij lnzj C z j i > 2; 2

where xi z is the conditional demand for the ith input.

4 Denote the set of cost function arguments as z y1 ; y2 ; w1 ; . . . ; wn . Dene the subset z0 fz : y2 0. Condition C.1 implies that C S : is the restriction of C M : to z0 . 5 This example ignores complications that arise when outputs are not exgogenously determined. 6 I am grateful to an anonymous referee for raising this point.

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The translog cost function is not nite when elements of z take the value of zero and cannot be implemented directly for specialized rms. Under the SVTF a small positive value is inserted for zi 0.7 The GTMCF transforms outputs with the Box-Cox metric, gzi zi ki 1=ki , i 1; 2, where ki is a parameter that is usually estimated from the data.8 The log-quadratic structure is maintained for input prices. The Box-Cox metric is analytic for zi 0 provided that ki is strictly positive, and limki !0 gzi lnzi . The Composite cost function combines the log-quadratic structure for input prices with the logarithm of a quadratic function of outputs, ! 2 2 P 2 2 n 2 P P P 1P ln C z ln a0 ai zi aij zi zj aij zi lnzj 2 i1j1 i 1 i1 j3
n 2 P i 3

ai lnzi

2 n 2 P P 1n aij lnzi lnzj : 2 i3 j3

The GHDF is given as PP P P p PPP p C z blm;ij yl ym /=2 wi wj bm;ij ym wi wj ;

l m i j m i j

where blm;ij bml;ji , bl;ij bl;ji (l and m index outputs and i and j index input prices) and / are parameters. The GHDF satises linearly homogeneity in factor prices automatically, and, no modications are required when zeros are present inasmuch as the square root metric is nite at zero. 2.2. Z-log multiproduct cost function Under the Z-log cost function, a log-quadratic structure is specied for strictly positive cost function arguments only. In the current setting, three convolutions of strictly positive output bundles are possible, although only two are assumed in the example. For multiproduct rms y1 > 0, and y2 > 0 and for specialized rms y1 > 0 and y2 0. Firms specializing in the production of y2 are not considered. The logarithm of multiproduct costs, ln C M z, is given in Eq. (1), with corresponding cost shares in Eq. (2). The logarithm of specialized cost is specied as P 1 PP e a0 e aij e aji : 5 ai lnzi aij lnzi lnzj ; e ln C S z e 2 i62j62 i62 with cost share P wi xi z e ai e aij lnzj S C z j62 i > 2: 6

Linear homogeneity is imposed P for the specialized rm costs with parameter P restrictions i>2e ai 1, and j>2e aij 0, for all i.
7 Kim (1987, p. 191) suggests using 10% of the variables sample mean. Gilligan and Smirlock (1984) substitute 0.001 for zero outputs. 8 If the assumption that ki 1 is maintained, the GTMCF reduces to a log-quadratic structure for input prices and a quadratic structure of outputs (see Toft and Bjrndal 1997, for an example).

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A tilde appears above the parameters in Eq. (5), emphasizing that under the most general specication of the Z-log model, the parameters of multiproduct costs C M z and specialized costs C S z are distinct. At the other extreme, a common parameter vector may be specied in Eqs. (1) and (5), i.e., a0 , ai e ai , and aij e aji for all i, j 6 2 are imposed. the restrictions a0 e These restrictions eectively impose the structural condition C.1 a priori. A third intermediate possibility is to test for separate parameter vectors for multiproduct costs, Eq. (1), and specialized costs, Eq. (5), which is eectively a test of the structural condition C.1. Whether a separate or a common parameter vector is specied relates directly to the degree of exibility that is required to be consistent with the maintained hypothesis of the model, in particular condition C.1. Consider the most restrictive, the most general and the intermediate cases. Under the most restrictive specication of the Z-log, condition C.1 is a 2 maintained hypothesis. This implicitly assumes there are 1 2 n 2 n 2 distinct economic eects that exhaustively characterize multiproduct cost minimizing behavior. Marginal costs, conditional input demands, substitution elasticities, and returns to scale are assumed the same for multiproduct and specialized costs. In this case, a common parameter vector is specied 2 under the Z-log model providing 1 2 n 2 n 2 free parameters for estimation, which is the amount needed to estimate the economic eects of interest. Thus, the Z-log is a exible functional form conditional on the maintained hypotheses.9 It is also parsimonious since there are no more parameters than needed to exhaustively characterize cost minimizing behavior. Note that the SVTF, GTMCF, Composite and GHDF are also exible functional forms when condition C.1 is a maintained hypothesis since each contains enough free parameters to estimate the distinct economic eects. The most general specication relaxes condition C.1. Under this main2 tained hypothesis there are potentially 1 2 n 1 n 1 additional economic eects of interest since now marginal cost, conditional input demands, substitution elasticities, and returns to scale possibly dier for multiproduct and specialized producers. If C.1 is relaxed separate parameter vectors are 2 specied under the Z-log model in Eqs. (1) and (5), thus adding 1 2 n 1 ai , e aij , i; j 6 2, for estimation. The n 1 additional free parameters, e a0 ; e added parameters are required to estimate the total number of distinct economic eects that are hypothesized to fully characterize cost minimizing rm behavior. Again, conditional on the maintained hypotheses for the structure of multiproduct and specialized costs, the Z-log cost function is a exible functional form, and is also parsimonious. In the most general specication, separate translog cost functions are estimated for each convolution of strictly positive outputs.10 Cases may arise where the number of output convolutions is large, or data contain few observations on rms producing particular output combinations. In these
9 Diewert (1974, p. 113) denes a exible empirical cost function as one that could provide a second-order dierential approximation to an arbitrary twice continuously dierentiable true cost function that satises linear homogeneity in prices at any point in the admissible domain. 10 It is clear that separate parameter vectors could be specied for diversied and specialized producers under each of the empirical functions considered. These functions could also be used to test the restriction in C.1. The decision of which empirical function to use should be determined by the desirable properties that each function provides.

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instances, estimating separate parameter vectors will be impractical due to limited degrees of freedom. When data are limiting, it may be necessary to impose similar structure for multiproduct and specialized costs a priori. Ideally, there will be sucient degrees of freedom to test for common eects for diversied and specialized costs, which is the third intermediate case suggested above. In the intermediate case, the number of distinct economic eects characterizing multiproduct cost minimizing behavior is unknown, and must be inferred from data. Under the Z-log model separate parameter vectors are specied in Eqs. (1) and (5) and tests for common structure, i.e., function values and curvature properties, are conducted. For example, the hypothesis of common marginal cost for diversied and specialized costs, oC M z=oy1 oC S z=oy1 , involves a test of the parameter restriction a0 e a0 a1 e a1 . Tests of second-order curvature properties follow similarly. A test of the null hypothesis that second-order own-price eects are the same for diversied and specialized producers involves a joint test of the restrictions aii e ai e ai 1, for i > 2. Finally, a test of structural conaii ai ai 1 e a 0 , ai e ai , and aij e aji dition C.1 involves a test of the joint hypothesis: a0 e for all i, j 6 2. Section 4 demonstrates this procedure with data from US rail producers (see also Diewert and Wales 1987). 3. Estimating the Z-log model A simple and commonly used approach for estimation is to append contemporaneously correlated error terms to the cost function and n 1 conditional input demand equations. Estimating the unknown parameters of the Z-log function proceeds by stacking the dependent and independent variables for multiple and single output producers. Because the Z-log is linear in parameters, iterative seemingly unrelated regression can be used for estimation under the assumption that errors have zero mean and a common nite variancecovariance matrix (details appear in most econometrics textbooks, for example, Greene 2000). A remaining question is how well the Z-log model performs empirically. Results from a Monte Carlo simulation experiment that addresses this question are reported next. 3.1. Monte Carlo simulation A Monte Carlo simulation experiment was used to assess the estimating ability of the Z-log function in the presence of zero outputs, and compare its performance to the SVTF, GTMCF, GHDF and Composite cost function. A description of the experimental design, and additional simulation results are available in an extended paper that may be obtained upon request from the author.11 The following results are from one of the simulation experiments, and are representative of the overall ndings.
11

The experimental design is adapted from Guilkey et al. (1983) with the following modications. Guilkey et al. (i) specify a known primal technology that is almost homothetic (their technology does not have a dual cost function with a closed form representation), (ii) build multicolinearity into their data, and (iii) compare true and estimated returns to scale and substitution elasticities (functions of curvature properties) rather than function values and partial derivatives.

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The experimental design involved simulating data for multiproduct and specialized rms under a known technology and varying assumptions for returns to scale. The data simulation procedure was repeated 100 times, and at each repetition, an iterative regression is used to estimate the unknown parameters of the ve empirical multiproduct cost functions introduced above. Estimated parameters were used to calculate (estimate) the true function value and its curvature properties, i.e., the rst and second partial derivatives. It should be emphasized that the simulation experiment is conducted under the maintained hypotheses of linear homogeneity in input prices, and importantly, the hypothesis that condition C.1 is true. Hence, a common parameter vector is specied under the Z-log cost function. The results reported in Table 1 are obtained under a true technology exhibiting variable returns to scale. The sample size is 75 rms with 50 multiproduct and 25 single output producers. Under a variable returns technologies, the GHDF scale parameter / must be estimated and thus the GHDF is nonlinear in parameters. The GTMCF is also nonlinear in parameters. The GHDF failed to converge in 18 of the 100 repetitions and the GTMCF failed to converge in 5 of the 100 repetitions. In these cases, the Hessian of the non-linear least squares objective function contained small values. Alternative starting values and data scaling did not improve estimation convergence and the specic source of the non-convergence is unknown. Nonconverged iterations were discarded and repeated. Table 1 reports the average value of the true cost function and its curvature properties, for the multioutput rms in the simulated data. The bias and standard deviation of each functions estimate of these true eects is also reported. The results in Table 1 indicate that the bias for the estimated output eects is excessive under the SVTF and GTMCF. The SVTF overestimates oC =oy1 by 158.4% and underestimates oC =oy2 by almost 100%. The GTMCF 2 by 213.8%. For the most part, the GHDF, Composite overestimates o2 C =oy1 and Z-log output eect estimates indicate relatively low bias, although the 2 by 38.4%. Z-log overestimates o2 C =oy1 The bias in the price eect estimates is a small percentage of the true value for all functions. Bias in the GHDF price eect estimates is relatively large as is the standard deviation of these estimates. At each of the 100 iterations, regularity conditions were assessed for each empirical function. No concavity violations were indicated for the SVTF, GTMCF, Composite and Z-log functions. The GHDF violated concavity in input prices in 10 of the 100 repetitions. Convexity violations were as follows: 14 for the SVTF; 16 for the GTMCF; 11 for the GHDF; 7 for the Composite cost function; and 37 for the Z-log function. Additional Monte Carlo simulation results (not reported) nd that the Z-log function produced low-bias and low standard deviation estimates of true function values and curvature properties when elasticities of substitution for outputs were similar and did not departed signicantly from unity. The performance of the Z-log function declined when these conditions did not hold. For example, output substitution elasticities for the true technology underlying the results in Table 1 vary between 0.27 and 1.4 in absolute value, 2 . In general, perforexplaining in part the Z-logs overestimate of o2 C =oy1 mance of the Z-log improved with true substitution elasticities close to unity.

Table 1. Monte Carlo simulation results for multiproduct rms under true technology exhibiting VRS. Reported values are the mean bias and the standard deviation (in parentheses) of each functions estimate of the true value. The results are for 100 repititions of the Monte Carlo simulation experiment
o2 C oy1 oy2 oC ow1 oC ow2 o2 C 2 oy2 o2 C oy1 ow1 o2 C oy1 ow2 o2 C oy2 ow1 o2 C oy2 ow2 o2 C ow2 1 o2 C ow1 ow2 o2 C ow2 2

True value )0.31 1.51 13.14 (9.65) 0.07 (1.75) )0.08 (1.15) 0.06 (0.51) 0.58 (2.47) 1.37 (0.88) )0.39 (1.26) 0.12 (1.69) 0.15 (0.48) 0.26 (0.74) 1.36 (0.90) )0.33 (1.13) )0.04 (2.54) 0.16 (0.49) 0.27 (0.71) )2.26 (1.97) )0.22 (0.87) )0.08 (1.71) )0.05 (0.38) 0.03 (0.93) 0.72 (2.30) 0.76 (2.33) 0.72 (2.48) 0.46 (2.38) 0.76 (2.32) 0.63 (1.89) 0.60 (1.91) 0.85 (2.59) 0.38 (1.92) 0.60 (1.92) )2.07 (1.50) )0.17 (0.67) 0.05 (2.51) )0.03 (0.40) 0.05 (0.75) )0.10 (1.23) )0.08 (1.21) )0.51 (8.35) 0.01 (1.26) )0.10 (1.22) 0.02 (1.10) 0.01 (1.11) 0.66 (8.85) )0.08 (1.13) 0.02 (1.11) 2.36 2.34 2.37 2.37 13.68 13.56 4.67 )0.74 (2.54) )0.35 (1.35) 0.12 (0.89) 0.00 (0.47) 0.19 (0.82) )4.86

oC oy1

oC oy2

o2 C 2 oy1

Estimating multiproduct costs

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6.93

6.98

1.52

)4.77 )0.09 (1.13) )0.08 (1.16) )0.98 (9.99) 0.02 (1.15) )0.09 (1.15)

Bias and standard deviation of function estimates SVTF )4.44 4.05 )6.24 0.30 (5.82) (2.42) (4.36) (1.73) GTMCF )0.79 )1.06 )0.52 3.25 (5.73) (3.29) (2.14) (5.99) GHDF 0.31 0.19 )0.02 )0.29 (5.96) (2.49) (1.96) (0.73) Composite )0.75 0.46 )0.10 )0.46 (5.91) (1.34) (1.02) (0.67) Z-log )0.97 0.77 0.16 )0.38 (5.69) (1.88) (2.21) (1.47)

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In sum the overall results are consistent with previous studies of the performance of the translog functional form (see Guilkey et al. 1983). The overall ndings of the Monte Carlo simulation experiment indicate that the SVTF and the GTMCF may be unreliable for empirical analysis of multiproduct cost structures when some outputs are not produced. The GHDF performed well but only when the true technology exhibits constant returns to scale and constant returns was imposed during estimation. This limitation makes the GHDF impractical for applied research. The Composite cost function produced low bias and low standard deviation estimates of the true technology. Observe however, that the true cost function assumed in the simulation is quadratic in outputs and thus the Composite cost function may lend itself to approximation. Additional simulations with dierent true technologies would provide a more comprehensive assessment of performance for the Composite cost function. 3.2. Application to US railway data This section illustrates the advantage of relaxing the structural condition C.1 in applications to real data. The data are from a cross section of 1963 US rail producers, originally analyzed by Caves et al. (1980) using the GTMCF. There are 56 rms; 41 rms provided both freight and passenger service and 15 rms provided primarily freight service. Freight output is measured as tonmiles of revenue freight carried. Passenger output is measured as revenue passenger miles. Input categories are fuel, labor, and capital. Details are provided in Caves et al. (1978, 1980). The analysis proceeds by specifying separate parameter vectors for the multiproduct and specialized costs, followed by tests of structural similarity across the two producer types. This approach will allow any dierences in the measured economic information across the two rail producer types to be revealed from the data. Following standard practice, outputs and input prices were normalized by their respective means. Linear homogeneity in input prices is maintained. Iterative seemingly unrelated regression is used to estimate the separate parameter vectors. Cross group curvature restrictions are tested using a likelihood ratio test that is asymptotically distributed as a chisquare random variable with degrees of freedom determined by the number of restrictions imposed. A test of common cost structure for multiproduct and specialized rail producers, condition C.1, is rejected at the 99.99% condence level (c.l.). The null hypothesis that all rst-order output and price eects are the same for diversied and specialized rail producers is rejected at the 99.75% c.l. Further investigation reveals that the labor rst-order price eect the conditional labor demand diers signicantly across producer types (a common eect is rejected at the 95.53% c.l.). The hypothesis that fuel and capital rst-order price eects are shared cannot be rejected at conventional levels (c.l. of rejection is 77.02%). The hypothesis that all second-order eects are shared is rejected at the 96.25% c.l. Finally, the hypothesis that second-order price eects are the same for diversied and specialized producers is rejected at the 97.84% c.l. The structural tests indicate that distinct parameter vectors are required to characterize the multiproduct and single output cost technologies, although

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common fuel and capital labor price eects are supported by the data. Structural tests of the technology, which follow, are conducted under the maintained hypotheses of common fuel and capital price rst-order eects. The following results are thus conditional on these hypotheses being correct. The hypotheses that the multiple output cost technology is weakly separable cannot be rejected at conventional levels (the c.l. indicated is 79.46%). The null hypothesis that the technology exhibits constant returns to scale is tested for single and multiple output producers simultaneously, and for each group separately. All tests of constant returns to scale are rejected at the 99.99% c.l. Lastly, the hypothesis that the multiproduct cost technology is nonjoint in inputs is rejected at the 99.98% c.l. Structural tests nd strong evidence that multiproduct and specialized costs exhibit dierent structural properties. Transformation relationships dier systematically depending on producer type. Evidence suggesting that the multiproduct rail technology is joint-in-inputs is a logical source of the diering eects. Evaluating cost elasticities at the mean output quantities for multiproduct producers indicates that a 1% increase in both freight and passenger output leads increase in costs. A measure of overall returns to scale, P to a 1.06% 1 , is 0:942 indicating overall diseconomies of scale for i o ln C =o lnyi diversied producers. Product specic returns to scale for passenger output is calculated as the ratio of average incremental costs and marginal costs, AIC2 =oC =oy2 , where AIC2 C y1 ; y2 ; w C y1 ; 0; w=y2 . This measure is 1.341, indicating passenger-specic economies of scale. Freight only returns to scale must be measured directly using the freight-only parameter estimates.12 This measure, o ln C =o lny1 1 , is 1.455 indicating positive economies of scale. A comparison of the returns to scale measures suggests that production economies are dissipated under diversied production. In fact, multiproduct costs exhibit diseconomies of scope. The estimated output cross derivative o2 C =oy1 oy2 is positive which means that the marginal cost of producing freight ton-miles increases with increased production of passenger miles, in other words, the multiproduct cost surface is trans-ray concave. 4. Conclusion and extensions This article proposes a methodology to estimate the translog multiproduct cost function in the presence of zero outputs. The Z-log function exhibits the desirable properties that empirical functional forms should possess and provides a simple framework to relax and test the assumption of common structure for multiproduct and specialized costs. A Monte Carlo simulation experiment nds that the Z-log function produces relatively low bias and low standard deviation estimates of known multiproduct cost function when some outputs are not produced. Application to a cross section of US rail producers nds that the multiproduct rail technology exhibits variable returns to scale and input-jointness. Estimating these properties was facilitated by relaxing the assumption of a common cost structure for diversied and specialized
An accurate measurement of the average incremental cost of freight output AIC1 C y1 ; y2 ; w C 0; y2 ; w=y1 cannot be obtained from the multiple output cost function because no passenger output only producers are observed in the data.
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producers. To the extent that these empirical ndings are representative, the added exibility oered by the Z-log function should have broad appeal for analyzing multiproduct costs when some outputs are not produced. The Z-log model was introduced in a cost minimization framework; zero output quantities are explicitly assumed to be exogenously determined. The principles underlying the Z-log model may be extended to study the more general problem of endogenous location at the boundary of a production set. Situations often arise where rms must choose between discrete technologies that employ a subset of available inputs and/or produce a subset of observed outputs (Lee and Pitt 1987).13 It is possible that competing technologies embody distinct input and output transformation relationships. The methodology underlying the Z-log cost function may uncover structural dierences across competing technologies. Such extensions may improve estimation of multiproduct technologies and enhance the understanding for rm behavior in the presence of binding non-negativity constraints on inputs and outputs. References
Baumol WJ, Panzar JC, Willig RD (1982) Contestable markets and the theory of industry structure. Harcourt Brace Jovanovich, Inc., New York Berger AN, Demsetz RS, Strahan PE (1999) The consolidation of the nancial services industry: causes, consequences and implications for the future. Journal of Banking and Finance 23:135195 Caves DW, Christensen LR, Tretheway MW (1980, August) Flexible cost functions for multiproduct rms. Review of Economics and Statistics 62(3):477481 Christensen LR, Jorgenson DW, Lau LJ (1973, February) Transendental logarithmic production frontiers. Review of Economics and Statistics 55(1):2844 Cowing TG, Holtmann AG (1983, January) Multiproduct short-run hospital cost functions: empirical evidence and policy implications from cross-section data. Southern Economic Journal 49(3):637653 Diewert WE (1974) Applications of duality theory, vol II. (Frontiers in quantitative economics) North-Holland Publishing Company, Amsterdam Diewert WE, Wales TJ (1987, January) Flexible functional forms and global curvature conditions. Econometrica 55(1):4368 Fuss M, McFadden D, Mundlak Y (1978) A survey of functional forms in the economic analysis of production, vol 1. (Production economics: a dual approach to theory and applications) North-Holland Publishing Company, New York Garcia S, Thomas A (2001, July) The structure of municipal water supply costs: Application to a panel of french local communities. Journal of Productivity Analysis 16(1):529 Gilligan T, Smirlock M (1984, March) An empirical study of joint production and scale economies in commercial banking. Journal of Banking and Finance 8:6776 Greene WH (2000) Econometric analysis, 4th ed. Prentice Hall Inc., Upper Saddle River, NJ Guilkey DK, Lovell CK, Sickles RC (1983, October) A comparison of the performance of three exible functional forms. International Economic Review 24(3):591616 Hall RE (1973, July/August) The specication of technology with several kinds of output. Journal of Political Economy 81(4):878892

13

For example, Lee and Pitt (1987) use the theory of virtual prices to develop a general framework to estimate a translog cost function in the presence of binding non-negativity constraints. Their likelihood function species a common parameter vector for dierent input use regimes (see p. 101109). A logical extention would specify and test for separate parameters (economic eects) across input use regimes.

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