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Proper quadratic cost functions with an application to ATandT

Author: Röller, Lars-Hendrik INSEAD Area: Economics and Political ScienceIn: Review of Economics and Statistics, vol. 72, no. 2, May 1990 Language: EnglishDescription: p. 202-210.Type of document: INSEAD ArticleNote: Please ask the Library for this articleAbstract: When choosing a flexible functional form to model multi-output cost structures, one is quickly confronted with severe violations of certain regularity conditions over large regions of output space. This problem is particularly troublesome when the economic analysis extrapolates cost information from such (improper) regions. This paper explicitly imposes regional properness on the parameter space of flexible functional forms, thereby using more economic theory in the modelling process. The apparent trade-off between functional flexibility and functional properness has been identified for the case of the quadratic cost function, and it is argued that this trade-off should be resolved in favour of properness, not flexibility, in order to obtain meaningful models of multi-output cost structures. Using the quadratic cost function, the proposed procedure is illustrated with an application to the Bell System
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When choosing a flexible functional form to model multi-output cost structures, one is quickly confronted with severe violations of certain regularity conditions over large regions of output space. This problem is particularly troublesome when the economic analysis extrapolates cost information from such (improper) regions. This paper explicitly imposes regional properness on the parameter space of flexible functional forms, thereby using more economic theory in the modelling process. The apparent trade-off between functional flexibility and functional properness has been identified for the case of the quadratic cost function, and it is argued that this trade-off should be resolved in favour of properness, not flexibility, in order to obtain meaningful models of multi-output cost structures. Using the quadratic cost function, the proposed procedure is illustrated with an application to the Bell System

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