The production approach to markup estimation often measures input distortions

Abstract

The production approach recovers markups using the output elasticity for a variable and undistorted input. We show using the revenue elasticity for a variable input recovers that input’s wedge. Our result has two implications. First, in the canonical setting with CES demand and monopolistic competition, past research using the production approach with revenue data should be recast as evidence of input, rather than output, distortions. Second, future research can use the production approach with revenue data to study input distortions, provided researchers can measure inputs in physical units. A promising application pertains to labor market distortions.