On the Estimation of Marginal Cost

This article proposes a general empirical method for the estimation of marginal cost of individual firms. The new method employs the smooth coefficient model, which has a number of appealing features when applied to cost functions. The empirical analysis uses data from a unique sample from which we observe marginal cost. We compare the estimates from the proposed method with the true values of marginal cost, and the estimates of marginal cost that we obtain through conventional parametric methods. We show that the proposed method produces estimated values of marginal cost that very closely approximate the true values of marginal cost. In contrast, the results from conventional parametric methods are significantly biased and provide invalid inference.