Explain the econometric method of estimating cost function. Why is this method more popular than the other two methods (accounting and engineering) estimation costs?
This method is also referred to as statistical method. It has a wide use in estimating the cost functions. This method, undertakes the historical data of cost and output for estimating the cost-output relationship, with the help of regression analysis basic techniques. The data used in this method may involve the time-series data pertaining to an individual firm in the industry or may relate to all the firms in the industry. Or the method may undertake a cross-section data relating to a particular year from various firms in the industry.
The short run or the long run cost functions may be thus determined based on the data used. under this method. For example, in case of time series, data of a firm, for which the output capacity has not been changed during the sample period is undertaken for analysis, then it would represent a short run cost function. Where as in case of cross section data pertaining to many firms with varying sizes, or the time series data of the industry is used, and then the estimated cost function will be a long-run cost function.
This, method is preferred over the accounting method because of the fact that in the accounting method, one has to maintain A detailed breakdown of costs over a period to determine good estimates of actual cost-output relationship, which tends to be a very cumbersome one. And as regards, its preference over the engineering method is based on the fact that the engineering method requires a thorough understanding of the engineering and a detailed sampling of the different processes under controlled conditions, which at times is not possible.