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Published online by Cambridge University Press: 14 April 2022
TFP is generally estimated as a residual – the difference between a firm's actual output and its predicted output. This requires a two-step procedure: first we predict the value of output based on information on a firm's use of inputs, a theoretical framework explaining how the inputs are combined and a consistent empirical estimation that measures this combination. Then we take the difference between the (correctly estimated) predicted output and the actual (observed) output. This residual will explain which part of the actual output we are not able to explain by looking at the way that firms have used inputs.
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