Applied Micro Seminar - Shengyu Li (UNSW)

Title:  Productivity and Quality of Multi-product Firms

Abstract: This paper proposes a novel method to estimate productivity and quality at the firm-product level, together with transformation function and demand parameters. The method relies on firm optimization conditions to control for unobservable variables. It has the advantage of allowing for heterogeneous unobserved intermediate input prices and scalability to handle a large number of products, without imputing firm-product input shares or relying on productivity evolution. We apply this method to a set of Mexican manufacturing industries. We find that products closer to a firm's core competence have both higher productivity and higher quality, with the former emerging as a stronger predictor of within-firm performance. However, firms face a trade-off between quality and productivity, which is referred to as the cost of quality. The cost of quality is higher for more differentiated products and declines with product age. In a counterfactual exercise, we show that a reduction in the cost of quality can lead to substantial firm-level productivity gains and that, on average, about 11.3 percent of these gains are due to the within-firm reallocation of production. Importantly, a larger product scope allows more room for intra-firm resource reallocation, leading to higher productivity gains. This reveals a new mechanism for explaining the superior performance of multi-product firms.