We study the costs of misallocation of inputs between multi-product firms that endogenously choose among heterogeneous products. Misallocation of in-puts between firms has been shown to be a significant drag on aggregate productivity: it is especially severe between farms in the agricultural sectors of low-income economies. Existing estimates of its costs have relied on models of single-product firms using a single aggregate production f unction. Using rich farm-crop-level data from India, we estimate product-level production functions and find that they are meaningfully different from one another and from the aggregate one. We build a general equilibrium model of firm-level misallocation in which multi-product firms (or farms) are able to choose the set and mix of heterogeneous products. Misinterpreting product heterogeneity as evidence of distortions and missing the endogenous product choice response to real distortions biases single-product models to overstate misallocation, while ignoring returns-to-scale heterogeneity and within-firm productivity dispersion biases them to understate it. On net, the single-product model understates the aggregate productivity cost of misallocation between Indian farms by 28%.
STEG Working Paper Series
• Research Theme 3: Agricultural Productivity and Sectoral Gaps,
Research Theme 4: Trade and Spatial Frictions,
Cross-Cutting Issue 3: Inequality and Inclusion
Misallocation and Product Choice
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