Comparison of two empirical cost functions

In this paper we compare two hypotheses regarding the cost function that have been used in past studies of production smoothing. The two hypotheses tested are not nested. The comparison is done using two types of tests designed for non-nested hypotheses: the J-test of Davidson and McKinnon and the Encompassing test. Each of the models was capable of explaining much of the observed monthly output variations in the twenty four industries studied. Yet the J-test leads us to reject both models. The results of the Encompassing test however, indicate that each of the models contributes significantly to the explanation of output variation after accounting for the contribution of the alternative model.