Output Quality, Productivity, and Demand: Evidence from the Chinese Steel Industry

ABSTRACT Unobserved objective output quality complicates the analysis of firm productivity and demand because higher‐quality products entail higher costs but offer greater consumption benefits. Using a panel of firms with output quality data, we decompose quantity‐based productivity into fundamental productivity and the costs of quality, and separate the demand residual into fundamental demand and quality benefits. Fundamental demand accounts for most revenue variation, whereas quality's revenue‐enhancing benefits are largely offset by its costs. During the 2008 global financial crisis, shifts in quality diverged from changes in fundamental productivity and demand, highlighting the role of quality in assessing firm and industry performance.