Revisiting the Decomposition of Cost Efficiency for Non-homothetic Technologies: A Directional Distance Function Approach
Juan Aparicio () and
No 2017/01, Efficiency Series Papers from University of Oviedo, Department of Economics, Oviedo Efficiency Group (OEG)
In the early 1980’s Kopp and Diewert proposed the decomposition of cost efficiency into allocative and technical efficiency for parametric functional forms based on the radial approach initiated by Farrell. We show that such approach is only valid for homothetic technologies where the radial distance function can be correctly interpreted as a technical efficiency measure since allocative efficiency is independent of the output level and radial input reductions leave it unchanged. For the general case of non-homothetic technologies where optimal input demands depend on the output targeted by the firm, as does the inequality between marginal rates of substitution and market prices allocative inefficiency, we show that the correct definition of technical efficiency corresponds to the directional distance function. Indeed, its flexibility ensures that allocative efficiency is kept unchanged through movements in the input production possibility set when solving technical inefficiency, and therefore the associated cost reductions can be solely and rightly ascribed to technical engineering improvements. The new methodology to consistently decompose cost inefficiency, which generalizes the approach introduced by Kopp and Diewert as well as subsequent refinements, is illustrated resorting to simple examples of both homothetic and non-homothetic production functions.
New Economics Papers: this item is included in nep-eff
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2) Track citations by RSS feed
Downloads: (external link)
Journal Article: Revisiting the decomposition of cost efficiency for non-homothetic technologies: a directional distance function approach (2017)
This item may be available elsewhere in EconPapers: Search for items with the same title.
Export reference: BibTeX
RIS (EndNote, ProCite, RefMan)
Persistent link: https://EconPapers.repec.org/RePEc:oeg:wpaper:2017/01
Access Statistics for this paper
More papers in Efficiency Series Papers from University of Oviedo, Department of Economics, Oviedo Efficiency Group (OEG) Departamento de Economía, Facultad de Economía y Empresa, Universidad de Oviedo, Avenida del Cristo, s/n. 33006 Oviedo - SPAIN. Contact information at EDIRC.
Bibliographic data for series maintained by Luis Orea ().