Shadow Profit Maximization and a Generalized Measure of Inefficiency

Subhash Ray

No 2005-14, Working papers from University of Connecticut, Department of Economics

Abstract: Determining the profit maximizing input-output bundle of a firm requires data on prices. This paper shows how endogenously determined shadow prices can be used in place of actual prices to obtain the optimal input-output bundle where the firm.s shadow profit is maximized. This approach amounts to an application of the Weak Axiom of Profit Maximization (WAPM) formulated by Varian (1984) based on shadow prices rather than actual prices. At these prices the shadow profit of a firm is zero. Thus, the maximum profit that could have been attained at some other input-output bundle is a measure of the inefficiency of the firm. Because the benchmark input-output bundle is always an observed bundle from the data, it can be determined without having to solve any elaborate programming problem. An empirical application to U.S. airlines data illustrates the proposed methodology.

Keywords: DEA; Shadow Prices; Non-radial Efficiency (search for similar items in EconPapers)
JEL-codes: C61 D21 (search for similar items in EconPapers)
Pages: 22 pages
Date: 2005-05
New Economics Papers: this item is included in nep-eff
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Persistent link: https://EconPapers.repec.org/RePEc:uct:uconnp:2005-14

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