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Measuring cost inefficiency: A dual approach

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  • Liu, Tung

Abstract

Total cost inefficiency comprises technical inefficiency and allocative inefficiency. Measuring cost inefficiency with these two components has been challenging both theoretically and empirically. Current literature has provided some solutions. However, these solutions are restricted to specific functions and their empirical estimations are complicated to implement, which lead to limited applications. Using the duality between production and cost functions, this paper proposes a new approach that is simple for estimation and applicable to general cases. Firstly, we define two types of allocative inefficiency and derive their input cost share inequalities. Secondly, a three-stage procedure is developed to estimate total cost inefficiency and its two components. Finally, an empirical presentation based on the existing data supplements the theory. Our results show that this solution can identify the inefficiency for each input and derive robust estimates of economies of scale, which are important for both policy implications and managerial decisions.

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  • Liu, Tung, 2021. "Measuring cost inefficiency: A dual approach," Economic Modelling, Elsevier, vol. 99(C).
    • Handle: RePEc:eee:ecmode:v:99:y:2021:i:c:s0264999321000468
    DOI: 10.1016/j.econmod.2021.02.012
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    More about this item

    Keywords

    Cost inefficiency; Technical inefficiency; Allocative inefficiency; Duality theory;
    All these keywords.

    JEL classification:

    • D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
    • D22 - Microeconomics - - Production and Organizations - - - Firm Behavior: Empirical Analysis
    • D24 - Microeconomics - - Production and Organizations - - - Production; Cost; Capital; Capital, Total Factor, and Multifactor Productivity; Capacity

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