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Weak Axiom of Cost Dominance: A Nonparametric Test of Cost Efficiency Without Input Quantity Data

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  • Subhash Ray

Abstract

Varian's Weak Axiom of Cost Minimization provides a nonparametric test of cost minimization, which can be applied only when both input price and quantity data are available for individual firms. In this paper we propose a Weak Axiom of Cost Dominance (WACD), which serves as the basis of an alternative test of cost-minimization applicable in situations where input quantity data are missing. Unlike a previous test developed by Diewert and Parkan, the proposed test does identify individual firms that violate the assumption of cost-minimizing behavior. It also provides an upper bound of the cost-efficiency of any observed firm. The test procedure is shown to be equivalent to applying dominance analysis using normalized input prices with reference to the Cost-indirect technology. The proposed method is applied to Nerlove's electrical utility data. The nonparametric results are also compared with parametric efficiency levels computed from a stochastic frontier cost function. Copyright Kluwer Academic Publishers 1997

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  • Subhash Ray, 1997. "Weak Axiom of Cost Dominance: A Nonparametric Test of Cost Efficiency Without Input Quantity Data," Journal of Productivity Analysis, Springer, vol. 8(2), pages 151-165, May.
    • Handle: RePEc:kap:jproda:v:8:y:1997:i:2:p:151-165
    DOI: 10.1023/A:1007747407212
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    1. Henry Tulkens & Philippe Eeckaut, 2006. "Non-Frontier Measures of Efficiency, Progress and Regress for Time Series Data," Springer Books, in: Parkash Chander & Jacques Drèze & C. Knox Lovell & Jack Mintz (ed.), Public goods, environmental externalities and fiscal competition, chapter 0, pages 373-394, Springer.
    2. Hanoch, Giora & Rothschild, Michael, 1972. "Testing the Assumptions of Production Theory: A Nonparametric Approach," Journal of Political Economy, University of Chicago Press, vol. 80(2), pages 256-275, March-Apr.
    3. Henry Tulkens, 2006. "On FDH Efficiency Analysis: Some Methodological Issues and Applications to Retail Banking, Courts and Urban Transit," Springer Books, in: Parkash Chander & Jacques Drèze & C. Knox Lovell & Jack Mintz (ed.), Public goods, environmental externalities and fiscal competition, chapter 0, pages 311-342, Springer.
    4. Jondrow, James & Knox Lovell, C. A. & Materov, Ivan S. & Schmidt, Peter, 1982. "On the estimation of technical inefficiency in the stochastic frontier production function model," Journal of Econometrics, Elsevier, vol. 19(2-3), pages 233-238, August.
    5. Varian, Hal R, 1984. "The Nonparametric Approach to Production Analysis," Econometrica, Econometric Society, vol. 52(3), pages 579-597, May.
    6. Aigner, Dennis & Lovell, C. A. Knox & Schmidt, Peter, 1977. "Formulation and estimation of stochastic frontier production function models," Journal of Econometrics, Elsevier, vol. 6(1), pages 21-37, July.
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    2. W D A Bryant, 2009. "General Equilibrium:Theory and Evidence," World Scientific Books, World Scientific Publishing Co. Pte. Ltd., number 6875, December.
    3. Paul Oslington, 2012. "General Equilibrium: Theory and Evidence," The Economic Record, The Economic Society of Australia, vol. 88(282), pages 446-448, September.
    4. Tom Kompas & Tuong Nhu Che, 2003. "Efficiency Gains and Cost Reductions from Individual Transferable Quotas: A Stochastic Cost Frontier for," International and Development Economics Working Papers idec03-6, International and Development Economics.
    5. KERSTENS , Kristiaan & VANDEN EECKAUT, Philippe, 1998. "Distinguishing technical and scale efficiency on non-convex and convex technologies: theoretical analysis and empirical illustrations," LIDAM Discussion Papers CORE 1998055, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
    6. Kristiaan Kerstens & Ignace Van de Woestyne, 2021. "Cost functions are nonconvex in the outputs when the technology is nonconvex: convexification is not harmless," Annals of Operations Research, Springer, vol. 305(1), pages 81-106, October.
    7. Sueyoshi, Toshiyuki & Sekitani, Kazuyuki, 2007. "The measurement of returns to scale under a simultaneous occurrence of multiple solutions in a reference set and a supporting hyperplane," European Journal of Operational Research, Elsevier, vol. 181(2), pages 549-570, September.

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