Input–output-based general equilibrium analysis of efficiency

Under constant returns to scale, price-taking behavior and no external effects the general equilibrium allocation is efficient. Input-output analysis need not make these assumptions and has the capacity to measure the inefficiency of an observed economic allocation. The objective of a national economy is to fulfill domestic final demand. In this chapter the level of domestic final demand is maximized subject to material balance constraints on products and production factors. The gap between the maximum and the observed levels measures the inefficiency in the economy. The linear program that finds the frontier of the economy features complementary slackness: binding constraints are signaled by positive prices and non-binding constraints by zero prices. The frontier program is translated into a complementarity problem, which is easy to solve. The consequent efficiency is decomposed in trade efficiency, Leibenstein's X-efficiency and allocative efficiency. Moreover, Solow's total factor productivity growth measure is decomposed in technical change, efficiency change and a terms-of-trade effect. The analysis encompasses environmental policy analysis.