Cost Efficiency in Models of Data Envelopment Analysis

Nonparametric cost efficiency models in data envelopment analysis (DEA) are more flexible in the sense that cost data are usually available even for public sector (nonprofit) enterprises and overall cost minimization may be used as an efficiency criterion, where output price data are not available. For profit-based industries cost minimization criteria may be applied even when there is increasing returns to scale in the production process. Cost efficiency also incorporates market prices of inputs and their impact on growth of firms. Another useful application of the cost frontiers derived from a DEA model is to measure the relative productivity contribution of strategic inputs like research and development (R&D) spending, advertisement, and net capital expenditure. If the cost frontier is quadratic, then marginal costs can be easily derived and hence by equating price to marginal cost the total industry supply function can be derived. Given the industry demand function one could compute the equilibrium price and output for the whole industry. This yields a measure of consumers’ surplus, which provides a social efficiency criterion. Under imperfect competition, for example, a Cournot-type market equilibrium price will be higher and total industry output lower, than in pure competition. Thus the consumers’ surplus would be lower in a Cournot-type market equilibrium, that is, social efficiency would be lower.