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On the technical (in)efficiency of a profit maximum

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  • Fandel, Günter
  • Lorth, Michael
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    Abstract

    In general, production-theoretical analysis aims at identifying an enterprise's (technically) efficient production alternatives. According to the principles of economy, achieving technical efficiency is considered as a prerequisite for a producer's further optimization behaviour and, therefore, as a matter of rationality. We will show in our article, however, that it might be economically unfounded to focus only on technically efficient production alternatives. Using a nonlinear inequality-constrained optimization framework, we demonstrate that a profit-maximizing production may imply technical inefficiency, i.e., in graphical terms, depending on the topology of the profit function the optimal input-output combination may be located in the interior of the producer's production possibilities set. In order to show this, we establish mathematical (and economic) conditions for the profit-maximization approach to yield a technically efficient or inefficient solution, respectively. In fact, inefficient solutions emerge when input or output prices are not strictly positive over the entire domain and/or the objective function is non-monotonic. We highlight some non-pathological economic situations that are likely to set the stage for technically inefficient profit maxima and provide an example that illustrates how an enterprise can make use of this approach in order to improve profits by choosing technically inefficient production points. In spite of those optimal inefficiencies, economic environments with positive prices and technical efficiency of the optimum shall remain the normal case.

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    Bibliographic Info

    Article provided by Elsevier in its journal International Journal of Production Economics.

    Volume (Year): 121 (2009)
    Issue (Month): 2 (October)
    Pages: 409-426

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    Handle: RePEc:eee:proeco:v:121:y:2009:i:2:p:409-426

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    Web page: http://www.elsevier.com/locate/ijpe

    Related research

    Keywords: Production theory Efficiency Profit maximization;

    References

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    1. Mas-Colell, Andreu & Whinston, Michael D. & Green, Jerry R., 1995. "Microeconomic Theory," OUP Catalogue, Oxford University Press, number 9780195102680.
    2. Bogetoft, Peter & Fare, Rolf & Obel, Borge, 2006. "Allocative efficiency of technically inefficient production units," European Journal of Operational Research, Elsevier, vol. 168(2), pages 450-462, January.
    3. Seiford, Lawrence M. & Zhu, Joe, 2002. "Modeling undesirable factors in efficiency evaluation," European Journal of Operational Research, Elsevier, vol. 142(1), pages 16-20, October.
    4. Baumgartner, Stefan & Winkler, Ralph, 2003. "Markets, technology and environmental regulation: price ambivalence of waste paper in Germany," Ecological Economics, Elsevier, vol. 47(2-3), pages 183-195, December.
    5. Dyckhoff, H. & Allen, K., 2001. "Measuring ecological efficiency with data envelopment analysis (DEA)," European Journal of Operational Research, Elsevier, vol. 132(2), pages 312-325, July.
    6. Steven, Marion & Zapp, Susanne E., 2008. "Technical inefficiencies and profit maximization," Arbeitsberichte des Lehrstuhls für Produktionswirtschaft 7, Ruhr-Universität Bochum (RUB), Lehrstuhl für Produktionswirtschaft.
    7. Jean Tirole, 1988. "The Theory of Industrial Organization," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262200716, December.
    8. Fare, Rolf, et al, 1993. "Derivation of Shadow Prices for Undesirable Outputs: A Distance Function Approach," The Review of Economics and Statistics, MIT Press, vol. 75(2), pages 374-80, May.
    9. Fare, Rolf, et al, 1989. "Multilateral Productivity Comparisons When Some Outputs Are Undesirable: A Nonparametric Approach," The Review of Economics and Statistics, MIT Press, vol. 71(1), pages 90-98, February.
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    Cited by:
    1. Jean-Philippe Boussemart & David Crainich & Hervé Leleu, 2012. "A decomposition of profit inefficiency into price expectation error, preferences towards risk and technical inefficiency," Working Papers 2012-ECO-04, IESEG School of Management.

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