Shadow Profit Maximization and a Generalized Measure of Inefficiency
AbstractDetermining the profit maximizing input-output bundle of a firm requires data on prices. This paper shows how endogenously determined shadow prices can be used in place of actual prices to obtain the optimal input-output bundle where the firm.s shadow profit is maximized. This approach amounts to an application of the Weak Axiom of Profit Maximization (WAPM) formulated by Varian (1984) based on shadow prices rather than actual prices. At these prices the shadow profit of a firm is zero. Thus, the maximum profit that could have been attained at some other input-output bundle is a measure of the inefficiency of the firm. Because the benchmark input-output bundle is always an observed bundle from the data, it can be determined without having to solve any elaborate programming problem. An empirical application to U.S. airlines data illustrates the proposed methodology.
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Bibliographic InfoPaper provided by University of Connecticut, Department of Economics in its series Working papers with number 2005-14.
Length: 22 pages
Date of creation: May 2005
Date of revision:
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More information through EDIRC
DEA; Shadow Prices; Non-radial Efficiency;
Find related papers by JEL classification:
- C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
- D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
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