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The law of one price in data envelopment analysis: Restricting weight flexibility across firms

  • Kuosmanen, Timo
  • Cherchye, Laurens
  • Sipilainen, Timo

The Law of One Price (LoOP) states that all firms face the same prices for their inputs and outputs in the competitive market equilibrium. This law has powerful implications for productive efficiency analysis, which have remained unexploited thus far. This paper shows how LoOP-based weight restrictions can be incorporated in Data Envelopment Analysis (DEA). Utilizing the relation between the industry level and the firm level cost efficiency measures, we propose to apply a set of input prices that is common for all firms and that maximizes cost efficiency of the industry. Our framework allows for firm-specific output weights and variable returns-to-scale, and preserves the linear programming structure of the standard DEA. We apply the proposed methodology for evaluating research efficiency of economics departments of Dutch Universities. This application shows that the methodology is computationally tractable for practical efficiency analysis, and that it helps in deepening the DEA analysis.

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Article provided by Elsevier in its journal European Journal of Operational Research.

Volume (Year): 170 (2006)
Issue (Month): 3 (May)
Pages: 735-757

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Handle: RePEc:eee:ejores:v:170:y:2006:i:3:p:735-757
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  1. Per Agrell & Jørgen Tind, 2001. "A Dual Approach to Nonconvex Frontier Models," Journal of Productivity Analysis, Springer, vol. 16(2), pages 129-147, September.
  2. Cherchye, Laurens & Kuosmanen, Timo, 2004. "Benchmarking Sustainable Development: A Synthetic Meta-index Approach," Working Paper Series UNU-WIDER Research Paper , World Institute for Development Economic Research (UNU-WIDER).
  3. Peter Bogetoft, 1996. "DEA on Relaxed Convexity Assumptions," Management Science, INFORMS, vol. 42(3), pages 457-465, March.
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  6. Léopold Simar & Paul W. Wilson, 1998. "Sensitivity Analysis of Efficiency Scores: How to Bootstrap in Nonparametric Frontier Models," Management Science, INFORMS, vol. 44(1), pages 49-61, January.
  7. Fare, Rolf & Zelenyuk, Valentin, 2003. "On aggregate Farrell efficiencies," European Journal of Operational Research, Elsevier, vol. 146(3), pages 615-620, May.
  8. Fare, Rolf & Grosskopf, Shawna, 1995. "Nonparametric tests of regularity, Farrell efficiency, and goodness-of-fit," Journal of Econometrics, Elsevier, vol. 69(2), pages 415-425, October.
  9. Blackorby, C. & Russell, R.R., 1996. "Aggregation of Efficiency Indices," G.R.E.Q.A.M. 96a25, Universite Aix-Marseille III.
  10. R. D. Banker & A. Charnes & W. W. Cooper, 1984. "Some Models for Estimating Technical and Scale Inefficiencies in Data Envelopment Analysis," Management Science, INFORMS, vol. 30(9), pages 1078-1092, September.
  11. Afriat, Sidney N, 1972. "Efficiency Estimation of Production Function," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 13(3), pages 568-98, October.
  12. Charles Blackorby & R. Russell, 1999. "Aggregation of Efficiency Indices," Journal of Productivity Analysis, Springer, vol. 12(1), pages 5-20, August.
  13. Charnes, A. & Cooper, W. W. & Rhodes, E., 1978. "Measuring the efficiency of decision making units," European Journal of Operational Research, Elsevier, vol. 2(6), pages 429-444, November.
  14. Timo Kuosmanen, 2003. "Duality Theory of Non-convex Technologies," Journal of Productivity Analysis, Springer, vol. 20(3), pages 273-304, November.
  15. Banker, Rajiv D & Maindiratta, Ajay, 1988. "Nonparametric Analysis of Technical and Allocative Efficiencies in Production," Econometrica, Econometric Society, vol. 56(6), pages 1315-32, November.
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