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Capacity utilisation and profitability: a decomposition of short run profit efficiency

  • COELLI, Tim
  • GRIFELL-TATJE, Emili
  • PERELMAN, Sergio

The principal aim of this paper is to measure the amount by which the profit of a multi-input, multi-output firm deviates from maximum short-run profit, and then to decompose this profit gap into components that are of practical use to managers. In particular, our interest is in the measurement of the contribution of unused capacity, along with measures of technical inefficiency, and allocative inefficiency, in this profit gap. We survey existing definitions of capacity and, after discussing their shortcomings, we propose a new ray economic capacity measure that involves short-run profit maximisation, with the output mix held constant. We go on to describe how the gap between observed profit and maximum profit can be calculated and decomposed using linear programming methods. The paper concludes with an empirical illustration, involving data on 28 international airline companies. The empirical results indicate that these airline companies achieve profit levels which are on average US$815m below potential levels, and that 70% of the gap may be attributed to unused capacity.

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Paper provided by Université catholique de Louvain, Center for Operations Research and Econometrics (CORE) in its series CORE Discussion Papers with number 2001052.

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Date of creation: 00 Nov 2001
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Handle: RePEc:cor:louvco:2001052
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  1. Fare, Rolf & Grosskopf, Shawna & Kokkelenberg, Edward C, 1989. "Measuring Plant Capacity, Utilization and Technical Change: A Nonparametric Approach," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 30(3), pages 655-66, August.
  2. Tulkens, H. & Vanden Eeckaut, P., . "Non-parametric efficiency, progress and regress measures for panel data: Methodological aspects," CORE Discussion Papers RP -1132, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  3. Eilon, Samuel & Teague, Judith, 1973. "On measures of productivity," Omega, Elsevier, vol. 1(5), pages 565-576, October.
  4. Eilon, S & Gold, Bela & Soesan, Judith, 1975. "A productivity study in a chemical plant," Omega, Elsevier, vol. 3(3), pages 329-343, June.
  5. Winston, Gordon C, 1974. "The Theory of Capital Utilization and Idleness," Journal of Economic Literature, American Economic Association, vol. 12(4), pages 1301-20, December.
  6. Lawrence R. Klein, 1958. "The Measurement of Capacity," Cowles Foundation Discussion Papers 49, Cowles Foundation for Research in Economics, Yale University.
  7. Berndt, Ernst R & Morrison, Catherine J, 1981. "Capacity Utilization Measures: Underlying Economic Theory and an Alternative Approach," American Economic Review, American Economic Association, vol. 71(2), pages 48-52, May.
  8. Eilon, Samuel, 1975. "Changes in profitability components," Omega, Elsevier, vol. 3(3), pages 353-354, June.
  9. Gold, Bela, 1973. "Technology, productivity and economic analysis," Omega, Elsevier, vol. 1(1), pages 5-24, February.
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