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Decompositions of Profitability Change using Cost Functions

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Abstract

Profitability at a period of time is defined as the value of outputs produced by a production unit divided by the corresponding cost. Using some earlier work by O?Donnell, the paper provides a decomposition of profitability growth over two periods into various explanatory factors. The explanatory factors are: the change in the production unit?s cost efficiency, an index of output price growth, returns to scale, technical progress and an index of input price growth. If output prices for the production unit are not available, the paper suggests that marginal costs could be used as prices to weight outputs in each period. Using marginal or average costs to weight outputs leads to a methodology for evaluating the productivity performance of nonmarket production units that is similar to the methodology suggested in the Atkinson report.

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  • W. Erwin Diewert, 2010. "Decompositions of Profitability Change using Cost Functions," CEPA Working Papers Series WP092010, School of Economics, University of Queensland, Australia.
    • Handle: RePEc:qld:uqcepa:55
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    File URL: https://economics.uq.edu.au/files/5232/WP092010.pdf
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    1. Christopher J. O'Donnell, 2010. "Measuring and decomposing agricultural productivity and profitability change ," Australian Journal of Agricultural and Resource Economics, Australian Agricultural and Resource Economics Society, vol. 54(4), pages 527-560, October.
    2. McFadden, Daniel, 1978. "Cost, Revenue, and Profit Functions," Histoy of Economic Thought Chapters,in: Fuss, Melvyn & McFadden, Daniel (ed.), Production Economics: A Dual Approach to Theory and Applications, volume 1, chapter 1 McMaster University Archive for the History of Economic Thought.
    3. Diewert, W. Erwin & Fox, Kevin J., 2008. "On the estimation of returns to scale, technical progress and monopolistic markups," Journal of Econometrics, Elsevier, vol. 145(1-2), pages 174-193, July.
    4. 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 568-598, October.
    5. Robert B. Archibald, 1977. "On the Theory of Industrial Price Measurement Output Price Indexes," NBER Chapters,in: Annals of Economic and Social Measurement, Volume 6, number 1, pages 57-72 National Bureau of Economic Research, Inc.
    6. Forsund, Finn R & Hjalmarsson, Lennart, 1983. "Technical Progress and Structural Change in the Swedish Cement Industry 1955-1979," Econometrica, Econometric Society, vol. 51(5), pages 1449-1467, September.
    7. Diewert, W.E., 1993. "Duality approaches to microeconomic theory," Handbook of Mathematical Economics,in: K. J. Arrow & M.D. Intriligator (ed.), Handbook of Mathematical Economics, edition 4, volume 2, chapter 12, pages 535-599 Elsevier.
    8. Fare, Rolf & Knox Lovell, C. A., 1978. "Measuring the technical efficiency of production," Journal of Economic Theory, Elsevier, vol. 19(1), pages 150-162, October.
    9. W. Diewert & Alice Nakamura, 2003. "Index Number Concepts, Measures and Decompositions of Productivity Growth," Journal of Productivity Analysis, Springer, vol. 19(2), pages 127-159, April.
    10. John C. Panzar & Robert D. Willig, 1977. "Economies of Scale in Multi-Output Production," The Quarterly Journal of Economics, Oxford University Press, vol. 91(3), pages 481-493.
    11. Bert Balk, 2003. "The Residual: On Monitoring and Benchmarking Firms, Industries, and Economies with Respect to Productivity," Journal of Productivity Analysis, Springer, vol. 20(1), pages 5-47, July.
    12. Samuelson, Paul A & Swamy, S, 1974. "Invariant Economic Index Numbers and Canonical Duality: Survey and Synthesis," American Economic Review, American Economic Association, vol. 64(4), pages 566-593, September.
    13. Diewart, W Erwin & Morrison, Catherine J, 1986. "Adjusting Output and Productivity Indexes for Changes in the Terms of Trade," Economic Journal, Royal Economic Society, vol. 96(383), pages 659-679, September.
    14. C.J. O'Donnell, 2008. "An aggregate quantity-price framework for measuring and Decomposing productivity and profitability change," CEPA Working Papers Series WP072008, School of Economics, University of Queensland, Australia.
    15. Bert Balk, 2001. "Scale Efficiency and Productivity Change," Journal of Productivity Analysis, Springer, vol. 15(3), pages 159-183, May.
    16. Hanoch, Giora & Rothschild, Michael, 1972. "Testing the Assumptions of Production Theory: A Nonparametric Approach," Journal of Political Economy, University of Chicago Press, vol. 80(2), pages 256-275, March-Apr.
    17. W. Diewert, 2011. "Measuring productivity in the public sector: some conceptual problems," Journal of Productivity Analysis, Springer, vol. 36(2), pages 177-191, October.
    18. W. Diewert & Kevin Fox, 2010. "Malmquist and Törnqvist productivity indexes: returns to scale and technical progress with imperfect competition," Journal of Economics, Springer, vol. 101(1), pages 73-95, September.
    19. W. Erwin Diewert, 1980. "Aggregation Problems in the Measurement of Capital," NBER Chapters,in: The Measurement of Capital, pages 433-538 National Bureau of Economic Research, Inc.
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    21. Varian, Hal R, 1984. "The Nonparametric Approach to Production Analysis," Econometrica, Econometric Society, vol. 52(3), pages 579-597, May.
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    Cited by:

    1. W. Erwin Diewert & Kevin J. Fox, 2017. "Decomposing Value Added Growth into Explanatory Factors," Discussion Papers 2017-02, School of Economics, The University of New South Wales.
    2. E. Grifell-TatjeÌ & C. A. K. Lovell, 2015. "Decompositions of Profitability Change Using Cost Functions: A Comment," CEPA Working Papers Series WP032015, School of Economics, University of Queensland, Australia.
    3. Thomas von Brasch, 2015. "On measuring the contribution from firm turnover to aggregate productivity growth. Selection on profitability and not productivity," Discussion Papers 819, Statistics Norway, Research Department.
    4. Diewert, W. Erwin & Fox, Kevin J., 2017. "The Difference Approach to Productivity Measurement and Exact Indicators," Microeconomics.ca working papers erwin_diewert-2017-10, Vancouver School of Economics, revised 24 Nov 2017.
    5. Agrell, Per J. & Grifell-Tatjé, Emili, 2016. "A dynamic model for firm-response to non-credible incentive regulation regimes," Energy Policy, Elsevier, vol. 90(C), pages 287-299.
    6. Diewert, W. Erwin & Fox, Kevin J., 2016. "A Decomposition of U.S. Business Sector TFP Growth into Technical Progress and Cost Efficiency Components," Microeconomics.ca working papers erwin_diewert-2016-8, Vancouver School of Economics, revised 30 Jun 2016.
    7. repec:eee:jbfina:v:90:y:2018:i:c:p:1-16 is not listed on IDEAS

    More about this item

    JEL classification:

    • C43 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Index Numbers and Aggregation
    • D24 - Microeconomics - - Production and Organizations - - - Production; Cost; Capital; Capital, Total Factor, and Multifactor Productivity; Capacity
    • D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis
    • E23 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Production
    • H44 - Public Economics - - Publicly Provided Goods - - - Publicly Provided Goods: Mixed Markets
    • O47 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - Empirical Studies of Economic Growth; Aggregate Productivity; Cross-Country Output Convergence

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