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The Law of One Price in Data Envelopment Analysis: Restricting Weight Flexibility Across Firms

  • Timo Kuosmanen

    (Wageningen University)

  • Laurens Cherchye

    (Catholic University of Leuven)

  • Timo Sipiläinen

    (Agrifood Research Finland)

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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Paper provided by EconWPA in its series Microeconomics with number 0312006.

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Length: 29 pages
Date of creation: 18 Dec 2003
Date of revision: 18 Dec 2003
Handle: RePEc:wpa:wuwpmi:0312006
Note: Type of Document - pdf; pages: 29
Contact details of provider: Web page: http://econwpa.repec.org

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