Decomposing Economic Efficiency into Technical and Allocative Components: An Essential Property

Abstract We introduce two desirable properties concerning the allocative efficiency term in decomposition of economic efficiency. Since Farrell, efficiency, defined terms cost, revenue, profitability, or profit functions, is decomposed into a technical measure and Resorting to duality theory, calculated as residual. In this framework, we show that residual numerically inconsistent for several decompositions: those based on Russell Efficiency Measures, Slack-Based Measure Weighted Additive Measures. It should be expected inefficient firm, if projected optimal benchmark, e.g., maximizing profit, efficient, yet above decompositions may signal it inefficient. Our first property, called ‘essential,’ demands satisfy criterion. also extend property by requiring technically evaluated at benchmark production frontier, coincides with itself. Regarding extension that, besides measures mentioned above, Directional Distance Function Hölder fail general comply it. However, prove thanks flexibility these approaches choosing common directional vector all assessed firms specific norm, extended essential property. conclude unless both are fulfilled, (residual) component many previously published cannot correctly interpreted price inefficiency.