Addition and Efficiency Author(s): Rolf Fare Source: The Quarterly Journal of Economics, Vol. 101, No. 4 (Nov.

, 1986), pp. 861-866 Published by: The MIT Press Stable URL: http://www.jstor.org/stable/1884181 Accessed: 02/11/2010 06:29
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ADDITION AND EFFICIENCY ROLFFARE* I. INTRODUCTION twoor more The thought thatit can be efficient combine to multiproduct firms (plants)is made preciseby Baumol,Panzar, of and Willig[1982].In particular, notion economies scope the of is introduced modelthe gains ofcombining or morefirms to two importance of (plants)producing different outputs. One economic economies scopeis statedin Proposition of 9.B.1, p. 248, ofBauin firms a commol,Panzar, and Willig [1982]: "Multiproduct mustenjoy leastweak)economies scope of petitive equilibrium (at thatis economies of overthe set ofproducts whichtheyproduce; of competitive scopeare necessary theexistence multiproduct for firms." to have been suggested testor Variousparametric methods estimate economies scope,e.g.,see Baumol,Panzar,and Willig of [1982]or Evans and Heckman[1984].The purposeofthispaper approach, is to introduce nonparametric a (linearprogramming) alongthe lines suggested Afriat by [1972];Diewertand Parkan or [1983];and Fare, Grosskopf, Lovell [1985]to estimate test and economies scope. of In The paper unfolds follows. SectionII a measurea la as combining Farrell is introduced gauge efficiency to gains from to twoor moremultiproduct firms (plants).SectionIII is devoted a method calfor developing nonparametric (linearprogramming) culating efficiency the gains.
II. DUALITY, ADDITION, AND EFFICIENCY

and Let pR'[ denotean inputpricevector, let ueRmdenote an output If associatedwith and u can vector. thecostfunction p be written as

(1)

k=t

Uk, p

k=1

E C(uk, p),

it is subadditive. From duality theory,1 subadditivityof the cost

ever. for comments *I am indebted a referee themosthelpful to 1. See Baumol,Panzar, and Willig [1982] or McFadden[1978].Note that for to certainassumptions invoked the dualitytheory apply.An excellent are survey givenin Diewert[1982]. is
? 1986bythePresident Fellows Harvard by Wiley Sons,Inc. & of College.Published John and CCC 0033-5533/86/040861-05$04.00 November 1986 TheQuarterly Journal Economics, of

862

QUARTERLY JOURNAL OF ECONOMICS

~~~~a L(Ul)+L(u2)

0 /

X2

FIGUREI

of for function all p is equivalentto superadditivity the input set;2i.e., requirement

K K Uk) E k=1

(2)

L(E

L(Uk)
k=1

two combining or more gains efficiency from estimating Therefore, the (plants)can be doneby comparing "fronfirms multiproduct tiers"ofL (k= 1 Uk) and EK 1 L (Uk). To elucidatesucha compariin exposition, which a son,let us consider simplediagrammatic by inputsare denoted xi, i = 1, 2. to belonging thesumL(u1) + L(u2). Letx0be an inputvector itself of contraction x0 along the ray through The proportional of the intersects boundaries (L(ul) + L(u2)) and L(ul + u2)at b The and c, respectively. ratioof the distancesbetween0 and b efFarrelltechnical and between0 and a measuresinput-based (L(ul) + L(u2)). technology to of ficiency x0relative thereference the In the same fashion, ratioofthe distancesbetween0 and c efFarrelltechnical and between0 and a measuresinput-based L(ul + u2).The technology to of ficiency x0relative thereference gain of quotient thesetwoFarrellmeasuresyieldsthe efficiency of the combining producers ul and u2. Let us a la Farrellfrom denotethisby
(3)
U.

G(ul, uI2,x0). output all yielding set 2. An inputrequirement L(u) denotes inputvectors

ADDITION AND EFFICIENCY

863

Simplearithmetic yields (4) G(u1, u2,x0) = ObIOc. Notethatifinputpricesare suchthatthe inputvectors b at and c, respectively, cost-minimizing, the gain function are then G has the costinterpretation, (5)
G (1,
u2jx?)

= I C(U1,p)

+ Cu2, p)

Therefore, underthe statedconditions, subadditivity the cost of function occurswhen the value ofthe gain function not less is thanone. To endthissection, us recallthemeaning (weak) econlet of omiesofscope.Following Baumol,Panzar, and Willig[1982,p. 71], we may interpret economies scopeas the restricted of form ofsubadditivitywhen ut.id = 0, i + j, i,j = 1, . . . , K; i.e., when Uiand id are orthogonal.
III. LINEAR PROGRAM GAUGING OF EFFICIENCY

consists K plantsand thatthereare of Supposethat a firm J firm observations. These could be different firms J obseror vationsovertimeofthe same firm. Let uik FRmdenotea nonnegative M-dimensional vector of observed outputs produced plantk offirm Let xik FRN denote by j. a nonnegative N-dimensional vectorofobserved inputsused by plant k of firmj (j = 1, . . ., J and k = 1, . . , K). If each plant'stechnology a convexset,an innerapproxiis mation(see Afriat [1972]and Diewertand Parkan [1983])to the inputrequirement for set plantk is L(uk) (6)
=

{x:

[Ulk,

. . . k,

u]Z

E[Xk, .

.. .,

xJk]Z _

x;

ZFRJZj

j=1

= 1}, k = 1, ... IK,

whereZ is a nonnegative J-dimensional vector thatdenotes the intensity level at whicheach observation run. is Thus,for ukgRm, k = 1, ... , K we maydefine sumofthe the inputrequirement L ( Uk) as set
K r
_

(7)

k=1

E L(uk) =1X:

[Ulk, ...,

UJk]Zk

Uk, ZkERJ

j=1

Zk3=

864

QUARTERLY JOURNAL OF ECONOMICS

1, ... ., K;

K E k= 1

[xlk

xJk]Zk<xj

measureassociatedwith Farrell efficiency The input-based (7) can be calculatedas the solutionto the the sum technology problem: linearprogramming
Fs (ux) (8)
=

minx, Zl
Zk?-Rj
K y [Xlk

.,Zk J

{X:

[uk,...,

uJk]Zk ?

EZjk j=1

=: 1,

k =1, ...
?

, K;

XJk]Zk

_A

where u

the combining K plants,we also the To compute gain from measureasFarrell efficiency the input-based need to calculate For Uk)* the combined technology L(I== sociated with for we define the inputrequirement-set , k K, 1, itEM firm as the combined

(ul,

. k),

L Euk
(9)
k[

\ J=*x:

K
z

K ul
,

Uk]Z

k= E j=1

z:

K
E k=1

EUk k==1

Z'

1;

[xlk,

XJk]Z< X.

approximation firm The combined is hereviewedas theinner ofthe sum ofthe plants.3 measureassociatedwith Farrell efficiency The input-based to (9) the combined technology can be calculatedas the solution problem: thelinearprogramming Fc(u,x) = minxz{A: E
(10) ZFRj+
E
f

[>lk,
K

.,

' uJk]Z

K
k=I

k=_

= 1;

[xlk,

j=1

k=i

x~k]z

is the technology moregeneral, wayofforming combined 3. An alternative, of plantsand to sumeach plantobservation (j,k) to each observation the other the thenfor innerapproximation.

ADDITION AND EFFICIENCY

865

the combining K plantsis obtainedas The gains from

(11) G(ux) = Fs(u,x)IFc(u x) _ 1,

the factthat X's whichare wherethe inequalityfollowsfrom feasiblefor(8) are also feasiblefor(10).
SOUTHERN ILLINOIS UNIVERSITY, CARBONDALE

REFERENCES EcoInternational Functions," of Estimation Production S. Afriat, N., "Efficiency XIII (1972),568-98. Review, nomic of and the Theory Markets Baumol,W., J. Panzar, and R. Willig,Contestable 1982). Brace,Jovanovich, (San Diego: Harcourt, Structure Industry Handbook in Theory," The in Approaches Microeconomic W. Diewert, E., "Duality eds. and Vol. 2, K. Arrow, M. Intriligator, (AmEconomics, ofMathematical Co., 1982). Publishing North-Holland sterdam: ConofRegularity Tests W. Diewert, E., and C. Parkan,"LinearProgramming and StudiesonProduction in Functions," Quantitative for ditions Production eds. and R. W. Prices, Eichhorn, Henn,K. Neumann, R. W. Shephard, (Wfirz1983). burg:Physica-Verlag, an of "A Evans,D., and J. Heckman, Test forSubadditivity the Cost Function, LXXIV (Sept. Review, Economic American to Application the Bell System," 1984),615-23. of of and Fare, R., S. Grosskopf, C. A. K. Lovell,The Measurement Efficiency 1985). Publishing, Kluwer-Nijhoff (Boston: Production Economics: in Functions," Production and Profit D., McFadden, "Cost,Revenue, North-Holland (Amsterdam: and Application A Dual Approachto Theory Co., 1978). Publishing