The law of one price in data envelopment analysis: Restricting weight flexibility across firms

The law of one price in data envelopment analysis: Restricting weight flexibility across firms

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Article ID: iaor2007492
Country: Netherlands
Volume: 170
Issue: 3
Start Page Number: 735
End Page Number: 757
Publication Date: May 2006
Journal: European Journal of Operational Research
Authors: , ,
Abstract:

The Law of One Price (LoOP) states that all firms face the same prices for their inputs and outputs under market equilibrium. Taken here as a normative condition for ‘efficiency prices’, 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 industry-level and firm-level cost efficiency measures, we propose to apply a set of input prices that is common for all firms and that maximizes the cost efficiency of the industry. Our framework allows for firm-specific output weights and for variable returns-to-scale, and preserves the linear programming structure of the standard DEA. We apply the proposed methodology to the evaluation of the 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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