A Unifying Framework for Decomposing Economic Inefficiency: The General Direct Approach and the Reverse Approaches

The usual and well-established methods, explained and used in most of the previous chapters, for deriving a specific overall economic inefficiency decomposition associated with a given technical efficiency measure (multiplicative or additive), which we refer to as the traditional approaches, rely on the same “modus operandi”; i.e., they are based on dual relationships where allocative efficiency plays a fundamental role. Allocative inefficiency is obtained as the residual from a Fenchel-Mahler inequality that shows that the normalized economic inefficiency for a specific firm is greater or equal to its technical inefficiency. Accounting for allocative efficiency allows the closure of the inequality and enables a decomposition of economic efficiency considering technical and price (allocative) criteria, with the value of allocative efficiency clearly depending upon the chosen technical efficiency measure. Researchers have been using these traditional methods for at least half a century, and we take stock of the existing contributions and current state of the art in the previous chapters.