TFP, Real Unit Costs and Malmquist

TFP, Real Unit Costs and Malmquist Quantitative Techniques in Practice City University MSc in Regulation and Competition

Outline • Productivity measurement • Real unit costs • Malmquist City University MSc in Regulation and Competition

Productivity measurement • Objective: identify prospects for real price reductions (X) • Total factor productivity – origin as “residual” in studies for determinants of economic growth =change in output less weighted change in inputs City University MSc in Regulation and Competition

TFP problems • based on measurement in physical units which may be difficult to measure accurately • Output = value added • Labour input: quality variation –how to measure • Capital input: issues of quality, depreciation? • Raw materials? (subtracted from output=> VA) • Effect of contracting out? City University MSc in Regulation and Competition

Summary on TFP Uncertainties in measurement => range of possible estimates. How to handle new services? Index number problems inevitable City University MSc in Regulation and Competition

Real unit costs = change in monetary costs/unit less change in price of inputs. RUC is dual to TFP. In a ideal world with no measurement or index number problems they would be equivalent City University MSc in Regulation and Competition

Example of equivalence Year 0 to make 1 gallon mature whisky takes 10 pints of “leets”. Unit price is £40. No other inputs are involved Unit cost in year 0 = 10  £40 = £400 In year 1 – only 9 pints needed, but unit price is £50 Unit cost in year 1 = 9  50 = £450 Real unit cost index = (450/400)/(50/40)=0.9 City University MSc in Regulation and Competition

Other advantages of RUC • Data needed on revenues, price indices • Audited, verifiable, difficult to distort • Conforms very closely to RPI-X formula City University MSc in Regulation and Competition

Difficulties with RUC • Are cost indices representative? • Index number problems: • Substitutions and changing proportions • New products and services: • Need for frequent update of components and weights • Treatment of capital still potentially problematic City University MSc in Regulation and Competition

Malmquist indexes - intro Based on multi-period DEA Pool data form several years => DEA score for each year Change in score = movement towards frontier + movement of frontier = pure efficiency improvement + “technical progress” City University MSc in Regulation and Competition

Malmquist example Input 2 Input 1 City University MSc in Regulation and Competition

Malmquist - properties • Radial measure – like DEA score • Weights on inputs and outputs <= putting company in “best possible light” • May not represent least cost inputs or highest value outputs • Disadvantages similar to DEA City University MSc in Regulation and Competition

Reading on Malmquist Total Factor Productivity Growth in Agriculture: A Malmquist Index Analysis of 93 Countries, 1980-2000 Tim J. Coelli and D.S. Prasada Rao http://www.uq.edu.au/economics/cepa/coelli-rao-agdea-aug03.pdf See also Chapter 3 of Coelli et al “A primer on Efficiency measurement for Utilities….” City University MSc in Regulation and Competition

TFP, Real Unit Costs and Malmquist