INTRODUCTION Technical efficiency, in general terms, refers to the firm's ability to produce the maximum possible output from a given combination of inputs and technology, regardless of market demand and prices. It is measured as a ratio of realized output to the potential output which may or may not be realized. The reliability of the measure of technical efficiency, therefore, depends on how accurately the potential output of the firm is estimated. In recent times, the two most popular techniques employed to estimate the potential output are the 'data envelopment analysis' and the 'stochastic frontier production func- tion' approach.2 The 'stochastic frontier production function' approach popularized by Aigner et al. (1977) and Meeusen and Van den Broeck (1977), uses statistical techniques to estimate the potential output assuming a parametric representation of technology. The aspect which distinguishes the stochastic frontier production function from the conventional production function is that the former includes the observation-specific production behaviour in the model along with conventional material inputs. The interest- ing question in this context is as to how does one model the observationspecific production behaviour in the stochastic frontier production function. These characteristics which vary across observations, are usually proxied by an
Oxford Bulletin of Economics & Statistics – Wiley
Published: Feb 1, 1994
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