Data Envelopment Analysis

Lesson 2. Output and input measurement:

Partial productivity measures and
aggregation

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 Outline for today

• 2.1. Measuring outputs and inputs.

• 2.2. Partial productivity indicators.
• 2.3 TFP indices.
• 2.4. Applications.

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 2.1. Measuring outputs and inputs.

What is Production?
Transformation of resources (inputs) into products and services (outputs).

Examples:
Agriculture: Grain farming
Inputs: land; labour; biochemical input (fertiliser, pesticides, seeds); capital
(equipment, power and buildings).
Output: corn, soybeans, wheat.
Industry: Cement production
Inputs: energy in calories; blue and white-collar workers (man hours/year); book
value of machinery and equipment; raw materials (especially: limestone).
Output: cement production per year (tonnes).
Services: Urban transport with busses
Inputs: staff; fuel; vehicles.
Output: vehicle kilometres.

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Problems:
1. Sometimes there are positive or negative external effects in production.
Example: Electricity generation using fossil fuels creates pollutants like sulphur dioxide
and nitrogen oxide.

2. The internal organisation of production processes (including decision-making across

different hierarchical levels, intermediate production stages, etc.) is ignored (black box
models).

3. Problem of accurate measurement of inputs and outputs.

Example: Labour in agriculture should include farm family members.

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Richard Murray (1992), Measuring Public-Sector Output:
Throughput
Measures workloads and may even come close to input (number of cases)

Output
Goods or services delivered (number of cases handled)

Outcome
The result from the point of view of the principal or the customers

Bradford, Malt and Oates (1969):

Intermediate outputs : hours of service delivered
D-output : direct output consumed
C-output : outcome indicator reflecting the degree to which the direct outputs
translate into welfare improvements as perceived by consumers
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Measuring the inputs:
Human capital: (L), (L.w)
Physical capital: utilization of capacity of fixed inputs
Materials: quality differences

Banking sector (Humphrey, 1992)

Production approach

Physical inputs deposits + loans

Intermediation approach

Physical inputs
deposits loans

Number of accounts
Stock of money
Number of operations

Operating inputs

Human capital (employees, total hours worked) 7

Physical capital (fixed assets)
 2.2. Partial productivity indicators.
Source: Prior, D. Vergés, J. and Vilardell, I. (1993), La evaluación de la eficiencia en el
sector privado y en el sector público, Instituto de Estudios Fiscales. Madrid

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2.3. TFP indices (American Productivity
Center proposal):

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 2.3. TFP indices.
• When we have just one input and output the
TFP change between period 1 and 2 is:
q2 q1 q2 x2
TFP12  
x2 x1 q1 x1

• When we have more inputs and outputs we

must aggregate using index numbers
• A basic property of any TFP index is that
when q2=aq1 and x2=bx1, then TFP12=a/b
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 Index number formulae
• When we have more than one input or output
we need to find an aggregation method

• Four most popular indices are:

– Laspeyres (prices dependent)

– Paasche (prices dependent)
– Fisher (prices dependent)
– Divisia/Tornqvist (good property: connected with
production theory)

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 Price Index Numbers
• Measure changes (or levels) in prices of a set of
commodities.
• Let pmj and qmj represent prices and quantities (m-th
commodity; m = 1,2,...,M and j-th period or firm j =
s, t).
• The index number poblem is to decompose value
change into price and quantity change components.

Vt p q it it
 i
 Pst  Qst  Price Index  Quantity Index
Vs
p
i
q
is is

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 Laspeyres price index numbers
N
 pit qis N
pit N
PstL  i 1
N
  is , where is  pis qis  pis qis
pis
 pis qis i 1 i 1

i 1
• Price change index for N goods from period s to
period t
• pit = price of i-th good in t-th period, qit =
quantity
• Uses base-period (period s) quantity weights
• Share-weighted sum of individual price indices
• Very popular in CPI calculations 15
 Paasche price index numbers
N
 pit qit 1
PstP  i 1

N pis
 pis qit  pit
 it
i 1 i

• Uses current-period (period t) quantity

weights
• Share-weighted harmonic mean of
individual price indices
• Paasche  Laspeyres - when people respond
to relative price changes by adjusting mix of
goods purchased (in periods of inflation) 16
 Fisher price index numbers

F L P
Pst  Pst  Pst

• Fisher index is the geometric mean of the

Laspeyres and Paasche index numbers
• Paasche  Fisher  Laspeyres - when
consumers respond to relative price changes
by adjusting mix of goods purchased (in
periods of inflation)
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 Tornqvist price index numbers
is it
N N
 pit  2  is  it 
Pst        ln pit  ln pis 
T
, ln PstT
i 1  pis  i 1  2 

• Share-weighted geometric mean of

individual price indices
• Uses average of value share from period t
and period s
• Log form is commonly used in calculations -
has an approximate percentage change
interpretation 18
 Quantity Index Numbers
Approaches to the compilation of quantity
index numbers.
1. Simply use the same formulae as in the case
of price index numbers – simply interchange
prices and quantities.
2. Use the index number identity:
 

Vst 

i
pit qit 
 p q
i
it it / Pst
Qst    / Pst 
Pst  
  pis qis 
 p is qis
 i  i
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 Four quantity index numbers
To obtain the corresponding quantity index
numbers we interchange prices and quantities:
N N
 pis qit  pit qit
Laspeyres = QstL  i 1
N
, Paasche = QstP  i 1
N
 pis qis  pit qis
i 1 i 1

Fisher = QstF  QstL  QstP

is it
N N
 qit  2  is  it 
Tornqvist = QstT    , ln QstT     ln qit  ln qis 
i 1  qis  i 1  2 

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Which index is best for use in TFP studies?

• Two methods are used to assess the suitability of

index number formulae:
– economic theory or functional approach
• Exact and superlative index numbers
– axiomatic or test approach
• Index numbers that satisfy a number of desirable
properties
• Both approaches suggest that the Fisher and
Tornqvist are best (Diewert)

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 Tornqvist TFP index
The Tornqvist has been the most popular TFP
index
Output Indexst
ln TFP Indexst  ln
Input Indexst

 ln Output Indexst  ln Input Indexst

1M 1 K
 
   ris  rit  ln qit  ln qis    s js  s jt ln x jt  ln x js
2 i 1 2 j 1

This approach is also know as the Hicks-Moorsteen Approach –
defines productivity index simply as the ratio of output and input
index numbers. 22
 Example
• Two firms producing t-shirts using labour
and capital (machines)
• Let us now assume that they face different
input prices

firm labour capital cost output

x1 w1 x2 w2 q
A 2 80 2 100 360 200
B 4 90 1 120 480 200
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• In this example we compare productivity
across 2 firms (instead of 2 periods)
• First we calculate the input cost shares
• Labour share for firm A
= (280)/(280+2100) = 0.44
• Labour share for firm B
= (490)/(490+1120) = 0.75
• Thus the capital shares are (1-0.44)=0.56
and (1-0.75)=0.25, respectively
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Ln Output index = ln(200)-ln(200)
= 0.0

Ln Input index = [0.5(0.44+0.75)(ln(2)-ln(4))

+0.5(0.56+0.25)(ln(2)-ln(1))]
= -0.13

ln TFP Index = 0.0-(-0.13)

= 0.13

TFP Index = exp(0.13)=1.139

ie. firm A is 14% more productive than firm B

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 Properties of index numbers
• Used to evaluate index numbers
– Economic theory
– Axioms
• Both suggest Tornqvist and Fisher best for
TFP calculations

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 Economic theory arguments

• Laspeyres and Paasche imply simplistic

linear production structures
• Fisher is exact for quadratic - Tornqvist is
exact for translog - both are 2nd-order
flexible forms - thus “superlative” indices
• If we assume technical efficiency, allocative
efficiency and CRS, then Tornqvist and
Fisher indices can be interpreted as
production function shift (technical change)
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 Example:

Output Data for the Australian National Railways Example

Quantities Prices
Mainland Tasrail Passenger Mainland Tasrail Passenger
Freight (1,000 Freight (1,000 (1,000 Freight Freight ($/PTK)
NTKs) NTKs) PTKs) ($/NTK) ($/NTK)
5235000 383000 2924 0.02 0.07 10
5331000 420000 3057 0.03 0.07 12
5356000 375000 2992 0.03 0.08 14
4967000 381000 2395 0.03 0.08 18
5511000 401000 2355 0.03 0.08 20
5867000 403000 2188 0.03 0.08 22
6679000 402000 2486 0.03 0.09 23
6445000 429000 2381 0.03 0.09 23
7192000 455000 2439 0.03 0.09 23
7618000 459000 2397 0.03 0.08 26
7699000 413000 2316 0.03 0.11 32
7420000 369000 1664 0.03 0.12 47

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 Quantities Prices
Labour Fuel (1,000 Other Inputs Labour Fuel ($/litre) Other Inputs
(persons) litres) ($1,000 )a ($/person) (index)
10481 77380 119113 13097 0.18 0.45
10071 80148 112939 14730 0.26 0.50
Other 9941 77105 108263 16692 0.28 0.56
inputs 9575 72129 110210 18651 0.37 0.62
9252 85868 109292 20166 0.37 0.66
8799 89706 97594 21307 0.39 0.70
8127 96312 93178 24990 0.41 0.75
7838 92519 80054 26412 0.42 0.81
7198 96435 77716 28572 0.43 0.87
6648 101327 74147 32617 0.39 0.94
6432 98874 80826 34565 0.43 1.00
5965 96016 73172 35646 0.46 1.04

Quantities Prices
Land, Building Plant and Rolling Land, Plant and Rolling
and Perway Equipment Stock Building and Equipment Stock
($1,000 )a ($1,000 )a ($1,000)a Perway (index)b (index)b
Capital (index)b
1858038 94057 332307 10 50 50
inputs 2101035 93927 308491 20 80 80
2059365 89764 285626 30 120 120
2118357 93271 269265 30 100 100
2117625 91837 275134 70 140 140
2095680 90120 261495 70 160 160
2069494 89617 251588 50 90 90
2034867 88773 239736 70 120 120
2017626 89653 235834 80 200 200
1998345 98762 252514 80 240 240
2011753 100495 251850 80 190 190
2018802 107654 242662 130 200 200
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 Output, Input and TFP index numbers

Year Output Input TFP

79/80 1.0000 1.0000 1.0000
80/81 1.0343 0.9782 1.0573
81/82 1.0188 0.9515 1.0707
82/83 0.9304 0.9345 0.9956
83/84 1.0014 0.9316 1.0748
84/85 1.0311 0.8950 1.1521
85/86 1.1543 0.8596 1.3428
86/87 1.1268 0.8191 1.3756
87/88 1.2293 0.7885 1.5590
88/89 1.2766 0.7690 1.6600
89/90 1.2607 0.7684 1.6407
90/91 1.1283 0.7376 1.5296

• All the index numbers reported here are calculated using the
Tornqvist index number formula.
• All the indices here are reported for the base year 79/80.
•While there is a steady increase in output over the years, the
input index shows a secular decline resulting in TFP growth over 30
time.
End of this session

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