Pitfalls in the estimation of a cost function that ignores allocative inefficiency: A Monte Carlo analysis [An article from: Journal of Econometrics]

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Description:
In the stochastic frontier literature, it is a widely held view that allocative inefficiency can be lumped together with technical inefficiency in the estimation of cost frontiers. Therefore, a one-sided error term in the cost function is believed to capture the cost of overall (technical plus allocative) inefficiency. In this paper we challenge that view through a detailed Monte Carlo investigation. The results show that failure to include the cost of allocative inefficiency explicitly in the cost function biases the estimates of: (i) the cost function parameters, (ii) returns to scale, (iii) input price elasticities, and (iv) cost-inefficiency.