A concept of efficiency is approached from two side approaches, namely the input and output orientations Farrell, 1957. It needs the availability of input
price information and an isoquant curve showing combinations of inputs used to produce output at maximum level raises the approach on the input side. The
approach on the output side is the approach used to see the extent of the output amount is proportionally increased without changing the number of inputs used.
3.2 Efficiency Measurement Concepts
Firm is efficient while it successes in producing maximum outputs using a given inputs Farrell, 1957. The efficiency of firm consists of two components,
technical efficiency TE and allocative price efficiency AE. TE reflects the ability of the firm to achieve maximum outputs from a given set of inputs. AE
reflects ability of firm to use the inputs in optimal proportions, given price and production technology respectively. The achievement of both efficiencies implies
economic efficiency EE.
3.2.1 Input Orientated
The input orientated TE is measure to answer the ques tion “How much
quantity of inputs can be proportionally reduced without changing the output quantity produced?” TE and AE of the case represented in Figure 3.
Figure 3 illustrates the unit of isoquant of fully efficient firms, represented by SS΄. If the firm uses a given set of input, defined by the point A, to produce a
unit of output, the technical inefficiency of that firm could represent by the distance DA. This is the amount by which all inputs are proportionally reduced
without a reduction in output. It also expressed in percentage terms by the ratio DA0A. This is represents
the percentage by which all inputs need to be reduced to achieve technically efficient production. The TE of a firm is commonly measured by the ratio as on
Equation 3.1. TE
i
= 0D0A Where: TE
i
is the input orientated technical efficiency 3.1
Source: Coelli, Rao, Battese, 1998
Equation 3.1 is equal to 1 – DA0A. It will take value between zero and one,
and therefore provides an indicator of the degree of technical inefficiency of the firm. A value of one indicates the firm is fully technically efficient. The point D is
technically efficient because it lies on the efficient isoquant. If the input price is also known, represent
ed by CC΄ the slope of isocost in Equation 3.1, permits the measurement of AE. The AE of the firm operating at A
is defined to be ratio as on Equation 3.2. AE
i
= 0B0D Where: AE
i
is the input orientated allocative efficiency 3.2
The distance BD represents the reduction in production costs. If the production were to occur at point D, the allocatively and technically efficient
would occur. While the point D΄ shown the technically efficient but allocatively inefficient.
The achievement of the TE and AE implies EE. The EE is defined to be ratio as Equation 3.3.
x
2
y S
A
D B
D΄ S΄
x
1
y C΄
C
Figure 3 Technical and Allocative Efficiencies of Input Orientation
