Data Envelopment Analysis
Data envelopment analysis (DEA) is a nonparametric method in operations research and economics for the estimation of production frontiers. It is used to empirically measure productive efficiency of decision making units (or DMUs). Non-parametric approaches have the benefit of not assuming a particular functional form/shape for the frontier, however they do not provide a general relationship (equation) relating output and input. There are also parametric approaches which are used for the estimation of production frontiers (see Lovell & Schmidt 1988 for an early survey). These require that the shape of the frontier be guessed beforehand by specifying a particular function relating output to input. One can also combine the relative strengths from each of these approaches in a hybrid method (Tofallis, 2001) where the frontier units are first identified by DEA and then a smooth surface is fitted to these. This allows a best-practice relationship between multiple outputs and multiple inputs to be estimated.
"The framework has been adapted from multi-input, multi-output production functions and applied in many industries. DEA develops a function whose form is determined by the most efficient producers. This method differs from the Ordinary Least Squares (OLS) statistical technique that bases comparisons relative to an average producer. Like Stochastic Frontier Analysis (SFA), DEA identifies a "frontier" on which the relative performance of all utilities in the sample can be compared: DEA benchmarks firms only against the best producers. It can be characterized as an extreme point method that assumes that if a firm can produce a certain level of output utilizing specific input levels, another firm of equal scale should be capable of doing the same. The most efficient producers can form a 'composite producer', allowing the computation of an efficient solution for every level of input or output. Where there is no actual corresponding firm, 'virtual producers' are identified to make comparisons" (Berg 2010)
Read more about Data Envelopment Analysis: History, Techniques, Inefficiency Measuring With DEA
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