1. City University MSc in Regulation and Competition TFP, Real Unit Costs and Malmquist Quantitative Techniques in Practice

2. City University MSc in Regulation and Competition Outline Productivity measurement Real unit costs Malmquist

3. City University MSc in Regulation and Competition Productivity measurement Objective: identify prospects for real price reductions (X) Total factor productivity – origin as “residual” in studies for determinants of economic growth =change in output less weighted change in inputs

4. City University MSc in Regulation and Competition TFP problems -based on measurement in physical units which may be difficult to measure accurately -Output = value added -Labour input: quality variation –how to measure -Capital input: issues of quality, depreciation? -Raw materials? (subtracted from output=> VA) -Effect of contracting out?

5. City University MSc in Regulation and Competition Summary on TFP Uncertainties in measurement => range of possible estimates. How to handle new services? Index number problems inevitable

6. City University MSc in Regulation and Competition Real unit costs = change in monetary costs/unit less change in price of inputs. RUC is dual to TFP. In a ideal world with no measurement or index number problems they would be equivalent

7. City University MSc in Regulation and Competition Example of equivalence Year 0 to make 1 gallon mature whisky takes 10 pints of “leets”. Unit price is £40. No other inputs are involved Unit cost in year 0 = 10  £40 = £400 In year 1 – only 9 pints needed, but unit price is £50 Unit cost in year 1 = 9  50 = £450 Real unit cost index = (450/400)/(50/40)=0.9

8. City University MSc in Regulation and Competition Other advantages of RUC Data needed on revenues, price indices –Audited, verifiable, difficult to distort Conforms very closely to RPI-X formula

9. City University MSc in Regulation and Competition Difficulties with RUC Are cost indices representative? Index number problems: –Substitutions and changing proportions –New products and services: Need for frequent update of components and weights Treatment of capital still potentially problematic

10. City University MSc in Regulation and Competition Malmquist indexes - intro Based on multi-period DEA Pool data form several years => DEA score for each year Change in score = movement towards frontier + movement of frontier = pure efficiency improvement + “technical progress”

11. City University MSc in Regulation and Competition Malmquist example Input 1 Input 2

12. City University MSc in Regulation and Competition Malmquist - properties Radial measure – like DEA score Weights on inputs and outputs <= putting company in “best possible light” May not represent least cost inputs or highest value outputs Disadvantages similar to DEA

13. City University MSc in Regulation and Competition Reading on Malmquist Total Factor Productivity Growth in Agriculture: A Malmquist Index Analysis of 93 Countries, 1980-2000 Tim J. Coelli and D.S. Prasada Rao http://www.uq.edu.au/economics/cepa/coelli-rao- agdea-aug03.pdf See also Chapter 3 of Coelli et al “A primer on Efficiency measurement for Utilities….”