Frontier Production Function: The Stochastic Coefficients Approach

In the literature, technical efficiency generally is used as a relative concept. The potential output of the firm is used as the norm with which the firm's actual output is compared with to arrive at a measure of technical efficiency. While setting up the norm and modeling the actual production behavior of the firm, it is always assumed that the production coefficients of the material inputs are constant across sample observations. This is unrealistic. This restrictive assumption is relaxed in this paper and the advantage of measuring technical efficiency is then demonstrated using firm-level data from the machine building industry in China.