Parametric Estimation of Technical and Allocative Inefficiency with Panel Data

The error-components approach to estimating allocative inefficiency imposes restrictive assumptions on the distributions of the errors and functional form. The parametric approach does not require special assumptions about the error distribution or technology but typically assumes technical efficiency or restrictive functional forms. The parametric approach also allows for systematic firm responses to shadow prices. The authors generalize the parametric approach to a panel data setting and show that input and firm-specific allocative inefficiency, as well as firm-specific technical inefficiency, can be identified and estimated using a flexible functional form. This is demonstrated empirically with an application to U.S. airlines.