Cost and productivity

Abstract

We develop an analytical model capable of decomposing both intertemporal and multilateral cost variation. We begin by attributing cost variation to a price effect and a quantity effect. We then decompose the quantity effect into a productivity effect and an activity effect. The productivity effect in turn decomposes into a cost efficiency effect and, in the intertemporal context, a technical change effect. We also show how the intertemporal and multilateral cost decompositions can be implemented, using linear programming techniques. These techniques offer certain advantages over conventional econometric techniques whenever a substantial portion of cost variation is due to variation in cost efficiency. We illustrate the two cost decompositions with a pair of benchmarking exercises based on a panel of 93 US electric power generating companies, in which variation in cost efficiency does play a key role.