Measurement of profit efficiency using behavioural and stochastic frontier approaches

Abstract

The objectives of this study are to estimate profit inefficiency of farms in the North-west Frontier Province of Pakistan using stochastic frontier and the behavioural profit functions. The derived measure of inefficiency, based on a half-normal distribution of the stochastic error term, is related to socio-economic variables; and of these, the size of holding, fragmentation of land,subsistence needs the higher age of farmers contribute positively to inefficiency. The behavioural approach satisfies most of the assumptions of the dual profit function and the likelihood ratio test rejects the market efficiency hypothesis. It is also shown that use of manures, labour and fertilizers is below the optimum. Small farms seem to have higher productive efficiency than large farms and, therefore small farm ownership needs to be encouraged.