Introduction

Any decision-making problem faced by an economic agent (such as a consumer or a producer) has three basic features. First, there are the variables whose values are chosen by the agent. These are the choice or decision variables in the problem. Second, there are the restrictions that define the set of feasible values from which to choose. Finally, there is some criterion function that assigns different values to the outcomes from alternative decisions.

In the context of production, the decision-making agent is the firm. The choice variables are the quantities of outputs to be produced as well as the quantities of inputs used. The input–output combination selected by the firm must be technically feasible in the sense that it must be possible to produce the output bundle selected from the associated input bundle. For a commercial firm facing well-defined market prices of inputs and outputs, the profit measured by the difference between revenue and cost serves as the criterion of choice. It is possible, therefore, to rank the alternative feasible input–output combinations in order of the profit that results from them.

When the criterion function has a finite maximum value attainable over the feasible set of the choice variables, this maximum value can be used as a benchmark for evaluating the efficiency of a decision-making agent. The closer the actual profit of a firm is to the maximum attainable, the greater is its efficiency.