Effectiveness: A Measure of Demand Effect in Productivity Analysis

Abstract

Demand fluctuations lead to variations in the output levels affecting technical efficiency measures. The present study defines “effective production” and proposes a measure called “effectiveness” to separates the capacity construction and demand processes in a production system. The effectiveness measure complements the efficiency measure which does not capture the demand effect. The Malmquist productivity index is used to measure the demand effects characterized as the difference between the production function associated with efficiency and the demand-truncated production function associated with effectiveness. The proposed profit effectiveness also corrects the bias estimation of profit efficiency caused by ignoring demand. An empirical study about US airlines demonstrates these concepts can be used to describe the strategic positioning and to perform a dynamic analysis. These results show the concept of effectiveness is useful in modeling demand fluctuations and identifying the efforts in demand generation.