Technical and allocative inefficiencies and factor elasticities of substitution: An analysis of energy waste in Iran's manufacturing

Ignoring technical and allocative inefficiencies or embedding one of them alone in a system of input demands may result in biased elasticities. We consider a comprehensive model including technical inefficiency (in input and output forms) and allocative inefficiency and apply it to panel data from Iran's manufacturing sector. The results show that the presence of both inefficiencies affects the computed elasticities of demand and substitution. Moreover, in spite of current waste of energy in Iran's manufacturing, the elimination of environmental constraints will prompt the manufacturing firms to increase the utilization of energy relative to both capital and labor.