Efficiency: A dynamic approach

Most firms work with a technology less efficient than the best available. In a dynamic context, this is perfectly rational, since it is uneconomical to scrap old capital equipment as soon as a new and better model appears in the market. In a dynamic context, we would expect a difference between the observable technology of a firm and the technological frontier, a sort of “rational inefficiency”. In this paper we construct an equilibrium growth model that allows us to calculate the size of this particular inefficiency, and we discuss how it relates to the efficiency measures in the widely used Farell model.