X-inefficiency
Encyclopedia
X-inefficiency is the difference between efficient behavior of firms assumed or implied by economic theory and their observed behavior in practice. It occurs when technical-efficiency is not being achieved due to a lack of competitive pressure. The concepts of x-inefficiency was introduced by Harvey Leibenstein
.
Economic theory assumes that the management of firms act to maximize economic profits -- which is accomplished by adjusting the inputs used or the output produced. In perfect competition
, the free entry and exit of firms tends toward firms producing at the point where price equals long run average costs and long run average costs are minimized. Thus firms earn zero economic profits and consumers pay a price equal to the marginal cost
of producing the good. This result defines economic efficiency or, more precisely, allocative economic efficiency
.
Empirical research suggests, however, that a number of firms do not produce at the point where long run average costs are minimized. Some of this can be explained away by the mechanics of imperfect competition
; what cannot be explained by traditional economics is described as X-inefficiency.
With market forms other than perfect competition
, such as monopoly
, it may be possible for x-inefficiency to persist, because the lack of competition makes it possible to use inefficient production techniques and still stay in business. In addition to monopoly, sociologists have identified a number of ways in which markets may be organizationally embedded, and thus may depart in behavior from economic theory.
X-inefficiency is not the only type of inefficiency in economics. X-inefficiency only looks at the outputs that are produced with given inputs. It doesn't take account of whether the inputs are the best ones to be using, or whether the outputs are the best ones to be producing, which is referred to as allocative efficiency
. For example, a firm that employs brain surgeons to dig ditches might still be x-efficient, even though reallocating the brain surgeons to curing the sick would be more efficient for society overall.
is a price maker in that its choice of output level affects the price paid by consumers. Consequently, a monopoly tends to price at a point where price is greater than long-run average costs. X-inefficiency, however tends to increase average costs causing further divergence from the economically efficient outcome. The sources of the X-inefficiency have been ascribed things such as overinvestment and empire building
by managers, lack of motivation stemming from a lack of competition, and pressure by labor unions to pay above-market wages.
X-inefficiency can also occur when monopolies or even oligopolies produce higher than the minimum average cost .
Harvey Leibenstein
Harvey Leibenstein was a Ukrainian born American economist. One of his most important contributions to economics was the concept of X-efficiency....
.
Economic theory assumes that the management of firms act to maximize economic profits -- which is accomplished by adjusting the inputs used or the output produced. In perfect competition
Perfect competition
In economic theory, perfect competition describes markets such that no participants are large enough to have the market power to set the price of a homogeneous product. Because the conditions for perfect competition are strict, there are few if any perfectly competitive markets...
, the free entry and exit of firms tends toward firms producing at the point where price equals long run average costs and long run average costs are minimized. Thus firms earn zero economic profits and consumers pay a price equal to the marginal cost
Marginal cost
In economics and finance, marginal cost is the change in total cost that arises when the quantity produced changes by one unit. That is, it is the cost of producing one more unit of a good...
of producing the good. This result defines economic efficiency or, more precisely, allocative economic efficiency
Allocative efficiency
Allocative efficiency is a theoretical measure of the benefit or utility derived from a proposed or actual selection in the allocation or allotment of resources....
.
Empirical research suggests, however, that a number of firms do not produce at the point where long run average costs are minimized. Some of this can be explained away by the mechanics of imperfect competition
Imperfect competition
In economic theory, imperfect competition is the competitive situation in any market where the conditions necessary for perfect competition are not satisfied...
; what cannot be explained by traditional economics is described as X-inefficiency.
With market forms other than perfect competition
Perfect competition
In economic theory, perfect competition describes markets such that no participants are large enough to have the market power to set the price of a homogeneous product. Because the conditions for perfect competition are strict, there are few if any perfectly competitive markets...
, such as monopoly
Monopoly
A monopoly exists when a specific person or enterprise is the only supplier of a particular commodity...
, it may be possible for x-inefficiency to persist, because the lack of competition makes it possible to use inefficient production techniques and still stay in business. In addition to monopoly, sociologists have identified a number of ways in which markets may be organizationally embedded, and thus may depart in behavior from economic theory.
X-inefficiency is not the only type of inefficiency in economics. X-inefficiency only looks at the outputs that are produced with given inputs. It doesn't take account of whether the inputs are the best ones to be using, or whether the outputs are the best ones to be producing, which is referred to as allocative efficiency
Allocative efficiency
Allocative efficiency is a theoretical measure of the benefit or utility derived from a proposed or actual selection in the allocation or allotment of resources....
. For example, a firm that employs brain surgeons to dig ditches might still be x-efficient, even though reallocating the brain surgeons to curing the sick would be more efficient for society overall.
Examples
Monopoly : A monopolyMonopoly
A monopoly exists when a specific person or enterprise is the only supplier of a particular commodity...
is a price maker in that its choice of output level affects the price paid by consumers. Consequently, a monopoly tends to price at a point where price is greater than long-run average costs. X-inefficiency, however tends to increase average costs causing further divergence from the economically efficient outcome. The sources of the X-inefficiency have been ascribed things such as overinvestment and empire building
Empire Building
The Empire Building at 71 Broadway, Manhattan, New York City is a 21 story steel framed curtain-wall skyscraper designed by Kimball & Thompson and built by Marc Eidlitz & Son in 1895. It is one of the earliest skyscrapers built on pneumatic caissons and one of the oldest still standing today. It...
by managers, lack of motivation stemming from a lack of competition, and pressure by labor unions to pay above-market wages.
X-inefficiency can also occur when monopolies or even oligopolies produce higher than the minimum average cost .