X Inefficiency occurs when a firm has little incentive to control costs. This causes the average cost of production to be higher than necessary. When there is this lack of incentives, the firm will not be technically efficient.
X Efficiency would be when competitive pressures cause firms to combine the optimum combination of factors of production.
Causes of X Inefficiency
1. Monopoly Power. A monopoly faces little or no competition. Therefore, it might be easy for the monopolist to make supernormal profits. Therefore, in the absence of competitive pressures, they may not try very hard to control costs.
2. State Control. A nationalised firm owned by the government may face little or no incentive to try and make profit. Therefore, it has less incentive to try and cut costs.
Examples of X Inefficiency
- Employing workers who aren’t necessary for the productive process. For example, a state owned firm may be more concerned about the political implications of making people redundant than getting rid of surplus workers.
- Lack of Management Control. If a firm doesn’t have supervision of workers, then productivity may fall as workers ‘take it easy’
- Not Finding Cheapest Suppliers. Out of inertia, a firm may continue to source raw materials from a high cost supplier rather than look for cheaper raw materials.
Theory of X Inefficiency
X Inefficiency was first mentioned in:
Leibenstein, Harvey (1966), "Allocative Efficiency vs. X-Efficiency", American Economic Review 56 (3): 392–415
- Problems of Monopoly
- Types of Efficiency