Occurs when a firm lacks the incentive to controlcosts, causing the averagecost of production to be higher than necessary
Potential AC
The average cost curve the firm could have if it was technically efficient.
When there is a lack of incentives, the firm will not be technically efficient
X Inefficiency
The difference between a firm's actualaveragecosts and its potentialaveragecosts
X Efficiency
Occurs when competitivepressures cause firms to combine the optimum combination of factors of production and produce on the lowest possible averagecostcurve
Causes of X Inefficiency
Monopoly Power
State Control
Principal-agent problem
Lack of motivation
Monopoly Power
A monopoly faces little or nocompetition, so it might be easy for the monopolist to make supernormal profits without trying to control costs
State Control
A nationalised firm owned by the government may face little or noincentive to try and make a profit, so it has lessincentive to try and cut costs
Principal-agent problem
Shareholders may wish to maximiseprofits and minimisecosts, but managers and workers may pursue other objectives like keeping costslow enough to protect their job but then allowingcosts to rise as it makes work more enjoyable
Lack of motivation
Workers and managers may simply lack the necessary motivation to work hard, for example due to poor industrial relations
Examples of X Inefficiency
Employing workers who aren't necessary for the productiveprocess
Lack of Management Control leading to workers 'taking it easy'
Not finding the cheapest suppliers
X-Inefficiency Diagram
In theory, the firm could have an average cost curve at “PotentialAC” but due to organizationalslack, it’s actual averagecosts are higher.
The difference between actual and potentialcosts is the x-inefficiency.