X-Inefficiency

• X Inefficiency


  Occurs when a firm lacks the incentive to control costs, causing the average cost 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 actual average costs and its potential average costs
• X Efficiency

  Occurs when competitive pressures cause firms to combine the optimum combination of factors of production and produce on the lowest possible average cost curve
• Causes of X Inefficiency

  • Monopoly Power
  • State Control
  • Principal-agent problem
  • Lack of motivation
• Monopoly Power

  A monopoly faces little or no competition, 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 no incentive to try and make a profit, so it has less incentive to try and cut costs
• Principal-agent problem

  Shareholders may wish to maximise profits and minimise costs, but managers and workers may pursue other objectives like keeping costs low enough to protect their job but then allowing costs 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 productive process
  • 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 “Potential AC” but due to organizational slack, it’s actual average costs are higher.

  The difference between actual and potential costs is the x-inefficiency.

  A) Actual AC

  B) Potential AC

  C) x-inefficiency