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Main Dictionary X

X-efficiency

X-efficiency is the ability of an economic agent (firm) to reduce costs and increase productivity at a given technology by stimulating organizational improvements, increasing the motivation of employees and managers, improvements in a wide range of business decisions, including hiring and firing, promotions, salaries and bonuses, spatial placement, choice of furniture, phones, parking lots, etc.

X-efficiency explained

The functioning of a firm is comparable to the X-efficiency if it produces the maximum possible output with the available set of resources and the best available technology. If X-efficiency is not achieved, then there is the X-inefficiency of the firm. Individuals or firms never perform as good as they could.

One source of increased output is the three elements of the X-efficiency: intra-firm motivational efficiency, extrinsic motivational efficiency, and non-market resource efficiency.

Causes of X-efficiency include: 

  • incomplete labor contracts; 
  • non-market inputs; 
  • not all production functions are specified or known; 
  • covert cooperation or imitation of competing firms with each other due to interdependence and uncertainty.

In contrast to the classical concept of allocative efficiency, X-efficiency considers conditions when resources are not redistributed in the system, but a given set of resources is used to produce output. The X-efficiency does not take into account the possibility of the best use of these resources in other areas of activity. For example, a firm that uses neurosurgeons to dig pits may be X-efficient, even though using neurosurgeons to treat patients would probably be more efficient for society.

The X-efficiency occurs when costs in a monopoly are lower than in free competition. This occurs in industries where monopolization allows a firm to take advantage of economies of scale by moving along a declining average cost curve. The monopolist's output in X-efficiency theory, while decreasing relative to the output of the industry as a whole, remains higher than that of the individual competing firm. In addition, according to the X-efficiency, the innovation activity of the monopolist may be higher than that of the competitor, which also contributes to lower industry costs. In these cases, the economy only benefits from monopolization.

X-inefficiency

X-inefficiency in economics - the difference between the efficient behavior of firms assumed by economic theory and their behavior observed in reality.

Economic theory assumes that managers of firms act to maximize the welfare of owners by reducing risk and increasing economic profit, which is achieved by reducing costs and increasing revenues. According to classical notions, under perfect competition, firms' free entry and exit opportunities result in firms choosing a production volume in which the price coincides with the long-run average cost and the long-run average cost is minimized. As a result, firms earn zero economic income, and consumers pay a price equal to the marginal cost of producing the goods. This result corresponds to allocative economic efficiency.

However, empirical research suggests that a large number of firms do not produce at a rate that minimizes average costs. This can be explained in part by the effects of imperfect competition. The part of the deviation that cannot be explained by traditional economic theory is treated as X-inefficiency.

Monopoly is technically less efficient than competition because the presence of barriers to entry protects the monopolistic firm from competitive pressures. Therefore, a monopolist may use industry resources inefficiently, and its cost to produce each volume of output is higher than the corresponding cost of a firm in a perfectly competitive market.

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