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Under
imperfect competition, X-Efficiency characterizes
the level of efficiency upheld by firms. According to neoclassical theory, in a perfect competition framework, firms are expected to operate at X-Efficiency, reaching the maximum level of efficiency, denoted as 100%. This implies that a firm must generate the maximum output (product) with the available inputs (such as capital and labor) to avoid being displaced by competitors and to ensure its survival. These firms are thus considered X-efficient. However, this theory does not hold in situations of imperfect competition, such as in a monopoly or duopoly. In such cases, firms may produce less than the maximum output, hence operating at X-inefficiency. X-Efficiency was developed to measure how much more efficiently a firm could operate under perfect competition.
Harvey Leibenstein
Source: www.hetwebsite.net
In economic theory, it is assumed that economic agents act rationally.
Rational behavior entails maximizing production while minimizing costs. This principle generally applies even to markets that are inefficient (monopolies, duopolies). However, observations have shown that companies do not always act rationally. The Harvard professor and economist Harvey Leibenstein named the term "X" to denote this anomaly, referring to irrational behavior. Leibenstein introduced the human element, suggesting that factors attributable to management or employees may prevent the maximization of production or the achievement of minimal production costs. In the absence of competition, this could diminish the motivation of both the company and its employees, consequently leading to X-Inefficiency. Nonetheless, some economists argue that the concept of X-Efficiency merely represents adherence to the utility-maximizing compromise between work and leisure for employees. Empirical evidence supporting the theory of X-Efficiency remains mixed.
Economics offers several explanations for the existence of X-Inefficiency. Naturally, multiple factors can contribute to X-Inefficiency.
- Monopoly Power. A monopoly represents a company's dominant position in an industry or sector. With little or no competition, the company faces minimal competitive pressures. As the sole provider, it can easily generate above-average profits. Consequently, there might be less emphasis on cost control.
- Government Ownership. State ownership of a company prioritizes objectives other than profit maximization, thereby potentially impacting initiatives aimed at reducing costs.
- Principal-Agent Problem. Shareholders aim for profit maximization and cost minimization. However, this objective might conflict with the interests of managers and employees. They naturally strive to retain their positions, incentivizing them to keep costs low. Simultaneously, they seek a comfortable work environment, which often increases the company's costs.
- Lack of Motivation. Employees and management might lack motivation. Various reasons can lead to employees not being fully productive in the workplace.
In general, both terms refer to the same concept, assessing how efficiently a company operates. Efficiency is expressed as a percentage. For instance, if a company's X-Efficiency is 75%, it means the company is utilizing 75% of its optimal efficiency. X-Inefficiency measures a similar concept, yet it centers on the disparity between a company's attained efficiency and its potential maximum efficiency. The following figure illustrates X-Inefficiency.
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