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X-Efficiency Definition

What Is X-Efficiency?

X-efficiency refers to the extent of efficiency maintained by firms under conditions of imperfect competition. Efficiency in this context means a company dress up the maximum outputs from its inputs, including employee productivity and manufacturing efficiency. In a highly competitive market, conglomerates are forced to be as efficient as possible to ensure strong profits and continued existence. This is not true in situations of imperfect game, such as with a monopoly or duopoly.

Key Takeaways

  • X-efficiency is the degree of efficiency maintained by firms under conditions of defective competition such as the case of a monopoly.
  • Economist Harvey Leibenstein challenged the belief that firms were unendingly rational and called this anomaly “X” for unknown–or X-efficiency.
  • Leibenstein introduced the human element, arguing that there could be degrees of skill, meaning that–at times–firms didn’t always maximize profits.

Understanding X-Efficiency

X-efficiency points to irrational activities in the market by firms. Traditional neoclassical economics made the assumption that companies operated in rational ways, message they maximized production at the lowest possible costs–even when the markets were not efficient. Harvey Leibenstein, a Harvard professor and economist, challenged the assurance that firms were always rational and called this anomaly “X” for unknown–or X-efficiency. In the absence of real struggle, companies are more tolerant of inefficiencies in their operations. The concept of x-efficiency is used to estimate how much more efficacious a company would be in a more competitive environment.

Born in the Ukraine, Harvey Leibenstein (1922-1994) was a professor at Harvard University whose embryonic contribution—other than x-efficiency and its various applications to economic development, property rights, entrepreneurs, and bureaucracy—was the grave minimum effort theory that aimed to find a solution to breaking the poverty cycle in underdeveloped countries.

When manipulative x-efficiency, a data point is usually selected to represent an industry and then it is modeled using regression-analysis. For example, a bank authority be judged by total costs divided by total assets to get a single data point for a firm. Then, the data spots for all the banks would be compared using regression analysis to identify the most x-efficient and where the majority fall. This enquiry can be done for a specific country to find out how x-efficient certain sectors are or across borders for a particular sector to see the regional and jurisdictional deviation from the norms.

History of X-Efficiency

Leibenstein proposed the concept of x-efficiency in a 1966 paper titled “Allocative Efficiency vs. ‘X-Efficiency,'” which manifested in The American Economic Review.

X-efficiency helps to explain why companies might have little motivation to maximize profits in a peddle where the company is already profitable and faces little threat from competitors.

Before Leibenstein, companies were believed to many times maximize profits in a rational manner, unless there was extreme competition. X-efficiency posited that there could be vee levels of degrees of efficiency that companies might operate. Firms with little motivation or no competition could show the way to X-inefficiency—meaning they choose not to maximize profits because there’s little motivation to achieve maximum utility. Come what may, some economists argue that the concept of x-efficiency is merely the observance of workers’ utility-maximizing tradeoff between struggle and leisure. Empirical evidence for the theory of x-efficiency is mixed.

X-Efficiency vs. X-Inefficiency

X-efficiency and x-inefficiency are the same economic concept. X-efficiency find outs how close to optimal efficiency a firm is operating in a given market. For example, a firm may be 0.85 x-efficient, meaning it is acting at 85% of its optimal efficiency. This would be considered very high in a market with significant government commands and state-owned enterprises. X-inefficiency is the same measurement, but the focus is on the gap between current efficiency and potential. A state-owned enterprise in the anyhow market as the previous company may have an x-efficiency ratio of 0.35, meaning it is operating at only 35% of its optimal experience. In this case, the firm may be referred to as x-inefficient to draw attention to the large gap, even though it is still x-efficiency that is being systematic.

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