Inefficiency
The cost of a quiet life
The major criticism of monopoly has traditionally been that of the monopoly's power in selling the good. The firm charges a price above MC. This is seen as allocatively inefficient because at the margin consumers are willing to pay more than it is costing to produce (P > MC); and yet the monopolist is deliberately holding back, so as to keep its profits up.
Monopolies may also be inefficient for another reason: they may have higher costs. But why?
Higher costs may be the result of X inefficiency1 (sometimes known as technical inefficiency). Without competitive pressure on profit margins, cost controls may become lax. The result may be overstaffing and spending on prestige buildings and equipment, as well as less effort to keep technologically up to date, scrap old plant, research new products, or develop new domestic and export markets.
Thus the more comfortable the situation, the less may be the effort which is expended to improve it. The effect of this X inefficiency is to make the AC and MC curves higher than they would otherwise be.
Beginning in the early 1980s, there have been significant reductions in X inefficiency in many countries. With a world-wide recession at that time, and a fall in both sales and profits, many firms embarked on cost-cutting programmes. Much out-of-date plant was closed down, and employment was reduced. Those firms that survived the recession (and many did not) tended to emerge both more competitive and more efficient.
Another factor causing a reduction in X inefficiency has been the growth in international competition. As markets have increasingly become global in scale, and as customs duties and other barriers to trade have been reduced, so many companies are facing fiercer competition from abroad.
Questions
1. How might you measure X inefficiency?
2. Another type of inefficiency is productive inefficiency. What do you think this is? (Clue: it has to do with the proportions in which factors are used.)
1This term was coined by Harvey Leibenstein, ‘Allocative efficiency or X efficiency', American Economic Review, June 1966.