X’ efficiency

Efficiency

Assessing the efficiency of firms is a powerful means of evaluating performance of firms, and the performance of markets and whole economies. There are several types of efficiency, including allocative and productive efficiency, technical efficiency, 'X' efficiency, dynamic efficiency and social efficiency.

Allocative efficiency

Allocative efficiency occurs when consumers pay a market price that reflects the private marginal cost of production. The condition for allocative efficiency for a firm is to produce an output where marginal cost, MC, just equals price, P.

Productive efficiency

Productive efficiency occurs when a firm is combining resources in such a way as to produce a given output at the lowest possible average total cost. Costs will be minimised at the lowest point on a firm's short run average total cost curve.

This also means that ATC = MC, because MC always cuts ATC at the lowest point on the ATC curve.

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Technical efficiency

Technical efficiency relates to how much output can be obtained from a given input, such as a worker or a machine, or a specific combination of inputs. Maximum technical efficiency occurs when output is maximised from a given quantity of inputs.

The simplest way to differentiate productive and technical efficiency is to think of productive efficiency in terms of cost minimisation by adjusting the mix of inputs, whereas technical efficiency is output maximisation from a given mix of inputs.

Identifying allocative and productive efficiency points

To identify which output a firm would produce, and how efficient it is, we need to combine data on both costs and revenue.

We can assume that most real firms face a downward sloping demand (AR) curve, and MR falls at twice the rate.

Diagrammatically, productive efficiency occurs where ATC is at its lowest, and is equal to MC.

X’ efficiency

X efficiency is a concept that was originally applied to management efficiencies by Harvey Leibenstein in the 1960s. The concept can be applied specifically to situations where there is more or less motivation of management to maximise output, or not.

X efficiency occurs when the output of firms, from a given amount of input, is the greatest it can be. It is likely to arise whenfirms operate in highly competitive markets where managers are motivated to produce as much as possible.

When markets are less than perfectly competitive, as in the case of oligopolies and monopolies, there is likely to be a loss of 'X' efficiency, with output not being maximised due to a lack of managerial motivation.

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