X-Efficiency

X-Efficiency refers to the economic phenomenon in which firms maintain a certain level of efficiency in an imperfect competition. The main purpose of this theory is to determine the functioning of firms and their competitiveness in an imperfect market. 

Economist Harvey Leibenstein proposed this theory in 1966. The term efficiency refers to the maximum output received from the inputs used in the production. However, it does not stand true as per the x-efficiency theory by Leibenstein. The firms behave differently in the imperfect competition, and it creates a degree of efficiency. 

• X-efficiency, a theory proposed by Harvey Leibenstein, highlights how firms maintain a certain efficiency in imperfect markets. It focuses on maximizing output by balancing inputs used. 
• It was first conceptualized in the American Business Review article presented in the year 1966. 
• While firms may initially operate below optimal levels in imperfect markets, efficiency can be improved through better management and resource allocation, mitigating inefficiencies and maximizing output relative to inputs. 
• X-efficiency centers on internal firm optimization, while allocative efficiency and productive efficiency focus on resource allocation across the broader economy.

X-efficiency in economics refers to the behavior of firms in an imperfect market and states the amount of pressure the companies face while competing with other firms. However, it is visible only in the perfect competition. In the later stages, the efficiency level reduces, impacting the business in the long run. Firms turn irrational under the conditions of imperfect competition. 

The x-efficiency theory by Harvey Leibenstein is not true in the monopoly and duopoly. He suggested that if the market has no competition or any sort of pressure, the firms are unlikely to use their resources and factors efficiently. In short, the firms start operating below their required levels. As a result, the way of conducting business also drops, and it affects efficiency. Ultimately, the firms lose their efficiency, and the resulting impact influences the businesses. As a result, the x-efficiency theory of entrepreneurship becomes prevalent. And it primarily occurs when the firm denies minimizing the cost and maximizing the output. In other words, the output must be more than the input. 

However, these firms can improve their efficiency and minimize costs, better management, and optimal allocation of resources. It is a further step to avoid inefficiency in the business. 

Economist Harvey Leibenstein presented the x-efficiency theory of entrepreneurship in the mid-20th century. He challenged the fact that firms are always rational and have efficiency in all conditions. Leibenstein believed that in an imperfect market, the scenario changes with the change in the competition. Thus, in 1966, an article published in the American Economic Review described entrepreneurs as gap-fillers or bridges in imperfect competition. In other words, they are responsible for any lower levels of efficiencies in the business. So, with this theory, it is possible to determine a firm's behavior or how they would behave in a competitive environment. 

This x-efficiency diagram is further plotted on a graph using the regression analysis model. It allows the economists to select a data point and assign a particular industry or firm. Thus, in the end, every data point will collectively decide which firm is more efficient and which is less one. Likewise, every industry or country can perform it.   

Let us look at some examples of x-efficiency to comprehend the concept better:

Example #1

Suppose Samuel owns a business that manufactures t-shirts for all age groups. In the initial years, the firm owned a monopoly and dominated the market. They soon became the sole market leaders, sharing an 80% market share. However, this glory was short-lived for them. In the next few years, three new firms entered this industry, and they had better quality and variety to offer them. So, most customers switched to other suppliers as well. And it was also applicable to different wholesalers and retailers. Now, at this stage, Samuel was a little skeptical about this business. 

In the first few years, the business was doing good as they were the sole owners of the industry. However, they were also compromising on the quality of their products being the only providers of it. The customers had no choice but to buy them at the cost decided. But, when the other firms started entering this industry, it paved the way for imperfect competition. Everyone got an adequate amount of share in the industry. Now, Samuel got tensed on his position and tried to compete with the other players. He tried to improve his products, which, in turn, led to an increase in his efficiency and the acquisition of new customers. 

Example #2

Another example concentrates on the other sectors of the market. Suppose Mary owns a chip-manufacturing business, but her costs are high due to the technology and raw materials used. She ensures superior quality of goods that work on par with the revenue generated. However, for some time, Mary's costs increased by 10%, which led to a rise in the product price. After evaluating and deploying the x-efficiency diagram, she compared other firms and took effective measures to reduce it.  

Although there are some similarities between x-efficiency and x-inefficiency, they are different indeed. Let us look at them:

Following is the distinction between x-efficiency, allocative efficiency, and productive efficiency. Let us look at the differences:

This article has been a guide to X-Efficiency and its definition. Here, we explain its examples, comparison with productive and allocative efficiency, and history. You may also find some useful articles here -

• Competition Policy
• Monopoly vs Oligopoly
• Marginal Productivity