Market Structure and X-inefficiency

Harvey Leibenstein. "Allocative Efficiency and X-inefficiency," American Economic Review, June 1966: 392-415.

Conventional price theory predicts that structure will affect market prices and quantities, but not production costs. Leibenstein argued that monopolistic (or dominant) firms may exhibit X-inefficiency--that is, a tendency to operate at a point above the theoretical (minimum) cost curve.

Note that competitive firms have no choice but to minimize production costs since (in the long run, anyway) they will be eliminated if they fail to do so. However, monopolistic (or oligopolistic) firms typically enjoy some freedom from the iron discipline of competitive market forces. As such, they can survive with cost structures that would not be viable under competitive conditions.

But firms behave to maximize profits, right? Can a maximizing firm exhibit X-inefficiency?

NO. X-inefficiency must be the manifestation of "non-maximizing" behavior by firms. However, the separation of ownership and control characteristic of giant corporations creates the possibility that top decision makers within the firm may select strategies or establish policies that are not strictly in line with the interests of shareholders. (See Adolph Berle and Gardiner Means. The Modern Corporation and Private Property, 1934).

(Secondary) causes (or outward manifestations) of X-inefficiency: