X-inefficiency refers to situations where firms are operating far less efficiently than they could technically. It is often associated with the lazy monopolist who is not forced by competition to take the time and trouble to be as efficient as he could be. To illustrate X-inefficiency we need to draw a picture in which a firm faces two ATC curves; one that it could operate on if it were not being lazy (labeled as ATC1 on the diagram) and the one it actually is operating on, which is higher than it otherwise would be (labeled as ATC2). If the firm seeks to maximize profits, it produces Q1. At this level, economic profit is represented by the area ADFC. A lazy monopolist does not operate efficiently and allows ATC to rise to, say, ATC2. In this case, economic profit is squeezed down to area ADEB.
Lazy monopolists are managers that don't make the effort required to maximize profits. The resulting inefficiency is called "X-inefficiency," which occurs when firms operate far less efficiently than they could technically. Although these producers have monopoly power, they don't make full monopoly profits. If there are no threats of competition from outside the industry, lazy monopolists will not be concerned about losing their jobs and X-inefficiency will continue.
Because of lazy monopolists, many takeovers are based on the expectation that new management can manage a company's assets much more profitably. Those looking to buy a company believe that they can raise the value of the assets by improving the efficiency. Hence, a major market check on lazy monopolist behavior is the threat of a corporate takeover. Though the firm's survival is not threatened, the firm's management is. When managers fear that their company may be taken over (and they might be out of a job), they may work to make their company more efficient so as not to give any corporate raider a reason to think that the company can be improved by a takeover and subsequent turnover of management.
Monopolists can try to prevent other firms from entering their markets by spending money on advertising to make their products seem unique, by lobbying for government regulations that would prevent the entry of other firms by producing products that are difficult to copy and by charging less than the profit-maximizing price to discourage entry.
Since the benefit of being a monopolist is earning positive economic profit, a rational monopolist will spend up to the entire dollar amount of the expected positive economic profit amount to get and keep its monopoly.
Problems and Applications