Health Economics

  • X-inefficiency is the difference in costs between efficient and inefficient firms engaged in essentially the same activity and on the same scale, i.e. it does not arise from differences in product mix and is not a consequence of economies (or diseconomies) of scale or scope. It generally arises in situations when either or both of the product market or the capital market (the market for the firm's ownership) are not competitive, resulting in price-searching behaviour and an increase in the costs to owners of monitoring and enforcing their own interests within the firm (sometimes referred to as a 'separation' of ownership from control). This enables managers to act in ways that may not be in the interest of owners but that are consistent with utility-maximizing by managers in pursuing their own interests. Since most sources of (on-the-job) utility are costly, this necessarily implies that costs will be higher in utility-maximizing firms than in profit-maximizing firms. The difference is X-inefficiency.