Considerable knowledge (aka perfect information) is required to understand/calculate the optimal technical output for a firm, but it must be understood so that a firm can make the best decisions regarding production. It must be noted that sometimes it is not possible for a firm to actually produce on the ‘optimal technical efficiency’ because there is simply not enough demand.
The X-Inefficiency is also known as the ‘production cost gap’ and is found in companies that are producing the maximum output, but are not producing at the optimum technical efficiency. There are several reasons this may occur:
- the firm is not producing at the optimal scale of production.
- the firm does not function efficiently and wastes resources.
It can be seen from the diagram above that there are several points of interest. These include:
- X’ is the point where maximum output is reached but the cost of production is too high, as it does not sit in the Average Total Cost Curve.
- the vertical distance between X’ and the ATC Curve is the X-Inefficiency.
- X is a poor position for a firm to be producing at, as the cost of production is high (above the ATC Curve) and output is low. This firm would be in danger and would require restructuring.