X-Innefficiency

   While we are constructing average-total-cost curve, we assume that firms have the most efficient technology. In other words, the firm owns the technology that permits to achieve the lowest average-total-cost at whatever the quantity output is. X-Innefficiency is the failure of firm to produce any specific output at lowest possible average total cost.
Why does X-inefficiency occurs if it reduces firm’s revenue? The answer is that some entrepreneurs may have such goals as easier work time, corporate growth, avoidance of business risks or giving some jobs to their relatives that aren’t competent in performing them, so these causes may be in conflict with cost minimization. X-inefficiency also may arise when firm’s workers are poor motivated or under-supervised, also it happens when a firm is inert when it comes to making decisions about future business actions.
Question is where more likely X-inefficiency is prevailing: monopolistic or competitive industry? Firms in competitive industry are under pressure from rivals, so that they are forced to be efficient at production if they want to survive and get profit, but monopolists are protected from such competition and pressure by entry barriers, so that lack of this pressure may lead to X-inefficiency.
There is one general evidence that probability of X-inefficiency increases as competition decreases. Also, it is estimated that X-Inefficiency may be 10% or more of costs for monopolies and just 4% on average for oligopolies where four biggest firms produce more than 60% of total output.  There were a saying :” X-inefficiency exists and it’s more possible to be reduced when there is competitive pressure on firm rather than it is isolated”.

In the figure shown above, both costs are higher than minimum ATC, this implies that in this firm(industry) X-inefficiency exists, since the firm(industry) is operating at greater than lowest cost of a specific level of output. For Q1 ATC should be 1, but for Q2 ATC should be 2.

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Long-Run Production Costs

 Economies and Diseconomies of scale
     In the Long Run like in Short Run average total cost (ATC) is U shaped, but why? We can’t explain this by law of diminishing returns, because only in short run plant’s capacity is fixed. In long run all resources are variable. Since prices of the resources are constant we can explain the form of the ATC in terms of economies and diseconomies of scale:
 
   Economies of Scale or economies of production explain the down-sloping part of ATC curve. The following factors may lower ATC of production:
 Management Specialization
     Large-scale production also means the better us and specialization of management. A manager that can supervise 50 people will be used inefficiently when the firm will employ only 20. Small plants won’t use managers to their best advantage, because they will have to divide time among more functions. Greater production means that manager will do his job full time so a higher efficiency will be achieved. This may result in lower product price.
Labor Specialization
     Increased specialization of labor becomes more achievable when factor’s size is increased. Hiring more workers means that tasks can be divided and subdivided, so that each worker has its own function. In this case a worker will perform only one job instead of five. In a small firm some skilled machine operators won’t be used efficient since they will perform unskilled task, leading to higher production costs.
   Workers by performing fewer tasks will become more proficient at them. Also greater labor specialization eliminates the time loss needed for them to switch their job.
Efficient Capital
       Small businesses may not afford to buy the most efficient machineries.  Some of these machineries are available only for mass-production, so a high efficiency is achieved only when there is used a big amount or resources. So a small firm is in dilemma between choosing to produce at inefficient equipment or at efficient one but with small amount of resources, but in both cases output is inefficient and too costly.
Other Factors
   An example of factor that creates economies of scale is advertising. These costs for advertising are decreased as more units are sold. So if there is an increase in quantity of resources ex: 30% followed by a greater increase in quantity of output ex: 50% then this event  declines ATC and may be a factor of economies of scale.

Diseconomies of Scale
   While a firm is expanding, their ATC may increase, so the curve of it becomes up-sloping. The main factor of diseconomies of scale is the difficulty of controlling and operating a bigger firm. In small ones a single manager may make all decisions for plant’s operations.
   But as the firm grows there is need for more managers. One person can’t digest and understand all the information needed for decision making. Expansion of management hierarchy leads to problems of communication and cooperation. So decision making may be slowed down so that they fail to respond immediately to change in consumer’s demand.
   In massive production workers may feel free from their employers so that they care less about working efficiently. So if there is an increase in quantity of resources ex: 30% followed by a smaller increase in quantity of output ex: 20% then this event increases ATC and may be a factor of diseconomies of scale.

Constant Return Scale
     In some industries a wider range of output may exist between the output at which economies of scale end and output at which diseconomies of scale begin. This range is called constant return scale and may exist over a wide part of long-run curve in which average total cost (ATC) doesn’t change. So if there is quantity Q input there will be also quantity Q output.