Allocative Efficiency, X-Efficiency and the Measurement of Welfare Losses

In estimating the loss from monopoly, 1 it has been common to assume that inputs are used as efficiently as in competitive markets. The presumed reason for this assumption is that firms have a clear interest in minimizing costs per unit of output. While the ‘carrot’ of greater profits may well be a major determinant of firm behaviour, the competitive ‘stick’ may be equally important, and to this extent, monopoly will affect costs as well as prices.

In this context, the welfare loss from monopoly should include the reduction in what one of the authors has called ‘X-efficiency’ 2 as well as the extent of allocative inefficiency, and therefore the combined welfare loss from monopoly may be very much larger than the usually calculated loss.