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Diseconomies of scale and X-inefficiency
Edexcel IAL Economics · WEC13 Business behaviour
Beyond a certain size, average costs can start to rise. Diseconomies of scale and X-inefficiency explain why bigger is not always better.
Diseconomies of scale
Diseconomies of scale: rises in long-run average cost as scale increases beyond a certain output. Causes:
- Communication problems: messages pass through more layers and become slow or distorted.
- Co-ordination and control: harder to make many departments and sites pull in the same direction.
- Motivation: workers in huge organisations may feel alienated, raising absenteeism and staff turnover.
- X-inefficiency: the specification lists it as a source of diseconomies of scale, because a very large firm with market power can let slack build up (see below).
External diseconomies also exist, such as congestion and rising local wages and rents when an industry crowds into one area.
X-inefficiency
X-inefficiency occurs when a firm produces above its lowest possible average cost curve for the output it makes, because of organisational slack: overstaffing, wasteful spending, poor management. It is most likely where there is little competitive pressure, for example in a monopoly or a protected SOE.
Diagram in words: mark a point above the AC curve at the firm's output; the vertical gap is X-inefficiency. The specification lists X-inefficiency as a source of diseconomies of scale, since slack tends to grow as firms become large and dominant. But be precise on a diagram: X-inefficiency is a point above the cost curve, while the other diseconomies of scale make the LRAC curve itself rise.
Reducing them
Firms can decentralise decisions, use better communication technology, split into smaller units (or demerge), or use performance-related pay. Competition and the threat of entry put pressure on firms to remove X-inefficiency.
Worked example
A state-owned postal service with no competitors employs more staff than it needs. Explain what type of inefficiency this is and why it arises.
- Overstaffing means it is producing its output at a higher cost than it could.
- This comes from a lack of competitive pressure: with no rivals, slack is not punished by lost customers.
- So costs are above the lowest possible AC curve: X-inefficiency, which the specification lists among the sources of diseconomies of scale in large, dominant organisations.
Answer: X-inefficiency: costs are above the minimum possible because there is no pressure to cut slack.
Check yourself
- Which is a cause of internal diseconomies of scale?
- Bulk-buying discounts
- Specialist managers
- Cheaper borrowing
- Poor communication between many layers of management
Show answer
Poor communication between many layers of management. The others are economies of scale.
- X-inefficiency is best defined as
- producing where price exceeds marginal cost
- producing at a cost higher than the lowest possible for that output
- failing to reach minimum efficient scale
- a fall in average cost as output rises
Show answer
producing at a cost higher than the lowest possible for that output. It is organisational slack: costs higher than they need to be.
- X-inefficiency is most likely in
- a perfectly competitive market
- a highly contestable market
- a market with many price-cutting rivals
- a monopoly protected from competition
Show answer
a monopoly protected from competition. Without competitive pressure, firms can survive with slack.
- Rising rents and traffic congestion as more firms crowd into an industrial area are examples of
- external diseconomies of scale
- internal economies of scale
- X-inefficiency
- minimum efficient scale
Show answer
external diseconomies of scale. They come from the growth of the industry in an area and raise costs for all firms there.
- How can worker alienation in a very large firm raise average cost?
- It increases bulk discounts
- It lowers fixed costs
- Lower motivation raises absenteeism and lowers productivity
- It raises the price of the product
Show answer
Lower motivation raises absenteeism and lowers productivity. Less output per worker for the same wage bill means higher cost per unit.
- Describe how X-inefficiency is shown on a cost diagram.
Show answer
The firm's actual average cost is shown as a point above the average cost curve at its output; the vertical distance between that point and the curve is the X-inefficiency.. It is a point above the curve, not a movement along it.
Sources
Last updated 8 November 2026. Spotted a mistake? Tell us.