Companies may not always be able to identify exactly their short-run or long-run

technical optimum, as this requires considerable knowledge of the nature of production

costs as output rises. Even in the presence of complete information, there may not
always, of course, be sufficient demand for the firm’s product to justify increasing output
to reach the optimal long-run scale of production.

Companies’ unit costs may be higher than is technically feasible – a ‘production-cost’

gap may arise – for the following two broad reasons:

- The firm is not producing at its optimal scale of production.

- The firm wastes resources and its costs are higher than necessary at its existing
scale of production. This type of inefficiency is often referred to as X-inefficiency
because it can exist to any degree.

X-inefficiency is the difference between efficient behavior of firms assumed or implied

by economic theory and their observed behavior in practice.

Economic theory assumes that the management of firms act to maximize owners' wealth
by minimizing risk and maximizing economic profits -- which is accomplished by
simultaneously maximizing revenues and minimizing costs, usually through the
adjustment of output. In perfect competition, the free entry and exit of firms tends toward
firms producing at the point where price equals long run average costs and long run
average costs are minimized. Thus firms earn zero economic profits and consumers pay a
price equal to the marginal cost of producing the good. This result defines economic
efficiency or, more precisely, allocative economic efficiency.