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A Level Economics > Theme 3 - Business Behaviour and the Labour Market > Flashcards

Theme 3 - Business Behaviour and the Labour Market Flashcards

1
Q

Why do firms grow

A
  • experience economies of scale
  • greater market share
  • diversification
  • managerial objectives
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2
Q

What do firms get from experiencing economies of scale when growing

A
  • reduce costs of production
  • sell more goods and make more revenue
  • make more profit, firms are motivated by profit
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3
Q

What do firms get from having a greater market share when growing

A
  • market power
  • ability to influence prices
  • restrict ability of other firms to enter market
  • make greater profits in long run
  • reduce costs by driving down prices of raw material with monopsony power
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4
Q

What do firms get from diversification when growing

A
  • greater security
  • build up assets and cash
  • can be used in financial difficult times
  • likely to sell greater range of goods in more markets
  • less affect by changes to products or places
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5
Q

How is there a principle agent problem

A
  • separation of ownership and control
  • separation causes problems due to differing aims of the two stakeholders
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6
Q

How is there separation of ownership and control (principle agent problem)

A
  • firms owned by shareholders (not involved in day to day running of business)
  • managers work for company and make day to day decisions
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7
Q

What problems are caused due to the differing aims of the two stakeholders (principle agent problem)

A
  • owners want to maximise returns on investments so want to short run profit maximise
  • managers want to maximise their own benefits
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8
Q

What is the principle agent problem

A
  • one group (agents) make decisions on behalf of another group (principle)
  • agent should maximise benefit for those they look after but have temptation to maximise their own benefit
  • due to this, many firms run to profit satisfice instead of profit maximise
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9
Q

What is the public sector

A
  • part of economy owned or controlled by local or central government
  • purpose is to provide service for UK citizens
  • profit is not main aim
  • some may make a loss, funded by taxpayer
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10
Q

What is the private sector

A
  • part of economy which is owned and run by individual or groups
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11
Q

How can the private sector be further split

A
  • profit organisations
  • not for profit organisations
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12
Q

What are profit organisations in the private sector

A
  • run to make a profit and maximise financial benefits for shareholders
  • not always profit-maximising but long term goal is to make money
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13
Q

What are not-for-profit organisations in the private sector

A
  • any profit made is used to support aim of maximising social welfare
  • include organisations such as charities
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14
Q

What do firms get in terms of managerial objectives when growing

A
  • managers receive numeration packages, determined by sales performance of firm
  • provides incentives to increase size of firm
  • may increase size of firm to satisfy ego
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15
Q

Why do some firms choose to remain small

A
  • diseconomies of scale
  • extra work and risks
  • legal requirements
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16
Q

How do diseconomies of scale disincentivise firm growth

A
  • occurs when business grows
  • can increase costs per unit
  • leads to an overall increase in costs
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17
Q

How does extra work and risk disincentivise growth for firms

A
  • growth involves sunk costs which cannot be recovered if expansion fails
  • much more labour and other factors needing to be controlled
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18
Q

How do legal requirements disincentivise growth for firms

A
  • small firms face less, more compliable regulations than larger firms
  • staying small allows for a more manageable regulatory framework for firms
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19
Q

Why must some firms remain small

A
  • finance
  • niche market
  • knowledge
  • resources
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20
Q

How does finance prevent some firms from growing

A
  • unable to finance expansion
  • banks and lenders see small firms as risky borrowers
  • either offered credit on strict terms (not ideal) or not at all
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21
Q

How do niche markets prevent some firms from growing

A
  • small customer base
  • no need to grow
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22
Q

How does knowledge prevent some firms from growing

A
  • knowledge, skills, and expertise may be lacking
  • not all businesses have entrepreneurs with ability to steer through a successful expansion
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23
Q

How do resources prevent some firms from growing

A
  • firm may lack resources to cope with additional regulations and bureaucracy that expansion entails
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24
Q

What are the types of growth

A
  • organic growth
  • inorganic growth
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25
Q

What is organic growth

A
  • internal growth
  • occurs when a business gets larger by increasing scale of its own operations rather than relying on integration with other businesses
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26
Q

What is inorganic growth

A
  • external growth
  • occurs when a business gets larger by buying other companies or forming a business relationship with them
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27
Q

What are the advantages of organic growth

A
  • cheaper than external growth
  • firm is able to keep control of their business
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28
Q

What are the disadvantages of organic growth

A
  • sometimes another firm has a market or asset which the company would be unable to gain through organic growth (expanding into markets in another country)
  • organic growth may be too slow to maximise salaries for directors
  • difficult to get new ideas
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29
Q

What are the types of inorganic growth

A
  • vertical integration
  • horizontal integration
  • conglomerate integration
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30
Q

What is vertical integration

A
  • integration of firms in the same industry but at different stages in the production process
  • forwards vertical integration
  • backwards vertical integration
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31
Q

What is forwards vertical integration

A
  • integration with a firm in the same industry but closer towards the final good produced
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32
Q

What is backwards vertical integration

A
  • integration with a firm in the same industry but closer towards the supplier
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33
Q

What are the advantages of vertical integration

A
  • increased potential for profit as firm takes potential profit from a larger part of chain of production
  • less risks - suppliers do not need to worry about buyers not buying goods and buyers do not need to worry about suppliers not supplying goods
  • backward integration allows increased control of quality of supplies and allows costs to be kept low
  • forward integration secures retail outlets and can restrict access to outlets for competitors
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34
Q

What are the disadvantages of vertical integration

A
  • firms may have no expertise in the industry they take over
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35
Q

What is horizontal integration

A
  • when firms in the same industry at the same stage of production integrate
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36
Q

What are the advantages of horizontal integration

A
  • reduces competition as competitor is taken out and leads to increased market share
  • firms able to specialise and rationalise, reducing areas of businesses which are duplicated
  • able to grow in a market where it already had expertise (more successful)
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37
Q

What are the disadvantages of horizontal integration

A
  • increases risk for business - if market fails then they have nothing to fall back on
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38
Q

What are examples of horizontal integration

A
  • AstraZeneca acquiring ZS Pharma for $2.7bn in 2015 allowing them access to new compounds
  • Curry’s and PC Worlds
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39
Q

What are examples of vertical integration

A
  • Tesco taking over Booker for £3.7bn in 2018, led to increase in sales for Tesco
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40
Q

What are examples of organic growth

A
  • LEGO, introduced new products such as LEGO Friends and board games to expand customer base
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41
Q

What is an example of the principle agent problem

A
  • Enron Scanal of 2001, executives used loopholes to hide billions of dollars in debt from Board of Directors. Shareholders filed a lawsuit to the firm and the executives when share prices fell from nearly $100 to less than $1 in just over a year
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42
Q

What is conglomerate integration

A
  • when firms in different industries with no obvious connections integrate
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43
Q

What are advantages of conglomerate integration

A
  • useful for firms where there is no room for growth in present market
  • reduces risk for firms as if whole industry fails, they will still survive due to other parts of business
  • easier for each individual part of business to expand than if they were on their own finance
  • can transfer resources (managers) from company to company
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44
Q

What are disadvantages of conglomerate integration

A
  • firms going into markets in which they have no expertise
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45
Q

What is an example of conglomerate integration

A
  • General Electric was founded as a lighting business and is now involved in aircraft, water, oil and gas, financial services, healthcare, energy, aviation, rail, and software. Successful model as they conducted extensive market research into each market
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46
Q

What are demergers

A
  • business strategy in which a single business is broken into two or more components
  • components either operate on their own, are sold, or are dissolved
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47
Q

What is an example of a demerger

A
  • Pepsi announcing demerger of its Pizza Hut, KFC and Taco Bell restaurants to focus on competition with Coca Cola
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48
Q

What are reasons for demegers

A
  • lack of synergies
  • value of company/share price
  • focussed companies
  • competition authorities
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49
Q

How do lack of synergies lead to demergers

A
  • different parts of company have no impact on each other and fail to make each other more efficient
  • managers are having to split time between areas which are so different
  • can lead to diseconomies of scale, firm splits to prevent these
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50
Q

How does the value of the company/share price lead to demergers

A
  • value of separate parts of company is worth more than the company combined
  • some parts of business might be doing well and have potential to grow but is restricted due to lack of success/potential for growth of other parts
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51
Q

How can focussed companies lead to demergers

A
  • some people believe if company and management are more focussed on an individual market, they become more efficient and successful = more profit
  • managers can improve skills and knowledge by focusing on only one area
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52
Q

How do competition authorities lead to demergers

A
  • large businesses gain attraction from competition authorities
  • demerging leads to attention avoidance from competition authorities
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53
Q

What are the impacts of demergers on the workers

A
  • workers can gain or lose
  • separate firms may need managers so chances of promotion
  • goal of making firm more efficient may lead to job losses
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54
Q

What are the impacts of demergers on the businesses

A
  • concentrating on smaller core businesses allow it to be more efficient
  • concentration may lead to more innovation and surging higher competition
  • size of small firms could lead to loss of economies of scale and reduced efficiency
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55
Q

What are the different objectives a business may choose to follow

A
  • profit maximisation
  • revenue maximisation
  • sales maximisation
  • satisficing
  • managerial utility maximisation
  • marginal cost pricing/allocate efficiency
  • ethical and environmental concerns, corporate social responsibility (CSR)
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56
Q

What is the business objective of profit maximisation

A
  • assumes interests of owners/shareholders are most important
  • firms aim to profit maximise in short run to maximise owners’ returns
  • assume all firms profit maximise for all market structures
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57
Q

Why do firms choose profit maximisation as a business objective to follow

A
  • reinvest back into the firm
  • provide dividends back to shareholders
  • lower costs, pass on lowered costs to consumers by lowering prices which increases demand and possibly market share
  • reward entrepreneurship
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58
Q

Where does profit maximisation take place

A
  • MC = MR
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59
Q

Why does profit maximisation occur at MC = MR

A
  • anything to the right of MC = MR leads to a higher cost than revenue so those units make a loss and reduce profit
  • anything to the left of MC = MR allows space for revenue to still be greater than cost with any increase in units until MC = MR
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60
Q

Why may firms not choose profit maximisation as a business objective to follow

A
  • cannot compute / lack knowledge of MC = MR
  • avoid scrutiny from competition authorities and regulators
  • key stakeholders may be harmed (consumers, workers, government, environmental groups)
  • other objectives may be more appropriate
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61
Q

What is the business objective of satisficing

A
  • occurs due to the principle agent problem
  • make enough profit to keep shareholders happy whilst following other object and not profit maximising
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62
Q

When does revenue maximisation occur

A
  • MR = 0
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63
Q

Why does revenue maximisation occur at MR = 0

A
  • any additional units leads to a fall in revenue leading to a loss
  • any less units allows for space of marginal revenue to still increase
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64
Q

What is the business objective of revenue maximisation

A
  • managers are interested in revenue as that is what their salary is dependent on
  • even when not directly related to salary, revenue growth is positive for business and can lead to managerial rewards from shareholders
  • fall in revenue can lead to downward spiral for company
  • firms aim to revenue maximise as long as they provide some profit for owners
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65
Q

When does sales maximisation occur

A
  • AC = AR
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66
Q

What are examples of companies that pursue profit maximisation as a business objective

A
  • Apple and pharmaceutical companies
  • need money to reinvest
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67
Q

What are examples of companies that pursue revenue maximisation as a business objective

A
  • amazon, generating revenue nearing £120bn in 2015 but profit staying relatively stable
  • aim is to dominate the market
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68
Q

What are examples of companies that pursue sales maximisation as a business objective

A
  • Netflix and Spotify
  • both trying to increase size of their businesses
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69
Q

Why does sales maximisation occur at AC=AR

A
  • an increase in units lead to a loss being made
  • any point before this allows for an increase in units while costs still stay below revenue
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70
Q

What is the business objective of sales maximisation

A
  • managers aim to maximise growth of company as salary is linked to company size
  • easier for people to judge level of growth rather than profit => prestige
  • size is linked with security
  • growth increases market share and can push other firms out of business => increased market power
  • short term strategy
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71
Q

Why do firms not choose to pursue revenue maximisation or sales maximisation as business objectives

A
  • they necessitate a fall in price
  • other firms may copy this so there may be no or little increase in revenue or sales (important in oligopoly)
  • bring lower profits
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72
Q

What is the business objective of managerial utility maximisation

A
  • managers will make decisions to maximise their own satisfaction
  • dependent on salary, number of staff controlled, power over decision making, and other benefits received
  • result of this may be to cut into profits and make these lower than they would otherwise be
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73
Q

What is the business objective of marginal cost pricing/allocate efficiency

A
  • MC = AR
  • some firms aims to maximise social welfare
  • this is done by producing where the value society places on the good is equal to extra cost of producing that good
  • achieves allocative efficiency
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74
Q

What is the business objective of corporate social responsibility

A
  • pursuit of self interest does not need to conflict with ethic and environmentally responsible behaviour
  • negative image can cut into revenue and profit
  • socially irresponsible behaviour may lead to government regulation
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75
Q

Where does each business objective involving maximisation produce at and price at

A
  • profit maximising firms produce at OA and price at OE
  • revenue maximising firms produce at OB and price at OF
  • sales maximising firms produce at OC and price at OG
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76
Q

Why do firms choose revenue maximisation as a business objective to follow

A
  • economies of scale benefits, could lead to lower costs
  • predatory pricing, firm undercuts rivals, by lowering profits, to drive out competitors from market
  • principle agent problem, managers may ask for more benefits due to growth occurring
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77
Q

Why do firms choose sales maximisation as a business objective to follow

A
  • economies of scale
  • limit pricing, takes away incentive for new firms to join market
  • principle agent problem, managers may ask for more benefits due to growth occurring
  • flooding market to make consumers aware of product to gain loyal customers then changing objective to make profit
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78
Q

What is revenue

A
  • money earned from sale of goods and services
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79
Q

What are the types of revenue

A
  • total revenue (TR)
  • average revenue (AR)
  • marginal revenue (MR)
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80
Q

What is total revenue (TR)

A
  • total amount of money coming into the business through sale of goods and services
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81
Q

How do you calculate total revenue (TR)

A
  • quantity x price
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82
Q

What is average revenue (AR)

A
  • revenue per unit sold
  • = P
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83
Q

How do you calculate average revenue (AR)

A
  • total revenue / output
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84
Q

What is marginal revenue (MR)

A
  • extra revenue firm earns from selling one more unit of production
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85
Q

How do you calculate marginal revenue (MR)

A
  • change in total revenue / change in output
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86
Q

What type of firms experience a perfectly elastic demand curve

A
  • those in perfect competition
  • no price setting power
  • price taker
  • price received by firms for good is constant so MR=AR=D
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87
Q

Why is the total revenue curve upward sloping for firms in perfect competition

A
  • prices are constant
  • more goods sold, higher revenue is made
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88
Q

What type of firms experience a downward sloping demand curve

A
  • those in imperfect competition
  • have price setting power
  • price maker/giver
  • AR = D, indicates price consumers are willing to pay
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89
Q

What is the elasticity of the downward sloping demand curve in revenue linked to

A
  • marginal revenue
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90
Q

How does marginal revenue being positive affect the downward sloping demand curve

A
  • when firm sells product at a lower price or increases output, total revenue still grows and so demand is elastic
  • until output Q, demand curve is elastic
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91
Q

How does marginal revenue being negative affect the downward sloping demand curve

A
  • total revenue decreases as price decrease / output increases
  • demand curve is inelastic
  • after output Q, demand curve is inelastic
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92
Q

How does marginal revenue = 0 affect the downward sloping demand curve

A
  • total revenue is maximised
  • demand curve is unitary elastic at point Q
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93
Q

What are the different types of costs

A
  • total cost (TC)
  • total fixed cost (TFC)
  • total variable cost (TVC)
  • average total cost (ATC)
  • average fixed cost (AFC)
  • average variable cost (AVC)
  • marginal cost (MC)
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94
Q

What is total cost (TC)

A
  • cost of producing a given level of output
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95
Q

What is total fixed cost (TFC)

A
  • costs that do not change with output and remain constant
  • e.g. rent, machinery
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96
Q

What is total variable cost (TVC)

A
  • costs that change directly with output
  • e.g. materials
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97
Q

What is marginal cost (MC)

A
  • extra cost of producing one extra unit of a good
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98
Q

How do you calculate total cost (TC)

A
  • fixed costs + variable costs
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99
Q

How do you calculate average total cost (ATC)

A
  • total costs / output
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100
Q

How do you calculate average fixed costs (AFC)

A
  • total fixed cost / output
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101
Q

How do you calculate average variable cost (AVC)

A
  • total variable cost / output
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102
Q

How do you calculate marginal cost (MC)

A
  • change in total cost / change in output
  • total cost of producing N goods - total costs of producing (N-1)
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103
Q

What is the short run

A
  • time period in which at least one factor of production is fixed
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104
Q

What is the long run

A
  • time period in which all factors of production are variable
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105
Q

What is the law of diminishing returns / diminishing marginal productivity

A
  • when one variable factor of production is increased while other factors stay fixed, eventually the marginal returns from the variable factor will begin to decrease
  • marginal output decreases as more inputs are added in the short run
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106
Q

How does the costs curve look like
(MC, ATC, AVC, AFC)

A
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107
Q

Why is the average fixed cost curve (AFC) shaped like that

A
  • starts high because whole fixed costs are being divided by a small output
  • as output is increased, AFC falls as the same amount is being divided by a larger amount
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108
Q

Why is the average total cost curve (ATC) shaped like that

A
  • U shaped due to law of diminishing marginal productivity
  • costs initially fall as machinery is used more efficiently
  • as production expands, efficiency falls as machinery is overused
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109
Q

Why is the average variable cost curve (AVC) shaped like that

A
  • U shaped but gets closer to ATC as output increases since AFC gets smaller
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110
Q

Why is the marginal cost curve (MC) shaped like that

A
  • U shaped due to law of diminishing marginal productivity
  • initially fall as machines are used more efficiently
  • rises as production continues to rise
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111
Q

How does the total cost curve look

A
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112
Q

How can average total costs (ATC) be calculated from a total cost curve (TC)

A
  • at point A, average costs are C/D
  • at point B, average costs are E/F
  • average costs at B are lower than at A, since the gradient of A is steeper than B
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113
Q

Why are both the short run average cost curve (SRAC) and long run average cost curve (LRAC) U shaped

A
  • SRACs are U shaped because of the law of diminishing returns
  • LRACs are U shaped because of economies and diseconomies of scale
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114
Q

How does the average cost curve, including SRAC and LRAC look

A
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115
Q

Why is the average cost curve shaped like that

A
  • LRAC is either equal to or below SRACs
  • firm may initially be set to produce a certain amount but increase this causing a rise in SRAC = law of diminishing returns as some factors are defined
  • in LR, factors become variable so SRAC can be shifted
  • new SRAC is lower due to economies of scale until diseconomies of scale
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116
Q

What does the LRAC curve show

A
  • boundary represents minimum level of average costs attainable at any given level of output
  • points below LRAC are unattainable
  • producing above LRAC is inefficient
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117
Q

What does movement along the LRAC show

A
  • change in output which changes the average cost of production due to internal economies/diseconomies of scale
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118
Q

What does a shift in the LRAC show

A
  • occurs due to external economies/diseconomies, taxes, or technology, which affects the cost of production for a given level of output
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119
Q

What do the different sections under the LRAC curve represent

A
  • until Q1, firm is experiencing economies of sale and thus sees falling LRAC
  • from Q1 to Q2, the firm has constant returns to scale / maximum efficient scale where their LRAC are constant
  • any output above Q2 shows the firm experiencing diseconomies of scale and their LRAC rising
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120
Q

What are economies of scale

A
  • advantages of large scale production
  • enables a large business to produce at a lower average cost than a smaller business
  • the firm is able to experience increasing returns to scale, where an increase in inputs by a certain percentage will lead to a greater percentage increase in output
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121
Q

What are diseconomies of scale

A
  • disadvantages that arise in a large business
  • reduce efficiency and cause costs to rise
  • firm experiences decreasing returns to scale, where output increases by a small percentage than inputs
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122
Q

What are constant returns to scale

A
  • where firms increase inputs and receive an increase in output by the same percentage
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123
Q

What is the minimum efficient scale

A
  • minimum level of output needed for a business to fully exploit economies of scale
  • it is where the LRAC curve first levels off and when constant returns to scale is first met
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124
Q

What are internal economies of scale

A
  • advantage that a firm is able to enjoy because of a growth in the firm, independent of anything happening to other firms or the industry in general
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125
Q

What are the types of internal economies

A
  • technical economies
  • financial economies
  • risk bearing economies
  • managerial economies
  • marketing and purchasing economies
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126
Q

What are technical economies

A
  • arise as a result of what happens to the production process
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127
Q

What can change in the production process of a technical economy leading to growth

A
  • specilisation
  • balanced teams of machines
  • increased dimensions
  • indivisibility of capital
  • research and development
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128
Q

How can specialisation lead to growth in technical economies

A
  • large firms able to appoint specialist workers and buy specialist machines
  • allows for job to be done quicker and better than machines/workers which are not specialised
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129
Q

How can balanced teams of machines lead to growth in technical economies

A
  • large firms can afford to buy a number of every kind of machine for each stage of production
  • by combining these machines, they can ensure they run each machine at its optimal level
  • smaller companies may only be able to afford one machine for each stage, if one stage of production runs faster than other then machines will spend a long time turned off
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130
Q

How can increased dimensions lead to growth in technical economies

A
  • relates to the fact if the size of walls was double, area increase by 4 times
  • 4x increase in capacity occurring without the cost increasing by 4x
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131
Q

How can indivisibility of capital lead to growth in technical economies

A
  • some processes require huge items of machinery and investment that make it only possible for them to produce on a large scale
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132
Q

How can research and development lead to growth in technical economies

A
  • often large firms can afford to carry out large scale R&D
  • means they are able to gain large advantage over competitor
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133
Q

What are financial economies and how can they lead to internal growth

A
  • greater security as they have more assets and therefore harder to be forced out of business overnight
  • easier for them to obtain finance and interest rates will be lower due to lower risk
  • makes investment more accessible
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134
Q

What are risk bearing economies and how can they lead to internal growth

A
  • large companies able to operate in a range of different markets, producing different products
  • means if one area of business falls, whole business will not collapse
  • higher room for growth
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135
Q

What are managerial economies and how can they lead to internal growth

A
  • large companies can afford to appoint specialist managers in every field, who have greater knowledge so can do job better
  • staff represent an indivisibility and so small firms cannot employ specialist staff
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136
Q

What are marketing and purchasing economies and how can they lead to internal growth

A
  • can buy in bulk
  • can specialise
  • can distribute
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137
Q

How can buying in bulk lead to internal growth in marketing and purchasing economies

A
  • large firms able to buy in large numbers
  • may be able to buy raw materials at a cheaper price than competitors
  • lower costs
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138
Q

How can specialisation lead to internal growth in marketing and purchasing economies

A
  • businesses can afford to take on specialist buyers and sellers who could be more efficient due to the extra time and knowledge
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139
Q

How can distribution lead to internal growth in marketing and purchasing economies

A
  • large firms can enjoy preferential rates from transport companies as they offer company a lot of business
  • will transport in large batches, which is cheaper
  • can also establish regional distribution centres, allowing them to reduce costs
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140
Q

What are external economies of scale

A
  • advantage which arises from the growth of the industry within which the firm operates, independent to the firm itself
  • cause LRAC curve to shift downwards
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141
Q

What are examples of external economies

A
  • labour
  • support services
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142
Q

How can labour lead to growth in external economies

A
  • businesses established in an area with other successful firms from same industry find labour comes to that area, reduces cost and time taken to recruit
  • local education and training providers likely to develop courses to prepare people to take up jobs in these businesses
  • firms able to hire staff trained by other businesses = cheaper and more efficient
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143
Q

How can support services lead to growth in external economies

A
  • businesses who provide products/services for large businesses naturally move to area where those businesses are based
  • reduces transport cost / time delays for business
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144
Q

What can lead to diseconomies of scale

A
  • workers
  • geography
  • change
  • prices of materials
  • management
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145
Q

How can workers lead to diseconomies of scale

A
  • people can think their efforts go unnoticed so love motivation and work less hard
  • decreased productivity
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146
Q

How can geography lead to diseconomies of scale

A
  • firm may have to transport finished products huge distances and firms may find it harder to control parts of business far away
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147
Q

How can change lead to diseconomies of scale

A
  • takes much longer and is much more difficult for a large firm to respond to change
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148
Q

How can prices of materials lead to diseconomies of scale

A
  • as business grows, demand for raw materials and equipment do to
  • although this increases bargaining power, increase in demand causes prices to risk => costs
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149
Q

How can management lead to diseconomies of scale

A
  • coordination and control
  • as business grows, it becomes difficult to coordinate different parts
  • can lead to poorer quality to work and business decisions that don’t work well together
  • communication
  • can be slowed and lose accuracy because of distance and number of people it has to be passed through
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150
Q

What is profit

A
  • difference between revenue and costs
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151
Q

What are the conditions to maximise profit

A
  • TR and TC are further apart, with TR above TC
  • MC = MR
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152
Q

What is normal profit

A
  • return that is sufficient to keep the factors of production committed to the business
  • if firm covers its costs, it earns normal profit
  • AC = AR OR TC = TR
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153
Q

What is supernormal profit

A
  • when profit is greater than normal profit
  • abnormal profit
  • AR > AC OR TR>TC
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154
Q

What is a loss

A
  • when a firm fails to cover its costs
  • AR < AC OR TR < TC
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155
Q

What are the conditions for normal profit, supernormal profit, and loss

A
  • normal profit is at AC = AR or TC = TR
  • supernormal profit is at AR > AC or TR > TC
  • loss is at AR < AC or TR < TC
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156
Q

When should a firm shut down in the short run

A
  • when making a loss, shutting down is not always necessary, dependent on the average variable cost
  • if AVC < AR, firms should continue production
  • each good made generates more revenue than it costs to produce, so can make a contribution to their fixed costs
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157
Q

When should a firm shut down in the long run

A
  • if AVC > AR, producing more increases loss, so firm should shut down
  • firm needs to make at least normal profit to stay open in long run
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158
Q

Why do firms produce on the short tun

A
  • does not affect losses
  • do not want to let go of workers or let down customers
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159
Q

When does a firm make a loss, include a diagram

A
  • AC is greater than AR so firm is seen to be making a loss
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160
Q

What is efficiency

A
  • used to judge how well the market allocates resources
  • shows relationship between scarce inputs and outputs
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161
Q

What are the different types of efficiency

A
  • allocative efficiency
  • productive efficiency
  • dynamic efficiency
  • X-inefficiency
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162
Q

When is allocative efficiency achieved

A
  • resources are used to produce goods and services which consumers want and value more highly
  • social welfare is maximised
  • occur when value to society from consumption is equal to marginal cost of production
  • P = MC
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163
Q

When is productive efficiency achieved

A
  • when products are produced at lowest average cost so fewest resources used to produce each product
  • minimum resources used to produce maximum output
  • only exist if firms produce at bottom of AC curve, MC=AC in the short run
  • possible if there is technical efficiency, given output is produced with minimum inputs
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164
Q

When is dynamic efficiency achieved

A
  • resources are allocated efficiently over time
  • concerned with investment, bringing new products and production techniques
  • achieved in markets where competition encourages innovation but there are copyright/patent laws
  • supernormal profit required
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165
Q

What is X-Inefficiency

A
  • firm failing to minimise its average costs at a given level out output
  • occurs when there is a lack of competition so firms have little incentive to cut costs
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166
Q

What is perfect competition

A
  • market where there is a high degree of competition
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167
Q

What are the characteristics of perfect competition

A

MAIN
- many buyers and sellers
- freedom of entry and exit from industry
- perfect knowledge
- homogenous product
- firms aim to profit maximise
- firms are price takers

EXTRA
- no buyer or seller can influence market price/output
- no externalities
- price is set by forces of demand and supply
- each firm faces a perfectly elastic demand
- P=MR=AR
- allocativelly and productively efficient
- dynamically inefficient
- cannot earn supernormal profit in the long run

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168
Q

How does have many buyers and sellers in a market lead to perfect competition

A
  • no one firm or customer is able to influence market
  • decision of one firm to double output has no effect on rest of market
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169
Q

How does freedom of entry and exit from the industry lead to perfect competition

A
  • when a business is making profits, anyone can enter and start producing that product themselves
  • businesses are unable to make huge profits in the long run and tend to make normal profits instead
  • if making a loss, can leave easily
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170
Q

How does perfect knowledge lead to perfect competition

A
  • enables firms to know when other firms are making profits, attracting them to the market
  • all firms have same costs as they can use same production techniques
  • any attempt to raise prices above market determined level will lead to no sales, customers aware and will look at other firms
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171
Q

How does homogeneity lead to perfect competition

A
  • products are identical, cannot tell difference between one make and another
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172
Q

What are firms in perfect competition

A
  • price takers
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173
Q

What is the competition spectrum

A
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174
Q

Explain short run profit maximising for perfect competition

A
  • firms assumed to short run profit maximise, so firm produces at MC = MR
  • firms in perfect competition can only make normal profit in long run
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175
Q

Draw the short run perfect competition diagram, and explain it

A
  • prices set by market at P1 where S1=D1 => firms faces demand curve of AR1=MR1 and product at MC=MR1 at Q1
  • perfect information and easy entry with supernormal profit encouraging new firms to enter
  • this increases supply from S1 to S2, leading to fall in price from P1 to P2
  • firm now has AR2=MR2, producing at MC=MR2 at Q2
  • also AR2=AC, so normal profit being made
  • if loss being made, firms leave industry decreasing supply pushing prices up returning to normal/supernormal profit
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176
Q

What types of efficiency are and are not present in perfect competition

A
  • productively efficient as they produce at MC=AC
  • allocative efficient as they produce where P=MC
  • therefore are static efficient
  • not dynamic efficient and no firm has enough for R&D
  • perfect knowledge also prevents competitive benefits
  • competition should keep costs low, therefore prices as well
  • however, firms unable to benefit from economies of scale meaning costs are higher than they could beesa
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177
Q

What is monopolistic competition

A
  • form of imperfect competition
  • downward sloping demand curve
  • e.g. hairdressers, estate agents, and restaurants
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178
Q

What are the characteristics of monopolistic competition

A
  • many buyers and sellers
  • no/low barriers to entry and exit
  • low concentration ratio
  • non-homogenous goods
  • firms aim to profit maximise
  • market power to an extent
  • imperfect information
  • downward sloping demand curve
  • price maker
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179
Q

What type of profit do firms in monopolistic competition make in the short run and the long run

A
  • can make supernormal profits, normal profits, or losses in the short run
  • due to lack of barriers to entry/exit, firms can only make normal profit in the long run
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180
Q

Draw and explain the profit maximising equilibrium diagram for firms in monopolistic competition

A
  • firms assumed to be short run profit maximisers, producing at MC=MR1, producing at Q1 at P1, making supernormal profit
  • new firms enter market in long run due to supernormal profits, causing demand to decrease => AR and MR shift inwards
  • firms then produce at MC=MR2 at P2Q2
  • firm is now at AC=AR2, making normal profits
  • if industry making loss, firms leaves industry, increasing demand for other firms => normal profit in long run
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181
Q

What are the limitations of the profit maximising equilibrium model for monopolistic competition

A
  • information may be imperfect so firms may not enter market as predicted due to being unaware of supernormal profits
  • firms may also be of differing size, with different cost structure allowing them to maintain supernormal profits
182
Q

What types of efficiency are and are not present in monopolistic competition

A
  • only make normal profit in LR, AC=AR, and as they profit maximise, MR=MC, so allocatively inefficient
  • MR ≠ AR so AC ≠ MC or MR, so productively inefficient
  • dynamically efficient due to differentiated profits
183
Q

What is an oligopoly

A
  • small number of firms, none of which can keep the others from having significant influence
184
Q

What are the characteristics of an oligopoly

A
  • goods can be both homogenous or differentiated
  • profit maximisers
  • firms are interdependent
  • market power
  • high barriers to entry and exit
  • indeterminate demand
  • firms can collude
  • allocatively and productively inefficient
185
Q

What is the kinked demand theory

A
  • if firm raises price in oligopoly, others do not follow
  • they have lower prices so are more competitive
  • if firm lowers prices, others must follow to remain competitive
  • issue with theory is that it assumes there is an initial price set within the market but does not explain why this price was set
186
Q

Draw and explain the kinked demand theory diagram in oligopolies

A
  • assume price set at P1
  • above P1 curve is elastic (competitors offer lower prices)
  • below P1 curve is inelastic (firms also lower prices)
  • result is a kink in demand, meaning no gap in MR so rise/fall in costs/demand is unlikely to impact price or output
  • prices thus tend to be stable
187
Q

What are N-firm concentration ratios

A
  • concentration of supply in the industry, which measures percentage of total market that a particular number of firms has
188
Q

How can you calculate the N-concentration ration

A
  • (total size of formula / total size of market) x 100
189
Q

What is collusion

A
  • when firms make collective agreements that reduce competition
  • when firms don’t collude, it is a competitive oligopoly
190
Q

Why does collusion occur

A
  • if firms compete, lowering prices will cause others to lower prices
  • when working together, they can maximise industry profits
  • reduces uncertainty
  • firms may decide to be a non-collusive oligopoly since collusion is illegal
  • firm with strong business model will not want to collude as they feel they can increase market share
191
Q

When does collusion occur best

A
  • few firms that are all well known to each other
  • firms not secretive about costs and production methods, and costs and production are similar
  • producing similar products
  • one dominant firm which others are happy to follow
  • market is relatively stable
  • high barriers to entry
192
Q

What are the types of collusion

A
  • overt when firms come to a formal agreement
  • tacit when there is no formal agreement
193
Q

What are methods of collusion

A
  • price fixing
  • synchronising advertising
  • insider information
194
Q

How does price fixing cause collusion

A
  • prices may be forcibly lowered to drive out smaller competitors
  • prices may be inflated to a level to support group colluding
  • can eliminate competition while also leading to even higher barriers for new entrants
195
Q

How does synchronising advertising cause collusion

A
  • partnering businesses may limit consumers’ knowledge about a product or service for an added advantage
196
Q

How does insider information cause collusion

A
  • colluding groups can gain advantages from sharing of private or preliminary information with one another
  • can allow parties to enter and exit trades before the shared information is publicly available
  • predominant in financial industry
197
Q

What is a collusive agreement

A
  • called a cartel
  • group of firms who enter into agreement to mutually collude
  • rules laid out in a formal document which may be legally enforced and fines be charged for firms who break these rules
198
Q

How do cartels operate

A
  • agree on price for good and compete freely using non-price competition to maximise market share, or agree to divide market according to present market share of each business
199
Q

What is the problem with cartels

A
  • no firm is likely to set prices/output at level they would not ideally choose
  • constant temptation to break cartel
  • more successful the cartel, greater incentive to break it
  • important for firms to be the first to break and not be the firm who is left to deal with after effects
  • since collusion is illegal, firms may be involved in tacit collusion such as price leadership and barometric firm
200
Q

What is price leadership in a collusive oligopoly

A
  • one firm has advantages due to size or costs and becomes dominant firm
  • other firms follow as they are fearful of taking on the firm in a price war
  • as a result, dominant firm decides price and allows other firms to supply as much as they want at this price
201
Q

What is barometric firm price leadership in a collusive oligopoly

A
  • firm develops a reputation for being good at predicting next move in industry
  • other firms decide to follow their leader
202
Q

What is a non-collusive oligopoly

A
  • behaviour of a firm depends on how it thinks other firms will react to its policies
  • game theory can be used to examine best strategy a firm can adopt for each assumption about its rivals
203
Q

What are factors that deter collusion

A
  • antitrust laws
  • supervision in industries
  • defection
204
Q

What is an example of a cartel

A
  • Organisation of Petroleum Exporting Countries (OPEC)
  • made up of 13 oil producing countries
  • acts as a monopoly by restricting output and raising prices
  • lead by Saudi Arabia as price leadership
205
Q

What is game theory

A
  • explores reaction of one player to changes in strategy by another player
  • aim is to examine best strategy a firm can adopt for each assumption about rival’s behaviour
  • provides insight into interdependent decision making that occurs in competitive markets
206
Q

How does game theory work

A
  • two strategies firm could take, maximin policy or maximax
  • maximin involves working out the strategy where worst possible outcome is the least bad
  • maximax policy involves working out best outcome
  • if maximin and maximax don’t have same solution, this is the called the dominant strategy
  • dominant strategies aren’t common and best strategy tends to depends on what the other firm does
  • some cases have a Nash Equilibrium
207
Q

What is a Nash Equilibrium

A
  • neither player is able to improve their position and has optimised their outcome based on the other plays expected decisions
  • no incentive to change behaviour, unless someone changes theirs
208
Q

What is the prisoner’s dilemma

A
  • two people questioned over involvement in crime and are kept apart to not communicate
  • dominant strategy is to confess, with best reward
  • if prisoners could collude, or had confidence in each other, best option is to deny crime
209
Q

What are the types of price competition

A
  • price wars
  • predatory pricing
  • limit pricing
  • cost plus pricing
  • psychological pricing
  • market-led pricing
  • price skimming
  • penetration pricing
210
Q

What are price wars

A
  • occur in markets were non-price competition is weak, goods have weak brans and consumers are price conscious
  • also occur in markets where it is difficult to collude
  • drives prices down to levels where firms are making losses
  • in short run, firms continue to produce if AVC is below AR but in long run they leave
  • firms will have to leave and prices will rise since supply falls
  • lowers industry profits
211
Q

What’s an example of where price wars occur

A
  • supermarkets
  • firms desperately trying to offer lower prices than rivals
212
Q

What is predatory pricing

A
  • occurs when established firm is threatened by new entrant, or if one firm feels another is gaining too much market share
  • established firm sets low price so others cannot make a profit, driving them out of the market
  • existing firm then puts price back up
  • illegal and only works when one firm is large enough to be able to have low prices and sustain losses
213
Q

What is limit pricing

A
  • firms set low prices (limit price) to prevent new entrants
  • price is high enough to make normal profit but low to discourage other firms entering market
  • greater the barriers to entry, higher the limit price
  • mainly used in contestable markets
  • drawback is firms cannot make profits as high as they would be able to
214
Q

What is cost plus pricing

A
  • firms work out their AC and add a percentage increase, determining level of profit
  • size of this increase depends on level of competition and barriers to entry
  • problem is that it does not consider market
215
Q

What is psychological pricing

A
  • firms use non rounded numbers to give impression price is cheaper than it is
  • aim is for consumers to feel they can afford good and be encouraged to buy it
216
Q

What is market-led pricing

A
  • firms set prices simply by looking at prices charged by competition
  • price their good close to other firms
  • if price is higher than people would not buy it
  • if price is lower than they lose profit
  • no consideration of costs
217
Q

What is price skimming

A
  • when product initially launched, firms set high prices to cover research and development costs and keep demand at management levels
  • once no longer new, price is lowered
  • mainly used by technology firms
218
Q

What is penetration pricing

A
  • when product first introduced, firm sets prices low to encourage people to use it for first time
  • hopefully people like product and continue to buy even at higher prices
219
Q

What are the types of non-price competition

A
  • advertising
  • loyalty cards
  • branding
  • quality
  • customer service
  • product development
220
Q

How is advertising a form of non-price competition

A
  • creates awareness of company/product
  • can persuade customer to purchase profit
  • if successful, increases sales and market share for a business, which increases profits in long run
  • can also make demand for a product/service more inelastic
221
Q

How are loyalty cards a form of non-price competition

A
  • encourage repeat purchases by rewarding customers for loyalty
  • also provide firms with lots of data on consumers’ buying habits, which firm can use to increase sales
222
Q

How is branding a form of non-price competition

A
  • successful brand help increase loyalty and repeat purchases for a business
  • people trust band and quality represented, so will be likely to continue buying
  • established brands find it easier to release new products
223
Q

How is quality a form of non-price competition

A
  • firm known for good quality can charge higher prices and is likely to have strong brand loyalty
  • have a good reputation and benefit from positive recommendations
224
Q

How is customer service a form of non-price competition

A
  • encourage loyalty amongst customers and give business a more positive reputation
225
Q

How is product development a form of non-price competition

A
  • business that invests in product development will have a competitive advantage over rivals
  • if they are first to release a new produce, they would see an increase in sales, likely to help with branding
226
Q

What are problems with non-price competition methods

A
  • often expensive, firms will need money before they undertake competitor
  • only large firms can do large scale advertising, research and development
  • no guarantee that it will be successful
227
Q

What types of efficiency are and are not present in oligopolistic competition

A
  • statistically inefficient tas they are not productively or allocative efficient
  • dynamically efficient, making supernormal profits so have funds and incentives to invest
  • able to exploit economies of scale, lowering costs
228
Q

What are the incentives in an oligopoly

A
  • incentive to collude
  • incentive to compete
229
Q

What is the incentive to collude

A
  • limit competition
  • reduce uncertainties
  • maximise profits
230
Q

What is the incentive to compete

A
  • capture portion of its rivals’ market shares and profits
231
Q

What is strategic behaviour

A
  • based on plans of action taking into account rivals’ possible action
  • strategic behaviour of oligopolistic firms is results of their mutual interdependence
  • firms planning strategies make efforts to guess actions and reactions of rivals to formulate their own strategy
232
Q

What factors make it difficult for cartels to be established and maintained

A
  • incentive to cheat
  • cost differences between firms
  • number of firms
  • possibility of a price war
  • recessions
  • potential entry into industry
  • industry lacking dominant firm
233
Q

How does the incentive to cheat make it difficult for cartels to be formed

A
  • every firm faces incentive to cheat by offering lower prices for more buyers
  • can result in higher market share and profits
  • leads to collapse of cartel
234
Q

How do cost difference between firms make it difficult for cartels to be formed

A
  • each firm faces different costs and cost curves
  • price is mutual to all firms
  • firms with higher AC have lower profits
  • leads to difficulties in coming to agreeing on common price
235
Q

How does the number of firms in a market make it difficult for cartels to form

A
  • more firms, more difficult to reach an agreement
  • more numbers of differing views
  • harder to reach compromises
236
Q

How does the possibility of a price war lead to difficulties in cartels forming

A
  • price war would make all firms of an industry collectively worse off due to lower prices and lower profits
237
Q

How do recessions make it difficult for cartels to form

A
  • sales fall and profits are reduced
  • firms have stronger incentive to lower prices and cheat on agreement
238
Q

How does potential entry into the industry make it difficult for cartels to form

A
  • if successful, cartel makes large economic profits, encouraging entry of new firms into industry
  • if there are no entrants, industry supply increases, driving down price and curing into cartel’s profits
  • cartel’s long run survival depends on high barriers to entry, blocking new entrants
239
Q

How does the lack of a dominant firm make it difficult for a cartel to form

A
  • presence of dominant firm facilitates reaching agreement, as this firm can assume leadership in negotiations
  • lack of dominant firm makes agreement among cartel members more difficult to reach
240
Q

What is a duopoly

A
  • where two companies own all/nearly all of the market for a given product or service
  • can have same impact on market as a monopoly if both collude on prices or output
241
Q

What is a monopoly

A
  • market structure where a singular seller or producer assumes a dominant position in an industry
  • discourages in free market economies, as they stifle competition and limit substitutes for consumers
242
Q

What are the characteristics of a monopoly

A
  • only one firm exists in the market
  • demand curve is downward sloping
  • no close substitutes for goods
  • very high barriers to entry
  • price markers
  • can price discriminate
  • allocative and productively inefficient
243
Q

Draw and explain the profit maximising equilibrium in a monopoly

A
  • downward sloping demand curve, since people can still choose whether to buy good or not
  • profit maximising is at MC-MR
  • produce at Q1 at P1, and make supernormal profits
  • firm is able to earn supernormal profits or loss in long run since there is no freedom of entry and exit to market
244
Q

What is price discrimination

A
  • competitive pricing strategy
  • involves use of different prices charged to various customers for same product/service
  • company can enhance profits by charging each customer maximum they are willing to pay, eliminating consumer surprises
245
Q

What are the types of price discrimination

A
  • first degree
  • second degree
  • third degree (need to know)
246
Q

What is first degree price discrimination

A
  • personalised pricing / perfect price discrimination
  • businesses accurately determine what each customer will pay for a specific product/service
  • expectation to negotiate
  • e.g. eBay and the auto industry
247
Q

What is second degree price discrimination

A
  • ability to gather information on every buyer is not possible
  • companies price products based on preferences of groups
  • does not eliminate consumer surprise but allows company to increase profit margin
  • can be done through quantity discounts, buy 2 get 1 free, coupons, and loyalty rewards
  • e.g. warehouse retailers such as Costco
248
Q

What is third degree price discrimination

A
  • companies price products and services based on unique demographic of customer base
  • consumer groups that may not be willing to purchased a product due to lower income can be captured by this strategy
  • companies understand characteristics of consumers more easily than preferences of individuals
  • reduces consumer surprises by catering to price elasticity of demand
  • companies need to ensure customers don’t sell cheaper products and services to others
  • common in travel, tourism, and entertainment
249
Q

What are the characteristics of price discrimination

A
  • market power
  • information
  • ability to resell
250
Q

How does market power affect price discrimination

A
  • price discrimination not possible in perfectly competitive market, where no seller has power to charge other than going market price
  • can only take place where firms have some ability to vary price
251
Q

How does information affect price discrimination

A
  • firm needs to be able to identify different groups of consumers with different willingness to pay
  • price discrimination is profitable because different consumers display different sensitivities to price, they have different price elasticities of demand
252
Q

How does ability to resell affect price discrimination

A
  • price discrimination not possible if consumers could resell product
253
Q

Draw and explain the third degree price discrimination diagram

A
  • firm produces where MC=MR in each market, making supernormal profit in each
  • in inelastic market, they produce at Q1P1
  • in elastic market, they produce at Q2P2
  • in combined market, they produce at Q3P3
  • shows two separate markets in price discrimination, rather than combined market, allowing for higher profits
254
Q

What are the costs and benefits from third degree price discrimination

A
  • firms can increase profits, which can be reinvested into research and development, improving dynamic efficiency
  • those in elastic market gain as they are able to pay a lower price, benefiting from cross subsidisation, allowing for an increase in equality by buying goods they could not previously access
  • consumers lose some consumer surplus to producers and some pay higher price
255
Q

What is a natural monopoly

A
  • economies of scale are so large that even a single producer is not able to fully exploit all of them
  • decreasing cost industries
  • e.g. National Grid, Royal Mail, and National Rail
256
Q

Draw and explain a natural monopoly diagram

A
  • AC and MC continue to fall
  • firm will profit maximise
  • produces where MC=MR at Q1P1
  • makes supernormal profit
257
Q

What are key factors for natural monopolies

A
  • pointless to encourage competition, as it raises AC for industry
  • new firms entering market will be priced out due to high costs, raising question for competition policy and nationalisation
  • tend to be found in industries with very high fixed costs, e.g. railways
  • need to invest bullions in track, tunnels, bridges, and stations, whilst running extra trains shows small increase in costs, meaning AC decreases drastically
  • allocative and productively inefficient as there is no minimum on AC curve and at allocative efficiency loss is made
258
Q

What are the costs and benefits of monopolies for firms

A
  • potential to make huge profits for shareholders through profit maximisation
  • existence of supernormal profit allows for investments and building reserves to overcome short term difficulties
  • firms able to compete against large overseas organisations
  • firms able to maximise economies of scale, reducing costs furthering increasing profit
  • firms may not choose to profit maximise due to X-inefficiencies, sales or revenue maximising, profit satisficing, or contesability, leading to limit pricing. Firms become complacent in long run from lack of competition
259
Q

What are the costs and benefits of monopolies for employees

A
  • monopolists produce at lower outputs so will employ fewer workers
  • inefficiency of monopoly may mean employees receive higher wages
260
Q

What are the costs and benefits of monopolies for suppliers

A
  • impact depends on extent the monopolist is also a monopsonist
  • if monopolist buys all/most of suppliers’ goods, reduces suppliers’ profits as monopolist will decrease prices
261
Q

What are the costs and benefits of monopolies for consumers

A
  • more efficient, customers enjoy higher consumer surplus
  • increased range of goods due to cross subsidisation
  • survival of product from price discrimination, benefitting some customers
  • consumers may pay higher prices for poorer quality due to lack of competition
  • less choice as there is only one firm
262
Q

What types of efficiency are and are not present in monopolies

A
  • productively inefficient as they do not produce at MC=AC
  • allocative inefficiency since P>MC
  • dynamically efficient as they make supernormal profit, but lack of competition leads to lack of incentives to invest
263
Q

Draw and explain movements on the Williamson Trade Off diagram

A
  • shows effects of a monopolist compared to perfect competition
    0 assumed that industry is a constant constant industry, where AC=MC
  • if market perfectly competitive, it produces where P=AR=MC at Q1P1
    If industry was a monopoly, it produces where MR=MC at Q2P2
264
Q

Draw and explain the theory behind the Williamson Trade Off diagram

A
  • shift from perfect competition to monopoly => less production => less resources => deadweight loss BCD
  • fall in consumer surplus from ADP1 to ABP2
  • P2BCP1 turned into producer surplus
  • MC=AC may rise => further fall in consumer surplus
  • large monopolist could enjoy large EoS => AC falls + consumer surplus growing to larger than in perfect competition
  • avoid undesirable duplication of services, preventing misallocation of resources
  • Cross subsidisation may waste resources
265
Q

What types of efficiency are and are not present in the Williamson Trade Off diagram

A
  • X-inefficient, lack of competition
  • productively efficient, low costs through investment into new production techniques from retained profits
  • allocative efficient, new products in market
  • dynamically efficient
266
Q

What are the similarities between perfect competition (PC) and monopolistic competition (MC)

A
  • both have large numbers of small firms
  • competition exists in both markets
  • firms do not earn supernormal profit in long run
  • both profit maximise
  • firms can earn supernormal profit/losses in short run
  • demand is elastic
267
Q

What are the differences between perfect competition (PC) and monopolistic competition (MC)

A
  • homogenous/identical products in PC but slightly differentiated in MC
  • price takers in PC but price makers in MC
  • perfect substitutes in PC but close substitutes in MC
  • PC is allocative and productively efficient but MC are inefficient
  • perfect knowledge in PC but imperfect knowledge in MC
268
Q

What are the similarities between perfect competition (PC) and oligopolies (O)

A
  • competition in both markets
  • both profit maximisers
269
Q

What are the differences between perfect competition (PC) and oligopolies (O)

A
  • homogenous in PC but slightly differentiated in O
  • no barriers to entry in PC but higher barriers in O
  • PC is price taker, O is price maker
  • collusion possible in O but not in PC
  • uniform prices in PC but price rigidity in O
  • perfect knowledge in PC, imperfect knowledge in O
  • no selling costs in PC but present in O (advertising)
  • PC firms are independent but O firms are interdependent
  • demand curve in PC is perfectly elastic but indeterminate in O
  • productively and allocatively efficient in PC but inefficient in O
270
Q

What are the similarities between perfect competition (PC) and monopolies (M)

A
  • both profit maximise
  • both suffer economies loss
271
Q

What are the differences between perfect competition (PC) and monopolies (M)

A
  • price in PC = MR but not in M
  • allocative and productively efficient in PC but inefficient in M
  • abnormal profit in M in long run but not in PC
  • M are price makers but PC are price takers
  • high barriers to entry in M but none in PC
  • demand curve for M is downward sloping but horizontal line for PC
272
Q

What are the similarities between monopolistic competition (MC) and oligopolies (O)

A
  • allocatively and productively inefficient
  • imperfect knowledge
  • price makers
  • multiple firms in market
  • unlikely to price discriminate
273
Q

What are the differences between monopolistic competition (MC) and oligopolies (O)

A
  • slightly differentiated goods in MC but perfectly differentiated or homogenous in O
  • low barriers in MC but high in O
  • few firms big in O but many small firms in MC
  • demand curve for MC is downward sloping but non determinable for O
  • excess capacity in MC but less likely in O
  • price competition not common in MC but common in O
  • collusion common in O but uncommon in MC
274
Q

What are the similarities between monopolistic competition (MC) and monopolies (M)

A
  • profit maximisers
  • downward sloping demand curve
  • MR curve lower than demand curve
  • excess capacity present
  • price makers
  • allocatively and productively inefficient
275
Q

What are the differences between monopolistic competition (MC) and monopolies (M)

A
  • high barriers in M but low in MC
  • M can make supernormal profit in long run, MC only makes normal profit
  • no competition in M but high levels in MC
  • close substitutes in MC but not in M
  • price discrimination possible in M but not in MC
  • product differentiation and non price competition common in MC but absent in M
  • M has high levels of market power
  • M can influence supply of goods in market
276
Q

What are the similarities between oligopolies (O) and monopolies (M)

A
  • price markers
  • high barriers to entry
  • imperfect knowledge
  • price greater than MR
  • influence market output
  • profit maximisers
  • allocatively and productively inefficient
277
Q

What are the differences between oligopolies (O) and monopolies (M)

A
  • one supplier in M but multiple in O
  • no close substitutes in M but goods in O can be homogenous or differentiated
  • M can price discriminate, O cannot
  • price decisions interdependent on O but prices set in M with no regard for competitors
  • collusion possible in O but not M
  • single price in M but price rigidity in O
278
Q

What is a monopsony

A
  • only one buyer in the market
  • same characteristics as a monopoly
  • prevents new firms entering market
  • aims to profit maximise
  • barely exist but many firms experience monopsony power, they they buy large percentage of market
  • pay suppliers lowest price possible to lower costs through being the only buyer, allowing them to maximise profits
279
Q

Draw and explain the monopsony diagram

A
  • produce where MC=AR => MC=D
  • MC curve is above supply curve, since it costs more to pay for last good than average cost of all goods
  • if market competitive, then they produce where S=D at Q2P2
  • in monopsony, firm produces at MC=AR at Q2P2
280
Q

What are the costs and benefits of monopsonies to firms

A
  • monopsony gains higher profits by purchasing at lower prices => investments
  • purchasing economies of scale => lower costs and increase profits
281
Q

What are the costs and benefits of monopsonies to consumers

A
  • customer can gain from lower prices being passed on from lower costs
  • fall in supply, business buys less inputs
  • counter-weight to monopolists
  • fall in quality as prices fall
282
Q

What are the costs and benefits of monopsonies to employees

A
  • suppler sells less goods and so employ less people, while monopsonist may employer less/more/same amount since they have less inputs for production but costs are lower
  • monopsonist may pay higher wages as a result of higher profits
283
Q

What are the costs and benefits of monopsonies to suppliers

A
  • lose out as they receive lower prices
  • less supplied leading to some firms leaving marker
284
Q

What is contestability

A
  • model concerned with possibility of firms entering market if opportunity to make money is seen
  • high threat of new entrants, keeping firms producing at competitive level
285
Q

What are the characteristics of a contestable market

A
  • perfect knowledge
  • freedom of entry/exit => relative absence of sunk costs
  • low product loyalty
  • short run profit maximisers, producing at MC=MR
  • number of firms can vary from one in control, many in control and none in control
  • firms compete and do not collude to fix prices
  • can be homogenous or branded goods
286
Q

What types of profit are made in contestable markets

A
  • supernormal profits can be made in short run
  • normal profits can be made in long run
  • if firms in market were making supernormal profit, other firms would join market
  • supply would increase, driving prices down so only normal profit/losses are made
  • when firms start making losses, they leave market, decreasing supply, allowing for prices to rise
287
Q

What type of efficiency is present in contestable markets

A
  • productively and allocative efficient
  • if firms do not produce at lowest point on AC curve then new firms can enter market and undercut them by offering lower prices (productively inefficient)
  • as they only make normal profits at AC=AR, and produce at lowest point at AC=MC => AC=MR=AR so value on society is equal to cost
288
Q

What are the type of barriers to entry and exit from a market

A
  • innocent entry barriers
  • legal barriers
  • marketing barriers
  • pricing decisions of incumbent firms
  • capital start up costs
  • economies of scale
  • barriers to exit
289
Q

What are innocent entry barriers and how do these stop new firms from entering the market

A
  • natural barriers
  • can include monopolies and high entry/sunk costs
290
Q

What are legal barriers and how do these stop new firms from entering the market

A
  • prevent new firms from entering an industry
  • laws put in place making it more difficult for firms to enter marker
  • can sometimes prevent firms entering at all
  • can include patents and exclusive rights to production (television)
  • some industries, such as taxi industry, gain market licenses to operate
291
Q

What are marketing barriers and how do these stop new firms from entering the market

A
  • high levels of advertising having built up consumer loyalty => inelastic demand
  • brand can sometimes be associated with product, e.g. ‘Hoover’ with vacuum cleaners
  • new firms entering market unlikely to have funds to undertake large scale advertising, so struggle to compete with incumbent firms
292
Q

How do pricing decisions of incumbent firms act as barriers to entry into a market

A
  • predatory pricing means prices are so low that they can be driven out of market
  • makes it extremely difficult for firms to enter
  • limit pricing discounters entry of other firms as prices are set at a level preventing entrants
  • some firms may employ anti-competitive practises, such as refusing to supply retailers which stock competitors
293
Q

How do capital start up costs act as barriers to entry into a market

A
  • high costs to begin production
  • most firms may not have funding
  • sunk costs may also be high
294
Q

How do economies of scale act as barriers to entry into a market

A
  • firms unable to produce on same AC curve as large, incumbent firms
  • if they were to enter industry, their costs would be higher, so prices are higher and they are unable to compete
295
Q

What are barriers to exit

A
  • prevent firm from leaving a market quickly and cheaply
  • include cost to write off assets, pay leases, and making workers redundant
296
Q

What are sunk costs

A
  • fixed costs that a business cannot recover if it leave the industry
  • includes property (if lease is longer than it is actually used for), machinery and equipment that cannot be resold, and advertising
  • all businesses face sunk costs, even if things are resolved, it is generally for a lower price
297
Q

What is hit and run competition

A
  • firms can enter a market at low cost attracted by high profits then leave the market at low cost when profits fall
298
Q

What is degree of contesability

A
  • refers to ease which new firms can enter and exit a market
  • measured by extent to which the gains from market entry for a firm exceed the costs of entering the market
  • market with no sunk costs and no barriers to entry/exit is a perfectly contestable market
  • the more contestable a market, the more unstable it is as there can be regular hit and run competition
  • no market is likely to be perfectly contestable, always likely to be some sunk costs
299
Q

What are the reasons for increased contestability

A
  • recession meant entrepreneurs do not accept existing market structure is fixed
  • deregulation of markets allowed reduction of some barriers to entry
  • competition policy meant firms can not use predatory pricing and cartels so markets are more contestable
  • globalisation has increased contestability since foreign firms can enter domestic markets
  • changes in technology has reduced entry costs as capital is more mobile
300
Q

What does the demand curve for labour show

A
  • quantity of labour that employers would wish to hire at each possible wage rate
301
Q

How is the demand for labour determined

A
  • marginal revenue product (MRP)
  • extra revenue generated by an individual worker
  • higher MRP, higher demand for workers
  • law of diminishing marginal productivity means increasing number of workers, whilst other factors are fixed, is likely to increase MRP at first then decline
  • demand for labour assumed to be downward sloping
302
Q

Why is demand for labour assumed to be downward sloping

A
  • in long run, all factors of production vary, so high wage rates encourage businesses to use machinery instead of workers
  • in short run, firms have fixed levels of capital, so diminishing marginal productivity means adding extra workers gives lower return so to employ workers, wage rate has fallen
303
Q

How do you calculate the marginal revenue product (MRP)

A
  • marginal output x price OR difference in total revenue
304
Q

How is demand derived for labour

A
  • firms hire workers in order to produce goods to meet aims (profit)
  • demand for labour is derived demand as it is derived from demand for the product the labour produces
  • businesses only want the worker for as long as people are willing and able to buy the product they produce
305
Q

What are factors that influence demand for labour

A
  • wage rates
  • demand for the product
  • prices of other factors of production
  • wages in other countries
  • technology
  • regulation
  • state of economy
306
Q

How do wage rates influence the demand for labour

A
  • wage is price of labour so has same influence on demand for labour as price on demand for a product
  • as wage rates increase, demand for labour contracts
  • MRP of labour must be higher for it to be worthwhile employing more people
  • less people employed
307
Q

How does demand for the product influence demand for labour

A
  • labour is a derived demand
  • if there is no demand for product, there is no demand for labour
  • firms won’t employ people if the good will not make a profit
  • increase in demand for product leads to increase in demand for labour
  • linked to concept of MRP, increase in output/price of good increases demand for labour
308
Q

How do prices of other factors of production influence demand for labour

A
  • if machinery and equipment becomes cheap, people will switch machinery for labour and therefore demand for labour falls
309
Q

How do wages in other countries influence demand for labour

A
  • if wages are lower in other countries but high in the UK, people will be employed in other countries as it is a lower cost for businesses
  • means demand in the UK is low
310
Q

How does technology influence the demand for labour

A
  • improvements in computers and technology means many jobs have been lost with work being done by machines
  • means there is less demand for labour, but demand for labour in technological based industries is increasing
311
Q

How do regulations influence the demand for labour

A
  • as laws are passed, some jobs disappear while others are made
  • high regulations within labour market is likely to discourage firms from hiring since it can be expensive, so demand reduces
312
Q

How does the state of the economy influence demand for labour

A
  • state affects demand for product
  • when economy is in a poor state, there is low demand for product
  • state also affects expectations for future and business confidence
  • when business confidence low, workers are laid off
313
Q

What price elasticity of demand for labour

A
  • responsive of the quantity of labour to the wage rate
314
Q

What influences the PED of labour

A
  • PED of product
  • proportion of wages to TC of production
  • substitutes
  • time
315
Q

How does the PED of the product affect the PED of labour

A
  • if good is elastic, rise in wages and hence rise in prices for consumers, will have large impact on quantity sold
  • business then reduces number of people employed, in order to make a profit
  • if good is inelastic, rise in wages and hence rise in price for consumers, will have minimal impact on quantity sold
316
Q

How does the proportion of wages to TC of production affect the PED of labour

A
  • if wages are a huge proportion of costs, increase in wages increases costs massively
  • results in a large fall in demand for labour
  • elastic
317
Q

How do substitutes affect the PED of labour

A
  • many substitutes (machinery and labour in other countries), demand is elastic
  • high skilled jobs tend to be more inelastic than slow skilled jobs as labour cannot be easily replaced
318
Q

How does time affect the PED of labour

A
  • in long run, demand is more elastic as machinery can be developed and jobs can be moved
  • in short run, firms have to employ workers and redundancy payments can be expensive so in more inelastic
319
Q

What does the supply of labour curve show

A
  • ability and willingness of people to make themselves available to work at different wage rates
320
Q

What affects the supply of labour

A
  • wages
  • population and distribution of age
  • non-monetary benefits
  • education, training, qualification
  • trade unions and barriers to entry
  • wages and conditions of other jobs
  • legislation
321
Q

How do wages affect the supply of labour

A
  • supply of labour curve for an individual is backward bending, increase in wages leads to increase in hours worker first but after it decreases in hours worked
  • supply curve for a industry labour is upward sloping
  • firms can increase number of hours worked by in existing labour force or recruiting new workers
  • although increase in wage rates may not increase hours worked by existing labour, it will increase number of workers
322
Q

Draw and explain the supply of labour curve for an individual

A
  • when wages are low, individual increases hours to increase income
  • when income is high, individual reduces hours of work to increase leisure time
323
Q

Draw and explain the supply of labour curve for an industry

A
  • people willingly work more hours when wages are higher
324
Q

How does the population and distribution of age affect the supply of labour

A
  • high population means there is large supply of labour
  • distribution of age ensures there is lots of labour, even from people of high working age
  • migration also affects size of workforce and high migration of working age come to the UK to work
325
Q

How do non-monetary benefits affect the supply of labour

A
  • supply of labour increases if there is high job satisfaction
  • some jobs are attractive as they are close or in a social area and require little commuting
  • some jobs offer perks such as free healthcare
  • factors such as holiday, hours of work, flexibility, and opportunity for promotions also influence supply
326
Q

How does education/training/qualifications affect the supply of labour

A
  • more educated workers means higher supply of workers
  • important for industries where certain qualifications are necessary
  • occupations requiring high levels of education may suffer from lower supply of labour compared to low skilled jobs
327
Q

How do trade unions and barriers to entry affect supply of labour

A
  • trade unions able to restrict supply of labour by introducing barriers to entry
  • for example, degree required for teaching
328
Q

How do wages and conditions of other jobs affect supply of labour

A
  • if many jobs in local area are considered to be unpleasant and offer low wages, supply for alternatives will be higher
329
Q

How does legislation affect the supply of labour

A
  • government rules can affect supply
  • e.g. school leaving age and retirement age
330
Q

How is market failure present in the labour market

A
  • labour immobility
331
Q

What is labour immobility

A
  • barriers preventing mobility of labour
  • workers being unable to move from job to job, despite high amounts of unemployment
332
Q

What are the types of labour immobility

A
  • occupational immobility
  • geographical immobility
333
Q

What can labour immobility lead to

A
  • excess supply of labour in one area/occupation but excess demand in another
  • even if wages are higher where there is excess demand, people are unable to leave where there is excess supply to get a job in that area/occupation due to immobility
334
Q

What is occupational immobility of labour

A
  • workers find it difficulty to move from one job to another
  • due to a lack of transferable skills
  • difficult in short term when workers need to get new training
  • possible in long run at high costs
335
Q

What is geographical immobility of labour

A
  • workers find it difficult to move from one place to another due to cost of movement, family, etc.
  • workers may also not know about vacancies in other areas and would not be able to attend interviews
  • also related to issue of housing as people possibly do not have funds to purchase new housing
  • those on lower incomes are more geographically immobile
336
Q

Does the UK suffer from immobility of labour? How?

A
  • severe skills shortage which could cost £90bn a year following Brexit
  • four million too few high skilled people but six million too many low skilled people
  • engineering suffering particularly badly from skills shortages
337
Q

What is elasticity of supply of labour

A
  • responsiveness of supply of labour to a change in wage rates
338
Q

What can affect the elasticity of supply of labour

A
  • level of qualifications and training
  • availability of suitable labour in other industries
  • time
  • level of unemployment
339
Q

How does the level of qualifications and training affect the elasticity of supply of labour

A
  • if there are high levels of qualifications necessary for job, people will not be able to easily take up job so supply of labour is inelastic
  • if not much training/qualifications necessary then supply is elastic
340
Q

How does the availability of suitable labour in other industries affect the elasticity of supply of labour

A
  • if a company can poach workers from other industries then it is seen to be elastic
341
Q

How does time affect the elasticity of supply of labour

A
  • long run supply of labour is elastic as people have time to train
  • if job is vocational, it is inelastic since even if wages fall, people will not leave job
342
Q

How does the level of unemployment affect the elasticity of supply of labour

A
  • high levels of unemployment makes supply more elastic
  • firm can increase number of people it employs without having to raise wage rates significantly
343
Q

How can government intervention affect the supply of labour

A
  • high tax rates and high welfare benefits reduce incentives to work meaning there is lower supply
  • this affects whole workforce, and so therefore will have an impact on individual occupations
344
Q

What are factors that can affect wage rates

A
  • age
  • education
  • training
  • work experience
  • skill/talent/ability to perform tasks
  • sex
  • ethnic background
  • sex and ethnic background are illegal to affect wage but still is an issue
345
Q

High do wage rates differ

A
  • highest paid workers have low supply and high MRP
  • immobility of labour means there may be excess supply in one area/occupation, causing low wages, and not enough in others, meaning high wages
  • low elasticity means minimal change in employment, regardless of change in wage rates
  • effect also dependent on size of shift
346
Q

How are wages set in perfect competition

A
  • wages determined by demand and supply
  • all workers paid the same
  • if worker not paid the same then they would move somewhere else where rate was higher
  • would reduce supply and increase wages in first area while increasing supply and reducing wages in second
347
Q

How are wages set in a monopsony

A
  • only one buyer of labour
  • businesses know to increase labour they need to increase wage
  • increase of wage for one is an increase for all
  • MC curve is above AC of labour as it costs more to employ additional worker than AC of labour
  • firm will determine how many workers to employ where cost of employing is equal to value of worker
348
Q

Draw and explain the diagram showing how wages are set in a monopsony

A
  • employed at MC=D at Q1 and W1
  • compared to a perfectly competitive market (W2Q2), they employ less people at a lower wage rate
349
Q

How are wages set in a monopoly

A
  • existence of trade unions means they operate as only seller of labour
  • can set barriers of entry which reduce supply
  • could set wages at a specific wage and ensure workers are not prepared to work for less, creating kinked supply
  • both lead to higher wages but cause a fall in employment from the perfectly competitive equilibrium of Q1W1
350
Q

Draw and explain the diagram showing how wages are set in a monopoly

A
  • supply is perfectly elastic till QS
  • if company wants to hire more, they need to increase wages
  • firm employs where S = D at QDW2
351
Q

What is a bilateral monopoly

A
  • when there is a monopoly and monopsony in a labour market
352
Q

How are wages set in a bilateral monopoly

A
  • firm is monopsonist, wanting to employ at Q2W2
  • union still sets minimum wage at W1, causing kicked supply
  • wage set depends on relative bargaining strength of both
353
Q

What can affecting bargaining power in a bilateral monopoly

A
  • times of economic recession and unemployment may reduce bargaining power of unions and wage is set at W1
  • times of full employment, unions have high levels of power so wages set at W3
  • unions can have a positive impact on wages and number of people they employ
  • able to increase wages to W3 without impacting number of workers
354
Q

What are the possible issues in the labour market

A
  • skills shortage
  • young workers
  • retirement
  • wage inequality
  • zero hour contracts
  • the ‘Gig economy’
  • migration
355
Q

How are skill shortages an example of an issue in the labour market

A
  • UK suffers from geographical and occupational immobility
  • means even if there is enough of one profession, there may not be enough in certain areas
356
Q

How are young workers an example of an issue in the labour market

A
  • workers joining workforce during recessions tend to receive lower lifetime earnings than those entering in better times
  • during hard times, firms are unlikely to employ new workers and reluctant to let go of current staff so young struggle to find jobs
357
Q

How is retirement an example of an issue in the labour market

A
  • rising life expectancy and increasing people reaching retirement age has negative effects on government budget
  • pensioners make up over 50% of welfare spending
  • retirement age continues to rise but government is trying to encourage people to save for their own pensions
358
Q

How is wage inequality an example of an issue in the labour market

A
  • those on highest wages have seen their wages grow by bigger percentages than those on lowest wages
  • contentious issue and raises questions over relative poverty and level of redistribution required
359
Q

How are zero hour contracts an example of an issue in the labour market

A
  • rise in zero hour contracts causing problems for employees who do not know how much they will earn in a week and receive little notice of when they will work
360
Q

How is the gig economy an example of an issue in the labour market

A
  • many more people self employed and undertake short term contracts
  • concerns over rights of these workers and unreliability of their pay each week
361
Q

How is migration an example of an issue in the labour market

A
  • many people suggest migration causes wages to fall
  • allows employers to recruit from a larger pool of workers and helps fill skills shortages
362
Q

How does the government intervene in the labour market

A
  • national minimum wages
  • maximum wages
  • public sector wage setting
  • tackling immobility
363
Q

What is the national minimum wage

A
  • Labour introduced national minimum wage in April 1999
  • raises people out of poverty
  • decent minimum standards in workplaces
  • changes ever April
  • all workers over school age receive minimum wage
  • failure to pay employees minimum leads to fines
364
Q

What are arguments for the national minimum wage

A
  • reduces poverty
  • reduces male/female wage differentials
  • makes employees less likely to leave job, decreasing labour turnover and therefore training costs
  • more content workforce leading to more productivity, but it assumes all people are motivated by money
  • provides incentive to work, preventing unemployment trap
  • ensures everyone receives fair wage
365
Q

What are arguments against the national minimum wage

A
  • potential loss of jobs in the industry
  • minimum wage raises costs for companies
  • wage spiral as people will try to protect wage differentials between them and lowest price workers
  • no consideration of regional differences
  • most people on minimum wage are secondary earners meaning minimum wage is ineffective at reducing poverty
366
Q

What macroeconomic effects does the minimum wage have

A
  • reduce inequality
  • leads to rise in AD since poorest see rise in income and have an MPC => economic growth
  • Punic finances worsened as government employs many on minimum wage
  • rise in business costs reduces competitiveness, affecting trade balance and reducing net trade of AD, also increases SRAS causing inflation in short term
367
Q

What are maximum wages

A
  • some people suggest there should be a maximum wage for chief executives or a maximum pay ratio compared to lowest wage earners
  • government can set maximum pay limits for public sector workers in order to keep public spending down
  • helps reduce inequality
368
Q

What can maximum wages lead to

A
  • excess demand within industry
  • people think they can get higher wages abroad so UK suffers from loss of best workers, reducing quality and competitiveness
369
Q

What is the impact of maximum wages dependent on

A
  • elasticities of supply and demand
  • argued that supply and demand for highest paid is very inelastic as there’s a small supply and firms tend to only need one chief executive
  • their cost is then a very small part of total costs
  • could mean maximum wages have no effect on market apart from reducing wages
370
Q

What is public sector wage setting

A
  • government can make whatever wage decisions it decides in short run to improve budget
371
Q

Why can the government make whatever decisions it decides in the short run with public sector wage setting

A
  • trade unions in the UK are weak
372
Q

What is an example of public wage setting and what effect did it have

A
  • between 2010-15, public sector workers experience pay freeze
  • put downward pressure on private wages
  • few people likely to leave private for public
  • private employers used this as evidence to limit pay rises for workers
373
Q

What is the consequence of public sector wage setting in the long run

A
  • if private workers receive pay rises and public workers don’t, people shift from public to private sector
  • forces government to increase public sector wages in order to expand supply
  • thus, wages of public and private sector tend to rise by same percentage over long period of time but can rise by different rates in short term
374
Q

What is tackling immobility as a form of government intervention in the labour market

A
  • government attempting to improve either geographical or occupational mobility of labour
375
Q

How can the government tackle geographical mobility of labour

A
  • improve supply of houses and reduce price of properties making easier for people to move
  • improve transport links
  • national advertising
  • subsidised on houses in area with labour shortages
  • move public agencies out of London => DVLA was moved to Swansea, may not improve mobility of labour but prevents excess demand for labour in one place and excess supply in another
376
Q

How can the government tackle occupational mobility of labour

A
  • vocational training increase
  • encourage further study
  • encourage greater spending on training within work
  • targeted education
377
Q

What is the main competition organisation

A
  • Competition and Markets Authority (CMA)
378
Q

What does the CMA do

A
  • works to promote competition for benefit of consumers
  • investigates mergers and breaches of UK and EU competition law
  • enforces consumer protection law
  • brings criminal cases against individuals who participant in cartels
  • impose financial penalties, prevent mergers taking place and force businesses to reverse actions already taken
379
Q

How are mergers controlled

A
  • mergers assed in terms of specific Ciri chances of each case
  • consideration of whether there will be a substantial lessening of competition (SLC)
  • CMA considers likely competitive situation if the merge goes ahead compared to if it does not
  • merger will be approached if its potential benefits are greater than costs
380
Q

When is a merger investigated

A
  • if it will result in a market share greater than 25%
  • if it meets the turnover test of a combined turnover of £70 million or more
381
Q

What is the aim of controlling mergers

A
  • preventing two large companies merging so they do not exploit customers by raising prices, offering poorer quality service and reducing choice
  • prevents firms from gaining monopoly power
382
Q

What is the problem with controlling mergers

A
  • very few mergers are investigated every year
  • CMA can suffer from regulatory capture and may not have all the information necessary to make a decision
383
Q

What are examples of controlling mergers

A
  • Tesco’s takeover of Booker was allowed as CMA believed impact on competition would not be too high since supermarkets are in a hyper competitive industry
  • European Commission blocked merger of Ryanair and Aerlingus in 2010 as they would control more than 80% of all Europe flights from Ireland
384
Q

Why do monopolies need to be controlled

A
  • allocative and productively inefficient
  • firms may exploit dominant position in industry to stifle competition and become anti-competitive
  • most regulation occurs for utilities, which tend to be natural monopolies
385
Q

What are the main ways of controlling monopolies

A
  • price regulation
  • profit regulation
  • quality standards
  • performance targets
386
Q

What is price regulation

A
  • used to regulate natural monopolies in the UK
  • objective is to bring price closer to allocatively efficiency (P=MC)
  • important for utilities as there is a need to make them more affordable since they are essentials
  • two main forms of price regulation used
  • used in airport industry
387
Q

What are the two types of price regulation used

A
  • RPI-X
  • RPI+K
388
Q

What is RPI-X and use an example to explain it

A
  • form of price regulation used as a price cap
  • maximum prices firms are allowed to make is RPI-X
  • RPI is the retail price index which is a measure of inflation
  • X refers to expected efficiency gains
  • if one year RPI was 2.4% and regulator calculated that X was 1.5%, RPI-X would be 0.9%, i.e. the maximum price rise in the industry would be 0.9%
389
Q

Who uses RPI-X

A
  • OFGEM and ORR
390
Q

What does RPI-X aim to achieve

A
  • restrain price rises for essential services
  • incentivise utility providers to increase efficiency
391
Q

How does RPI-X aim to force producers to make efficiency gains

A
  • a firm’s total profit is equal to total revenue minus total costs
  • RPI-X lowers price of the good/service thereby limiting total revenue
  • there force, to maintain or increase profit, a firm must reduce costs i.e. become more efficient
392
Q

Why are monopolists less likely to make efficiency gains than other types of firms

A
  • they face an absence or lack of competitive pressures
  • means there is less incentive to cut costs as they are unlikely to lose customers regardless of actions they take
393
Q

How does the regulator calculate X for RPI-X

A
  • regulator investigates costs of firms in the industry to gain an understanding of possible efficiency gains
  • it is vital that the regulator has access to all necessary information and has a sufficient number of competent staff
394
Q

What are the advantages of RPI-X

A
  • protects consumers by restraining producers’ ability to raise prices. Important for goods and services that are considered essential or produced by firms that have significant monopoly power
  • gives incentive for firms to be efficient as if they lower costs by more than X then they can enjoy increased profits
  • prevents excessive prices and ensures that gains are passed onto consumer
395
Q

What are the disadvantages of RPI-X

A
  • setting X requires time and manpower
  • asymmetric information as information of efficiency gains comes from firms who may lie
  • less inventive for firms to make efficiency gains if X is set too low
  • firms less likely to make profit and thus leave if X is set too high
396
Q

What is profit regulation and where it is used

A
  • used to regular utilities in the US
  • involves regulators setting limits on amount of profit firms can make
  • one form is rate of return regulation
397
Q

How does rate of return regulation work

A
  • regulator allows firms to cover costs and earn a return based on amount of capital used
  • therefore, more capital employed then higher amount of profit can be earned
  • regulator wants to incentivise investment as productivity gains and general maintenance are vital for utilities
398
Q

What are advantages of rate of return regulation

A
  • firms are incentivised to increase capital investment which is vital for maintaining and improving quality
399
Q

What are disadvantages of rate of return regulation

A
  • little pressure for firms to be productively efficiency as regulator guarantees costs will be covered
  • danger firms overload on capital investment to earn higher profit. Involves investment that is done for the sake of it rather than maintenance or improving quality
400
Q

What are quality standards and use examples

A
  • monopolists only produce high quality goods id this is the best wat to maximise profits
  • government can introduce quality standards, ensuring firms do not exploit customers by offering poor quality
  • Post Office has to deliver letters on a daily basis to all areas
  • OFGEM requires energy providers to restore power supplies within a certain time period, also need to have enough cavity to prevent blackouts
401
Q

What are performance targets

A
  • used to regulate monopolies and also incentive improvements in public organisations
  • e.g. Office of Rail and Road sets out quality standards such as number of times a train company is allowed to be late
402
Q

What is the reason behind using quality and performance targets to regulate monopolies

A
  • incentive to improve quality is provided by need to meet/exceed consumer expectations and stay ahead of rivals
  • for a pure/natural monopoly, this incentive is absent as there are no competitors and a captive market
  • setting quality standards and performance targets regulators aim to motivate monopolies to meet minimum standard of provision
403
Q

What are advantages of performance targets and quality standards

A
  • if set correctly, may act as a surrogate for competition by forcing firms to behave as if they were in a contestable market
404
Q

What are the disadvantages of performance targets and quality standards

A
  • without sufficient sanctions, firms may not be motivated to meet targets/standards e.g. Network Rail failed to deliver on performance targets for their long distance sector in 2013-14
  • risk people game system, e.g. surgeons avoiding difficult surgeries in order to maintain high success rate
  • unintended consequences e.g. police spending time completing paperwork to meet standards than protecting public
  • requires political will and understanding to introduce and firms will try to meet targets without improving
405
Q

What is an SME

A
  • small and medium enterprise
  • outnumber large companies by a wide margin and employ more people
406
Q

What is a start up

A
  • company initiated by an entrepreneur to develop a scalable business model
  • refer to businesses that intend to grow large beyond the solo founder
407
Q

What benefits do SMEs and start ups bring

A
  • create competition
  • create jobs
  • increased consumer choice
  • source of exports
  • be a seedbed for innovation
  • may be more innovative, flexible and quick in responding to changes in market conditions
408
Q

What problems do SMEs and start ups face

A
  • credit => banks see smaller businesses as risky so small businesses struggle to find funding
  • business skills => some people feel they lack skills to succeed in business
  • recruitment => finding competent staff can be difficult
409
Q

What can the government do to support SMEs and start ups

A
  • provide information on how to set up businesses
  • deregulate making it easier to enter markets
  • streamline process for setting up and running a business
  • provide training to help people gain business skills
  • educational reforms to increase skills of workforce
  • provide business mentoring services
410
Q

What is deregulation

A
  • removal of government regulations in a market
  • became a popular policy tool from the 1980s
411
Q

What is the aim of deregulation

A
  • removing regulations make entry and exit to a market easier, thereby raising contestabilty
  • should increase number of firms in market
  • incumbent firms will be more fearful of near entry
  • therefore, competition increases, leading to greater efficiency and consumer satisfaction
412
Q

How will deregulation affect the contestability of a market

A
  • increases contestability as it reduces barriers to entry and exit
413
Q

What are the advantages of deregulation

A
  • incumbent firms less likely to profit maximise, increased competition puts downward pressure on prices
  • puts pressure on incumbent firms to raise quality
  • level of innovation increases
  • efficiency increases
414
Q

What are the disadvantages of deregulation

A
  • firms may take excessive risks and load up on debt causing market failure (08 Financial Crisis)
  • may lead to deterioration in public safety => many believe deregulation was an important factor behind Grenfell Tower disaster
415
Q

What is competitive tendering

A
  • process in which private sector firms compete to win contracts to perform tasks on behalf of government
  • government chooses firm they believe will be best for public in terms of quality and cost
416
Q

What is the rationale behind competitive tendering

A
  • idea is that introducing profit motive to economic activity performed by state leads to increase in efficiency and quality, allowing taxpayer to benefit frmo improved/cheaper public services
  • relies on assumption there will be a competitive market for government contracts and government will be able to competently administer contracts
417
Q

What are the benefits of competitive tendering

A
  • if there is a competitive market for government contracts, private sector will be responsible for allocating more resources in economy
  • allows for market forces to improve quality and choice
  • prices fall
  • taxpayer benefits highly
418
Q

What are the downsides of competitive tendering

A
  • if government focuses heavily on price of contracts firms may respond by reducing quality
  • firms involved often have ability to drive hard bargain in contract talks so may overpower government, meaning taxpayer ends up with poor value for money
  • contracts UK government puts to tender often only have a few bidders, lack of bidders meaning competition is limited
419
Q

What act prevents anti-competitive practises

A
  • Enterprise Act 2002
  • means firms engaging in anti-competitive practises (collusion and predatory pricing) can face up to five years in prison and unlimited fines
  • in 2011, 9 supermarkets in the UK were found to be fixing price of milk and cheese products
  • Tesco alone was fined £10ms
420
Q

How does the government protect suppliers

A
  • fines and jail sentences
  • increased contesability
  • minimum prices
421
Q

How do fines and jail sentences protect suppliers

A
  • to discourage buyers from exploitative practises such as delaying payments, regulators could make such offences punishable through fines and/or jail sentences
422
Q

How does increasing contestability protect suppliers

A
  • firms are able to obtain favourable terms from suppliers due to monopsony power, emanating from limited number of firms
  • increasing number of firms reduces monopsony power meaning suppliers are no longer bullied by sole buyers
423
Q

How do minimum prices protect suppliers

A
  • monopsonies cannot pay low prices to suppliers when minimum prices are set
  • reduces exploitation
  • promotes profitability and investment for suppliers
424
Q

How does the government protect workers

A
  • minimum wages
  • legislation to improve working conditions
  • fines and jail sentences
425
Q

How do minimum wages protect workers

A
  • prevents workers from receiving pay rates that leave them in poverty
426
Q

How does legislation to improve working conditions protect workers

A
  • health and safety legislation aims to reduce risks of injury in workplace
  • paid leave and break period legislation aims to prevents burnout at work and allows for healthy work-life balance
  • pension legislation aims to allow workers to be financially secure in retirement
427
Q

How do fines and jail sentences protect workers

A
  • employers breaking labour laws can be made to face fines and jail sentences
  • if punishment is sever enough and authorities are vigorous, unscrupulous employers will be forced to mend their ways or be forced to leave market
428
Q

How can restrictions be put on monopsony power

A
  • government can prevent monopolists exploiting suppliers by reducing prices by passing anti-monopsony’s laws, making certain practises illegal and introducing independent regulators forcing monopsonists to buy fairly
  • fines can be put in place
  • self regulation can be used but is weak
429
Q

What is privatisation

A
  • when a firm or whole industry changes from being run by public sector to private sector
430
Q

Why do supporters of privatisation argue it increases efficiency

A
  • transferring economic activity to private sector introduces profit motive and competition
  • there force, firms seek to reduce costs and improve quality to increase profit, resulting in increased efficiency
431
Q

Which industries have been privatised in the UK

A
  • most, e.g. rail, energy, water
432
Q

What are the disadvantages of privatisation

A
  • poor regulation/natural monopoly conditions may not improve outcomes for consumer
  • social costs and benefits likely to be ignored
  • government loses out on source of revenue
  • public sector assets often sold too cheaply
  • infrastructure arguably better under state control as it is vital to national interest
  • externalities and inequality
433
Q

What are the advantages of privatisation

A
  • stronger incentive to cut costs and be more efficient and productive
  • government gains revenue from sale of assets
  • encourages greater competition, reducing X-inefficiency
  • managers become more accountable
  • reduces government interference, allowing long term investment instead of worrying about a changing government
434
Q

What are the advantages of nationalisation

A
  • better for natural monopoly to be run by state
  • government considers externalities
  • guarantee of minimum level of service
  • dangerous for key industries to fall into private hands
435
Q

What are the disadvantages of nationalisation

A
  • public industries suffer from principal agent problem and moral hazard
  • experience X-inefficiency
  • influenced by government decisions
  • government may not have enough money to invest (NHS)
436
Q

What is a Private Finance Initiative (PFI)

A
  • government taking competitive bids for and then buts a whole investment project package
  • government pays back the costs of the whole project over a set period of time
437
Q

What are the advantages of PFI

A
  • private sector is more efficient than public
  • allows for extra funding to kick start more projects, bringing economic and social benefits
  • private sector has higher dynamic efficiency
  • PFI firms pay tax meaning it could be cheaper for the government
438
Q

What are the disadvantages of PFI

A
  • high debt costs => financing PFI is typically 3-4% of government debt
  • inflexibility and poor value for money => long term contracts are hard to change
  • risk lies with public sector
  • high spending on administration
  • government can be overdependent on PFI
439
Q

What type of profit regulation is used by natural monopolies

A
  • RPI + K
440
Q

What is RPI + K and what industries are regulated by RPI + K

A
  • price cap
  • used by OFWAT to regulate private water companies in England and Wales
  • maximum price firms are allowed to make is determined by RPI + K
  • K stands for capital investment
441
Q

Why is K necessary in RPI + K

A
  • regulators and the water industry argue that capital investments required to maintain a high quality service are far larger in the water industry
  • therefore, firms need to be able to earn higher revenues to make this investment viable
442
Q

What is regulatory capture

A
  • economic theory saying regulatory agencies may come to be dominated by the industries or interests they are charged with regulating
  • result is that an even y, charged with acting in the public interest, instead acts in ways benefitting the industry it is supposed to be regulating
443
Q

What are the different causes of regulatory capture

A
  • bribery
  • familiarity
  • revolving door
444
Q

How is bribery a cause of regulatory capture

A
  • government officials to some extent are motivated by financial reward
  • firms regulated by government often stand to benefit from weak oversight
  • firm may have chance to earn high amounts but is stopped by regulator
  • becomes tempting to bribe government official responsible
445
Q

How is familiarity a cause of regulatory capture

A
  • to regulate industries, government officials often work closely with members of firms the regulate
  • can mean regulators and employees become friendly
  • can lead to bias and increased willingness to go easy on those they are regulating
  • UK audit regulators have been accused of this
446
Q

How is the revolving door a cause of regulatory capture

A
  • regulators often go work for companies they were previously responsible for regulating
  • people often paid large salaries
  • jobs may be rewarded due to lenient treatment these firms received during the time regulators were in office
447
Q

What are the different areas that regulatory capture has an impact on

A
  • quality
  • price
  • externalities
  • asymmetric information
448
Q

How is quality affected by regulatory capture

A
  • if regulators do not enforce minimum standards of service, quality of goods and services and likely to fall
  • e.g. if regulatory capture occurs in the regulator responsible for rail service, quality of service would likely deteriorate over time
449
Q

How are prices affected by regulatory capture

A
  • likely to be higher if a regulator has been captured
  • for natural monopolies, this means regulators likely to be more generous when setting permitted price rises
  • e.g. RPI +3% instead of RPI + 2%
  • impacts poorer households more than richer ones => regressive effect
450
Q

How are externalities affected by regulatory capture

A
  • external costs more likely to be ignored if regulators have been captured
  • e.g. restaurant regulator that has been captured is less likely to ensure high food hygiene standards
  • could result in outbreaks of food poisoning, causing people to miss work and increase costs for public health care
451
Q

How is asymmetric information affected by regulatory capture

A
  • competition policy partly relies on information
  • e.g. OFWAT must have good understanding of costs and levels of required investment in water industry to effectively regulate the water industry
  • it is likely firms have better knowledge of their firm and industry than regulators
  • therefore there is a risk information is withheld by firms or that regulators lack resources to properly oversee firms
  • decreases changes of them being effective

A Level Economics (5 decks)

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