Economics Theme 3 Flashcards
(241 cards)
1
Q
What are 6 reason firms may want to grow?
A
Profits: Bigger business –> More sales revenue –> Higher levels of profit
Economies of scale: Bigger business –> Can buy with lower costs, receive better interest rates etc…
Market share: Bigger business –> More sales in market –> More marke share –> More selling powers –> More profit
Diversification: Bigger business –> Higher profits –> Diversify product portfolio and enter new markets –> Spread risk across multiple markets and products –> Increase chance of survival
Managerial motives: e.g. larger salaries or increased leisure time (bigger businesses can hire managerial directors)
More security - able to build up assets and cash which can be used in financial difficulties
2
Q
What are 4 reason firms may remain small?
A
Operate in niche markets – Some businesses may operate in a niche market and therefore don’t have sufficient demand for the goods/services that they sell for their business to grow
Barriers to entry – This may make it difficult for firms to expand into different markets and grow. e.g. some markets may be dominated by large businesses that have much lower operating costs than their business and can therefore offer a more competitive price
Small can be a selling point – e.g. local business support, closer customer service, more personal experience (customer and seller know each other)
Business objectives - Not always to grow/make money
3
Q
What is the significance of divorce of ownership from
control?
A
Shareholders own the business and appoint directors and managers to
run it on their behalf. Shareholders want to maximise profits to maximise their
dividends, whereas managers might have different motives, such as wanting to
increase sales and revenue at the expense of profits. This divorce of ownership
creates the principal-agent problem.
4
Q
What is the principal-agent problem?
A
As a business grows, the shareholders (principals) often appoint managers (agents) to run the business from day to day e.g. financial managers, sales managers etc
However, the managers may have different objectives from the shareholders
e.g the shareholders want to maximise dividends and therefore want the business to profit maximise. The managers may have objectives such as revenue maximisation.
The principal-agent problem stems from asymmetric information as the shareholders don’t always know how managers are behaving and what decisions they’re making.
In order to try and reduce this problem, some businesses may put in place schemes that help align the principal’s objectives with the agent’s.
e.g. if the owners were to give managers a percentage of the business’s shares, then the managers may switch their objectives from sales maximisation to profit maximisation. This is because they also want to maximise the dividends they receive.
5
Q
What is the difference between public and private sector organisations?
A
Public sector organisations are run by the government e.g. the NHS.
Private sector organisations are run by private individuals and are therefore left to the free market.
6
Q
Why are private sector firms usually more efficient than public sector organisations?
A
Private firms that are constantly making a loss are likely to become bankrupt as they need to make a profit in order to survive in the free market. This means that unlike public organisations, private firms have a profit motive. This encourages private firms to be as efficient as they possibly can in order to survive and to make a profit, whereas public organisations don’t have this incentive as they act in society’s interest and do not face competition.
7
Q
What is the difference between profit and not-for-profit organisations?
A
Not-for-profit organisations have a main objective that differs from profit, such as helping the local community.
They are exempt from certain taxes that for-profit firms have to pay. The profits that not-for-profit firms make will go towards their main objective which will help to improve society, but they may not make a profit.
Profit organisations have profit as their main aim, and they oftenmake decisions that are in their own self-interest and may have a negative impact on society, but are profitable to make.
8
Q
What are the 5 ways a business can grow?
A
Organic growth
Horizontal integration
Forwards vertical integration
Backwards vertical integration
Conglomerate integration
9
Q
Organic growth definition
A
Organic growth is where a business grows internally by reinvesting profits or
borrowing from banks.
10
Q
Vertical integration definition (and difference between forwards and backwards)
A
Vertical integration is where two businesses at
different stages of production, but in the same industry, join together.
Forward vertical is where a firm integrates with a firm in a stage of
production closer to the customer in the same industry.
Backwards vertical is where a firm integrates with a firm in a stage of
production further away from the customer in the same industry.
11
Q
Horiontal integration definition
A
Horizontal integration is where two businesses at the same stage of
production in the same industry join together.
12
Q
Conglomerate integration definition
A
Conglomerate integration is where two businesses in different industries
merge.
13
Q
What are some examples of organic growth?
A
Subway, Wasabi, Poundland, Hotel Chocolat
14
Q
What are some examples of vertical integration?
A
Forward:
Vehicle manufacturer buys a car retail business
Fishing business buys fish and chips shop
Backward:
Book shop buys a publishing company
Coffee shop buys a coffee bean supplier
Vodafone / Mannesmann (mobile and broadband service buys electronics and steel manufacturer)
15
Q
What are some examples of horizontal integration?
A
Supermarket merger
Northern Rock and Virgin money (banks)
Pfizer and Warner-Lambert merger (developing and selling in the pharmaceutical indsutry)
16
Q
What are some examples of conglomerate integration?
A
Amazon and Ring
Amazon and Twitch
17
Q
What are 2 advantages of organic growth?
A
Reduced risk – The main advantage of growing organically is the reduced risk of enduring any of the detrimental effects that may occur during mergers and takeovers e.g. a clash of business cultures.
Helps to avoid diseconomies of scale – By growing organically it allows the business to grow at a more sustainable pace. As a result of this, there is less chance of the business experiencing increased costs as a result of diseconomies of scale.
18
Q
What are 2 disadvantages of organic growth?
A
Slow growth – By growing organically it will take longer for the business to increase its market share, by which point their competitor that has grown through a merger/takeover may be dominating the market.
Less competitive - If other businesses merge, they experience economies of scale, allowing them to lower their prices and become more competitive.
19
Q
What are 3 advantages of vertical integration?
A
Guaranteed supplier or outlet for product
Greater control over supply chain – Can make more efficient to reduce costs, or make changes to increase quality
Impacted less by varying levels of demand – Can easily increase or decrease supply when necessary
20
Q
What are 2 disadvantages of vertical and horizontal integration?
A
Potential diseconomies of scale
Culture clash
21
Q
Whare are 3 disadvantages of conglomerate integration?
A
Lack of knowledge - Entering a new market can be extremely risky if the business owner does not have experience or expert knowledge of the market. As a result of this, they can may make poor decisions and are unable to attract new customers or may even lose existing customers.
Culture clash
Potential diseconomies of scale
22
Q
What are 3 advantages of horizontal integration?
A
Economies of scale
Reducing competition - greater market power, potentially a monopoly
Spreading risk - if failed investment for example, costs are spread over the entire business, which is now bigger. Has a lower impact on profits.
23
Q
What is an advantage of conglomerate integration?
A
Reduces risk - diversification. The business no longer has to rely on the performance of one market alone
24
Q
What are 4 constraints on business growth?
A
Size of the market
Access to finance
Owner objectives – Principle-agent problem
Regulation
25
Why is the size of the market a constraint on business growth?
Businesses may operate in small or niche markets, meaning that the demand for their goods/services will be limited. As a result of this, there is little room for the business to expand.
Larger markets have a much wider scope for innovation, and firms can take
advantage of huge selling opportunities.
26
Why is access to finance a constraint on business growth?
It is more difficult for smaller businesses to access finance. They are unlikely to be making supernormal profits, and the risk of investing in them is higher for banks and other lenders as they aren't yet well-established. As a result, they either won't be able to access finance, or will have a high interest rate.
27
Why are owner objectives a constraint on business growth?
The business owner may not have the objective of growth. For example, instead they may aim for corporate social responsibility. By doing so they may increase their costs of production, thus reducing their profit and ability to grow. Short-terminism can take place too (profits in the short run at the expense of long-term growth)
28
Why is regulation a constraint on business growth?
Excessive regulation (red tape) can limit the quantity of output of a firm (e.g. environmental laws and taxes might result in firms only
being able to produce a certain quantity before exceeding a pollution permit).
Excessive taxes, such as a high rate of corporation tax, might discourage firms
earning above a certain level of profit, since they do not keep as much of it. This
might limit the size that a firm chooses, or is able to, grow to.
29
Demerger definition
A demerger is when a business sells off one or more of the businesses that it
owns into a separate company.
30
What are 6 reasons for demergers?
Cultural differences
Creating more focused firm (Mergers can often result in the business losing focus of its key aims and objectives)
Protect value of firm (remove loss making parts)
Reduce risk of diseconomies of scale
Raise finance
Meet requirements of competition authority
regulators
(A business is broken into two or more
components, either to operate on their own, to be sold or to be dissolved)
31
What are 3 impacts of demergers on the business itself?
Allows to focus on the core business - more efficient and innovation
Raises funds
Removes loss-making parts of the businessn - higher profits
32
What are 2 impacts of demergers on workers?
Increased job security if loss-making parts of the business are demerged
Reduced culture conflict - more motivated
33
What are 2 impacts of demergers on consumers?
Better products and cheaper prices (efficiency and innovation, increased competition now smaller)
34
What are the 4 different business objectives?
Profit Maximisation
Revenue Maximisation
Sales Maximisation
Profit Satisfising
35
Why do firms have an objective to promit maximise?
Private firms have a profit motive because the assumption of rationality means that shareholders will seek to maximise their utility by maximising profits, and therefore dividends. Other influences on the business, such as owners, directors and managers may also have a profit motive if their salary is directly or indirectly influenced by the level of profit.
36
Why might firms have an objective to sales or revenue maximise?
Managers are sometimes paid a salary that is linked to the number of sales or amount of revenue the firm achieves.
More sales increases market share for the firm, which enables them to experience greater economies of scale in the long run, so that the firm can lower costs, and therefore lower price.
Lowest possible prices increases brand loyalty and attracts new customers. This may also push rival firms out of the market as they can't compete with such low prices and are losing customers. In the long-run, with high market share, the firm will then be able to raise prices with a more inelastic demand, and therefore increase profit.
If the firm has a social or political aim, they will sales maximise to spread their message to as many people as possible.
37
Why might firms have an objective to profit satisfice?
Managers and directors may be motivated by high salaries, the number of people under their
control or the availability of fringe benefits, as these will increase their utility more than profit maximising. However, if they ignore profit, shareholders can revolt and may vote them out. So firms may profit satisfice where they satisfy the demands of shareholders whilst being free to maximise their rewards from the company.
E.g: Working fewer hours to enjoy more leisure time; behaving ethically.
38
Profit Satisficing definition:
When a firm makes a level of profit below profit maximisation that satisfise the needs of the shareholders of the firm.
39
Where is profit maximisation?
MC = MR
40
Where is revenue maximisation?
MR = 0
41
Where is sales maximisation?
AC = AR
42
Formula for Total Revenue:
Price x Quantity
43
Formula for Average Revenue:
Total Revenue / Quantity
(also Price)
44
Formula for Marginal Revenue:
Change in Revenue / Change in Quantity
45
1. When demand is elastic, increasing price will:
2. When demand is elastic, decreasing price will:
3. When demand is inelastic, increasing price will:
4. When demand is inelastic, decreasing price will:
1. Total Revenue decrease
2. Total Revenue increase
3. Total Revenue increase
4. Total Revenue decrease
46
Formula for Total Cost:
Total Fixed Cost + Total Variable Cost
(also Average Cost x Quantity)
47
Formula for Total Variable Cost:
Average Variable Cost (Variable Cost per Unit) x Quantity
48
Formula for Average Total Cost:
Total Cost / Quantity
49
Formula for Average Fixed Cost:
Total Fixed Cost / Quantity
50
Formula for Average Variable Cost:
Total Variable Cost / Quantity
51
Formula for Marginal Cost:
Change in Cost / Change in Quantity
52
Short Run definition:
A time period when at least one of a firm's factors of production are fixed.
53
Long Run Definition:
A time period when all of a firm's factors of production are variable.
54
Why is there diminishing marginal productivity in the short run?
In the short run there is at least one fixed factor of production. The law of diminishing marginal productivity states that adding more units of a variable input
to a fixed input, increases output at first. However, after a certain number of inputs are added,
the marginal increase of output becomes constant, and then when there is an even greater input,
the marginal increase in output starts to fall. In the long run, all factors of production are variable.
55
What is the difference between internal economies of scale and external economies of scale?
Internal economies of scale: A decrease in average costs as a result of an increase in the scale of the production of a firm.
External economies of scale: A decrease in average costs as a result of an increase in the scale of production within the industry in which the firm operates.
56
What is the minimum efficient scale?
The point of lowest LRAC is the minimum efficient scale. This is where the optimum
level of output is since costs are lowest, and the economies of scale of production
have been fully utilised.
57
What are the 7 types of economies of scale?
Technical
Purchasing
Marketing
Managerial
Financial
Distribution / Network
Risk-Bearing
58
Explain technical economies of scale.
Large-scale businesses can afford to invest in expensive and specialist capital machinery that increases efficiency and decreases average costs, as they can spread fixed costs over high output. The businesses also have more money to spend on R&D.
For example, a large supermarket can invest in technology that improves stock control, but this would not be cost-efficient for a small corner shop.
59
Explain purchasing economies of scale.
Large firms can buy in bulk and achieve purchasing discounts.
For example, supermarket chains can buy fresh fruit in much greater quantities than a small fruits and vegetable supplier, and at discounted rates.
60
Explain marketing economies of scale.
A large firm can spread its advertising and marketing budget over a large output, and can purchase its inputs in bulk and at discounted prices.
For example, Amazon or Virgin can advertise multiple products at the same time and with the same studio.
61
Explain managerial economies of scale.
Large-scale businesses have the money to employ specialist labour (e.g. accountants, lawyers, technical experts), and to use division of labour to make production more efficient. They can employ managers to supervise these systems and oversee human resources.
62
Explain financial economies of scale.
Large-scale firms are usually rated by financial markets to be more credit worth as there is less risk involved for them. This gives the firms access to credit facilities, with favourable rates of borrowing. Small firms often face high interest rates on overdrafts and loans, or struggle to access credit at all.
63
Explain distribution / network economies of scale.
When a large-scale firm introduces new products, they can make use of existing distribution and supply networks.
64
Explain risk-bearing economies of scale.
When a firm becomes larger, they can expand and diversify their production range.
Therefore, they can spread the cost of uncertainty. If one product is not successful, they
have other products to fall back on.
65
Economies of scale definition:
The advantages enjoyed by a business as output increases and average cost decreases.
66
Diseconomies of scale definition:
The disadvantages experienced by a business as average cost increases as a result of output increasing.
67
What are the 3 main types of diseconomies of scale?
Communication
Coordination
Control
68
Explain communication diseconomies of scale.
Larger firms find it more difficult to communicate efficiently within the organisation and there are increased communication costs.
Managers of small firms find it easier to communicate with all members of the workforce.
Workers may also start to feel alienated and excluded as the firm grows. This could lead to a fall in productivity and increases in average costs, as they lose their motivation.
69
Explain coordination diseconomies of scale.
Larger firms find it more difficult to manage the increased number of personnel and customers as they grow.
It might become increasingly difficult to delegate and motivate workers.
Processes become less efficient, which increases average costs.
70
Explain control diseconomies of scale.
It becomes harder for a firm to monitor how productive and motivated employees are as the firm gets larger and employs more workers. Workers may become lazy if they are not being monitored, as the risk of being made redundant increases.
If the firm decides to employee managers to prevent this, this is a large increase in fixed costs. (However, could lead to managerial economies of scale).
71
What is the significance of supernormal profit?
It creates an incentive for firms to increase production and for new firms to enter the industry.
It is a reward for production that can benefit shareholders in the form of dividends and workers in the form of pay.
It can be used to reinvest, such as R&D, which results in dynamic efficiency.
Corporation tax is paid on profits, which creates significant revenues for the government.
72
Supernormal profit definition.
When total revenue exceeds total costs
73
Normal profit definition.
When a firm's total revenue is equal to their total costs.
74
Subnormal profit / loss definition.
When a firm's total revenue is lower than their total costs.
75
Where is the short-run shut-down point? Why?
AVC = AR
When AR is above AVC, some of the revenue can go towards paying fixed costs, therefore decreasing the loss the firm is making.
76
Where is the long run shut down point? Why?
ATC = AR
Every additional unit of output where ATC > AR creates a loss. Firms require normal profit to operate in the long run.
77
What is the significance of normal profit?
Normal profit is the minimum reward required to keep entrepreneurs
supplying their enterprise in the long run. It covers the opportunity cost of investing
funds into the firm and not elsewhere.
78
Allocative efficiency definition.
When society is producing goods to match the needs of consumers. Quantity supplied is equal to quantity demanded and consumer satisfaction is maximised.
79
Productive efficiency definition.
When minimum inputs are used to produce maximum outputs at the lowest cost.
80
Dynamic efficiency definition.
Where firms improve efficiency in the long run by investing in R&D or production process.
81
X-inefficiency definition.
When firms produce at a given output higher than the potential minumum cost.
82
Why might firms be X-inefficient? What type of market structure?
Firms, particularly monopolies, sometimes feel complacent due to the lack of competition, so have little incentive to reduce waste and minimise costs.
Uncontestable markets, monopolies, lack of competition, lack of regulation.
May also be due to: organisational slack, a waste in the production process, poor management, laziness.
83
Where is allocative efficiency?
AR = MC
84
Where is productive efficiency?
AC = MC
85
Where is dynamic efficiency?
AR > AC
86
Where is X-inefficiency?
Anywhere above AC (not on the AC curve)
87
Which types of efficiencies in which market structures:
Allocative efficiency
Productive efficiency
Dynamic efficiency
X-inefficiency
Perfect competition
Monopolistic competition
Oligopoly & Duopoly
Monopoly
Perfect competition: Allocative efficiency, Productive efficiency
Monopolistic: None
Oligopoly & Duopoly: Dynamic efficiency
Monopoly: Dynamic efficiency, X-inefficiency
88
What are the 4 characteristics of perfect competition? Explain them.
Many buyers and sellers, none of whom are large enough to influence price.
No barriers to entry and exit to and from the industry
Buyers and sellers possess perfect knowledge of the market
Homogeneous products
89
What is the significance of there being no barriers to entry and exit in perfect competition?
There are no or very few entry costs, such as capital expenditure and research and development costs.
There are no or very few sunk costs, such as advertisements.
90
What is the significance of there being homogeneous products in perfect competition?
Buyers can't tell the difference between products from different firms. There is no branding, brand loyalty or marketing and advertising.
91
What is the significance of buyers and sellers having perfect knowledge of the market in perfect competition?
Buyers and sellers have a comprehensive understanding of all factors within a market (e.g. prices and availability).
Firms produce the same quality output as they use the same processes as other firms.
92
What is the significance of there being many buyers and sellers in perfect competition?
Because there are so many, no one buyer or seller is large enough to influence price. Firms are price takers, and all charge the same price. All firms make normal profit because if a firm makes supernormal profit, there will be an incentive for new firms to enter the market, who will increase supply in the market, increasing the price (AR curve), and if a firm makes a loss, they will be forced out of the market.
93
What are the 3 characteristics of monopolistic competition?
Large number of small firms
Low barriers to entry and exit
Firms produce similar, but differentiated products
94
What profit levels do firms in perfect competition and monopolistic competition make in the short run and long run? Why?
Short Run - Supernormal profit and losses
Long Run - Normal profit
In the long run, supernormal profits will be eroded because new firms will enter the market owing to a lack of barriers to entry. The entry of new firms will increase supply, shifting the average revenue curve downwards to the point where AR=AC, as in the diagram. If the firm was making a loss, it would leave the industry, reducing supply and shifting the AR curve upwards again to a point where AR=AC. Therefore, in the long run, a firm in monopolistic competition can make neither supernormal profits nor losses.
95
What are the 4 characteristics of an oligopoly?
High barriers to entry and exit
High concentration ratio
Interdependence of firms (the actions
of one firm will impact other firms in the industry)
Product differentiation
96
Oligopoly definition.
An oligopoly is a market dominated by a few large firms. They are interdependent and therefore either compete or collude.
A market with a high firm concentration ratio.
97
Duopoly definition.
A duopoly is a market dominated by two large firms. They are are interdependent and therefore either compete or collude.
98
Monopoly definition.
A market with one firm, or a market with multuple firms, but just one dominant firm.
99
Monopsony definition.
When there is a single buyer in the market with strong buying power.
(Oligopsony - few firms with strong buying power)
100
What is the significance of n-firm concentration ratios?
The higher the concentration ratio, the less competitive the market, since fewer firms are
supplying the bulk of the market. Higher ratios are oligopolies, duopolies and monopolies. Low ratios are monopolistic competition and perfect competition.
101
Why do firms in oligopolies have an incentive to collude instead of compete?
Firms in oligopolies are interdependent, so are impacted by the actions of their competitors, and are therefore forced to compete or collude to maintain market share. Firms may choose collusion over competition so that they can joint profit maximise and act as a monopoly, so that they can increase prices without losing a significant amount of demand, and therefore increase profit levels. Competing may result in price wars or investment in marketing, both of which lower profit levels.
102
Collusion definition.
Collusion occurs when rival firms agree to work together to reduce competition and make higher profits at the expense of consumers.
103
Why do firms in oligopolies have an incentive to compete instead of collude?
Collusion is risky - It is illegal and punishable with a fine of up to 10% of annual turnover or managers facing jail time. The rival firm could be a whistle-blower and gain immunity, whilst the firm will be punished. It could also damage reputation if consumers find out. The rival firm doesn't have to keep to the agreement as it isn't legally binding. It increases market contestability as it is easier for new entrants to make supernormal profit.
Competition reduces prices for consumers, is more ethical, is legal and is encouraged by regulators.
104
What is the significance of there being high barriers to entry and exit in oligopolies?
It makes the market less contestable, so there are unlikely to be new entrants to the market. There are high barriers due to the high level of sunk costs, particularly those involved in non-price competition, such as advertising and R&D.
105
What are the two theories about firms' behaviour in markets?
Neo-classical theory suggests that the behaviour of a firm is dependent on the number of firms in the industry, whilst contestable market theory suggests that the behaviour of a firm is dependent on the threat of new entry into the market.
106
What is the significance of firms being interdependent in oligopolies?
They are forced to compete or collude to maintain market share. They are also uncertain of their competitor's actions, which increases risk and creates the prisoner's dilemma.
107
What is the significance of there being product differentiation in oligopolies?
Firms can compete in price and non-price competition. The elasticity of the demand curve of each firm may vary as they are selling differentiated products. As a result, some firms may be able to increase profit by increasing or decreasing price, and other firms may be only able to increase profit by increase the quality of their products or another form of non-price competition.
108
What are the three types of collusion?
Overt collusion
Covert collusion
Tacit collusion
109
What is the difference between overt, covert and tacit collusion?
Overt - When there is tangible evidence (e.g. OPEC is a formal cartel)
Covert - When there is no tangible evidence, but can still be caught
Tacit - When no agreement has taken place, so it can't be proven
[Don't need to know covert]
110
When is overt collusion most likely to take place?
When there is an oligopoly with very few dominant firms, so that it is more difficult for one of the firms to refuse.
111
What is a cartel?
A group of two or more firms that have agreed to control prices, limit output, or prevent the entrance of new firms into the market. They may also divide the market and agree to not compete in each other's market.
112
What is price leadership?
When a dominant firm in the market changes their price and the other firms follow. They do this because they otherwise risk losing market share to the dominant firm.
113
What is the significance of price leadership?
The price
leader is often the one judge to have the best knowledge of prevailing market conditions, so the best strategy for other firms will usually be the same as the one the price leader undertakes, and they will copy this as they look up to the firm. If a less dominant firm increases their price, other firms may not follow and will instead gain customers from the firm. There will be price stability in an oligopoly if the price leader does not change their price, or only increases it by a small amount over time.
114
What is game theory / payoff matrix, and how can it be used?
Game theory suggests that firms can't predict their competitors' actions, so the dominant strategy is the one that will maximise their own interests, regardless of the actions of their competitors.
It can be used to predict how firms in oligopolies and duopolies might behave, to
explain why firms may collude, and to explain why collusive agreements may break down.
115
What 2 things can the kinked demand curve be used to show?
Price stability in oligopolies
Non-price competition in oligopolies
116
What are the 3 types of price competition?
Price Wars
Predatory Pricing
Entry Limit Pricing
117
What are the 2 pricing strategies?
Predatory Pricing
Entry Limit Pricing
118
Explain the concept of a price war.
Price wars occur when a firm lowers their price in order to attract customers and increase market share. However, other firms react to (or to prevent) losing market share by lowering their prices too. This will create a downwards spiral of lower prices, which decreases the levels of profit the firms make. It does, on the other hand, benefit consumers as they receive lower prices. E.g. UK supermarket market
119
Explain the concept of predatory pricing.
It occurs when a firm attempts to force competition out of the market by setting low prices, so that customers will leave the rival firm and move to their firm. The low price may be below average cost in the short run so that the rival firm can't afford to also lower their price to the same level. Once the rival firm has left the market, the firm can increase their price to regain the lost revenue (and pay off the loss they made).
120
Explain the concept of entry limit pricing,
This occurs when a firm does not profit maximise and chooses to make lower levels of profit. It ensures that the price of a good is below that which a new firm seeking to enter the market would be able to sustain. This deters firms from entering the market as it would be unprofitable. This supports contestable market theory, as the firm's behaviour is dependent on the threat of new entry into the market.
121
What are 8 types of non-price competition?
Quality / R&D
Advertising / Marketing
Loyalty cards
Special offers/discounts/free gifts
Customer service
After-sales service
Closing time / next-day delivery
Environmental friendliness
122
What is the aim of non-price competition?
A firm will use non-price competition to distinguish or differentiate their products from their competitors.
It reduces the likelihood of price wars, where all firms lose out from lower revenue; the cost of non-price competition is usually less than the cost of engaging in a price war.
New product development - have better products than competitors
Maintain and increase brand loyalty - e.g. environmentally friendly
Attract customers and increase demand / make demand more inelastic
123
What are 3 characteristics of a monopoly?
Only one firm in the industry (market demand curve = firm demand curve)
High barriers to entry
Firm is a price maker
124
What are the 4 types of monopolies?
Pure monopoly (diagram assumption)
Legal monopoly (>25% market share)
Local monopoly (only in a specific location)
Natural monopoly (lowest LRAC when only one firm)
125
Pure monopoly definition.
When there is one firm in the market with 100% market share.
126
Legal monopoly definition.
A firm with at least 25% market share.
127
Local monopoly definition.
A firm that has monopoly power in a specific location.
128
Natural monopoly definition.
When a firm's economies of
scale are so large, new entrants into the market would find it impossible to match the costs and
prices of the established firm.
When the potential for economies of scale is so great, it only makes sense for there to be one firm in the market.
129
What quantity do monopolies produce?
They profit maximise in the short run and long run, so where MC = MR.
130
Third degree price discrimination definition.
Third degree price discrimination is when a business charges different prices for the same product to different groups of customers with different PEDs.
131
What are the 3 necessary conditions for price discrimination?
A high degree of monopsony power
Ability to identify different groups of consumers with different PEDs
Ability to prevent seepage
132
What are the advantages and disadvantages of price discrimination for consumers and producers?
Advantages:
Firms can increase their profits and have higher producer surplus in the inelastic market
Higher profits result in dynamic efficiency, which increases the quality of products for consumers and lowers costs for the firm
Consumers in the elastic market pay lower prices and have greater consumer surplus
More consumers can afford the product
Disadvantage:
Consumers in the inelastic market pay higher prices and lose consumer surplus
133
What are the advantages of monopolies for firms?
Firms make high levels of supernormal profit:
Allows for dynamic efficiency, so they can decrease LRAC
Provides finance for investment to
maintain competitive edge
Provides reserves to overcome short-term difficulties
Allows for cross-subsidisation to products in other industries
Firms have high selling power, so can price-discriminate
Firms often have monopsony power, so can buy from suppliers at low prices
Firms can compete against large overseas organisations
134
What are the advantages for consumers of monopolies?
High supernormal profits allow for dynamic efficiency, which creates higher quality products and lower prices for consumers.
Access to significant economies of scale and cross-subsidisation allows firms to lower prices for consumers.
Consumers with elastic demand may receive lower prices.
135
What is the disadvantage of monopolies for suppliers?
Monopolies have strong monopsony power when they are the only buyer or majority buyer, so can negotiate low prices. (e.g. Tesco milk)
136
What are the disadvantages of monopolies?
High levels of supernormal profit and lack of competition allows the firm to become complacent and not be dynamically efficient, so LRAC will not decrease and consumers will not receive higher quality products.
Monopolies are not usually productively or allocatively efficient.
Monopolies may waste resources when financing losses in another sector.
Consumers with inelastic PEDs may lose out on consumer surplus and receive higher prices.
Monopolies may be inefficient to protect market dominance (such as entry limit pricing)
137
What are the disadvantages for consumers of monopolies?
Higher prices and lower quality if the monopoly doesn't have any competition.
Less choice / no choice if fewer firms / one firm.
138
What is the advantage of monopolies for employees?
High levels of profit and inefficiency make it more likely that workers will receive higher wages.
139
What are 2 examples of natural monopolies in the UK? What type of industry?
Railway tracks, Water supply
Usually in an industry with high fixed costs. E.g. trains - fixed costs include tracks,
tunnels, bridges and stations, whist there are fewer variable costs.
140
Why does it not make sense for a firm to enter a market where there is a natural monopoly?
It would raise average costs for the industry, and the firm would be easily priced out as
their costs would be so much higher.
141
What is the difference between monopsony power and oligopsony power?
In a monopsony, there is a single buyer that can dictate the price of several sellers. In an oligopsony, there are multiple buyers that can dictate the prices of sellers.
142
What are the characteristics of a monopsony?
One buyer in the market
High buying power
Profit maximises
Pays suppliers the lowest possible price
Suppliers supply less than if the market was competitive
143
What is the advantage and disadvantage of being a monopsonist firm?
Advantage - minimises costs and maximises profit by paying suppliers the lowest possible price
Disadvantage - relationship with supplier may worsen, and the supplier may even shut down
144
What is the advantage and disadvantage of being a consumer of a monopsonist?
Advantage - lower prices if the monopsonist passes on the lower costs
Disadvantage - quality may decrease if the supplier has to cut costs to remain profitable (however, quality may not decrease and price will decrease instead if the supplier is forced to be dynamically efficient)
145
What is the advantage and disadvantage of being an employee of a monopsonist? + Disadvantage of being an employee of a monopsonist supplier.
Advantage - the monopsonist may be able to pay employees higher wages due to the lower supply cost
Disadvantage - may question the ethics of the way the firm is acting and therefore be unhappy with their job
Disadvantage - employees may lose their jobs as the supplier cuts supply or shuts down
146
What are 2 advantages and a disadvantage of being a supplier of a monopsonist?
Advantage - the supplier may be able to gain monopoly power if they are the sole supplier to the firm
Advantage - the supplier is forced to be dynamically efficient to lower LRAC, so that they can meet the monopsonist's low prices
Disadvantage - will receive lower prices and be exploited as they have no alternative firms to supply to, so may become unprofitable and be driven out of the market
147
Why are monopsonists able to control the prices they buy at?
The demand of the monopsonist is the same as the demand of the market as the monopsonist is the only firm in the market. Suppliers will supply at the market equilibrium price and quantity, which is also the firm's equilibrium price and quantity. The monopsonist has an inelastic demand curve as the suppliers have no alternative firms to supply to, so if they ask for higher prices, the supplier has no choice but to oblige, unless they will become unprofitable and be forced to leave the industry.
148
What are 2 examples of monopsony power?
Tesco buying milk from farmers
NHS buying cancer drugs
149
Contestability definition.
Contestability is a measure of the extent to which a market is open to new entry, determined
by the level of sunk costs.
150
What are the 6 characteristics of contestable markets?
No barriers to entry or exit
No sunk costs
New firms have no competitive disadvantage compared to the incumbent firms
All firms have access to the same technology
Firms make normal profit (if firm sets price above AC, new firms come into the market with lower prices and erode supernormal profit)
Perfect information
151
What are 3 recent examples of contestable markets?
Uber entering the taxi market
AirBnB entering the hotel market
Ocado entering the groceries market
152
Why do firms in contestable markets often not profit maximise?
Supernormal profit would make them vulnerable to a ‘hit and run’ entry by a new firm. This is when a new firm enters the market, takes some of the profits, and then exits the market. To avoid this, incumbent firms charge where price = AC, so that they don't make supernormal profits, and there is no incentive for other firms to enter the market. Firms may also undertake entry limit pricing to deter new entrants.
153
How do contestable markets differ to perfectly competitive markets?
Products may be homogeneous or heterogeneous
Firms may have monopoly power
May be a small number of firms (e.g. oligopoly)
154
What are the implications of contestable markets on the behaviour of firms?
Firms will enter the market if they see other firms are making supernormal profits, and they will remain in the market until competition prevents them from
making a profit.
It is therefore difficult for incumbent firms to make supernormal profits, and it could even force
them out of business. As a result, the firm will likely prevent this is by using entry limit pricing.
In a perfectly contestable market, firms will only be able to prevent this by making normal profits. They will therefore be allocatively efficient, producing where AC = AR.
There may be dynamic efficiency; firms are unlikely to make high levels of supernormal profit, however, they have access to all technology in the industry.
Firms may try to make the market less contestable through legal barriers (patents, trademarks, copyrights) and R&D (the firm can lower costs more than a new firm can).
155
Barriers to entry definition.
Obstacles that limit a firm’s ability to enter, set up or
extend into new markets.
156
Hit and run competition definition.
When a firm enters a market to take advantage of short-term supernormal profits, and then leaves once they can no longer make supernormal profits.
157
Barriers to exit definition.
Factors that prevent a firm leaving
a market, or when a firm is making a loss, make it more unprofitable to leave.
158
What are 6 barriers to entry?
Legal barriers
Exclusive right to production (e.g. television)
Licences for production (e.g. taxi)
Patents, copyright etc
Price decisions of incumbent firms
Entry limit pricing
Predatory pricing
Marketing requirements, Brand loyalty
Capital start-up costs, High R&D costs
Access to economies of scale, Nature of the business
Level of sunk costs
159
What are 4 barriers to exit?
Level of sunk costs
Ability to and cost of:
Terminating contracts
Selling assets
Making workers redundant
160
What are the 3 types of barriers to entry?
Natural barriers (nature of the business)
Legal barriers (legislation, patents etc)
Illegal barriers (anti-competitive behaviour e.g. predatory pricing)
161
Sunk costs definition.
Fixed costs than cannot be recovered upon exit of the industry.
162
What are 3 sunk costs?
Advertising
Rent
R&D (if didn't acheive anything)
163
How is the degree of contestability measured?
The degree of contestability is measured by the extent to which the gains from market entry for a firm exceed the costs of entering the market.
A market with no sunk costs and no barriers to entry and exit is a perfectly contestable market. The
more contestable a market, the more unstable it will be as there can be regular hit-and-run competition.
164
How can the government make markets more contestable?
Regulation - competition law prevents firms abusing market power (e.g. predatory pricing)
Deregulation - Liberalising markets lower barriers to entry
165
What 6 factors influence demand for labour?
Wage rate (more willing to buy labour at lower cost)
Demand for product (derived demand, so higher demand for product = higher demand for labour)
MRP / Productivity of labour (lower unit costs)
Labour substitutes (if cheaper to buy capital, demand for labour falls)
Profitability of the firms (higher profits = more able and willing to buy labour)
How many firms in the market (more firms = higher demand for labour)
166
Derived demand definition.
The demand for the product is dependent on the demand for the final good or service that they produce.
e.g. labour
167
Where does the supply and demand of labour come from?
The supply of labour comes from people
in households and the demand for labour comes from businesses.
168
What 7 factors influence supply of labour?
Wage rate (higher pay = higher utility)
Demographics of the population (retirement age, school leaving age, higher education students, migration)
Non-pecuniary benefits (non-monetary benefits of working)
Trade unions (more employment rights = more willing to supply labour)
Taxes / benefits (if income tax high, less willing to supply labour. If benefits high, opportunity cost of supplying labour is higher)
Qualifications (difficulty, cost, time to complete)
Compensating differentials (compensation for undesirable aspects of the work)
169
How does migration influence supply of labour?
Migrants are usually of working age, so the supply of labour at all wage rates tends to
increase.
Migration particularly affects the supply of labour at the lower wage rates,
because migrants are usually from economies with average wages lower than the UK
minimum wage.
170
What are 4 examples of non-pecuniary benefits?
Amount of statuary leave (allowed days off work per year)
Potential to be promoted
Working conditions
Number of hours per day / Flexible working hours
171
Why is labour immobility a type of market failure in labour markets?
Labour immobility is the inability of workers to easily move between
jobs. It is a misallocation of resources.
172
Occupational mobility of labour definition.
When workers are able to move between
jobs as they have the appropriate skills or training.
173
Geographical mobility of labour definition.
When workers are able to move to different
places to seek and find work.
174
What are 6 causes of geographical immobility of labour?
Family / Social ties
Financial cost of moving / higher house prices / Higher living costs
Availability of housing
Imperfect knowledge of work
Transport links
Migration policy (e.g. EU migration policy)
175
What are 2 causes of occupational immobility of labour?
Skills & Education
Industry decline (e.g. coal mining)
176
What will happen if wages are too high or too low?
If too high:
High labour supply, but low labour demand
Excess supply leads to unemployment
In competitive markets, workers will be forced to accept lower wages or go without a job
The wage rate will fall to the market-clearing wage
If too low:
High labour demand, but low labour supply
Shortage of supply leads to job vacancies and lower output
Firms will be forced to pay higher wages to incentivise workers to work
The wage rate will rise to the market-clearing wage
177
How are wage rates determined?
Labour market equilibrium is determined where the supply of labour and the
demand for labour meet. This determines the equilibrium price of labour, i.e. the
wage rate.
178
Why did Keynes believe wages are sticky?
In the real labour market, wages are not very flexible and do not adjust to changes in demand.
The minimum wage makes wages sticky and means that during a recession, rather
than lowering wages of several workers, a few workers might be sacked instead.
179
What is the difference between the unemployment rate and the participation rate?
Unemployment rate: Percentage of economically active people who do not currently have a job but are actively looking for work.
Participation rate: Percentage of the population that is either working or actively looking for work.
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Economically active definition.
People aged 16-66 who are employed or unemployed (either working or actively looking for work).
181
Underemployment definition.
When an individual is employed, but their job does not fully utilize their abilities, or does not provide sufficient hours or pay to meet their needs.
182
What are 11 current labour market issues?
Skills shortages
Wage differentials
Labour immobility
Unemployment
Underemployment
Retirement age
Schooling age
Minimum wage / NLW
Migration
Flexible working and zero-hour contracts
Trade unions / Collective bargaining
183
What is marginal revenue product (MRP)?
MRP is the change in total revenue from the employment of an extra unit of labour.
A firm will employ an additional worker as long as MRP is positive.
Skilled workers usually have a higher MRP than unskilled workers, so are worth more to an employer.
184
What are the 6 characteristics of perfectly competitive labour markets?
Many buyers of labour (firms)
Many suppliers of labour (workers)
Perfect knowledge of wage rates, job available and market conditions
Homogeneous jobs
Homogeneous workers with the same skills and qualifications
No barriers to work
185
Why are skills shortages a labour market issue?
Inefficient allocation of resources as demand is higher than supply
Wages will rise in competitive industries, so the labour supply (if elastic) will increase
Productivity may rise as firms invest in capital to replace workers
However, firms may leave the country instead
186
Skills shortages definition.
Skills shortages are a type of labour market failure in which not enough labour possesses the skills demanded by employers.
187
Wage differentials definition.
The differences in wages between different groups of workers, or workers in the same occupation.
188
What are 3 causes of wage differentials?
Skills / MRP
Qualifications
Discrimination
189
Why is unemployment a labour market issue? (5 reasons)
Unemployed people have less disposable income and their standard of living may fall.
The government would receive less tax revenue from income and expenditure
The government would have to spend more on JSA payments.
There could be negative externalities in the form of crime.
When people are not working, their skills deteriorate. This makes it harder to find
a job, and it leads to long-term unemployment.
190
Why are the retirement age and schooling age labour market issues?
A higher retirement age and lower schooling age increase the economically active population, and therefore the size of the workforce. Older workers may have a higher MRP due to the experience they have built up over a long time. However, there is an opportunity cost involved with lowering the schooling age because a longer education would increase the quality of the workforce in the long-run. Older workers may also be slower and less able to do physical work.
191
Why is migration a labour market issue? (5 reasons)
Immigration are often of working age, so increase the size of the workforce and labour supply
Immigrants can fill labour shortages and skills shortages
There may be increased competition for jobs in some industries
If the immigrants are high-skill / from developed countries, they may increase productivity of firms and competitiveness of the UK
If the immigrants are low-skill / from developing countries, they may bring down wages in low-skill industries. This is because they are more willing to work for low wages, as the wages they were previously making were likely even lower.
192
What are 5 advantages of flexible working and zero-hour contracts?
Allows employers to manage variations in demand (seasonal demand, weather dependent)
Worker able to refuse work if doesn’t fit in with plans
More satisfied with their jobs than people in full time work (surveys)
Mothers and young people who need most their time elsewhere. People on the move
Easier to meet high and low levels of demand without hiring/firing
193
What are 5 disadvantages of flexible working and zero-hour contracts?
Employers may insist employees are self-employed, so that workers have fewer rights and they pay less tax
No holiday pay, no sick pay, long hours
Unlikely to make as much money as a full-time job
More difficult to take out a mortgage
Workers most vulnerable to economic downturns
194
Flexible working, Zero-hours, Gig economy definitions
Flexible working: Working conditions that better suit the needs of the employee, such as alternate working hours or working from home.
Zero-hours: A type of employment contract between an employer and an employee whereby the employer is not obliged to provide any minimum number of working hours to the employee.
Gig economy: A labour market characterized by the prevalence of short-term contracts or freelance work as opposed to permanent jobs.
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Why are trade unions a labour market issue?
Trade unions are national organisations whose role is to protect the welfare of their members.
Trade unions benefit from collective bargaining, opposed to the individual bargaining of workers not part of a trade union.
This gives workers better negotiating power, and if they can't reach an agreement, industrial action can be taken (e.g. strike, overtime ban).
This can lead to increased short-term costs (unproductivity) and long-term costs (higher wages).
196
What are the 4 aims of the NLW / minimum wages?
Reduce poverty (increase incomes for the lowest-paid workers)
Reduce wage differentials (reduce the wage gap between high income earners and lower income earners)
Incentive to work (increase the opportunity cost of not working to incentivise those economically inactive to re-enter the labour force)
Counter monopsonist (reduces wage setting power)
197
What are the 4 disadvantages of the NLW / minimum wages?
Creates unemployment (supply higher than demand)
Youth unemployment (older workers have a higher MRP due to experience. If they are receiving the same wage as young workers, young workers will be the first to be unemployed and last to be employed)
Increased cost to firms (become less competitive within the market and globally as may have to raise their prices to cover cost)
Doesn't take into account regional variations in cost of living (If the NLW is set according to the cost of living in the north, then it is likely to have little impact on those living in London)
198
What are two advantages of a maximum wage?
Reduction in the costs of labour for firms employing high skilled workers
Higher SNP can be spent on being dynamically efficient
Cost saving may be redistributed in the form of a wage rise to lowest paid workers, helping to decrease wage differentials
199
What are two disadvantages of a maximum wage?
Workers are paid based on their marginal revenue product, so don't receive the wage that a free labour market dictates they deserve.
Skilled labour may move to a country where they can make higher wages (decreases productivity and GDP).
200
Minimum wage definition.
The lowest pay workers are entitled to per hour.
201
Maximum wage definition.
The highest pay workers are entitled to per hour.
202
Who are public sector workers?
People who work in the compilation of industries owned by the government.
203
Why do the government have monopsony power? Why might the government be reluctant to increase the NLW? (public sector pay)
The UK government are one of the biggest employers of labour in occupations such as teaching and nursing. The government employ hundreds of thousands of people across the UK, and many of these workers are low-skill and paid the NLW. They have monopsony power as the workers have few alternative employers in the same career. If the government increases the NLW, there will be a large increase in labour costs for them, so government expenditure or the fiscal deficit will increase.
204
What 5 policies can the government use to tackle labour market immobility?
Improve transport infrastructure
Free government training schemes
Subsidise apprenticeships
Subsidise worker rellocation
Improve provision of job vacancy information
205
Why do private and public sector wages tend to rise at the same rate?
When public sector wages are frozen, private sector employers have an excuse to limit pay rises.
If private sector workers do receive pay rises, workers will move from the public sector to the private sector, so the government increasses public sector wages to prevent this.
As a result, the wages of public and private sector workers tend to rise by the same amount in the long-run, but in the short term they can rise at different rates.
206
Wage elasticity of demand definition
Measures how responsive the demand for labour
will be to changes in wages
%changeQd / %changeW
207
Wage elasticity of supply definition.
Measures how responsive the supply of labour will be to changes in wages.
%changeQs / %changeW
208
What happens when?
1. WED is elastic and wages increase
2. WED is elastic and wages decrease
3. WED is inelastic and wages increase
4. WED is inelastic and wages decrease
5. WES is elastic and wages increase
6. WES is elastic and wages decrease
7. WES is inelastic and wages increase
8. WES is inelastic and wages decrease
1. Firms make lots of workers redundant
2. Firms employ lots of additional workers
3. Firms make a few workers redundant
4. Firms employ a few additional workers
5. Labour supply will increase significantly
6. Labour supply will decrease significantly
7. Labour supply will increase by a small amount
8. Labour supply will decrease by a small amount
209
What 4 factors influence WED?
PED of the final product (if wages increase and the product has inelastic demand, the increased cost can be passed on to the consumer)
Proportion of wages to the total cost of production (if wages make up a small proportion, firms will only see a small change in costs)
The skill level and availability of substitutes (high-skill workers are more inelastic because they are more difficult to replace with machines. Low-skill workers are more elastic because if wages rise, it becomes more profitable to replace them with machines)
Time period (more elastic in the long run. In the short run there are employment and redundancy costs, and in the long-run firms can from workers to machines)
210
What 4 factors influence WES?
Level of qualifications & Training (too difficult, can't respond immediately)
Vocational element (natural talent required, too social/unsocial)
Non-pecuniary benefits & Compensating differentials (Additional benefits of the job)
Time period (in the long run can train and gain qualifications)
211
Government intervention definition.
When the government interferes with decision making by firms and individuals through regulatory action in an attempt to overcome market failure.
212
Why does the government intervene to control mergers?
The CMA investigates mergers that result in a combined market share of >25% or combined annual turnover of >£70m, to prevent uncompetitive behaviour in the market.
They aim to prevent firms from exploiting customers in the form of high prices, low quantity, low quality and less choice, by blocking mergers that will result in significant market share and monopoly power.
213
Why does the government intervene in markets? (4 reasons)
To control mergers
To control monopolies
To promote competition and contestability
To protect suppliers and employees
214
Why does the government intervene to control monopolies? (3 reasons)
Monopoly power allows the firm to be anti-competitive and exploit consumers, so they must be controlled to prevent this.
Monopolies are allocatively and productively inefficient when not controlled, as they have a profit motive.
Some natural monopolies, such as utilities (water, sewage, electricity), are too important to not be somewhat controlled by the government.
215
What are the 4 ways governments intervene to control monopolies?
Price regulation
Profit regulation
Quality standards
Performance targets
216
How does the government control monopolies through price regulation?
The government can set a price cap (such as RPI-X), which forces the monopoly to lower their price. Output will move from profit maximisation to, for example, allocative efficiency. Consumers will receive lower prices and there will be a smaller deadweight loss of economic welfare to society.
RPI-X is often used as it allows the firm to cover some inflationary cost increases, whilst decreasing real prices for consumers. It also forces the firm to become more efficient as they are receiving less revenue in real terms and will need to lower costs. X is the price decrease consumers will see in real terms.
RPI +/- K is sometimes used too. K is the percentage that allows the firm to make a large enough profit for capital investment.
217
How does the government control monopolies through profit regulation?
Profit regulation, such as "rate of return regulation", looks at the amount of profit the firm is making in proportion to the size of the firm or the amount of capital employed.
The government will regulate firms that are making disproportionate levels of profit through taxation. This incentivises the firm to increase their capital employed so that they can operate on a larger scale and keep their profits.
218
What is the disadvantage of profit regulation?
It creates an incentive for firms to be inefficient, as they aren't trying to lower costs to make high levels of profit.
It may also be wasteful, if it incentivises firms to employ more capital and produce at a higher quantity than the allocatively efficient quantity.
219
How does the government control monopolies through quality standards?
Monopolists will only produce high-quality products if it maximises profits. It may be more profitable to lower quality, and therefore costs.
The government can introduce quality standards, which will ensure that the firm offers a sufficient level of quality.
220
How does the government control monopolies through performance targets?
Performance targets can be implemented in order to ensure that firms are operating in the consumer’s interest.
These may be targets over price, quality, consumer choice or costs of production.
However, this may be ineffective if the firm can find ways to meet targets
without actually improving.
221
What are the 4 ways governments intervene to promote competition and contestability?
Enhancing competition between firms through promotion of small business
Deregulation
Competitive tendering for government contracts
Privatisation
222
How and why does the government promote small business to promote competition and contestability?
The promotion of small business is usually done through deregulation, subsidies, grants or tax incentives.
The increased competition and contestability will prevent X-inefficieny as firms can't become complacent. They will aim to produce along their AC curve and will likely become dynamically efficient.
223
How and why does the government deregulate to promote competition and contestability?
The government removes legal barriers to entry to allow private firms to compete. The increased competition forces firms to lower their costs and become dynamically efficient, so that they can improve their productivity and quality, lower their prices and not lose market share to the other firms.
224
How and why does the government privatise to promote competition and contestability?
The government sells off publicly owned organisations to the private sector. This increases contestability as new entrants feel they can compete more effectively with private firms that may have fewer resources available to them.
225
What are 4 disadvantages of deregulation and privatisation?
Deregulation may decrease contestability and competitiveness as it is easier for firms to be anti-competitive. It is also easier for firms to increase price and lower quality.
It can be too risky to deregulate/privatise some markets, as seen with the deregulation of financial markets before the global financial crisis.
It is difficult to deregulate natural monopolies as it would just increase their monopoly power, making the market even less contestable.
Deregulating monopolies can also result in duplication of services, such as local buses, which leads to congestion.
226
Privatisation definition.
When a firm or industry is transferred from the public sector to the private sector.
227
Deregulation definition.
Removing government legislation that could restrict competition.
228
How does the government use competitive tendering for government contracts to promote competition and contestability?
The government provides public goods as it is unprofitable for the private sector to do so. However, the government can contract out the
provision of a service to private companies through competitive tendering to make it profitable for them. This increases competition as private firms bid for the right to provide the service, and the firm given the right is the one that can do it at the lowest cost. This minimises costs for the government and ensures efficiency.
229
What is the disadvantage of competitive tendering for government contracts?
The private sector may not aim to
maximise social welfare in the same way the government would and could use
cost-cutting methods that reduce quality.
Also, the process of collecting bids can be costly and time-consuming.
230
What are the 2 ways governments intervene to protect suppliers and employees?
Restrictions on monopsony power of firms (e.g. minimum prices)
Nationalisation
Not in specification - Workers' rights
Health and safety laws
Employment contracts
Redundancy processes
Maximum hours
The right to be in a trade union
Minimum wage
231
How does the government restrict monopsony power of firms to protect suppliers and employees?
Passing anti-monopsony laws which make certain practices illegal (e.g. minimum price)
introducing an independent regulator who will force monopsonists to buy
fairly
Fines (of up to 10% of global annual turnover - The Enterprise Act 2002)
232
How does the government nationalise firms to protect suppliers and employees?
Nationalisation involves a private sector company or industry being brought under state
control, to be owned and managed by the government.
Unlike private firms, the government won't take advantage of monopsony power by paying suppliers and employees low prices and wages.
233
What are 4 impacts of government intervention on prices?
Prevents monopolies charging excessive prices
Ensures consumers pay fair prices
Ensures suppliers receive fair prices
Private firms can charge lower prices than public firms due
to economies of scale, but might not as they have a profit motive
234
What are 4 impacts of government intervention on profit?
Limits the amount of profit monopolies can make
Allows firms to make some supernormal profit so that they can be dynamically efficient
Public firms make lower profits than private firms due to
their inability to be efficient and lower costs
Private firms often have expertise and knowledge which the government might not have, so they can lower costs
235
What are 4 impacts of government intervention on efficiency?
Private firms (unless regulated) aren't allocatively or productively efficient because they have a profit motive and profit maximise
Price regulation prevents firms from being X-inefficient as they need to lower costs to maintain the same amount of profit
Some regulation can incentivise firms to be dynamically efficient, but too much regulation can result in low profits and no dynamic efficiency
Public firms are usually allocatively efficient as they aim to maximise economic welfare
236
What are 4 impacts of government intervention on quality?
Private firms often have expertise and knowledge which the government might not have, so they can increase the quality.
Regulation ensures private firms supply sufficient quality products
Public firms will aim to have high-quality products as they aim to maximise economic welfare
If private firms are pressured to lower costs, they may do this at the sacrifice of quality
237
What are 2 impacts of government intervention on choice?
If the market is a private competitive/contestable market, there will be more choice as there are more firms, and the firms will want to differentiate their products to gain market share and brand loyalty
Public firms will provide little choice as there is only one firm producing the good or service
238
What are the 2 limits to government intervention?
Regulatory capture
Asymmetric information
239
What is regulatory capture, and how does it limit government intervention?
Regulatory capture is when regulators become dominated by the interests they regulate and not the public interest.
This may occur if regulators are empathetic towards the firm they are regulating or if they are biased due to their personal connections within the industry
It limits the government's ability to intervene as the regulator may be ineffective, and may lead to government failure if it fails to bring about the social optimal position of the firm.
240
What is asymmetric information, and how does it limit government intervention?
Asymmetric information is when one economic agent has more information than another economic agent in a market.
In the case of government intervention, the regulatory bodies have to use information provided to them by the industries when setting price targets, performance targets etc.
It is in the industry’s best interest to maximise their profits and so may provide inaccurate or limited information, meaning regulators are unable to set correct targets, prices etc.
As a result, government failure may occur if regulation such as RPI-X or quality standards are not set correctly, as it fails to bring about the social optimal position of the firm.
This limits the ability of the government to intervene as they will be unable to regulate the firms accurately.
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Asymmetric information definition.
When one economic agent has more information than another economic agent in a market.
