Topic 6 - Market Structures Flashcards

Question

Perfect competition is not dynamically efficient, what may this mean for investment ?

Answer 1

there is underinvestment in the market in the long run Dynamic efficiency requires innovation and research over time, which needs supernormal profits. Perfectly competitive firms only make normal profit because any abnormal profits would be immediately competed away. So perfectly competitive firms are not dynamically efficient

Answer 2

Firms that are perfectly competitive make no supernormal profit long term. Any supernormal profits will signal to competing firms to enter the industry and competing away the profits. As new firms enter the industry, supply shifts right to S1. Firms must start to produce at their minimum average cost, so only normal profits are made. Low barriers to entry and perfect information make this possible. But perfect information may not exist in reality. Perfect competition is JUST A MODEL

Answer 3

Electricity Farmers markets

Answer 4

Electricity is a homogeneous good. When it is being consumed, there is no way of knowing in which power plant it has been produced or whether it has been produced by gas, coal, solar, wind or hydro power plants. Over the last decade, households who generate their own electricity (e.g. using solar power), have been able to sell what they don’t use back to the national grid. There are lots of electricity sellers in the market Price comparison websites make information more widely available and the wholesale price of electricity is available on a public market. But there are some barriers to entry for a household to make electricity (solar power cells) and sell it to the National Grid

Answer 5

At a farmers' market, there are dozens of farmers from a local areas selling homogenous goods like potatoes and tomatoes. Information is readily available- walking around a few stalls will give a good idea of price. There are some barriers to entry, like the cost of a stand and the need for farm equipment. No market is exactly like perfect competition, but we can use the model of perfect competition to predict what outcomes for consumers and firms will be.

Answer 6

In a fish market, there are very low barriers to entry, many buyers and sellers and good price information for consumers, as well as very similar goods - these are all characteristics of a market in perfect competition. But goods are similar but not identical and, partly as a result of this, sellers are able to charge different prices to consumers for the same good. This suggests that the price could be above the cost and so it is possible to make supernormal profits in the long-run. So a fish market could be quite close to perfect competition but not the same. But perfect competition is a very theoretical model with many assumptions.

Answer 7

There is product differentiation between many small to medium-sized firms. E.g Mars bars are not the same as Dairy Milk. This means that firms in an industry can compete on things other than price (e.g taste of chocolate). The larger the differences in product, the more inelastic demand is. There is price and non-price competition. The barriers to entry are low to medium. Firms can have some price-setting power and there can be brand loyalty.

Answer 8

Each firm has some price-making power in monopolistic competition. This means the demand curve slopes downward. Firms will try to maximise profits by producing where marginal cost is equal to marginal revenue. This is at a higher price than is allocatively efficient. Firms make supernormal profits in monopolistic competition. This model is more similar to the model of monopoly

Answer 9

The supernormal profits that firms are earning signals to other firms that they should enter the industry. There are low barriers to entry, so they can join the industry and compete away the supernormal profits in the long run. So firms only make normal profit in the long run. This isn't allocatively efficient as the price is too high, or productively efficient as they are producing above the minimum average cost. But, it is more efficient than under a monopoly situation

Answer 10

Dynamic efficiency needs firms to make supernormal profits. Firms in monopolistic competition only make abnormal profits in the short run. There could be dynamic efficiency if they manage to use non-price competition to maintain supernormal profits. But this is unlikely because of the lower barriers to entry

Answer 11

Prices under monopolistic competition tend to be higher than under perfect competition. Under monopolistic competition, there is product differentiation. This means that firms can spend money on advertising their product for non-price competition. This increases the overall cost of producing and marketing the product. Firms in perfect competition would not need advertising because we assume there is perfect information. Firms in monopolistic competition have decide to limit output to maximise profits.

Answer 12

Non-price competition is a way for firms in monopolistic competition to make supernormal profits for a sustained period through generating brand loyalty and giving some price-setting power.

Answer 13

Marketing Special offers Customer service Quality of good/service

Answer 14

Advertising can allow a firm in a competitive market to create a brand image which will allow them to retain customers and achieve some price-setting power. This is usually an expensive process.

Answer 15

Promotions can help to attract customers initially, without having to reduce the market price for all customers. This may allow firms to retain some price-setting power

Answer 16

Providing excellent customer service can help to generate brand loyalty and allow a firm to set a higher price than competitors without losing sales. However, this is likely to cost money and so may have an impact on profit.

Answer 17

Providing a higher quality service may increase a firm's costs but can allow them to charge a much higher price and therefore to make supernormal profit for a continued period of time. Even just the perception of higher quality may be sufficient to charge a higher price!

Answer 18

Pubs Hairdressers Airlines

Answer 19

Most pubs offer a similar service, with similar menus & drinks, but prices can vary across pubs. Pubs can differentiate themselves on service, atmosphere (like Brewdog), the quality of food (gastropubs) or location (like bars with good views of London). Consumers can become loyal to a brand over time and keep going back to the same pubs. They generally provide similar goods and services, but can differentiate their offering to get some degree of monopoly power

Answer 20

Hairdressers offer essentially the same service but with variations in quality and the price charged. There can be quite low barriers to entry but brand loyalty and reputation are very important to the success of a business. Some hairdressers can make significant and sustained profits by charging much higher prices for a superior service.

Answer 21

Airlines operate in a monopolistically competitive market. They each provide a travel service with a number of firms offering essentially the same service – flying to and from the same countries, often the same cities and sometimes the same airports. Different companies have different brands - e.g EasyJet's orange uniforms and planes. Airlines compete on service, reputation and sometimes price. Price comparison websites like Skyscanner allow customers to compare prices easily.

Answer 22

Non-price competition

Answer 23

an industry which is dominated by a few firms

Answer 24

A few firms with a high concentration ratio and significant price-setting power. Supernormal profit in the short-run and long-run. Barriers to entry are relatively high. Product differentiation. Interdependence between firms. But they can often implement collusive strategies. Oligopoly can be defined through either its conduct (collusive or competitive), or its structure.

Answer 25

Concentration ratios measure the power of the firms in an oligopoly. If there are four firms in an oligopoly that take up 76% of the market, then the four-firm concentration ratio is 76%.

Answer 26

The n-firm concentration ratio is a measure of market structure. It combines the market share of the top n firms as a % of the total market. E.g If the top 3 firms control 80% of a market, the 3-firm concentration ratio is 0.8.

Answer 27

Firms in an oligopoly are interdependent. Their pricing and product strategies depend on the behaviour of the other firms. The prisoners' dilemma shows us that firms can receive a greater payoff by colluding. Firms can agree to raise prices.

Answer 28

Formal collusion Tacit collusion

Answer 29

Formal collusion: a spoken agreement between firms to keep prices high.

Answer 30

Tacit collusion: an unspoken agreement between firms. Tacit collusion often works through price leadership. Here, it is in both firms best interest not to change prices

Answer 31

In a non-collusive oligopoly, firms compete with each other on a number of factors, including price. Non-collusive oligopolies are a common type of market structure

Answer 32

Non-collusive oligopolies are more likely when we see: Low entry barriers, a high number of firms, and different marginal costs. Collusive oligopolies are more likely when we see: High entry barriers, low number of firms, and similar marginal costs

Answer 33

Firms in an oligopoly may engage in a price war. By fiercely cutting prices (sometimes called 'predatory pricing'), firms are trying to gain market share. The idea is that by aggressively cutting prices, you will drive other firms out of the market because they can no longer compete. New firms will be discouraged to enter because of the low profits being made. Once firms have been driven out of the market, non-price competition can be used to maintain market share.

Answer 34

Informal collusion is less likely than it may appear, as one firm tends to defect, which brings down the entire cartel. This could lead to price wars, which are good for consumers due to the lower prices. Collusive oligopolies can achieve dynamic efficiency through non-price competition and product development. Competitive oligopolies also have the potential to be very efficient

Answer 35

Big 6 energy companies Coca-cola and Pepsi Mobile phone networks

Answer 36

Although this has since reduced, the 'Big Six' UK energy providers controlled virtually all of the gas and electricity markets. They have been accused of price fixing by politicians and made such large profits that there were calls for a special, one-off tax on these. The CMA has investigated this industry recently and it is under constant scrutiny. There are high barriers to entry and brand loyalty, mainly due to customers not switching to cheaper suppliers when this is possible

Answer 37

Technically, a market with two dominant sellers is called a duopoly. However, the interdependence and behaviour of these firms would be the same with three or more sellers and so Coca-Cola and Pepsi could be considered here. They have such strong brands that barriers to entry are very high and they also have strong price-setting power. Coca-Cola and Pepsi are also very dependent on each other in terms of their price and promotion levels.

Answer 38

There are several main mobile phone service providers in the UK, including Vodafone, EE, O2, etc. There are high barriers to entry due to the need to have a licence to operate and these firms spend heavily on marketing and promotions to gain customers. BT bought EE for £12.5bn after the CMA approved the deal, deciding that it would not cause there to be a substantial reduction in the level of competition.

Answer 39

a scenario where the benefits from cooperating are larger than the benefits of pursuing self-interest.

Answer 40

The Prisoner’s Dilemma is a type of game theory. This is a branch of mathematics where one analyses situations in which players must make decisions and then either benefit or lose out from the decisions of other players

Answer 41

Two criminals are arrested. When they are taken to the police station, they refuse to say anything and are put in separate interrogation rooms. Eventually, a police officer enters the room where Prisoner A is being held and says: “You know what? Your partner in the other room is confessing. Your partner is going to get a light prison sentence of just one year, and because you’re remaining silent, the judge is going to stick you with eight years in prison. If you confess, too, we’ll cut your jail time down to five years, and your partner will get five years, also.” Over in the next room, another police officer is giving exactly the same speech to Prisoner B. What the police officers do not say is that if both prisoners remain silent, the evidence against them is not especially strong, and the prisoners will end up with only two years in jail each.

Answer 42

If the two prisoners had both stayed silent, they would serve a total of four years in jail time between them. The prisoners would be better off if they cooperate with each other and neither confesses. If they pursue their own self-interest, they could receive longer jail terms.

Answer 43

If oligopolists cooperate in reducing output, then everyone can maintain high profits. If an oligopolist is pursuing its own self interest, however, then they would increase its output and then earn even more profits. Firm A being cheated by Firm B If A thinks B will cheat and increase their output, then A will also increase their output. This means that both firms receive £400 in profits. This is better than the profit of £200, which will happen if A doesn’t change their output levels. But this is lower than the £1,000 which A would have if B stuck to their agreement. Firm A cheating Firm B On the other hand, A could believe that B will stick to their agreement. If so, they will want to take advantage of this and raise their own output. This means that they will receive £1,500 in profits. Their competitor, B, will only have £200 in profits. Overall, it is in the best interest of Firm A and Firm B to both cooperate. Ultimately, however, they need to trust each other

Answer 44

To maintain high profits

Answer 45

Increasing punishments Keeping markets competitive Whistle blowing

Answer 46

If there is a very significant fine for collusion then firms are less likely to collude. British Airways was fined £270m in 2007 for colluding on price with another airline, Virgin Atlantic.

Answer 47

By keeping the number of firms in the market high they make it harder for firms to agree on colluding, reduce the payoff and increasing the chance of a whistleblower.

Answer 48

Encouraging firms to come clean about collusion, without them being punished, makes it more likely that collusion will be revealed.

Answer 49

Firms who collude or form cartels make the market less competitive and exploit their customers

Answer 50

Firms colluding can result in outcomes similar to a monopoly. Because of this, consumers are likely to have lower consumer surplus and producers will have higher producer surplus. Firms colluding on price will restrict their output and raise their prices closer to the profit maximising level (marginal cost equals marginal revenue). This creates a deadweight welfare loss to society and is statically inefficient. But firms will still compete in non-price competition, particularly through marketing.

Answer 51

A non-collusive oligopoly will still have a deadweight welfare loss, because output will not be at the statically efficient level of product that would be created under perfect competition. However, output is likely to be higher and prices are likely to be lower than in a collusive oligopoly.

Answer 52

OPEC is an organisation that coordinates 15 oil-producing countries. They try to manage the supply and therefore the price of oil for the benefit of their members

Answer 53

Despite the fact that there are 15 members, the oil-producing countries could be said to operating as a collusive oligopoly as they regularly meet and coordinate their output to manage the price of oil. There are clearly high barriers to entry and supernormal profits in the long-run. The countries are also interdependent.

Answer 54

Having so many members can make it extremely difficult to coordinate and control total output. The temptation for governments to 'cheat' and sell a little more oil to boost revenue is high as it is so lucrative. This drives the market price of oil down

Answer 55

Price stability in oligopolies

Answer 56

It relies on the assumption that if one firm raises price, no-one will follow, and if a firm lowers price, then everyone will follow. There is an equilibrium price. Any price above this, the demand curve is elastic; any point below, it is inelastic. So if a firm raises its price, the fall in quantity sold means total revenue will fall. If a firm lowers its price, the other firms in the oligopoly will follow. This position is stable.

Answer 57

The 'kink' is at the current market price which other small number of other firms in the market already set at. Initially the firm also chooses to produce at that price. Demand above the current market price is elastic and below the current market price is inelastic.

Answer 58

If the firm chooses to raise its price, rivals stick at the original price and steal their customers. If the firm chooses to lower its price, rivals will follow and cut their own prices in order to maintain their market share. As a result of the market price falling there is a small increase in quantity demanded but it's shared among all the firms in the market. Prices remain stable at the kink point because each firm knows if they increase or decrease their prices they'll lose profit.

Answer 59

The reward for collusion rises

Answer 60

A Nash Equilibrium is the point in the Prisoners' Dilemma problem, where both players are getting the best outcome possible, assuming that what the other player does is already fixed.

Answer 61

Confess-confess Both prisoners remaining silent is not a Nash Equilibrium because if Player B is fixed at remaining silent, Player A would get 1 year less in jail by confessing. If the other player confesses, moving from confessing to remaining silent adds 3 years to the prisoner's jailtime.

Answer 62

The model This is a two-player game illustrating game theory. Imagine there are two suspects being interviewed separately by the police accused of jointly committing the same crime. Importantly the prisoners can't talk to each other during the interrogation. Each prisoner has the choice between 'staying silent' and 'confessing'. With cooperation The prisoners' dilemma explains why firms cooperate with each other. Players without cooperation reach a Nash equilibrium, where no single player can achieve a superior outcome by moving because of uncertainty. This is, confess confess, where both prisoners get 5 years. Without cooperation With cooperation, firms can both agree to switch and achieve a mutually better outcome. They can agree to remain silent and get 2 years. By colluding, the firms can make higher returns Prisoners' dilemma - defecting The prisoners' dilemma also explains first mover advantage. Having both colluded, if one player defects, their outcome improves further. This is why some firms may choose to defect when they are in a cartel/oligopoly, like The Organization of the Petroleum Exporting Countries (OPEC).

Answer 63

Posner (2003) - The Social Costs of Cartels (Oligopolies)

Answer 64

Posner did research into the impact that oligopolies had on markets, prices and consumers. Posner found that the cartel in the aluminium industry caused a 100% increase in price with a 'social cost' worth 75% of the aluminium industry's total sales.

Answer 65

The number of firms in the industry The interest rates The frequency of sales The ease of detecting cheaters The ease of market entry The regularity of orders The cyclicality of the industry

Answer 66

Lots of businesses - having to co-ordinate between lots of businesses makes collusion harder.

Answer 67

High interest rates - because interest rates are high, future profits are discounted more heavily, so cheating today is more attractive.

Answer 68

Easy to detect cheating - things like price comparison sites can make cheating very obvious.

Answer 69

Easy market to enter - Motta (2004) shows that if it is easy to enter a market, firms are less likely to collude as a new entrant

Answer 70

Cyclical industry - Rotemberg & Saloner (1986) found that cyclical industries that do well in booms and badly in recessions are less likely to collude. They will all have spare capacity in a recession and will have an incentive to cheat.

Answer 71

Motta found that if orders are placed more regularly, then businesses are more likely to collude and less likely to cheat. If orders are regular and small, then the profits made each month are relatively small. If there were 1 large contract every 2 or 3 years, then there would be an incentive to cheat and try to win the contract.

Answer 72

Saloner Rotemberg

Answer 73

A pure monopoly is where one firm dominates a market for a good or service

Answer 74

Monopolies are price-setters. They choose the price at which the product is sold. Monopolies can get monopoly power legally: E.g a patent can stop other firms from entering a market. E.g a convincing advertising campaign that suggests a particular brand of drink is better than others can lead to a higher market share. E.g an industry may not have many firms competing within it

Answer 75

The monopoly demand curve is downward sloping. It will aim to maximise profits and so produce where marginal cost (MC) is equal to marginal revenue (MR). Here, supernormal profits are made. These profits are made in the long run also. The supernormal profits can be reinvested and dynamic efficiency can be achieved in the long run.

Answer 76

The monopoly is not productively efficient because marginal cost is not equal to average cost. The equilibrium price in the long run is above marginal cost. So it is not allocatively efficient either. Pm is above Pc.

Answer 77

Limited competition in the market - when there are only a few firms in a market, they will usually have some pricing power. Differences in products and advertising - firms may gain price-making power if consumers want their products more than others. Barriers to entry stopping new competitors from joining the market.

Answer 78

Where firms are price setters in the market, we assume they will aim to maximise profit by setting the output and quantity where marginal revenue equals marginal cost. This is profit maximising as if the firm produced any more then the cost of producing each extra unit would be greater than the extra amount earned by selling that unit.

Answer 79

Dynamically

Answer 80

A monopoly can benefit from economies of scale. E.g a firm could bulk buy on raw materials because they have a large market, reducing cost per unit. Dynamic efficiency can be achieved if a firm wants to reinvest its profits. Monopolies can create employment and jobs, like businesses in other industries. The ability to invest lots of profits in R&D and intellectual property can benefit the firm and society with new advances e.g Bell Labs in the USA invested heavily in Telecoms.

Answer 81

Consumers have fewer products to choose from. There is no guarantee that a monopoly will reinvest their profits and achieve dynamic efficiency. By the same logic, firms may not actually improve overall efficiency, even though they have the ability to do so.

Answer 82

Some industries have very high fixed costs. These industries may be natural monopolies. Natural monopolies are characterised by endless economies of scale, so the long run average cost continues to fall as output increases. In a natural monopoly, having one firm is usually more efficient than having two firms. For example, in the railways, it doesn't make sense for two firms to lay railway tracks next to each other. This would be inefficient.

Answer 83

High fixed costs High barriers to entry

Answer 84

to capture consumer surplus (the difference between someone's willingness to pay and the price they pay)

Answer 85

The groups being discriminated between must have a different price elasticity of demand. There must be a way of stopping arbitrage opportunities that arise from consumers buying cheap, and selling to those who have been charged a higher price. The firm discriminating must be a price-setter.

Answer 86

First degree price discrimination involves a complete transfer of consumer surplus (the disparity between the price the consumer is willing to pay and the actual product price) to the producer. This is because each customer is charged the very maximum they are happy and able to pay for a good or service.

Answer 87

This method is rarely used because of asymmetric information, and the difficulty of gathering information on every customer.

Answer 88

Second degree price discrimination involves charging different prices based on the quantity purchased. The more you purchase, the cheaper the product. This generates revenue from part of the consumer surplus that has been transferred. It also rewards customers for making larger orders. Bulk buying from a wholesaler like Costco may lead to cheaper prices. This is second degree price discrimination.

Answer 89

This charges different prices to customers based on which segment they are in - different age groups, geographies and industries. Software companies like Balsamiq charge different prices for non-profits. This is based on the idea that different segments of a market will have different price elasticity of demands. Profits are maximised when the price is set where marginal cost is equal to marginal revenue for each particular segment. Firms with more inelastic demand will be charged a higher prices

Answer 90

Consumers with more inelastic demand will be charged a higher price. They will receive less consumer surplus than if a firm could not segregate the two groups.

Answer 91

Price discrimination will lead to increased revenue for the firm. Higher profits could be reinvested and improve dynamic efficiency. Price discrimination often means that those with higher incomes pay more for a good or service than those with lower incomes. This may help cross-subsidise products so that poorer people can afford them. E.g Google Chromebooks in schools. To decide whether this is fair and improves equality or not, we need to make a value judgement

Answer 92

Price discrimination isn't allocatively efficient. This is because the price is greater than marginal cost. Some may argue that consumers paying a different price for the same good or service is unfair. This is more of a moral or normative judgement though.

Answer 93

A monopsony is a market where one firm purchases all the supply in a market. A common case study is a situation where one firm dominates the hiring in the market.

Answer 94

In a perfectly competitive labour market, a firm will hire where supply is equal to the marginal revenue product (MRP). A monopsony employer looking to maximise profits will hire labour at the point where the MRP is equal to the marginal cost. At this point, the wage is lower than under a perfectly competitive labour market. At each wage, the number of workers willing to work is shown by the average cost curve. Marginal cost is above average because they have to attract new workers with the prospect of a higher wage, while also paying existing staff more to compensate.

Answer 95

For a firm to have monopsony power, there must be one buyer and many sellers. The monopsony buyer will be a price setter or wage setter. Amazon may have buying power with books and companies like Nokia which dominated the Finnish economy may have some monopsony power.

Answer 96

A trade union could act as a minimum price in a monopsonistic market. This could increase wages & workers' welfare

Answer 97

Natural monopoly

Answer 98

how easy it is for firms to enter and leave a market

Answer 99

The level of contestability is related to the barriers to entry. If there are low barriers to entry in an industry, it is more contestable and easier to enter that market. Sunk costs refer to the cost of leaving an industry. Sunk costs cannot be recovered. For example, if Adidas invested in specific capital machinery to build shoes, this is likely to be unrecoverable. If sunk costs are high, a market is not very contestable.

Answer 100

High levels of advertising can increase brand loyalty and act as a barrier for new firms trying to enter. If firms are vertically integrated, they may have a monopoly over resources

Answer 101

Marketing Vertical integration Sunk costs Patents Limit pricing

Answer 102

In established markets, with a small number of major firms, the firms are recognisable to consumers and brand loyalty has been established. These firms can spend a significant amount on advertising to keep their brands popular. New firms would have to spend money on marketing and advertising in order to make their brand known and attract customers away from the established firms. For small firms or start-ups this considerable cost can be enough to put them off entering a market.

Answer 103

Large firms can use vertical integration to discourage new entrants. If a firm acquires a large proportion of the suppliers in the market they can make it difficult for new entrants to find suppliers themselves. The same is true for distributors. If new entrants can't easily find suppliers or distributors then they won't be able to enter the market.

Answer 104

Sunk costs are the irretrievable costs involved in entering a market. This could be in the form of licenses, research and development and capital which can't be resold. New firms can struggle to raise the funds required to pay these sunk costs which reduces their ability to enter the market. It can make it harder for firms to achieve normal profit which also discourages entry. An example of sunk costs are the costs of exploration for oil firms when deciding where to build their wells.

Answer 105

Patents prevent firms from copying protected technology and products without the patent holder's permission. Firms can negotiate a license fee for using a patented technology or product. This raises their costs. Patents are used to encourage innovation by guaranteeing that the firm who develop a new product or technology get the first opportunity to get a financial reward for doing so. Patents can lead to monopolies while they are in force.

Answer 106

Limit pricing is a strategy whereby established firms in a market set their prices low enough to discourage new firms from entering the market. If a new entrant can only afford to price at the red dot to cover its variable costs, an incumbent could cut price from A to B, in order to stop a new firm entering the market. If it considered sunk costs, it would not be able to make a profit. This is called predatory pricing. If the market price is too low then the new entrant can't make normal profit and they will not enter.

Answer 107

Hit-and-run entry Competing on quality Higher investment in R and D Development on new technology

Answer 108

Supernormal profits act as a signal to other firms. If barriers to entry are low, firms will come into the market and try to compete away the supernormal profits, then leave. This is known as hit-and-run entry.

Answer 109

As a result, incumbent firms will innovate to try maintain their market share. Some incumbent firms may lower price temporarily, until they have market dominance. They may try innovate their service and improve its efficiency to compete. They will compete on a number of non-price factors. Firms in this kind of market will strive for productive and allocative efficiency in the long run. This is because of supernormal profit being competed away.

Answer 110

Technology change can change the structure of a market. The efficiency of one or more factors of production may increase. Technology can also create or lower barriers to entry. Technology can also create monopoly power. First mover advantage may be possible if only one firm has a new technology. Technology can lead to bigger economies of scale.

Answer 111

The introduction of a new technology to an industry can 'destroy' the old product. E.g Netflix and online streaming services are taking over from free-to-air television. As a process, it is important because it highlights that large firms are still vulnerable to new technologies. So large firms must continue to innovate. It was Schumpeter who called this 'gales of creative destruction'.

Answer 112

Productive efficiency In a competitive market, firms who can produce goods and services using the fewest or cheapest resources can set the lowest price. Consumers would choose between identical goods based on price, therefore, the cheapest producers would win the customers. Allocative efficiency In a competitive market, firms chose what to produce based on what can generate the most profit from the resources they have. Each firm then looks at the market prices of goods and services and compares them to the costs of production. They then produce the most profitable goods. As price is based on the value of the goods and services, firms will be producing the most valuable goods and services to a market.

Answer 113

Firms aren't the only agents who compete in a market, consumers do too. When resources are scarce, consumers compete by offering more and more money for goods and services up to the amount they are willing and able to pay. As a result, those consumers who are willing and able to pay the most of a good or service gets to consume them.

Answer 114

Monopoly Competitive oligopoly

Answer 115

Explain the monopoly model Economic theory states that a monopoly is a market structure where there is a single firm. In practice, we take monopolies to be firms with over 25% market share. Monopolies are price-setters, meaning they face a downward sloping demand curve and can make supernormal profits, even in the long-run. Argument that monopolies are bad Monopoly markets are not productively efficient because they do not produce at the point where marginal cost equals average cost. The monopoly price is also set above marginal cost in the long run so the market is allocatively inefficient. Overall, the outcome is one where prices are higher than they would be under perfect competition and output is restricted. There is a deadweight loss to society and consumers can be exploited. Argument that monopolies are not bad Monopolies can achieve economies of scale as they are the dominant provider. Firms like Apple can, therefore, reduce their costs by expanding iOS technology and transfer this into lower prices for consumers. Supernormal profits also enable Apple to reinvest in the market. They can then achieve dynamic efficiency and innovate new products. Apple uses its monopoly position to engage in R&D, announcing new technologies and improvements every year. Evaluate Firms do not always reinvest their profits even when they have the ability to do so. Apple may be fighting to appease shareholders and profit maximise. The extent to which monopolies are bad may also depend on the levels of UK regulation.

Answer 116

Explain oligopolistic markets Oligopolistic markets are highly concentrated with a few dominant firms. Oligopolies can be collusive or competitive depending on the specific industry and circumstances. The 'Big Four' supermarkets are oligopolistic as their actions are interdependent. Argument that they lead to worse outcomes The 'Big Four' have been accused of tacit collusion, whereby one changes the price and the others follow. This leads to an uncompetitive outcome where prices are higher and consumers suffer. Argument that they do not lead to worse outcomes The supermarket industry is often engaged in price wars because they sell similar products. For example, milk is sold at a relatively stable and low price across the 'Big Four' because if someone raises the price, the others will gain market share. This is good for consumers. Price leadership also often breaks down as game theory shows us that there is a high incentive to defect and cheat the others. The 'Big Four' also engage in non-price competition which leads to innovation and new differentiated product ranges. Evaluate Overall, oligopolies are not necessarily bad for consumers but it depends on how the firms interact. Price wars and non-price competition are beneficial. However, if the market suffers from collusive practices then the outcomes are worse.

Answer 117

Nevo used the Lerner Index to examine the price elasticities of demand and whether the cereal businesses were colluding. Nevo thought that a Lerner Index of 70% would suggest collusion, whilst a Lerner Index of 40% would indicate no collusion. In 1995, the Lerner Index was 45%. He concluded that there was more product differentiation and competition than in an oligopoly.

Answer 118

The herfindahl index The Lerner index

Answer 119

It is a derived demand (a demand resulting from demand for something else) from demand for goods and services that labour can produce

Answer 120

The demand for labour is a form of derived demand. If the demand for a product increases, the demand for labour needed to produce the products will increase. Labour is only employed if they provide a net benefit to the firm

Answer 121

The marginal revenue product (MRPL) is the additional revenue from hiring one more worker. It is useful for the firm to continue hiring up until the MRP from the last labour input is equal to the marginal cost (cost of employing new employees). This assumes the wage is equal to the marginal cost - like in a perfectly competitive labour market. Firms should only employ workers that increase revenue by a greater amount than their cost to the firm. According to marginal productivity theory, MRPL determines demand.

Answer 122

Marginal revenue product (MRP) = marginal physical product of labour (MPP) × marginal revenue (MR).

Answer 123

Elasticity of demand for labour is a measure of how much demand for labour changes as wages change. Elasticity of demand for labour = % change in the quantity of labour demanded ÷ % change in the wage rate.

Answer 124

In the long run, it is more elastic. This is because there is more time to find a replacement worker. The easier it is to replace a worker, the more elastic the demand is. The more price elastic the demand for the product is, the more elastic the demand for labour will be.

Answer 125

If a firm can easily swap labour for capital (e.g. for machines) - demand will be elastic. If wages only make up a small amount of total cost - demand will be inelastic. Increases in wages won't have much effect on total costs. If wages make up a large amount of total cost - demand will be elastic. Increases in wages can have a great effect on total costs.

Answer 126

At point C, the firm should hire more workers as the MRP is above the MC of labour. Point B is the optimal amount of labour employed. At point A, the MRP each worker brings is less than the cost to hire them. This is not optimal.

Answer 127

The workers wage

Answer 128

Change in demand for good/service Number of firms Technology Education Government legislation

Answer 129

Demand for labour is based on the demand for the good or service being produced by a firm. E.g. the more new cars consumers demand, the greater the number of workers needed to produce them. Demand for labour is called a "derived demand".

Answer 130

An increase in the number of firms producing a product will increase demand for labour.

Answer 131

Technology can act as a substitute for labour. E.g the introduction of word processing decreased the number of typists needed. But technology can also act as a complement to labour. E.g the increased word processing has led to an increased demand for IT workers.

Answer 132

An increase in workforce education can cause an increase in the demand for labour. This is because greater education means the labour has more skills to offer firms, making them more productive and therefore more valuable.

Answer 133

Government regulation can increase or decrease demand for labour.

Answer 134

A movement along the labour demand curve

Answer 135

The demand for labour is more inelastic if labour costs are 1% of the total costs versus 50% of total costs. At 1% of the total cost, a doubling of wages increases the cost base by 1%. At 50% of total cost, a doubling of wages would increase the cost base by 50%.

Answer 136

Individual labour supply Occupational labour supply

Answer 137

Individual labour supply = the number of working hours labour are willing to work at a particular wage rate for a job. If wages rise, individual workers are incentivised to work more hours.

Answer 138

Occupation labour supply = the number of employees who will work at their wage rate. If wages rise, more people (employees) are attracted to an occupation. The supply curve for occupational labour is upward sloping.

Answer 139

the benefits a job offers on top of the wage (monetary) that attract prospective workers

Answer 140

The welfare that workers get from working is determined by both monetary and non-monetary factors.

Answer 141

Wages provide money which employees can use to buy goods and services. Purchasing these goods and services gives utility or welfare. Monetary factors therefore contribute to net advantage

Answer 142

Non-monetary factors that can give workers utility or welfare include: Free food (e.g the free breakfast & lunch offered for employees at Google). Dental care. Gym facilities. Training. Job satisfaction.

Answer 143

If someone is satisfied in their work, they may gain more welfare from their job. The non-monetary benefits contribute to the level of satisfaction. If an employee has high levels of satisfaction, they may settle for a lower wage because the non-monetary considerations make up for this.

Answer 144

The backward bending supply curve is a theory in which after a certain point, rising wages lead to a reduction in labour supplied. Initially as wages rise it becomes more valuable to work rather than to take leisure, due to the substitution effect of work becoming more beneficial. After wage W, the benefit of the extra money earned diminishes and instead labour chooses to take more leisure rather than work as long. This is due to the income effect.

Answer 145

Number of workers Education Wage rates Advertising Government policies

Answer 146

An increase in the number of workers will shift the supply curve right. This could be due to several factors: E.g increased immigration because of joining organisations like the European Union. If there's a shortage of skilled workers in a country, net migration of workers to that country can help to boost labour supply. Many countries need workers seasonally, especially for industries like the agricultural industry. So net migration can help boost labour supply during these periods too.

Answer 147

The higher the level of required education, the lower the supply of workers for that particular job. This is because not as many people in society (or the world) will have the necessary skills.

Answer 148

Workers will probably be drawn to higher paying jobs over others. The higher the wages, the greater the supply to that job

Answer 149

If a job is poorly advertised then less people will know that a job exists. If a job is well advertised, perhaps on recruitment platforms like talent.io or Linkedin, then the supply of labour for that job is likely to rise. In this case there is better information in the market.

Answer 150

Government policy can increase or decrease the supply of labour. E.g a government may support rules that set high qualifications for particular modes of work, which will decrease the number of qualified workers and the supply of labour at a given wage. Or the government may offer subsidies for nurses to gain their qualifications. A policy like this will increase the supply of labour.

Answer 151

Imperfect information Labour immobility Trade unions

Answer 152

There may be an asymmetry of information between employers and employees. This means that employers may not realise the actual value of an employee to the firm. This means that the employer may not pay them the correct wage according to their marginal revenue product.

Answer 153

Geographical immobility: not everyone can move to a different area for a job. Geographical immobility is the inability to change location for work. E.g it may not be feasible to work in London if you are from Manchester. Occupational immobility: it isn't always easy to switch to a new career if your skills are not transferrable. Occupational immobility is the inability to change careers. E.g former industrial workers may not be able to move into a services-based role as they do not have the skills.

Answer 154

Trade unions try to change the balance of power by forming an organisation of workers and dealing with employers as a group. These negotiations are often called collective bargaining. 1000 workers negotiating together are usually more powerful than 1000 workers negotiating separately. Critics argue that these unions disrupt the market, grabbing as much as they can in the short term, even if it blocks new technologies that could lead to economic growth in the long term.

Answer 155

Improves geographical mobility

Answer 156

Bowles et al (1983) argue that there is. Their research paper claims that workers put in more effort and are more productive when the threat of them losing their job is higher. Agell & Lundberg (1995) surveyed managers and the managers believed that workers put in more effort if local unemployment was higher than when local unemployment was lower. Lazear (2013) argues that many of the improvements in productivity after the 2007-8 Global Financial Crisis came because workers were putting in more effort because unemployment was higher.

Answer 157

Whether large, centralised trade unions (likely containing all workers in an industry) or tiny trade unions of small groups of workers led to higher unemployment. They found that a middle ground, between huge centralised unions & tiny powerless unions led to the highest level of unemployment. Huge, powerful trade unions recognise that they have a lot of power to determine wages and employment and take this into account. Small trade unions, like those at an individual factory have some power, but not enough power to affect the whole market hugely. Intermediate trade unions have market power and affect wages, but are more likely to ignore the impact that their demands have on the whole labour market.

Answer 158

UK enterprises had bad relationships with Trade Unions after World War 2. Eichengreen (1996) says that the intense wage pressure from unions helped to reduce investment in the UK and reduced the rate of economic growth. He cites Germany & Belgium as countries affected by World War 2 who created productivity agreements with workers. They combined wage restraints, investment-friendly policies and helped to revitalise their post-war economies.

Answer 159

Hicks (1993) however blames bad managerial and business incentives, instead of purely Trade Unions that were strong, but fragmented. Hicks argues that 'the best of all monopoly profits is a quiet life', believing that low growth & productivity was because of a lack of competition.

Answer 160

Firms will employ workers as long as the extra revenue the workers generate from producing goods and services is greater than the cost of employing them. The market equilibrium wage is where MRP=MC The firm will hire the number of workers where the two lines meet. Hiring any more than that means the firm loses money employing the extra worker. Hiring any less means the firm is missing out on potential profit.

Answer 161

The MRP (marginal revenue product of labour) curve shows the extra revenue that each worker generates.

Answer 162

The MC (marginal cost) curve shows the additional cost of employing each extra worker.

Answer 163

wages are determined by the forces of demand and supply.

Answer 164

In a perfectly competitive labour market, firms become price-takers, and so do not have control over the wage they pay. It is determined by the interaction of market labour demand and supply. This wage is equal to the marginal cost and average cost for the firm because the supply is perfectly elastic for an individuals firm's labour

Answer 165

The wage is the sum of economic rent (Triangle ATV) and transfer earnings (TVOQ). The economic rent is what is in addition to the minimum wage required to keep labour employed. As supply gets more elastic, economic rent reduces to zero (as the labour market for this particular job becomes more competitive).

Answer 166

The higher the MRP, the more valuable the worker is, because the worker generates more revenue for the firm. This should make the demand for more productive workers higher which should lead to a higher relative wage. E.g Investment bankers are paid more than gardeners in an office building because they generate more revenue for the firm.

Answer 167

The more skills a worker has, the more valuable they are. Skills are usually correlated with the MRP of a worker. Fewer workers will have these skills, so their supply is more inelastic. Workers with more inelastic supply will tend to get a higher relative wage. E.g Investment bankers are more inelastic in supply than gardeners.

Answer 168

Workers are paid differently within the same occupation and in different occupations. We call the wage differences wage differentials. Apart from skills differences, workers can receive different wages because of: Location - wages differ by region. Industry - some industries pay better than others. Trade unions - these can have an impact on wage rates.

Answer 169

Supply curves for low-skilled jobs are often elastic

Answer 170

Supply curves for low-skilled jobs are often elastic

Answer 171

while those for high-skilled jobs are usually inelastic.

Answer 172

Supply of labour is often elastic in low-skilled jobs. So small wage rate increases will result in large increases in quantity supplied. This is because wages are often similar in low-skilled professions. Any wage rate increases will likely attract more low-skilled workers. There are also many low-skilled workers. So many will be out of work and job hunting (available to work). Supply is often more elastic if workers are mobile (if they can move between occupations and to different job locations easily). Wage increases will increase supply.

Answer 173

Supply of labour is often inelastic in skilled jobs. This is because it takes a long time to become skilled. If wages increase for engineers in response to a shortage, people may be more motivated to study engineering. But it will take years for them to train. So while supply may change in the long term, supply will not change in the short term.

Answer 174

If the elasticity of labour demand is inelastic, then the labour demand curve is very steep.

Answer 175

labour demand is elastic, then the curve is closer to horizontal.

Answer 176

Wages are a low % of total costs If wages are a very small part of the total cost of production then wages will be less important to firms. Demand for the product produced is inelastic If demand for the final good or service is inelastic, then cost increases can just be passed on to consumers. Again, demand for healthcare is inelastic if treatment is needed. This would support there being inelastic demand for doctors. Capital cannot substitute for labour If machines could affordably replace workers, then the elasticity of demand for labour is likely to be low. A&E Doctors, who cannot be replaced by machines at all, face little threat of replacement. Demand for A&E doctors is inelastic.

Answer 177

It is a government-imposed law to try to improve the equality of living standards. National minimum wage makes sure the poorest in society have enough for their own basic needs The national minimum wage establishes minimum hourly pay rates for various age groups. The UK government brought in a national minimum wage in 1999. In 2018, it was £7.83 per hour for over 25s. The wage is designed to stop workers from being exploited

Answer 178

In a perfectly competitive labour market, the minimum wage will raise the wage level above equilibrium. This will cause firms to downsize, and there will be excess supply at the new wage level. This will generate unemployment.

Answer 179

The more inelastic the supply of labour of labour is, the smaller the increase in unemployment. Very elastic labour supply could lead to a large fall in employment. This is a market failure.

Answer 180

Workers should get a high enough wage to afford the essentials of life. This reduces poverty levels. E.g food, clothing. Incentivises people to work and get off unemployment benefits. It may increase the marginal revenue product of workers. Minimum wage can improve worker morale and productivity.

Answer 181

The introduction of a minimum wage reduces the quantity demanded of low-skill labour, leading to lost jobs and sometimes worsening of inequality. It can increase firm costs. It can decrease competitiveness. It may not actually alleviate poverty. This is because many of society's poorest members are unable to work (e.g. elderly), so cannot benefit. Setting the minimum wage below market equilibrium will have no effect.

Answer 182

A maximum wage can be set by the government if they believe wages are becoming too high in some industries

Answer 183

Can encourage hiring, often reducing unemployment levels. Can prevent wages spiralling out of control. Can reduce inequality (particularly if it's combined with a minimum wage).

Answer 184

Can reduce motivation as many workers are incentivised by higher pay and pay promotions. Workers may migrate abroad if they have higher earning prospects in other countries (that don't have maximum wages). Some people think its unfair to limit the rewards a worker can gain.

Answer 185

A living wage covers basic living costs on an hourly rate. The Living Wage Foundation sets the UK's living wage rate. At present, it's higher than the UK's national minimum wage. The London living wage rate is higher than that for the rest of the country. Employers voluntarily decide to meet the living wage rate. More than 1,000 employers in the UK have agreed to do so.

Answer 186

Wages are small % of costs Given that labour demand is inelastic, it is likely that wages are going to be a very small part of the total cost of production. Wages will be less important to firms and so changes to the wage rate will have little impact on the number of workers hired. Capital cannot substitute for labour If machines could cost-effectively replace workers, then the elasticity of demand for labour is likely to be low. We know that demand is inelastic, so this means that substituting workers for capital is not a viable strategy for the firm. Perhaps the firm sells medical services and its doctors cannot thus be replaced.

Answer 187

The free market can result in a misallocation of resources (or market failures). Governments can intervene to correct these market failures

Answer 188

Meeting basic needs Underconsuming merit goods Irrationality Overconsuming demerit goods

Answer 189

In a market-based economy, a consumer's ability to consume goods and services depends on their income and wealth. If a consumer has a low income, they may not be able to afford basic goods to satisfy their needs. The market is under-providing these goods and this can be a source of market failure.

Answer 190

Governments may want people to consume more things like education, which have positive externalities. Subsidies or free state provision may be used to encourage the consumption of merit goods.

Answer 191

The UK government has a Nudge unit, which implies that consumers may not be rational agents and need guidance.

Answer 192

Demerit goods like cigarettes may be overconsumed. Taxes or bans may be interventions to solve this issue.

Answer 193

Improving information Efficiency Focus on SMEs

Answer 194

Governments aim to improve the wellbeing of their citizens. One of the main ways to do this is by encouraging them to make rational choices, often through correcting market failures. This can be done by reducing the asymmetry of information - by giving consumers as much information as possible about the choices they make. Examples of information governments can provide include: Mandatory nutritional information on food packaging. League tables for schools.

Answer 195

A range of policies are needed to satisfy government goals. Some industries benefit from nationalisation because they do not function well under the price mechanism. Some industries, like train tracks or Network Rail may be natural monopolies and could benefit from nationalisation.

Answer 196

Another policy objective is the growth of small to medium size businesses. These businesses benefit from deregulation. A combination of policies (such as deregulation and nationalisation at the same time) are required by the government to achieve their goals.

Answer 197

The UK's competition policy aims to reduce the amount of anti-competitive behaviour in markets and to protect consumers

Answer 198

UK competition policy looks for anti-competitive play in the market. This can come from a number of different sources: E.g monopolies, mergers, cartels or financial support. There are industries that have their own regulatory bodies E.g. OFCOM deal with the communications industry and are in charge of ensuring fair play within it.

Answer 199

M&A policy Regulation Monopoly prevention The CMA can force the break up of firms which have become too powerful in a market. If they believe a firm is abusing its monopoly power it can force the firm to split or sell some of its assets to increase competition. It is rare to break up firms which have gained power through internal growth.

Answer 200

In the UK, any firm who looks to merge with or acquire other firms in their market which leads to them then having 25%+ market share will be considered and maybe investigated by the CMA. The CMA decides whether the transaction would lead to a lack of competition in that market and so excessive monopoly power. If they believe it will lead to excessive monopoly power, they can block the deal.

Answer 201

The power of these monopolies can be reduced by regulation. E.g. the introduction of a price ceiling by the government restricts the amount firms can raise their prices. Reducing the potential losses in efficiency. The price ceiling could be either: inflation minus real price, or inflation minus real price plus investment. Both of these are effective. Alternatively, the government could tax excessive profits, or set performance targets for monopolies.

Answer 202

Monopolies formed through mergers or agreements can often be inefficient. This is because they restrict quantity and agree to raise price to a level that isn't allocatively efficient. These are examples of anti-competitive strategies that governments want to avoid. Governments can prevent monopolies forming by blocking mergers. The UK government investigates all mergers which will result in a firm having greater than 25% market share (a legal monopoly).

Answer 203

Leads to: lower prices higher quality goods and services improvements in technology all of which leads to an increase in welfare.

Answer 204

If there is competition in the production of goods and services, it means firms have to make their products more attractive to consumers than their competitors in order to sell them. One way they can do this is to lower the price. Lower prices results in households being able to afford to consume more leading to improved welfare.

Answer 205

Firms don't just compete over price. Consumers will choose goods which are higher quality because they bring them more utility and improved welfare.

Answer 206

Another way firms can make their goods stand out against their competitors is to develop and use more advanced technology. Firms' investment in technology leads to positive spill over effects as the technology is shared through an economy. Each technological breakthrough pushes society further forward and again leads to improved welfare.

Answer 207

The market for video games illustrates the benefits of competition. There are a few major firms in the market but they are fiercely competitive among each other and in fending off potential new comers. Competition in this market regulates the price, if prices are too high then consumers would switch products. Video game producers know they have to create high quality games to be successful. The technology in gaming has developed rapidly over the last 20 years with positive spill overs.

Answer 208

Contestability in markets can be improved through deregulation. This is because barriers to entry have been lowered. This is good for competition in an industry.

Answer 209

The information needs to be reliable The power of the regulator

Answer 210

If the information received is trustworthy, governments can take action and punish anti-competitive behaviour. This will help to improve efficiency and the allocation of resources. But this is not possible if not enough information is received, or if the information is unreliable. Also, there is an opportunity cost to collecting this information. This could be seen as government failure if there is no action resulting from the collation of information.

Answer 211

For firms' behaviour to be influenced by regulation, the regulator (the CMA in the UK) needs to have sufficient powers and to be well-resourced. The CMA's ability to impose large fines and even imprison directors of companies means that firms are likely to think twice before engaging in price-fixing or joining an illegal cartel.

Answer 212

In the UK Utilitities industries, the respective regulators set a cap on how much prices can rise year on year based on the rate of inflation and planned levels of investment. The government can impose a maximum price on goods and services. This reduces the benefit to firms of constricting output to increase the price. Consumers can then access the goods and services at what the government deems a fair price.

Answer 213

The CMA investigated BT's proposed purchase of mobile network EE. BT are also involved with telephone and internet services. The deal was eventually allowed to go ahead, but only after BT agreed to the CMA's suggestion that they sell off certain parts of their business to make sure that they would not be too powerful in certain markets.

Answer 214

Where is the market boundary? What if there isn't competition, but prices are free?

Answer 215

Where is the market boundary? For Coca Cola, where is the market boundary? The sale of Cola-flavoured drink (so Coca Cola & Pepsi drinks only) The sale of carbonated (fizzy) drinks, which would include lemonade, Fanta and Dr Pepper. The sale of all bottled drinks (which would include bottled water like the Evian and Volvic brands)? Clearly the chosen market boundary, will have a big impact on the measured competition and therefore, competition policy.

Answer 216

The American Department of Justice defined the market boundary as 'the minimal set of products (over a product & geographical space) over which a hypothetical monopolist would find it profitable to raise price'. This test is called the small but significant non-transitory increase in price test (SSNIP test). In layman's terms, would increasing prices in that market be profitable for the firm. This measures whether goods are good substitutes are not. Would you drink bottled water instead if the price of Coca Cola rose 10%?

Answer 217

Cross price elasticity of demand

Answer 218

In 2019, there was a political clamour to break up 'Big Tech' companies like Amazon and Facebook. In 2018, Amazon had a 50% market share of online retail spending in the USA, but only 5% of all retail spending. Facebook owns WhatsApp, Instagram and Facebook. However, they are free for people to use. So it is hard for the Dept of Justice to test their SSNIP test. Competition policy has historically looked at mergers and acquisitions increasing prices for consumers, rather than making it harder for others to enter markets.

Answer 219

The state can provide a a number of goods and services for consumers

Answer 220

Nationalisation

Answer 221

The government either provides state provisions itself (e.g. state education) or provides free goods or services to the public that it's bought from the private sector (e.g. private health services offered free to NHS patients). The government pays for goods/services through tax revenues. It then offers them to the public for free.

Answer 222

The National Health Service (NHS). Police service. Secondary school education.

Answer 223

State provision can reduce inequality by redistributing money from the wealthy to the poor. This is something the market doesn't always do. Without state provision, some services might not exist as they aren't profitable. E.g. some train routes that aren't profitable do not exist. Value judgements need to be made about what the state can and can't provide well.

Answer 224

Without a drive for profit, there is less incentive to make a service as efficient as possible. The economic incentives for efficiency could be eroded. There is an opportunity cost of providing one service over another. With asymmetric information, there is a risk of government failure.

Answer 225

The government owns public firms and industries. Privatisation sees publicly owned firms/industries become privately owned firms/industries. Governments may privatise to boost competition.

Answer 226

Public Private Partnerships (PPPs) - when a firm in the private sector completes a project for the government that benefits the public (e.g hospitals are often leased to the government by private firms which own the building).

Answer 227

The incentive for profit means that resources will be allocated more efficiently. When the government sell off their enterprise, they will gain revenue that can be put to alternative use.

Answer 228

The drive for efficiency means that an element of humanity might be lost. Efficiency may come in the way of delivering a fair service. There is a moral argument against providing some services profitably. E.g should we be able to pay for better healthcare than others? Safety and spending on safety measures may be worse in privatised industry that are judged only on profits.

Answer 229

The Royal Mail was an entirely publicly held firm until 2013 when the government sold 60% of its stake to private investors and gave away 10% in shares to employees, leaving the government with 30%. The government sold the rest of its shares in 2015, and in total raised £3.3bn. The government argued that selling Royal Mail would allow it to raise funds to make the investment required to fend off new competition. The government used the money to pay off some of the UK's debt.

Answer 230

Governments contract out the provision of various services. The government then pays for the contract and distributes as if it had been publicly provided. By contracting certain jobs out, the government can get jobs done by specialist firms who service other customers and benefit from economies of scale. But by contracting out certain jobs, the government becomes reliant on other firms. There are risks that a firm with a contract goes bankrupt or faces strikes from its workforce.

Answer 231

Governments can put out jobs to tender, giving prospective suppliers the chance to bid for contracts to supply goods or services. Tendering is a competitive process with firms giving their best offers in order to win contracts. However, because the tendering process is based on what firms promise they can deliver, it is common for firms to over promise and under provide which can lead to large unexpected costs and reduced quality.

Answer 232

PPPs are when governments and private firms collaborate on a project. Funding comes from a combination of government payments and the firm being given the rights to earn money from this, on completion. Any shortfalls between initial costs and the government grant is covered through Public Finance Initiatives which raise money through selling bonds to banks and investors. The government is responsible for making sure the objectives are met and the firms are responsible for the execution.

Answer 233

Veolia and Suez are two multinational waste collection, disposal and water management companies. They both work closely with local and national governments across the world and often compete in the tendering for contracts and in being involved in PPPs. In 2018, Suez's UK projects included the opening of a 'Energy from Waste' plant in Cornwall and Wilton. This is a PPP with the firm working with local councils to bring the project to life.

Answer 234

Regulation involves setting rules that firms must comply with. These rules are imposed by the government to try and correct market failures. Deregulation is a loosening of these rules

Answer 235

Regulation can correct market failures that arise from externalities. E.g regulation can be imposed to limit the level of pollution firms make. Regulation can control monopolies and stop them from taking advantage of customers and reducing welfare. Legislation provides a means of punishing firms for their anti-competitive behaviour. Regulation can be used to protect the environment.

Answer 236

The allocation of resources will improve as the government will reduce their interference with the free market. By reducing the bureaucracy associated with legislation, efficiency will improve.

Answer 237

It's hard to know which industries to regulate, and how to regulate them. This often needs a value judgement. E.g what level does the government set for firm pollution? Why that particular level? It can be expensive to monitor firms to enforce regulation, and there is an opportunity cost attached to this. It can be expensive to follow regulations. Some firms may end up closing down or relocating because of high costs.

Answer 238

Customers are no longer protected from the anti-competitive behaviour of firms and might lose out. There are some market failures it cannot fix, such as the problem with externalities. E.g deregulation of industries may lead to an increase in pollution because of the tragedy of the commons. Some natural monopolies need regulation. E.g sewage services.

Answer 239

The Renewables Obligation scheme (RO) was launched in 2002. It set regulations to try to promote the use of renewable energy sources.

Answer 240

As part of the Renewables Obligation scheme (RO), Renewable Obligation Certificates (ROCs) are issued to electricity generators that generate sufficient amounts of renewable energy. Suppliers buy ROCs from accredited generators.

Answer 241

Electricity suppliers are set targets for the percentage of power they need to gain from renewable sources. If suppliers fail to meet these targets, they're fined. The money from fines is shared between suppliers that do meet targets.

Answer 242

Clause IV - The Labour Party's Clause 4 supported state ownership. It could be argued that this was a factor that contributed to a legacy of state ownership. Market failure - It could be argued that some markets were national monopolies and needed regulation or state ownership. This seems true in the Utilities, Railways and perhaps Telecoms sectors, but seems less likely to be true in Cars, Coal, Airlines, Shipbuilding, and Steel. In the 1970s and 1980s, the government owned stakes in British Airways, the car manufacturer British Leyland, and many other businesses. Externalities - Tawney (1919) argued that nationalisation can allow society to put the welfare of people first. However, this opens the debate around the efficiency of public ownership. Many people argue that without competitive pressure or incentives, consumers get less innovative products at higher prices, despite the intention being good. If the aim is to solve externalities, is it better to use taxes or to nationalise an industry?

Answer 243

France had traditionally had even higher state ownership than the UK. The French government owned a stake in a tobacco manufacturer called Gauloises. Gauloises was regarded as efficient. However, it also marketed smoking cigarettes as contributing to the French nation, because the government earned some of Gauloises' profits. This meant that the French government had a strong incentive not to discourage smoking or cigarettes. State ownership can create these moral conflicts in some cases.

Answer 244

Labour laws and the % of output owned by the government can impact social and cultural norms in a nation, as well as their economic & social history. A study by the Independent in 2016 found that 171 working days per 1,000 employees were lost to strikes (industrial action) in France each year. This number was 24 working days per 1,000 employees in the UK and 12 working days per 1,000 employees in Germany.

Answer 245

Pryke (1982) compared the performance of businesses that had been nationalised with private businesses. He found that the private businesses consistently performed better, citing the example that British Airways when nationalised was overstaffed relative to the private British Caledonian. Pryke (1981) also highlights that in 1975, Britain's core nationalised industries were loss-making, needing over £1bn p.a. in subsidies for losses. So perhaps it is just the UK government that is useless? Although Ehrlich et al (1994) claim that the private ownership of businesses leads to higher productivity growth & lower costs in the long run

Answer 246

Hannah (2004) highlights that from 1979, £33bn was raised by the government by privatising the Airlines, Electricity, Gas, Water, and Shipbuilding businesses. Nationalised businesses in the UK generally seem to have underperformed, however, Hannah (2004) states that "international comparisons reinforce the view that whilst state industries can be effectively managed, the British ones, in general, weren't." So perhaps it is just the UK government that is useless? Although Ehrlich et al (1994) claim that the private ownership of businesses leads to higher productivity growth & lower costs in the long run

Answer 247

A monopsony employer is where one firm dominates the hiring in the market

Answer 248

In a perfectly competitive labour market, a firm will hire where supply is equal to the marginal revenue product (MRP). A monopsony employer looking to maximise profits will hire labour at the point where the MRP is equal to the marginal cost. At this point, the wage is lower than under a perfectly competitive labour market.

Answer 249

At each wage, the number of workers willing to work is shown by the average cost curve. Marginal cost is above average because they have to attract new workers with the prospect of a higher wage, while also paying existing staff more to compensate.

Answer 250

Governments can increase workers' rights and help to protect them from a monopsony employer. Setting a national minimum wage may stop a monopsony employer from hiring workers at a point where the wage is lower than in a perfectly competitive labour market. Setting a minimum wage at MRP=MC could increase wages in a monopsony. However, the minimum wage must be set at the right level, or it may have no impact.

Answer 251

prices profits efficiency quality choice consumer surplus producer surplus

Answer 252

Nationalisation may be a solution to a natural monopoly or market with a monopsony employer. However, the lack of a profit incentive may encourage inefficiency. If a business is inefficient, then it has a higher cost base and prices for consumers may be higher. However, nationalisation or state provision may lead to an equal or equitable distribution of consumption. If there is one provider, there may be less choice and a lower incentive to produce quality.

Answer 253

Imposing a minimum wage or minimum price in a monopsony market can increase the welfare of workers. The government would need sufficient information to implement this. However, it seems reasonable to assume that a government would know about wages in the sector. However, implementing a minimum wage outside of a monopsony may increase unemployment. Increasing the wage in a single market may also distort other labour markets. If the minimum wage in farming rose very high, there may be labour shortages in retail stores like Zara. A minimum wage will likely reduce profits in that industry.

Answer 254

Increasing fines for colluding or encouraging whistleblowing should reduce prices and increase choice. This should increase quality and choice, whilst also encouraging efficiency. However, dynamic efficiency may fall if supernormal profits aren't made. This should decrease profits to below the monopoly level (at MC=MR).

Answer 255

In the 1980s, the UK government privatised companies like BT and British Airways. The theory was that the profit incentive would increase innovation, quality and that competition improved consumer choice. However, some people argue that the UK's Telecoms infrastructure - BT Openreach - has been underinvested in over the years. The UK's telecoms infrastructure is a natural monopoly.

Answer 256

Subsidies may encourage the consumption of merit goods. However, subsidies could reduce the incentive to be efficient. Choice should rise because of the increased incentive to enter the industry. Consumer surplus and producer surplus should rise. Subsidies should increase industry profits.

Answer 257

regulatory capture asymmetric information

Answer 258

This term was made popular by Joseph Stiglitz. Lots of investment bankers go on to work in government or in regulators. US Treasury Secretary, Steven Mnuchin, used to work at Goldman Sachs. Robert Rubin, who led Bill Clinton's National Economic Council also worked at Goldman Sachs.

Answer 259

Sometimes, firms may influence the regulating body so that they favour the firm in any decisions they make. When this happens, the regulator may prioritise the interest of the firm, rather than the consumer. This is an unintended consequence of government intervention and so is a form of government failure. E.g The Office of Communications (OFCOM) being persuaded by firms in the telecommunications industry.

Answer 260

In a world of perfect information, governments should be able to make the right decisions to improve allocation. Asymmetric information limits the governments ability to critically assess market failures and possible solutions. So the right decision isn't always made and government failure can arise.

Answer 261

Revolving doors

Answer 262

Explain privatisation Privatisation occurs when the government sells off publicly owned assets and gives them to the private sector to run. Argument for privatisation The government gains a one-off boost to the public finances by selling off state industries. The government claimed that the sale of Royal Mail, overall, gave them £3.3bn which was used to reduce public debt. Privatisation also introduces the profit motive. Royal Mail now had the desire to maximise profits which led to reduced costs and more efficient practices. Argument against privatisation But, privatisation does not always work. The government can no longer benefit from a stream of payments over time if the business was profit-making. The profit motive may also lead to the cutting of costs without improvements in quality.

Topic 6 - Market Structures Flashcards

(288 cards)