business behavior (paper 1) Flashcards
what are the reasons why some firms remain small?
1) existing firms with large market power. Due to their dominance, firms with monopoly power will have price setting power, which could be used to discourage new firms from entering the market or to grow. They may even have monopsony power which means they’re able to bargain for lower prices of raw materials, etc. For example: the NHS is the main buyer of drugs in the UK. Existing firms who are well established in the market already have great brand loyalty and a large customer base. it maybe hard trying to attract customers of your own if the largest firms are already so well known.
2) limited access to credit - smaller firms may be less likely to receive large enough loans from banks, as they are deemed riskier investment than a pre-existing firm looking to expand. Large firms are more likely to have to pay back a smaller amount of interest as they are viewed more stable.
3) no aspiration to grow. Some smaller businesses maybe content with their size and the lifestyle it provides, so they may not see the benefit in growing anymore if they’re already satisfied with their company’s size. For example: a family-owned bakery.
what are the reasons why a firm may grow?
Operating in a niche market. This is where there’s only a small amount of customers looking for your specific good, yet it’s extremely profitable as people are after your expertise and are willing to pay the higher prices.
Diversification. By expanding your product range, firms reduce their risk of making a loss, as they have other areas within the market to fall back on. For example, a company that produces wheels for cars may start to also produce windows too.
Prioritizing revenue maximization in the short run rather than profit. This is a simple way of increasing your customer base, as your typically low prices will entice customers to switch to you. This will increase your market share, and once a body of customers has been generated you can start to profit maximise.
what is the principal agent problem? (divorce of ownership from control)
including how such problem could be tackled
As firms grow, the owner will hire managers to run the business for them in different areas of the country, etc. There is a divorce between who owns the company and who runs it then. This creates the problem where owners and managers have conflicting interests. For example: shareholders wanting to maximise profits, yet managers wanting to maximise their salaries, or sales for that day so they can make a bonus.
This problem is exacerbated by information gaps – where the managers have a lot more information on the day to day running of the company in comparison to the owners. The managers can also control what information reaches the owners.
Evaluation: one-way owners aim to tackle this, is by giving their staff shares in the company, this will unite a shared want to profit maximise rather than any other objective. For example, the CEO may be partly paid in dividends rather than a salary, or the staff may all have their own small shares in the company - like John Lewis.
what is the difference between a public and private sector organisation?
public sector organizations – owned and controlled by the government. Their goal is not to maximize profit, instead it’s to provide a service - and thus maximise utility. For example, the NHS.
Private sector organizations – owned and controlled by private individuals. The goal of most private organizations is to maximise profit.
what is the distinction between a profit and not for profit organisation?
Both profit and not-for-profit organisations are found in the private sector, they are not owned by the government but rather private individuals in the market.
A “for profit” organisation is your average firm that wans to maximise profit in the market. For example: adidas.
However a not-for-profit organisation will still need to make some profit in order to survive in the market, yet its ultimate goal is not to profit maximise, but rather to provide a service for the public / utility maximise. For example, the British heart foundation. Many sell goods (like charity shops) and use the profit made to further advance in their objective/goal.
what is organic growth?
Organic growth – when a business expands its own operations without relying on a merger or takeover. Their growth is internal. It is achieved through re-investing your own profits to grow. This can occur through:
-Investment in capital or tech that increases their capacity
-Using marketing to attract a larger customer base
-Launching new products to attract new attention
-Borrowing money from the bank to open a new store
what are the advantages to organic growth?
1) It is less risky than a merger. The growth is financed by profit and the majority of mergers end up failing.
2)The pace of growth is manageable. You have the ability to plan ahead as the outcome is more predictable.
3) you maintain control - maintains existing management and culture, not need to compromise with another companies ethics.
what are the disadvantages to organic growth?
1) The growth id very slow, as it is mainly financed by profit made in previous years (or equally small loans made by the bank)
2) makes it harder to compete with other firms in the market who have grown through mergers - and have the benefit of greater expertise, human capital, economies of scale, etc.
3) Harder to benefit from internal economies of scale as your scope of production is likely to be smaller and reliant on other manufacturers, etc. for certain stages of production. this means the “middle man” company will also be making a profit - profit your company is now missing out on.
3) limited access to credit in the beginning stages - for the bank to loan to a smaller firm just starting up, this is a riskier loan than loaning to a pre-established firm with market presence, as it is less clear if such smaller firm will be able to pay it back as well. whereas companies who are already experiencing economies of scale and have more promising figures of turnover, etc, will be able to access more credit / funding.
what is vertical integration?
where a firm buys another firm in their supply chain. This can be either forwards or backwards.
-forwards: a car manufacturer buying a car dealership. They are moving forward to the end product.
-backwards: a clothes store buying a sweatshop. They are moving back down the supply chain.
what are the advantages to vertical integration?
1) reduces the cost of production as the middleman’s profits are eliminated. For example, the cost of shipping your product to the seller.
^you absorb the once profits - for example, the farm would’ve been making a profit on the milk they’ve sold to the ice cream place. You now absorb this profit yourself.
2)Better control over the quality of the product, if it’s backwards integration. For example: watering or feeding your plantations with more care than the previous company will lead to better crops.
3) can increase brand visibility, which makes it easier for businesses to distinguish themselves and gain loyal customers.
what are the disadvantages to vertical integration?
1) This can create barriers to entry for other new, potential firms wanting to enter the market. For example, if Nike owns a shoe factory they’ll charge more for other companies to use it.
2)Possibly little expertise in that specific field. For example, an ice cream company won’t know how to milk a cow. This may result in inefficiencies. Evaluation: it is more likely that the firm buying the new firm will keep on the majority of that firm’s workers, as they’re aware they will have more expertise than training new staff.
3) there may be a culture clash between the two companies. Existing employees will have existing ethos and expectations that the other company merging may not agree with. (like standards surrounding breaks, pay, etc.)
what is horizontal integration?
Horizontal integration – where a firm merges or takes over with another firm at the same stage in production. For example: Nike buying adidas.
what are the advantages to horizontal integration?
1) rapid increase of market share, reducing competition and possibly allowing negotiation power with companies below the supply chain.
2)Economies of scale will lead to a reduction in cost making the final product more profitable.
3) existing knowledge of the industry means the merger is more likely to be successful from two experts coming together.
what are the disadvantages to horizontal integration?
1) there can be a cultural clash between the two companies. For example, each firm will have their ethos and way of doing things. Disagreement may occur over standards of pay, holiday, breaks, pensions, etc.
2)Diseconomies of scale may occur. For example, being reluctant to make workers redundant during the initial merger, duplicating managers roles in the process to not upset anybody.
^managerial diseconomies of scale
^communicational diseconomies of scale
3) You’re still limited to one market. If market conditions change you have nothing else to fall back on as you’re fully committed. Equally, the CMA is likely to get involved.
what is Conglomerate integration?
a merger or takeover of a firm in an entirely different market. For example: John Lewis (retail) and Waitrose (supermarket).
what are the advantages to conglomerate integration?
1) reduces overall risk of business failure. If your company owns companies in multiple markets, you can fall back on your other companies if market conditions change in one specific industry. For example last year John Lewis made a loss of 4% yet Waitrose made a profit of 5% so overall the company made a profit of 1%.
2)If you’re already a big firm the CMA may block any horizontal growth, therefore conglomerate growth is another way to ensure you still grow without annoying the CMA.
what are the disadvantages to conglomerate integration?
1) possible lack of expertise in this new market
2)A culture clash
3) Diseconomies of scale - either firm maybe reluctant to lay off their own workers. This may lead to both communicational diseconomies of scale yet also managerial diseconomies of scale.
what are the constraints on business growth?
The size of a firm
A niche market will have limited opportunities for business expansion as it requires a certain taste for their products to sell. This is due to their limited customer base. However, larger firms will have a wider scope for innovation and a larger customer base in order to help grow.
Diseconomies of scale
As a firm gets larger, they may begin to experience diseconomies of scale rather than continue to grow at such a fast rate.
Access to finance
Smaller firms new to the market tend to have less access to finance than larger, well-established firms. This is because they’re viewed as riskier by the banks since the 2008 financial crisis. Without access to credit, firms cannot invest and grow as much.
Owners’ objectives
Some owners may have different objectives to others. Some may aim to maximized welfare, others may have an environmental impact in mind when making decisions, or some may simply want to maximize profits.
Regulations
Excessive regulation can limit the quantity of output that a firm produces. For example, environmental laws like pollution permits limit the amount of greenhouse gases a company can emit. Also, excessive corporation tax discourages firms from making huge profits as they don’t keep much of it.
what is a demerger?
when a firm sells off one part of the company or splits itself into two or more separate firms again.
what are the reasons for a demerger?
-cultural differences
-reducing diseconomies of scale
-complying with the demands of the CMA
what are the impacts of demergers on both the consumer and workers?
on workers – some may be made redundant. However, there may now be a better team dynamic if the reason the demerger happened was due to a culture difference. Thes people may see an opportunity for promotion as positions may start to open up.
On consumers – customers will have more variety now in the market as there has been an increase in competition. this may lead to lower prices in the long-run.
what is the business objective to profit maximise?
draw diagram
This is known as the rational business objective, and is the underlying assumption of neo-classical economics. profit maximisation occurs where marginal cost MC = MR marginal revenue on the diagram.
^if MR is bigger than MC, additional profits can still be made by producing another unit. yet if MC is bigger than MR, you are now making a marginal loss.
the profit made is supernormal profit.
what are the limitations to having profit maximisation as your business objective?
- in the real world it is very hard for a business to work out what their MC and what their MR is. This is especially hard because it is difficult to know the PED for a good, which effects the MR.
- in the short-term firms may not want to change their price as soon as MC changes, as this becomes confusing for consumers. Instead they may choose to absorb some of these higher marginal costs themselves, and thus sacrifice their profit maximising level of output.
what is the business objective to revenue maximise?
draw diagram
revenue maximisation occurs where MR = 0. At this output profit is still being made, but not the maximum level of profit.
Revenue maximisation can occur due to the principal agent problem. occurs when the agent makes decisions on behalf of the principle, which leads to them often placing their own agenda above the principle’s agenda. For example, the principal may want to maximize profit to pay off their dividends, however the agent may want to maximize revenue to reach their targets and get a bonus, etc. firms that look to revenue maximize are more likely to use price discrimination to extract extra revenue from consumers.
why may a firm want to revenue maximise instead?
Maximize revenue in the short term – this will increase output and allow firms to benefit from economies of scale. Therefore, firms may revenue maximise to break into a market, or even eliminate competition as their price is lower than when focusing on profit maximization. For example, amazon looked to maximize revenue in the short-run in order to become more competitive in shipping, etc. This led to many other shipping companies shutting down as amazon were not looking to make a profit initially, and therefore their prices were lower and more competitive.
what is the business objective to sales maximise?
draw diagram
where AC = AR. At this output, normal profits are made. This will make you just enough profit to stay in the industry.
If you maximize your sales your market share may grow, making you a more dominant firm in the industry. This will create a higher output, yet sold at a lower price.
^firms may use this in the short-term to clear excess supply, like during a sale. This means they sell remaining stock without making a loss per unit.
^ or small family run businesses may seek to sales maximise in order to bring in a profit all while surviving in the market. They may not have the aspirations for profit maximisation, or accountancy skills to find this equilibrium.
what does it mean if your business objective is to satisfice?
satisfies examine only a limited range of alternatives and then use a general rule of thumb rather than complex pricing strategies. They’re aware of their limited information and market knowledge and know their is time involved in finding the optimum pricing point for everything. They just work out their costs and then add a little bit of profit on to find their price. As long as they make a sufficient rate of return, then they’re happy. They are therefore striving for satisfactory profit, rather than maximizing it. This can occur in small businesses like a bakery or corner shop, where they just want enough profit for a means to live.
what is meant by total revenue, and what is the equation for it?
total revenue is the total amount of sale s a firm makes. it is price times quantity sold.
what is meant by average revenue, and what is the equation?
average revenue is the overall revenue per unit. the equation is total revenue divided by quantity.
the AR curve is the firms demand curve. this is because it is the price of the good. (assuming it is a competitive market)
what is meant by marginal revenue, and what is the calculation for it?
the extra revenue received from the sale of the last additional unit sold.
the equation is: change in total revenue divided by change in quantity.
when MR = , revenue is maximized
what is the relationship between PED and revenue?
PED measures how responsive demand is to a change in price. Whereas total revenue is price times quantity.
Therefore if a firm can figure out what the PED of their product is, then they can maximise revenue.
If PED of their product is price elastic, then they should reduce their price of their product - this will maximise total revenue. A change in the quantity demanded will be larger than the change in price.
However if the PED for their product is price inelastic, then they should raise the price of their product - this will maximise total revenue. This is because the change in price will be larger than the change (fall) in demand.
what is meant by a fixed cost?
A fixed cost is a cost that cannot change in the short-run. As output changes, the fixed cost remains the same.
For example:
-loan repayments
-insurance
-rent
^None of these factors change when the level of output changes. They are fixed. Yet they can be re-negotiated in the long-run.
what is meant by variable costs?
costs that vary with the level of output. for example: the cost of raw materials, workers wages, amount of machinery, etc.
All costs are variable costs in the long-run.
what is meant by marginal costs?
what is the equation?
the cost of producing an additional unit of output.
change in total costs divided by change in quantity
what is the difference between a short-run cost curve and a long-run cost curve?
(include the relationship between short-run AC curves and long-run AC curves)
short-run costs: a period of time where at least one factor of production is fixed. for example, it is difficult to change the amount of factories you own in the short-run, yet this can be changed in the long-run.
long-run costs: the period of time in which all factors of production are variable factors. this is known as the planning stage as firms can plan for an increase in capacity and thus production.
The long-run cost curve is made up of multiple previous short-run cost curves. The SRAC decreases over time, and therefore when a firm enters a new short run cost curve, it is lower than the previous. This can be illustrated on a diagram.
what is meant by the law of diminishing marginal productivity?
In the short-run, as more variable factors are added to fixed factors, there will be an initial increase in productivity, yet soon diminishing marginal productivity will occur.
The shape of the SRAC is determined by the law of diminishing marginal productivity.
^The marginal cost is larger than the average cost - this is what causes the SRAC curve to rise, creating its U shape.
^For example, imagine an ice cream van that currently employs only 1 worker. This worker has to take the orders and make the ice creams. If you were to employ another worker, division of labour could occur, and therefore an increase in productivity. However once you employ a third worker, it is unclear what work is left for them. Instead they may stand idle and get in the way. In this sense, the more variable factors you add (labour) to a fixed factor (the ice cream van) the more diminishment there will be in productivity.
what is the relationship between the short-run and long-run average cost curves?
Short-run: at least one factor of production is fixed in the short-run. Day to day operations take place at this output.
Long-run: all factors of production are variable factors. This is known as the “planning stage” as the firm can plan to increase their capacity / output.
^Once more output is generated, the firm can move into a new SRAC, in which the AC will be lower. In the long-run, firms will repeat this process, generating a more efficient SRAC curve as economies of scale occur.
what does economies of scale mean?
as a firm increases its output in the long-run, its long-run average cost will start to decrease - this is the economies of scale.
The same amount of inputs results in more outputs than previously.
what does increasing returns to scale mean?
an increase in inputs result in a larger increase in output. This is why the AC curve slopes down to begin with.
what does diseconomies of scale mean?
However as a firm continues increasing its output in the long-run, its average costs will begin to increase - this is the diseconomies of scale
what are the 3 types of economies of scale?
- financial economies of scale - as firms grow bigger, the more access to credit they will have. this is because banks will be more willing to lend to them, as they’re more likely to pay it back - therefore the loan is less risky for the banks. Greater access to credit enables to funding for greater innovation and technological advancement.
^They may even receive lower interest rates on their loans as they’re less risky. - purchasing economies of scale - larger firms have greater access to credit, and therefore can afford to buy their raw materials in bulk. known as bulk buying. bulk buying reduces the cost of each unit overall. these firms, due to the mass amount they are purchasing, have a lot of bargaining power over the suppliers. This is because their trade will make up a great proportion of the suppliers income, and therefore it is in the suppliers best interest to engage in such negotiation.
- technical economies of scale - as firms grow, they may re-invest profits (or take out loans) to invest in more advanced, better quality capital - that is ultimately more productively efficient and cost saving. This capital maybe specialist, and produce more units of output with each input - returning economies of scale. Equally, it may just produce better quality products.
what are the 3 types of diseconomies of scale?
- geographical diseconomies of scale - occurs when a firms area of operation is widely spread out, which leads to logistical and communication challenges. it may cost a lot to ship, language barriers, time zone differences, etc.
- communication diseconomies of scale - occurs when a firm has multiple layers of management, and decision making must go through more people than necessary, making decision making longer than it needs to be - thus less efficiency.
- management diseconomies of scale - occurs when managers work in their own self interest, rather than in the interest of the firm - managers can become territorial.
what is the minimum efficient scale?
the minimum efficient scale represents the lowest possible cost per unit that a firm can achieve in the long-run. it is the lowest point on the AC curve. at this point they will be experiencing constant returns to scale - increase in inputs leads to a proportional increase in output. if it continues to grow beyond this point, they will start to experience diseconomies of scale.
what is an internal economies of scale?
Internal economies of scale refer to the cost advantages that a single firm can achieve as it grows in size and expands its production capacity
what are the 3 examples of an internal economies of scale?
- financial economies of scale - larger firms receive lower interest rates on loans as they’re deemed less risky, and more likely to pay it back.
- purchasing economies of scale - when a larger firm buys raw materials in a bulk, they receive a discount on it. equally, larger firms have more bargaining power - if you’re a large business buying a large stock, you have more negotiating power to bargain the price down. for example, the NHS buying drugs.
- technical economies of scale - larger businesses can afford t invest in expensive and specialist capital machinery.
what is an external economies of scale?
occurs when there is an increase in the size of the industry that the firm belongs to / operates in
what are the 3 examples of an external economies of scale?
- geographical cluster - as an industry grows, firms that use a specific manufacturer move closer to where they are situated to cut costs and generate more business. For example: Reading is well known for its tech industry.
- transport links - improved transport links develop around growing industries in order to help get people to work / mobility of labour and improve the movement of materials / goods.
- favourable legislation - costs fall as the government supports certain industries and their objectives - for example the film industry in Bristol and Bath is growing due to a removal of taxation limitations that were previously present.
what is the difference between normal profit and supernormal profit?
normal profit - where total revenue and total costs equal . this is called the break even. You are making just enough to stay in the market.
Supernormal profit - where total revenue is greater than total cost. This occurs when firms have a level of market power and can set the price.
when should a firm shut down in the short run? (draw diagram)
Firms should shut down in the short run when AR = AVC.
^At this point the firm can fund its AVC, yet no contribution is being made towards their fixed costs. They are therefore making a loss.
diagram
when should a firm shut down in the long-run? (draw diagram)
Firms should shut down in the long-run if AC is larger than AR.
^They are making a loss in the long-run, and therefore should shut down. However, if this was in the short-run they should remain open, as AR is larger than AVC still.
diagram
what is meant by allocative efficiency?
resources are allocated in a way that maximises overall social welfare/ benefit. both consumers and producers get the maximum possible benefit - an equilibrium is met. Occurs where AR = MC. Where price equals MC.
what is meant by productive efficiency?
Productive efficiency is achieved when a firm or an economy produces goods and services at the lowest possible cost. It implies that resources are being used efficiently to minimize production costs. There is no wastage of scarce resources. occurs when MC = AC
what is meant by dynamic efficiency?
This is known as long term efficiency .
Dynamic efficiency refers to the ability of an economy to innovate and adapt over time. It involves the long-term competitiveness and growth potential of an economy. Dynamic efficiency is linked to innovation, technological progress, and the ability to adapt to changing circumstances
what is meant by x-inefficiencies?
occurs when there is little incentive to control production costs. (ATC is higher than it should be). This can occur in a market with great market power, or in government owned companies - both have a lack of competition, and thus no consequence if they produce at an inefficient rate.
(government owned companies also have moral hazard)
what two types of efficiency are present in perfect competition?
The firm is productively efficient as MC = AC
The firm is allocatively efficient as AR (Price) = MC
what type of efficiency is present in imperfect competition?
dynamic efficiency - as it can re-invest the supernormal profits in the long-run.
what is the market structure of perfect competition?
individual firms have no market power due to the amount of competition present, and therefore are unable to influence price
what are the characteristics of perfect competition?
- There are no barriers to entry or exit - firms can enter the market freely, there is no high start up costs. equally, firms can leave the market easily, there is no large sunk costs - this incentivizes firms to enter the market.
- The products are homogenous - the product is identical no matter who you buy it from. this makes it hard for firms to build brand loyalty as perfect substitutes exist. for example: wheat.
- perfect, symmetric information / knowledge (for both buyers and producers) - for example, if the seller lowers their price, all buyers will know, and will buy from elsewhere.
- there are many buyers and sellers - this makes firms “price takers” - they have to take the price from the market as they have no market share, and would therefore go out of business overwise.
what is the profit maximizing output in the short-run for perfect competition, vs in the long-run?
in the short-run: existing firms are able to generate a supernormal profit, yet due to the lack of barriers to entry and homogenous product element, more firms will enter the market as they’re attracted by this supernormal profit.
(Its important to note how they can also make a loss in the short-run). to show this, the AC would be above the AR horizontal line. firms making a loss will leave the industry easily.
draw diagram -> firm is producing where MC = MR. Yet at this point, MR is larger than AC. This represents the supernormal profit generated.
In the long-run: no supernormal profit is being made in the long-run, only normal profit. this is because new firms entered the market and leave the market until the equilibrium price is reached. quantity supplied will be lower in the long-run in comparison to transition period from short-run to long-run, as there is less incentive to produce more - from lack of supernormal profits.
draw diagram - > LRAC touching the MR.
what is a monopolistic market?
a market in which there are many firms offering a similar product / service, yet they slightly differentiate themselves.
what are the characteristics of a monopolistic market?
- There are a large number of small firms: each one is relatively small and can act independently of the market (they are not price takers)
- There is low barriers to entry and exit -firms can enter the market relatively freely, there is little/no high start up costs. equally, firms can leave the market relatively easily, there is little/no large sunk costs - this incentivizes firms to enter the market.
- The products are slightly differentiated - this exists due to marketing, advertisement, loyalty, etc. This gives individual firms a low degree of market power. For example: nail salons or hairdressers - both offer the same service.
what is the profit maximizing output in the short-run for monopolistic competition, vs in the long-run? (diagram)
In the short-run: firms will either be making supernormal profit, or a loss.
^(profit) - normal profit/cost curve diagram. label the supernormal profit made. label the fact they have some market power.
^(loss) - draw AC higher than AR (d) - just your normal loss diagram.
in the long-run: if firms are making a supernormal profit in the short-run, this will incentivize other firms to enter the market due to the opportunity of profit. This is achievable through the low barriers to entry. However, supernormal profit will be eroded overtime, thus the firm will be making normal profit in the long-run.
^dram diagram where the AC curve is touching the AR curve.
in the long-run: if the firm was making a loss in the short-run, then some firms will shut down due to the low barriers to exit. This will be determined by the shut down rule - where AR = AVC ( as they cant pay off any fixed costs) - this is your usual loss diagram.
what is the market structure of an oligopoly?
a market structure where a few large firms dominate the market, in which they all have significant market power over one another.
what are the characteristics of an oligopoly?
- High barriers to entry - entering the market is hard due to existing dominant firms, who have already asserted brand loyalty and celeb endorsement. There will be high start up costs - like production being capital intensive, e.g. making mobile phones. and leaving the industry will be hard due to high sunken costs.
- product differentiation - brands are able to highly differentiate themselves and their products, creating brand loyalty. consumers perceive the goods to be two different things, due to heavy advertisement. This is supported by behavioral economics, rather than the neo-classical rational choice theory.
- High concentration ratio - a concentration ratio reveals what percentage of the total market share a specific number of firms make up. For example, the top 5 firms make up 60% of the overall market.
- interdependence of firms - with relatively few competitors, firms study each others behaviors and respond to one another’s actions. This generates game theory.
what is the calculation of a firms concentration ratio in a market?
how much of the market share a specific number of companies own. You figure this out by adding up all the relevant companies, and then dividing it by the total amount of companies.
^if a single company makes up 25% of the market share, they’re considered a monopoly by the CMA.
what is collusive behaviour?
when firms co-operate to limit competition, usually achieved through fixing price or restricting output.
what is non-collusive behaviour?
when firms in an oligopoly are still actively competing with one another, to either maintain or increase their own market share.
what are the reasons for collusive behaviour?
- If your market has high barriers to entry, this makes it harder for new firms to enter the market and undercut your collusive prices. (a new company cannot come in and undercut you).
- if all firms in the oligopoly already have a high degree of brand loyalty, and firms have a set established market share, there is little incentive to compete with one another as consumers are unlikely to switch. thus in order to greater your profit, you may as well collude.
^similarly if your market is stable, and the profit made each year is stable and constant (and your costs and revenue are similar to your competitors) there is again little incentive to compete with one another.
what are the reasons for non-collusive behaviour?
- There is always the incentive to cheat in a collusive agreement. if you agree to produce at a given output, and the firm cheats and produces slightly more, they will make more profit than you, meaning all other companies will make less profit.
^This obviously is less likely to happen if they’ve colluded over price, as market price is visible to anyone - whereas output isn’t as obvious. - There’s the incentive to tell the CMA (competition market authority) - if you’re in an collusive agreement, yet you’re the one to tell the CMA, you do not get fined yourself. For example: in 2007 the 4 most dominant firms in transatlantic flights colluded over surcharges, yet it was virgin Atlantic who told the CMA, and thus didn’t get fined themselves. However, British airways was fined $546 million due to collusive behaviour.
What are the two main areas the CMA looks into, and what is an example of this?
-mergers - > where two companies merge together.
^Whitby seafoods are the largest supplier of scampi in the Uk, holding 90% of the market share. They wanted to buy Kilbourne Bay - the second largest supplier of scampi in the Uk. They notified the CMA before they tried to buy them, but the CMA ruled this would limit competition in the industry even further, and the merger was abandoned. They stated it would result in higher prices for pubs that sold scampi, and worsen quality.
-cartels - > is where firms agree on price and output.
^In 2010, the CMA concluded that British airways and virgin Atlantic airways engaged in anti-competitive practice by fixing the price. BA and VAA coordinated their surcharge pricing on long-haul flights to and from the UK between 2002-2006. BA admitted to the collusion., and was consequently fined £58.5 million.
what are the two different types of collusion?
(to include explanation of cartels and price leadership)
1) overt collusion - where firms explicitly agree to limit competition by raising price.
^a cartel is the most restrictive type of collusion, and is illegal. Tis is where firms not only agree on limiting price, yet also output. The group then acts as a monopoly. They can collude through: 1) price fixing - which is where they agree on a set price above market equilibrium 2) they can set output quotas - which limits supply and thus raises prices.
2) tacit collusion - occurs when the firm avoids formal agreement, yet closely monitor each others behaviour. This is not illegal.
^The most common form of tacit collusion is price leadership. This is where firms monitor the price of the largest firm in the industry and then adjust their price to match. Firms do this in order to stay competitive with their biggest competitor. Tacit collusion provides similar benefits as overt collusion, yet not to the same degree.
** it is hard to distinguish whether firms are overtly colluding or tacitly. This is why the CMA mainly relies on firms within a collusive agreement to snitch, through incentives - like avoiding a fine, while their largest competitor gets a larger fine.
what is the potential profit from collusive behaviour? show diagram
you restrict your output to the level it would be in a monopoly- at profit maximising output. Draw diagram
^in a competitive market you’d produce where AC = AR. if you did produce here you wouldn’t make a supernormal profit, as supply equals demand.
^ you’d produce at MC = MR if you colluded. This is restricting output, and thus the price is raised. here you make supernormal profit.
what is game theory?
where one players decisions depends on what the other players do, in a highly independent market (oligopoly)
what is the prisoners dilemma?
An example of game theory - where two rational agents can co-operate for mutual benefit or betray each other for greater individual reward.
what is an example of the prisoners dilemma?
draw a prisoners dilemma diagram
^two firms deciding whether to drop their price.
when do firms typically use game theory?
- deciding whether to raise or lower price
- deciding on new advertisement and branding initiatives
- deciding whether to invest in product innovation - for example after Apple introduced the touch screen, all other companies did the same, apart from blackberry which went bust as a result.
what is meant by price competition?
where firms try to undercut other firms prices in an oligopoly
what are the different types of price competition?
1) price wars - occurs when competitors repeatedly lower price to undercut each other in an attempt to gain market share. the goal is to steal customers from their competitors. For example: leading supermarkets often engage in extensive price cutting for staple goods after Christmas, when most families budgets are tight and people are more sensitive to prices than usual.
2) predatory prices - lowering your prices when a new firm enters the market in order to drive these new firms out. prices are often lowered to a point below the cost of production. Once they have left the market (as they cannot compete with this price) prices are raised again - this is illegal and anti-competitive.
3) limit pricing - occurs when firms set a limit for how high the price will go in their industry. this reduces profit incentives for other firms joining the industry. however the greater the barriers to entry, the higher the limit price is likely to be, as firms already have a low incentive to enter the market as it is.
what is non-price competition and what are the types of it?
non-price competition : competing in others ways to do with the product that doesn’t involve the price of the product.
-quality
-warranties
-customer service / ethics
- branding / advertisement
-loyalty cards
what is a monopoly?
a market where there is only one seller
what are the characteristics of a monopoly?
1) high barriers to entry - There will be high start up costs - like production being capital intensive, e.g. making mobile phones. and leaving the industry will be hard due to high sunken costs.
2) complete market power - has the full ability to set prices and control output. this allows for the firm to maximise supernormal profit. there is no long-run erosion to supernormal profits as competitors are unable to enter the market.
3) no substitutes - this means demand cannot shift elsewhere
what is the diagram for a monopoly market?
draw diagram
analysis - the single firm in the market is the entire market. it is a price maker - it can manipulate prices in order to maximise profit.
what is 3rd degree price discrimination?
Where a firm charges different prices to different consumers for the exact same good / service. sub groups, with different PEDs are made. These sub groups are usually based on time, age, location, income, etc.
From the different PEDs of each sub group, the firm can cut more into the consumer surplus of each group - and ultimately raise super profit, as you’re attracting more customers.
what is an example of 3rd degree price discrimination?
Clubcard’s - you’re charged less for exactly the same product.
Location - bottled water is more expensive in London compared to smaller towns. Equally, boots meal deal is more expensive in London than it is in other nearby towns.
Age - discounts like Unidays or elderly prices
Timing - peak vs off-peak train fair, or holidays more expensive in half term ,etc
what are the conditions needed for successful price discrimination?
1) varying consumer PED - in the different sub-divisions. you’d charge a lower price to the group with an elastic demand, and a higher price to the group with an inelastic demand.
2) ability to prevent arbitrage - this is where consumers move from one sub-division to another. for example, a student using their unidays discount for an adult.
^you can prevent arbitrage through:
- need for ID verification
what is the diagram for price discrimination?
draw diagram
3 diagrams to be drawn next to each other
MC line to run through all of them
1st diagram: elastic demand (in which a lower price is charged and clearly labelled)
2nd diagram: inelastic demand (in which a higher price is charged and clearly labelled)
3rd diagram: market total (made up of both the previous supernormal profits)
^By charging different prices for different PED groups, more supernormal profit is made
what are the advantages (benefits) to 3rd degree price discrimination?
(for both the consumer and producer)
consumer - less advantaged groups on lower incomes will benefit from cheaper prices. They may have a more elastic demand for non-essential goods, yet due to price discrimination they can now better afford goods they once couldn’t - improving their quality of life.
consumers - in cases like public transport, it can manage demand, and make it more of a pleasant experience - like controlling congestion. if there was no price discrimination on rail travel, rush hour would be even more crowded than what it already is. Therefore price discrimination successfully manages demand.
producers - producers benefit from higher revenue and higher profits. if they didn’t benefit in this way, they wouldn’t bother charging different prices in the first place.
^more profit means a firm can fund more investment - increasing their capacity of production by improving their current capital / scope of operation.
producers - will now have a larger customer base, and consequently be able to cut into more consumer surplus than previously.
what are the disadvantages (costs) of 3rd degree price discrimination?
(for both consumers and producers)
consumers - the firm can exploit their producer sovereignty - consumers who have an inelastic demand already (like workers who have to get the train for work as this is their cheapest alternative) may suffer as the higher price may become a burden for them, yet they have no alternative to pay it.
^Evaluation: however, the firms people work for may step in to subsides this.
producers - administration costs to ensure the price discrimination works, and arbitrage cannot occur. for example: the cost of employing someone to check if someone has a railcard or not - etc.
what is a natural monopoly?
a natural monopoly occurs when it is most productively efficient to only have one firm in the market. This is often due to infrastructure - like water, where it doesn’t make much sense to have multiple pipelines.
There are also usually high start up costs and sunk costs with natural monopolies, again decentivising other firms to enter the market.
^There is a lot of disagreement over the amount of profit a natural monopoly should be allowed to generate. They are therefore usually regulated by the government to ensure consumers aren’t charged monopoly prices.
what are the benefits of a monopoly?
(consider: the firm, employees, consumers)
The firm - supernormal profit for a monopoly will not eroded through new entrants into the market, due to barriers to entry present. Therefore a monopoly could invest their profit into the company for innovation - achieving dynamic efficiency in the long-run. This is where the AC curve is constantly falling overtime.
- firms may even experience economies of scale as they grow - like financial economies of scale (more access to credit and ability to bulk buy) yet also technological economies of scale (have t he profit to buy better quality machinery, etc)
Employees - as the firm will be making supernormal profit, they may re-invest back into the company.
^working conditions may improve - offices / buildings may be of higher standard.
^pension schemes / training programmes may improve or increase
^job prospects and chance of promotion may increase as the company grows
^ wages may even rise (this is more likely if the CMA is currently on their back checking if they’re not exploiting their market power)
Consumers - if the firm does re-invest in innovation, then products maybe of higher quality - and prices may fall if the firm passes on their cost savings in the form of lower prices.
What are the costs of a monopoly?
(consider: the firm, employees, consumers, suppliers)
The firm - Due to a lack of competition there is the reduced incentive to innovate as your high price is unlikely to be undercut. They will begin to experience x-inefficiencies.
The firm - CMA may begin scrutinising them
Employees -with monopoly power usually comes monopsony power. Having only one supplier in the industry limits the opportunity to change who you work for. this may mean they have to put up with conditions they wouldn’t usually - like work place bullying, etc.
Consumers - a lack of competition is likely to lead to higher prices for consumers, as no substitutes are available. this means consumer surplus will decrease.
High prices due to price setting power and high barriers to entry that make their high market share stable.
Suppliers - monopolies usually also have monopsony power, and so they have the power to dictate what price they’re wiling to pay to suppliers. this price may not be profitable in the long-run and suppliers may have to leave the industry.
what is meant by monopsony power?
monopsony - where there is only one buyer in the market. For example: The NHS is the main buyer of drugs in the Uk.
For example: supermarkets are the main buyers of milk, and together act as a monopoly.
what are the conditions needed for monopsony power?
1) limited substitute buyers - this limits the options for sellers to find alternative buyers.
2) barriers to entry - this will discourage new buyers to enter the market and thus means only one buyer remains.
what are the characteristics of a monopsony?
- They are profit maximisers - they aim to minimise their costs and maximise their profit, by paying their suppliers low prices. This means they can bargain for lower prices as the suppliers main source of income (their trade) is reliant on them.
- They are wage makers - if they’re the only buyer of a certain profession, they they set the wages. for example, Nurses in the UK - all employed by the NHS.
- Single buyer in the industry - a monopsony is characterised by a single dominant buyer in a particular market. this buyer has substantial market power and controls a significant share of the total demand for a specific good.
what are the benefits of a monopsony?
(consider: the firm, consumers, employees, suppliers)
firms - reduced cost of production leads to higher profits
consumers - lower costs may translate into lower prices, if the firm passes this advantage on
employees - higher profits result in higher wages. Equally; the government is usually a monopsony - line NHS workers employing doctors. If the Government is your employer, there are lots of associated benefits:
-better enforcement of regulations / safety standards
-stable income
-good pension scheme, holiday leave
-constant scrutiny -> BMA or Teachers union
suppliers - stability for their income. guaranteed buyer always -> stable market conditions for them
what are the disadvantages of a monopsony on suppliers, and what is the evaluation to this? (how can it be combatted)
if you’re a supplier, you have limited bargaining power to negotiate back, and the monopsony knows you’re reliant on their trade for income. this puts pressure on them to accept lower prices, or even have to leave the industry as the profit margins are too low now.
However, this can be combatted:
1) smaller buyers can group together to mimic a monopoly, and combat the monopsony power. For example, farmers union. farmers group together to make sure if you say no to a low price, the buyer cant jump to the next farm.
what are the disadvantages of a monopsony on consumers and the firm?
consumers - if the monopsony drives suppliers out of business, this may reduce overall quality, and result in less variety and potentially higher prices in the long run.
firms - firms may receive bad press in the media if they’re known for exploiting suppliers - for example, Tesco’s had to launch a whole campaign called “we stand with our farmers” to save their image / reputation after they were found out for exploiting farmers.
-if the government is the monopsony then it’s likely more tax revenue will be needed from consumers
-workers may go on strike against monopsony level pay
-CMA keeping a close eye on you as you likely have monopoly power too
what is meant by a contestable market?
a market where there is freedom of entry and the cost of exit is also low.
^if a market is contestable, it means the firms within the market will always face a threat of new competition from new firms. The outcome is that the existing firms will play it safe and keep prices at a low level to detract new firms from entering the market. It is not the number of firms that is important, but the ease by which new firms can enter the market.
what are the characteristics of a contestable market?
- low barriers to entry and exit
- hit and run competition - Short-run supernormal profit acts as a profit signaling mechanism & new firms easily enter the market, extract profit, then leave.
- many firms in the market usually
how would you consider how contestable a market is?
you would have to weigh up the associated barriers to entry and barriers to exit, in order to evaluate how contestable a market is.
what are the different types of barriers to entry?
- internal economies of scale - Economies of scale occur when increased output leads to lower average costs. Therefore new firms, with relatively low output, will find it difficult to compete because theirs average costs will be higher than the current firms benefiting from economies of scale. This may deter them form entering the market, as they’d have to charge a higher price in order to make a profit - yet this wont make them competitive.
- pre-existing brand loyalty - With a very strong brand image, a new firm would have to spend a lot of money on advertising, which is a sunk cost and a deterrent to entry. Some brands may be so strong, that no amount of advertising may be able to compete with the existing firm. For example, many firms have tried to enter the cola market, but none have been able to compete on a multi-national stage like Coco Cola and Pepsi have.
- anti-competitive behaviors (monopoly or oligopoly) - existing firms may want to create barriers to entry into the market in order to limit competitions.
^For example: A cartel. This is the most restrictive type of collusion, and is illegal. This is where firms not only agree on limiting price, yet also output. The group then acts as a monopoly. They can collude through: 1) price fixing - which is where they agree on a set price above market equilibrium 2) they can set output quotas - which limits supply and thus raises prices.
^or predatory pricing - this is when a new firm enters the market, so existing firms respond by setting their own price below average cost, in order to push these firms out of the market, as they cannot compete with their low prices. - legal barriers - for example, legal patents. A legal patent can provide a pure monopoly because other firms can’t use its patent (e.g. a pharmaceutical company can get a drug patent for seven years, meaning no one else can sell that particular drug). Equally, other legislation like trade pollution permits may act as a barrier to entry - existing firms will get a higher allowance of pollution to emit, yet new firms wont - but green energy is more expensive than polluting, and therefore their start up cost maybe higher.
what are the barriers to exit?
- high sunk costs - if a firm were to enter a market, that would include a lot of sunk costs had they ever have to leave the market, this will decentivise them to enter as there is more risk associated with such industry. For example: high levels of training is a sunk cost - this is a cost you will never be able to get back. The sunk cost cannot be recovered when the firm leaves the industry.
^equally, money spent on advertisement is a sunk cost if it is unsuccessful. - specialized equipment - Specialized manufacturing is an example of an industry with high barriers to exit because it requires a large up-front investment in equipment that can only perform specific tasks. If a specialized manufacturer wants to switch to a new form of business, there might be financial constraints due to the large sum of capital or money already invested in the cost of the equipment. Until those costs have been covered, the company may not have the resources to expand into a new line of business. they maybe able to sell the equipment, yet this may take time and advertisement.
- legal contracts that must be fulfilled first.
what are the factors that influence the demand for labour?
(including the definition of derived demand)
Labour is a derived demand - this means that the demand for labour depends on the demand for the good / service that labour is producing.
Factors that influence the demand for labour:
1. The demand for the final good, and how labour intensify the production of this good is.
- the business cycle - As demand for labour is a derived demand, when an economy is booming then demand for most goods/services will be high - and the demand for labour will be high in order to meet this higher demand present in the economy. this is why unemployment tends to fall as the economy booms.
- productivity of labour - If the productivity of labour increases (possibly through training) this will lower average costs & firms will likely demand more labour as they’re more cost efficient now.
- availability of substitutes for labour - this depends on how well capital machinery can substitute labour in the specific industry. if buying more machinery is more cost effective, then they will replace labour with these machines instead. for example: banks have replaced workers with card machines. machines do not have the associated costs of labour - like pressure from trade unions, giving breaks, contributing towards a pension, etc.
what are the factors that influence the supply of labour?
different factors for the supply of labour are illustrated in different markets. the supply of labour depends on:
- education / training period - Long training periods act as a barrier to entry and excludes many workers from offering labour in certain markets. For example, the number of qualified doctors is low, due to the 7 years needed in education and the extra training period, therefore supply is quite inelastic. For a job such as fast-food, the number of potentially qualified people is a high percentage of the labour force, therefore supply is much more elastic.
- the generosity of the welfare system - The higher the level of welfare benefits, the lower the incentive for low-skilled workers to offer their labour. they will therefore be apart of the inactive population - those capable to work, yet not offering their labour. However, if the welfare system was reduced, there would be a greater supply of labour, as people will need to find another form of income that isn’t from the government.
- changes in migration laws - policies that increase the net migration rate, like opening up borders, will increase the supply of labour as now new workers are able to fill vacancies in the Uk / join the labour force. For example: fruit picking is unpopular with British workers and therefore the industry rely on immigrant labour. If immigration slows down, there can be vacancies in these particular jobs. Post-Brexit vote, farmers reported difficulty in filling labour vacancies due to a slowdown in immigration
- substitute professions - Comparative wage rates in substitute labour markets strongly influence the supply of labour e.g. it is getting harder to recruit economics teachers as the private sector offers higher wages for their skills. equally, workers will take into account non-wage factors that will influence their willingness to move to a different sector. For example: working conditions, pension, amount f holiday, etc - will all effect if a worker moves from one industry to another, if they’re close substitutes. For example: an economist moving to be an economic teacher.
what are the two types of market failure present in the labour market?
- geographical immobility of labour. Labour maybe reluctant to move their town, or it maybe too costly to move elsewhere. For example: social ties and family heritage in a certain town - memories made and children already in schools. Or it maybe too costly to move - selling your property is a long process, and depends on the health of the property market to whether you’ll be able to sell your house, and find as suitable new one. Houses in your new destination maybe more expensive than your previous, this new area may have an over-subscribed school waiting list or only one hospital , etc.
- occupational immobility of labour - occurs when there are barriers limiting the mobility from moving to one industry to another. This occurs due to specialisation of labour. They may have specific skills that are not necessarily needed in a growing industry which causes a mismatch between the skills on offer from the unemployed and those required by employers looking for workers. This problem is called structural unemployment. This leads to a waste of scarce resources / labour and represents market failure.
what is the diagrammatic analysis of labour market equilibrium?
labour market equilibrium occurs when the demand for labour meets the supply of labour. There is no excess supply of labour or of demand at this point.
individual firms within an industry are price takers, as they have to accept the wage rate the industry is offering in order to be competitive. For example: a corporate lawyer would not be offered £20,000, as this isn’t what the industry is paying - and workers will therefore find a job elsewhere.
^if firms have lower wages than the equilibrium ,they will struggle to attract workers to apply
^there is no point offering a higher wage, as they can get the labour for less (industry price).
what are some current labour market issues?
- Skills shortage - A shortage of skilled labour means that firms are having to increase wage rates to attract labour. Jobs which require more training and education offer higher wages. Training workers is expensive for firms, so they compensate for this by offering workers, who have already undergone education and training, higher wages.
- The amount of 0 hour contracts - These contracts are extremely beneficial to the firm as they can decide when labour is needed, and only pay for it then. However, workers are not guaranteed work and only get paid for the work they do. This means they do not receive as many of the full benefits that workers on a contract do. These contracts will often lead to under-employment within a market and distort unemployment figures - s they are technically employed, yet not receiving as much work / if any work.
- The gig economy - segment of the labour market that concentrates on short-term jobs / contracts. The gig economy refers to a growing range of workers who don’t have typical stable employment but work as self-employed and temporary contractors. Workers in the gig economy will have looser labour market regulations which has enabled their jobs to be re-classified as self-employed - primarily to enable worse working conditions and pay.
What are the 3 types of government intervention in the labour market?
- maximum and minimum wage
- public sector wage setting
- policies to tackle labour market failure - > the immobility of labour
what is the minimum wage? (draw the diagram, and explain)
It is the legal minimum amount employees must pay per hour to their workers. The minimum wage has to be set above the free market price, just like other minimum prices, otherwise it would be ineffective. It is estimated that 5% of the work force receive the minimum wage. The minimum wage is used to reduce relative poverty in the Uk - as it benefits lower income earners directly, and will have an indirect effect on all other workers on similar wages as they will also expect a pay rise. The minimum wage will have the positive externalities of a decent wage, which will increase the standard of living of the poorest, and provide an incentive for people to work.
The efficiency wage theory argues that paying workers above low free market levels gives employees a psychological lift and incentivizes more people to engage in active job search.
diagram with its associated analysis
^The UK government imposes a national minimum wage (NMW) at W1
Incentivised by higher wages, the supply of labour increases from Qe to Qs
Facing higher production costs, the demand for labour by firms decreases from Qe to Qd
This means that at a wage rate of W1 there is excess supply of labour & the potential for real wage unemployment equal to QdQs
what are the limitations / draw backs of the minimum wage?
a minimum wage distorts pricing signals. There will be an expansion in supply of labour incentivises to enter the workforce due to higher wages, yet a contraction in the demand for labour. This will cause real-wage inflexibility unemployment, as it raises the cost of production for firms, and they may need to lay off workers in order to maintain their profit margins. This is especially an issue for firms where labour is their biggest cost of production - like the clothing industry, or smaller firms just starting up.
Even if more people did become employed as a result, this will have its own drawbacks. for example, the Phillips curve - where it represents the trade off between inflation and unemployment. s wages rise, demand will rise, and thus the price level will also have to rise in order to ration goods - known as demand-pull inflation.
Raises the cost of production for firms
what is a maximum wage? (include diagram and explain)
A maximum wage is a government imposed price ceiling below the market price & is rarely used. it can be used to re-distribute wealth across the Uk. There have been some discussion about setting a maximum wage for corporate CEOs - as their wages seem abnormal and contribute towards the disparity of income within the Uk.
In theory, a maximum wage should tackle inflation well, as there is less money circulating the circular flow of income.
draw diagram
what are the draw backs from a maximum wage?
imposing a maximum wage may encourage money to leave the Uk to other more profitable countries with looser legislation - known as capital flight.
imposing a maximum wage offers little incentive for firms to now innovate and become larger / more competitive, as at some point the money they take home will be capped.
Equally, some classical economists believe that the trickle down effect is an effective way to tackle inequality. This is where the richest will spend more within the economy, acting as an injection into the circular flow of income. However there is little evidence that this actually works, as higher income earners have a higher propensity to save.
what is the public sector?
A industries owned by the government - for example, the NHS, schooling, etc. The public sector employs 20% of all workers in the Uk. As the government tends to nationalise vital industries, they in turn gain monopsony power, and are wage makers / setters - they do not take their wage from the market. Private sectors then use the public sector wage as a benchmark when creating their own wage.
what are the implications involved in setting wages in the public sector?
(including evaluation)
As the government has complete monopsony power of labour and monopoly power of the final good /service, they decide the wage that they pay.
As anything in the public sector is funded through taxation (or borrowing) they must weigh up how they are going to fund an increase in wages, as this will also lead to a larger cost for themselves. The same applies for if they want to hire more people.
The government will not operate like your usual monopsony found in the private sector - they will not reduce the amount they pay and will not reduce the output they employ, as their primary goal is to provide a service / maximise utility - it is not to maximise profit.
what are some policies to tackle labour market immobility, in order to tackle labour market failure?
consider both occupational and geographical (and some possible evaluation)
occupational - occurs when there are barriers moving from one industry to another.
^increase in training / apprenticeship schemes - An increase in apprenticeship schemes allows for workers to train in a different field without baring most of the cost. However, most firms would rather pay more for workers who already have this training, than funding apprenticeship themselves, as this cost is a sunk cost and very expensive. Yet this can be reduced in terms of contracts - for example, if a firm trains you, you may have to work for them for the next 3 years.
^increase in education - By increasing education this means more workers have a larger range of skill set, allowing for them to move more easily between industries as they have foundational skills that can be applied across a range of jobs. For example, Rishi Sunak wants to reform the higher education system - and make taking A-level English and maths compulsory until 18. This should provide more young adults with a higher quality set of skills. However, it could be said that this would harm specialisation. for example currently A-level students can take subjects like Media, Politics, Food tech, etc - all subjects very specific and personal to their own interests. by forcing students to take a subject they do not enjoy, this doesn’t necessarily guarantee a more productive work force - it may just result in government failure, as its now a waste of resources.
geographical - occurs when there are geographical constraints from moving from one town to another.
^improved infrastructure - for example, HS2 would connect northern workers to southern vacancies at a faster speed and more pleasurable commute.
^Subsidies travel expenses - rail travel is currently subsidized by the government already, however an argument could be made for subsiding it further to incentivise people to work a little further away from home. Equally the government could subsidized cars or car pool sharing - if they subsidise electric vehicles this may also positively contribute towards their other macroeconomic objective of the environment.
^regulation in the housing market - regulation to make moving house easier, for example, by making it less expensive - like removing stamp duty tax.
^ Building more roads / motorways with better routes / connections, or with more services along the motorway to break up the journey if needed. for many the thought of driving for hours everyday is quite daunting, this maybe tackled by either increasing public transport where no personal effort has to be made to make the vehicle move, and they can simply just sit down, or by creating quicker links between towns via roads and better infrastructure.
what is meant by PED for labour?
How responsive a firms demand for labour is when there is a change in wages (price).
^if demand is elastic for labour, then firms will be very responsive to a change in wages. For example, if wages rise, there will be a larger fall in demand for labour.
^Whereas if demand is inelastic, if wages rise, there will be a little change in demand.
what are some factors that effect a firms PED for labour?
- Availability of substitutes - if there are a wide range of substitute’s available to labour (in the form of capital) then the PED for labour will be elastic. As technology increases its scope of production and firms innovate, they may find out it is more cost-effective to invest in more capital, rather than labour. For example, many banks have gotten rid of desks and now have card machines. This is because they are close substitutes - they perform all the same functions. They also do not have associated costs that paying for labour does - like contributing towards pensions, sick pay, etc.
^Whereas if there are relatively few substitutes for labour - like in the case of lawyers, where a human is needed to rationalise through a case and how it relates to the law, then there are little substitutes, and demand for labour becomes more inelastic. Therefore there appears to be a change in level of substitution when we consider a change in the complexity of the work - if a human brain is needed to reason through a problem (like involving ethics, something we wouldn’t trust a computer to fully grasp) then their demand becomes more inelastic. - The PED of the final product - As the demand for labour is a derived demand, if the PED for the product is inelastic, so will the PED for labour (assuming it cannot be substituted for capital easily). For example, there will always be a demand for oil rig workers, as there is always a demand for oil.
^Whereas the demand for leisure centre / spa subscriptions is more elastic in both PED and YED, and changes when the business cycle changes - as it is not an essential good. Therefore during an recession when there is less demand for spa subscriptions, there will also be less demand for workers at the spa.
^Equally, the proportion of labour cost to a firms total costs will also effect PED of labour. If labour costs is the majority of a firms cost of production, then an increase in this cost will have a much larger effect on their profit margins - making demand for elastic. Whereas if wages fall, then they’re more inclined to employee more workers - dependent on the MRP (Marginal revenue product) This measures how much more output is produced when you employee one more unit of labour.
how does the government intervene to control mergers?
The CMA (competition market authority) conducts enquiries and regulates mergers to control monopoly power present in the market. this is because it often leads to anti-competitive practices.
A merger is where two firms merge together to create one. This leads to a lot higher market share being kept by a single firm (assuming it is not a conglomerate merge).
For example: The whitby seafood merger inquiry. Whitby seafood is currently the largest supplier of breaded scampi, holding a market share close to 90%. Kilhorne bay is the second largest supplier, although they hold a much smaller market share.
Whitby seafood wanted to buy kilhorne bay, yet beforehand they voluntarily notified the CMA of their planned merge.
The CMA ruled that the merger would reduce competition for scampi, yet also create barriers to entry for new potential firms wanting to enter the market.
^The merger therefore was cancelled, to ensure prices didn’t rise and competition could remain in the market.
what are the 4 ways the government can control monopoly power in the market?
- price regulation (maximum price)
- profit regulation
- quality standards
- performance targets
what is meant by price regulation?(maximum prices)
consider its evaluation.
The CMA uses maximum prices in order to lower prices and increase output. This is because typically a monopoly will want to profit maximise - where MR = MC. Yet this results in limiting output for a higher price, in order to create this supernormal profit.
^the maximum price is often imposed on natural monopolies, like the national grid. For example: there’s a maximum energy cap in the Uk which limits the amount energy suppliers can charge consumers.
^The aim is to ensure the firm passes on their efficiency gains to consumers. they determine where the maximum price should be is to identify the point of allocative efficiency & set the maximum price there. Firms will make less supernormal profit than they did before, yet there is now the incentive to innovate and become more efficient as then they can keep generate more profit than previously.
However, it is very hard to know where this point of allocative efficiency actually lies. This is partially due to 1) technology constantly becoming more advanced - so it is hard to keep up, and 2) it is the company who give over their statistics of their efficiency rates. This company could easily lie, showing the problem of asymmetric information that the CMA has.
what is meant by profit regulation?
consider its evaluation.
The CMA may choose to limit the amount of supernormal profit a monopoly can make. This is used mainly in the USA, and is called “rate of return”. The price is set to cover all their costs, and allow for a “fair” profit margin, based on typical rates of return if the market was to be competitive.
However, there is much speculation over whether this actually tackles the problem in the best way. As the calculation is based on the rate of return of the firms capital, there is an incentive to buy more capital (that they don’t intend on using) in order to generate more profit. This may show government failure as now there is an inefficient allocation of capital.
There is also little incentive to becoming more efficient, as a reduction in cost will not lead to being able to keep more profit - as the profit is a percentage, and therefore will shrink when costs shrink.
how may the government use quality standards to tackle monopoly power?
monopolies tend to maximise profit by reducing the quality standard of the good they are selling, as this cuts their costs of production (namely their variable costs). This is exacerbated by if there is no substitutes for such good - for example, Thames Waters water quality has reduced in recent years, including how they dispose of their waste.
the government could therefore step in to ensure certain standards of quality are met. For example, Thames water has many targets on quality that they must meet, and the environmental agency has fined them over 8o times. However, as these fines are a mere drop in the ocean of their total profit, it appears that regulation needs to be stricter.
how may the government use performance targets to tackle a monopoly?
a performance target is a goal set by the government to ensure firms meet a certain criteria. such target can be imposed on variety, consumer choice, consumer satisfaction, etc.
For example, performance targets are often present in the railway service. These targets are set on consumer satisfaction - namely how many trains run a day and whether they run on time or not.
what are the 4 ways the government may intervene to promote competition and contestability in the market?
- privatisation
^Firms are hesitant to enter a market when the dominant firm present is owned by the government. this is because they will have much more funding than any private firm could mimic and would struggle to compete. Whereas privatisation encourages more firms to enter the market as they feel they are on a more equal footing with their competition, and have access to similar levels of investment, resources, etc - and therefore can compete. - deregulation
^This is the removal of legal or cost barriers to enable more firms to enter the market and compete. - competition for government contracts
^competitive tendering is where the government states a certain good / service it wants to provide, and then firms have to bid for the contract to provide said good / service. This is used in primary schools for catering firms. This enables for more competition, as the good is produced by the private sector, yet bought by the public sector. The firm offering the lowest price, alongside meeting quality requirements, will win the contract. This therefore also allows room for innovation in order to become cost effective. - promoting small businesses
^the government may provide tax incentives or subsidises in order to incentivise new firms to enter a market. This will increase competition, as now existing rims cannot afford to be x-inefficient, as new firms are likely to provide new products. There are schemes present that encourage investors to invest in small businesses through tax relief.
How may the government intervene to protect suppliers against monopsony power?
a monopsony is able to exploit suppliers. If you’re a supplier, you have limited bargaining power to negotiate back, and the monopsony knows you’re reliant on their trade for income. this puts pressure on them to accept lower prices, or even have to leave the industry as the profit margins are too low now.
^However the government could introduce different forms of legislation to ensure they are not exploited.
- impose a minimum price firms must pay suppliers for a good. For example, often farmers get exploited by big supermarket chains like Tesco’s - and therefore imposing a minimum price they must be paid will better protect their own profit margins. (like per litre of milk, etc.)
-They can appoint an independent regulator to ensure monopsony’s buy fairly and negotiate fairly.
how may the government intervene to protect employees against monopsony power?
- allowing trade unions to operate within a market
- minimum wage
- nationalisation
what are the limits to government intervention?
(regulatory capture and asymmetric information)
- regulatory capture - this is where the firm influences the regulator. the regulator will meet often with the firms employees, making them more empathetic to the situation. This weakens impartiality and their ability to regulate properly. For example, Vodaphone negotiated a tax reduction with their regulator in 2010.
^This can also be shown in the case of lobbying. This is where firms pay large amounts to lobbyists who can either influence politicians or regulators themselves. - asymmetric information - the government or regulator may not have all the relevant information present in order to cast a well rounded decision / verdict. Or they may not understand the complexity of the market they are regulating. for example, the financial market is fast moving and always adapting, and therefore it becomes much harder to stay up to date.
