Eco Flashcards
What is productivity?
Productivity measures the efficiency of the production process.
How is productivity calculated?
Productivity is equal to output per unit of input
or
Productivity is equal to output per person employed
What are factors that can affect the productivity of the labour force?
Degree of competition in a market Advances in technology Specialization within in a business Investment in new capital inputs Investment in apprenticeships/ training to improve labour skills Quality of the management in a business Having high quality national infrastructure including transport Level of demand for a product
What demand side factors affect labour productivity?
When demand is high businesses make more intensive use of existing inputs e.g. overtime shifts
High demand creates increased profits which can then be used to fund investment in newer more efficient capital.
What supply side factors affect labour productivity?
Skills, experience and qualifications of the workforce
Speed and efficiency of infrastructure e.g. telecoms and transport networks.
What is meant by the term ‘short run’ in economics ?
Short run is when at least one of the factor inputs is fixed, in the short run businesses are constrained with fixed and variable factors.
What is meant by the term ‘long run’? in economics?
All factors of production are variable and the scale of production can also change allowing a firm to benefit from economies of scale.
What is division of labour?
Specialization of individual tasks in the production process can lead to higher output per person.
When does division of labour occur or happen?
When the production process if broken down into many separate tasks.
How can division of labour increase productivity?
As people become increasingly efficient through constant repetition of a task.
What is specialisation?
Specialisation is when a employee focuses on a specific product or task.
What are the key advantages from specialisation?
Higher labour productivity and rising business profits
Specialisation creates a surplus output of goods and services that can be traded internationally
Lower prices cause higher real incomes and gdp growth
How does specialisation increase labour productivity and business profits?
Learning by doing (specialisation) increases output per hour worked, higher productivity lowers the unit cost of supply. Increased productivity leads to higher profits for businesses.
How can specialisation result in higher real incomes and gdp growth?
Lower prices via specialisation gives consumers greater real purchasing power, higher productivity allows businesses to pay increased wages and successful specialisation contributes massively to gdp growth.
What are the disadvantages of a firm implementing specialisation?
Unrewarding, repetitive work that requires little skill can lower motivation and eventually causes lower productivity.
Workers may take less pride in work and quality suffers
Dissatisfied workers causes absenteeism to increase
People move to less repetitive jobs causing higher labour turnover and increased hiring/training costs.
Can cause structural unemployment as workers receive little training and may struggle to find employment when out of work.
How is average cost per unit calculated?
Total cost/Output
How is Average fixed cost calculated?
Total fixed cost/Output
How is Average variable cost calculated?
Total variable cost/Output
What is marginal cost?
The change in total costs from increasing output by one extra unit.
How is total cost calculated?
Cost per unit*Output
What are fixed costs?
Fixed costs are costs that do not vary at all as the level of output changes in the short run.
They have to be paid no matter the level of sales achieved.
What are examples of fixed costs?
Rental cost
Fixed salary costs
Business insurance
What are variable costs?
Variable costs are the operating costs that relate directly to the production or sale of a product.
What are examples of variable costs?
Commission bonuses Wage costs Raw materials Energy and Fuel costs Packaging costs
What are constant returns to scale?
When an increase in inputs (capital and labour) cause the same proportional increase in output.
What are diseconomies of scale?
A business may expand beyond the optimal size and see the Long Run average cost rise.
What are economies of scope?
Where it is cheaper to produce a range of products- cost savings from product diversification.
What are external economies of scale?
External economies of scale occur when a whole industry grows larger and firms benefit from lower long-run average costs.
What are increasing returns to scale?
When output is rising faster than inputs when all inputs can be varied, resulting in economies of scale.
What is minimum efficient scale?
Where international economies of scale have been fully exploited. This is the lowest point on the firms LRAC curve.
What are internal economies of scale?
A decrease in the average cost of from the long term growth of the firm.
What are examples of internal economies of scale?
Technical economies-Shipping in larger shipments
Purchasing economies-Bulk-buy
Managerial economies-Employing specialised staff to raise efficiency
Financial economies-Lower interest rates on loans for larger firms
Risk Bearing economies-Arise from product and market diversification.
In the ‘long run’ of economies what is assumed?
Costs are assumed to be variable, there are no fixed factor inputs.
What are economies of scale?
The unit cost advantages from expanding the scale of production in the long run, the effect is to reduce average costs over a range of output.
These lower costs represent an improvement in productive efficiency and can give a business a competitive advantage, via lower prices and higher profits.
How is economies of scale shown on a long run average total cost curve?
If the curve is declining internal economies of scale are being achieved.
What is the lowest point on a LRAC curve called?
The lowest point on a LRAC is called is the output of productive effiency.
What does rising LRAC mean?
Diseconomies of scale.
If LRAC is falling when output is increasing then what is the firm experiencing?
The firm is experiencing economies of scale, e.g. a doubling of the the factor inputs leads to a more than double of output.
If the LRAC is constant what is the firm experiencing?
Constant return to scale, e.g. the increase in the factor inputs is equal to the increase in output.
How do internal economies of scale occur?
The firm expands itself
Lower lrac as output increases
Increasing returns from large scale production
Benefits such as technical and financial economies.
How do external economies of scale work?
Expansion of the industry of which the firm is a member
Benefits most/all firms
Agglomeration economies are important
Helps to explain the rapid growth of many cities
What are external economies of scale?
External economies of scale involve changes outside of the business, e.g. from the expansion of the entire industry of which the business is a member. The lower unit costs for many/all firms inside the market.
What are examples of external economies of scale?
Influx of highly skilled workers
Relocation of suppliers to the center of production
What is Agglomeration economies?
Agglomeration economies or external economies of scale refer to the benefits from concentrating output and housing in particular areas.
What are the benefits that can occur from Agglomeration economies?
Good supply networks
Supply of trained workers
Infrastructure built specifically for the industry
Good transport links.
What are diseconomies of scale?
Increases in the unit cost of supply in the long run due to decreasing returns to scale.
What does diseconomies of scale mean for a firm?
A business has moved beyond their optimum size
Businesses are suffering from productive inefficiency because of organisational slack.
Worker morale can suffer which reduces productivity and increases unit cost.
Businesses may have to raise prices to cover increased costs
Lost competitiveness could lead to declining market share and a fall in the share price.
What is the minimum efficient scale?
Is the scale of output where internal economies of scale have been fully exploited.
Where is the minimum efficient scale point on a LRAC?
The lowest point on the long run average cost curve.
What is revenue?
Revenue is the money flowing into the firm it is also known as turnover.
How do you calculate average revenue?
Total revenue/Output
What does the Average revenue curve look like?
The same as the demand curve
What is marginal revenue?
The change in revenue from selling one extra unit of output.
How do you calculate total revenue?
Price per unit*Quantity
Average revenue*Output
When is total revenue maximized?
When marginal revenue=zero
When on a linear demand curve is marginal revenue=0?
Directly underneath the mid point
When marginal revenue is zero, what is the value of price elasticity of demand?
1
What would happen if marginal revenue becomes negative?
If prices were cut then total revenue would fall.
What are price takers in an economy?
Price takers accept the ruling market price and sell each unit at the same price, this is when average revenue is equal to marginal revenue.
If average revenue is equal to marginal revenue, what would the firm be in an economy?
Price taker
What are price makers?
Price makers have some pricing power in the economy.
If a firm is a price maker in the economy, what will their average revenue and marginal revenue curves look like?
Downward sloping average revenue curve with marginal revenue below it.
In what markets do price takers exist?
Highly competitive markets
Generally how much market share do price takers have?
Low percentage market share
If a price takers demand curve is perfectly elastic, then what do Average revenue and Marginal revenue=?
AR=MR
In what markets do price makers occur?
This happens in all imperfectly competitive markets.
Can price elasticity of demand vary on a straight line demand curve?
Price elasticity of demand along a straight will vary.
What are abnormal profits?
Profits in excess of normal- also known as monopoly profit.
What are marginal profit?
The increase in profit when one more unit is sold.
What is normal profit?
Normal profit is the minimum reward necessary to keep him in his present industry.
What is profit maximisation?
Profit maximisation occurs when marginal cost=marginal revenue. It is the point at which the firm is achieving the highest possible revenue.
What is profit per unit?
Average revenue-Average Total cost
What is marginal profit?
Marginal profit is the increase in profit when one more unit is sold.
How do you calculate marginal profit?
The difference between marginal revenue and marginal cost.
What is the role of profit in a market economy?
Retained profits are a key source of finance for businesses undertaking capital investment and funds for acquisitions
Market entry- Rising profits sends signals to other producers within a market
Signals about the health of the economy- Rising profits might reflect improvements in supply side performance. They are also the result of higher levels of aggregate demand during economic recovery
What is operating profit margin?
Is a measurement of what proportion of a company’s revenue is left over after paying for variable costs of production.
What is the definition of invention?
Formulation of new ideas for products or processes
What is the definition of innovation?
Practical application of new inventions into marketable products or services
How does invention differ from innovation?
Invention is the act of coming upon or finding, whereas innovation is the creating of new intellectual assets. Innovation is making changes to something established .
What is product innovation?
Launching new or improved products or services onto the market.
What is process innovation?
Finding better or more efficient ways of producing existing products, or delivering existing services.
What are sustaining innovations?
Sustaining innovations are when new products are similar or incremental to existing ones.
Give an example of a sustaining innovation?
A new version of an app or health care product.
What are disruptive innovations?
Disruptive Innovation refers to a technology whose application significantly affects the way a market or industry functions
What are examples of disruptive innovations?
Uber
Online streaming services, such as Spotify and Netflix
The development of e-commerce has had massive effect in most industries and markets, what are examples of these impacts?
Size distribution of firms Distribution channels Profitability of businesses Nature of costs in the short and the long run Barriers to entry and exit Openness to international competition.
How can innovation be a barrier to entry?
Innovation can be a barrier to entering a market e.g. property rights embedded in a product innovations protected by patent laws.
How can innovation cause the exploitation of monopoly power?
There can be a first move advantage for successful innovators that gives them scope to exploit monopoly power.
How can innovation reduce the barriers to entry?
Technology may free businesses having to rely on a single source of supply.
Businesses can build monopoly power quickly using digital platforms e.g. consider the rise of Google
How can established firms challenge new rivals such as Amazon?
Brand loyalty
Physical store network, offer click and collect
What are the objectives of businesses?
Profit Maximisation
Revenue maximisation
Sales maximisation
Social enterprises
At what output level is profit maximised?
When Marginal cost=Marginal revenue
At what output is revenue maximised?
When marginal revenue=0
At what output is sales maximised?
Average revenue=Average cost
How would a company aiming to maximise revenue achieve this?
Price discrimination
Why would a business aim to maximise sales revenue rather than profits?
Because it wishes to deter the profitable entry of new firms/rivals into an industry and therefore maintain more market power.
What may be a consequence if a business decides to maximise sales revenue rather than profits?
A reduction in the price of the firm’s shares since operating profit is likely to be lower.
What is sales maximisation?
When a business sells as much as possible without making a loss.
What is a 3 firm concentration ratio?
The value of the highest three businesses’s market shares added together.
How does profit maximisation affect stakeholders?
Firm makes highest profit thus benefiting the shareholders, as potentially more dividends or increase in share value.
How does profit maximisation affect consumers?
Higher prices and lower output lead to a lower level of consumer surplus
How does profit maximisation affect wider community stakeholders?
Profits provide funds for investment and more tax revenue for the government
How does sales revenue maximisation affect shareholders?
Profits lower than profit max so less shareholder dividends
How does sales revenue maximisation affect consumers?
Lower prices than with profit maximisation so a gain in consumer surplus
How does sales revenue maximisation affect wider community stakeholders?
Likely to be nearer allocative and productive efficiency at a lower price and higher output thus community/society benefit.
How does sales maximisation affect shareholders?
Only normal profit is earned so shareholders recieve lower dividends.
How does sales maximisation affect consumers?
Prices are lower than profit max so customers benefit.
How does sales maximisation affect wider community stakeholders?
Average revenue is equal to average cost thus firm maximizes output which may benefit employment at the firm.
What are maximisers?
Maximisers behave in traditional way and always try to make the best possible choice from all available alternatives.
What are satisficers?
Satisficers examine only a limited set of alternatives and choose the best option between them.
When do some firms use simple rules of thumb for pricing policies?
If a business adopt satisificing, they may use simple pricing methods rather than complex pricing methods,
e.g. cost plus approaches.
Give an example of a possible satisficer and their motive?
Managers of a business who are more concerned with increasing sales revenue/ market share instead of seeking pure profit maximisation.
What are some examples of perfect competition?
Wheat
Sporting Bets
What are the key assumptions to assume that a market is perfectly competitive?
Homogeneous products
All firms have access to factors of production
Large number of buyers and sellers
No barriers to entry or exit
Perfectly elastic demand curve
Perfect knowledge for buyers/sellers
Profit maximization is assumed as the key objective of firms
Consumers are assumed to be utility maximisers.
Price taker
If firms are making abnormal profits in the short run what occurs in the economy?
Encourages the entry of new firms into the industry
Creating an outward shift in market supply
The increase in market supply will eventually reduce the market price until price=LRAC
What is allocative efficiency?
In both the short and the long run price is equal to marginal cost and thus allocative efficiency is achieved.
No one can be made better off without making some other agent at least as worse off.
What is productive effiency?
Productive efficiency occurs when the equilibrium profit maximising output is supplied at the minimum average cost.
If a firm is producing at the lowest point on their LRAC it means the firm must be productive efficient.
What is dynamic efficiency?
There is little scope for innovation designed to make products differentiated from each other and allow one or more suppliers to establish some monopoly power.
What is the ‘shut down price’?
The shut down price is the minimum price a business needs to justify remaining in the market in the short run.
What is the shut down price in the short run?
When price is of sale is greater than the average variable cost.
In the long run a business needs to make at least what type of profit to justify remaining in an industry?
At least normal profits. E.g. where Price is equal to Average cost
If a firm is making a loss in a market while may they still continue to operate?
Downturn is seen as temporary
Managers are satisficing
What does satisficing mean?
Satisficing behaviour is an alternative business objective to maximising profits. It means a business is making enough profit to keep shareholders happy or it’s sufficient for investors to maintain confidence in the management they appoint.
What does cross subsidised mean?
A strategy where support for a product comes from the profits generated by another product. This is usually done to attract customers to a newly introduced product by giving them a lower price. The low price is sustained by the earnings of another product sold by the same company.
What is monopolistic competition?
A monopolistic competitive market is one with freedom of entry and exit, but firms can differentiate their products. There are many producers and many consumers, with a low industry concentration ratio.
Non price competition is strong and lots of consumers switching takes place.
Producers are price makers.
What are some examples of monopolistic competition?
Shoe repairs and key makers Taxi Sandwich bars Coffee shops Hairdressing salons Dry cleaners Bars
What is industry concentration ratio?
A concentration ratio is the ratio of the combined market shares of a given number of firms to the whole market size. E.g. three firm concentration ratio.
How does having low barriers to entry and exit an advantage to a firm?
This allows producers to respond to changing profit signals.
What is a pure monopoly?
A pure monopolist is a single supplier that dominates the entire market, the market has a 100% concentration ratio.
What do the UK competition and Markets authority define a monopoly as?
A firm that has more than 25% market share.
How much market share does a ‘dominant firm’ have?
At least 40%
If a business has a downward sloping demand curve, it is able to…..?
Set prices in the market as it would have price marketing power.
How to barriers to entry help monopolists maintain monopoly power?
As it is more difficult to enter the market monopolists have less competition and are able to maintain their power.
What is assumed the general objective of a monopoly?
Profit maximisation but the actual conduct of firms with market power is often different in each market.
Often firms with market power do not profit maximise as one of their aims as they aim to maintain their market share.
What are potential barriers to entry to a monopoly market?
Economies of scale Vertical integration Brand loyalty Control of important technologies Expertise Goodwill Reputation
What is strategic entry deterrence?
Is any move by existing firms to reinforce their position against potential rivals.
What are some examples of strategic entry deterrences?
Hostile takeover/acquisitions
Product differentiation
Capacity expansions (Exploit economies of scale)
Predatory pricing (Losses in the short run to force competitions out of the market)
What are the main arguments against monopoly?
Produces a welfare loss
Prices are higher
Leads to a loss of allocative efficiency
Regressive effects on lower income households
Absence of market competition may lead to production inefficiencies (High advertising spending)
Higher prices=Lower output and lead to fewer economies of scale being used
Less drive to research and innovate as no competition so no need to improve
Monopoly may get too big leading to dis-economies of scale
If a market has a high market concentration ratio, why may it not always signal the absence of competition?
It can instead signal the success of firms in providing better quality products, more efficiently than their rivals.
What are the key advantages from Monopoly?
Profits can be used to fund capital investment and research
Natural monopoly benefits from significant economies of scale- leading to lower prices
Domestic monopoly faces global competition- domestic monopolies are needed to compete successfully in international markets.
Price discrimination may help some lower income consumers.
What is a natural monopoly?
A natural monopoly occurs when the most efficient number of firms in the industry is one.
Why is it most efficient to only have one firm in natural monopolies?
A natural monopoly will typically have very high fixed costs meaning that it impractical to have more than one firm producing the good.
Give an example of a natural monopoly?
An example of a natural monopoly is tap water. It makes sense to have just one company providing a network of water pipes and sewers because there are very high capital costs involved in setting up a national network of pipes and sewage systems. To have two different companies offering water wouldn’t make sense as the average cost would be very high compared to just one firm and one network. There would also be the inconvenience of having two firms dig up the road to lay a duplicate set of water pipes.
Why must natural monopolies be regulated?
Natural monopolies are incontestable and firms have no real competition. Therefore, without government intervention, they could abuse their market power and set higher prices. Therefore, natural monopolies often need government regulation.
What is price discrimination?
Price discrimination is when a business charges different consumers different prices for the same good or service.
What is 1st degree price discrimination?
This involves charging consumers the maximum price that they are willing to pay. There will be no consumer surplus.
What is 2nd degree price discrimination?
This involves charging different prices depending upon the quantity consumed. For example:
After 10 minutes phone calls become cheaper
What is 3rd degree price discrimination?
This involves charging different prices to different groups of people. E.g.
Student discounts,
Senior citizen rail card
What are the main aims of price discrimination?
To increase total revenue by extracting consumer surplus and turning it into producer surplus
To increase total profit providing the marginal profit from selling to consumers is positive
To generate cash flow especially during a recession
To increase market share and customer loyalty
To make more efficient use of a firm’s spare capacity
To reduce waste and cut the cost of keeping products in storage.
What is dynamic pricing?
When the market demand exceeds the available supply e.g. at peak times, the firm raises the average price to encourage more supply e.g. taxi drivers to take to the roads to the expand the supply.
What are the benefits to the economy of a firm using price discrimination?
Social benefits- charging lower prices for drugs in lower and middle income countries
Making better use of spare capacity can result in less waste
It brings new customers into the market, whom otherwise may not of been able to afford it.
Profit can be used for research or innovation that increases dynamic efficiency.
When evaluating price discrimination, what factors are against the use of it?
Exploitation of consumer the majority of consumers still pay more than marginal cost
If successful it reinforces monopoly power in the market
Possible use of discrimination as a limit pricing tactic and thus a barrier to entry to rival firms.
What is an oligopoly?
A market dominated by a few large firms
High market concentration ratio
Each firm supplies branded products.
There are barriers to entry and exit.
Price rigidity
Non price competition
Attempts to collude and fix price
What five firm percentage ratio does there have to be for a market to be a oligopoly?
Top five firms in the market have more than 60% of market sales.
What is market share?
Market share is the proportion of total sales in a market accounted for by a particular brand, product or company.
What is strategic interdependence?
Means that one firm’s output and price decisions are influenced by likely behavior of rival firms.
What is strategic behavior?
Conscious behavior arising among a small number of competitors or players, in a situation where all are aware of their conflicting interests and interdependence of their decisions.
What are examples of strategic behaviour?
Tacit collusion
Price leadership
Price fixing cartel
Game theory
What is tacit collusion?
When firms co-operate but not formally, e.g. price leadership or quiet co-operation.
What is price leadership?
When one firm has a dominant position and firms with lower market shares follow pricing changes prompted by the the dominant firm.
What is explicit collusion?
An explicit agreement between suppliers to avoid competition, e.g. by fixing prices or sharing a market.
When does price competition between firms occur?
Whenever firms use price as the basis for attracting and retaining customers.
What are different pricing strategies a firm can use?
Competitive
Destroyer/Predatory
Psychological
Penetration
Who are the winners of a price war between firms?
Regular consumers
Managers-(Increased sales)
Who are the losers of a price war between firms?
Shareholders lower profits
Suppliers may get forced into lower prices.
What is non price competition?
Non price competition refers to all forms of competition other than through the price mechanism.
What are examples of non price competition?
Quality of product Design Environment impact After sales services/replacement parts Product differentiation Branding Advertising
What is a product brand?
Brands associated with specific products. E.g. Pot noodle
What are service brands?
Brands that add perceived value to services, either delivered face to face or via online/apps. E.g. Uber
What are Umbrella brands?
Brands that are assigned to more than one product. Makes different product lines easily identifiable to the consumer, e.g. Cadbury
What are Corporate brands?
Promoting the brand name of a business as opposed to specific products or services. E.g. Nestle
What are own label brands?
A type of corporate branding where retail outlets assign their corporate branding to a range of goods and services, e.g. essential Waitrose or Sainsbury’s basics
What are global brands?
The ultimate brands- “household” names based on familiarity, availability and stability that are effective across global markets. E.g. Mcdonalds
In an oligopoly why do firms not raise prices?
Rivals are assumed to not follow price increases so the the acting firm will lose market share- therefore demand will be relatively elastic and a rise in price will lead to less revenue.
In an oligopoly why do firms not reduce prices?
Rivals are assumed to match the price fall to avoid a loss of market share. If this happens demand will be more inelastic and a fall in price will also lead to a fall in total revenue.
Why do oligopolies focus on non price competition?
As an increase or decrease in the price a good or service offered by firm will result in a decrease in total revenue either way.
Why do oligopolies collude?
Collusion lowers the cost of competition, e.g. expensive marketing wars which can run into millions.
Collusion reduces uncertainty in a market
Higher profits increase producer surplus/ shareholder value leading to higher share prices
Collusion in an oligopoly is easier to achieve when:
Industry regulations are ineffective- a source of regulatory failure
Penalties for collusion are low relative to the gains in profits-(fines therefore do not act as a deterrent)
Few firms in the market
Participating firms have a high percentage of total sales- allowing them to control market supply
Firms can communicate well and trust each other and they have similar strategic objectives
Products are standardised
Brands are strong so that consumers will not switch demand when collusion raises prices.
Why do businesses join together to form cartels and collude?
Businesses in a cartel recognize their mutual interdependence and act together- the main aim is to maximise joint profits.
Why do business cartels break down?
Economic recession creates spare capacity
Entry of non cartel businesses into market
Over-production within the cartel- falling prices
Whistle blowers expose cartel to authorities
What are the aims of a business cartel?
To restrict production to maximize their total profits.
How may entry of non cartel businesses into the market cause business cartels to break down?
Other firms who are not members of the cartel may opt to sell just under the cartel price, resulting in decreased demand for the cartel business.
How could a recession cause a business cartel to break down?
Falling market demand creates excess capacity in the industry and this puts downward pressure on profits and cash-flow in the cartel.
How could whistle blowers cause a cartel to fail?
The exposure of price fixing by a whistle blower firm, would mean that the authorities would issue large fines to all the firms associated with the cartel and causing a breakdown in the cartel.
What are the costs to the economy of oligopoly collusion?
Damages consumer welfare-
Higher prices/lost consumer surplus
Loss of allocative efficiency
Hits lower income families has a regressive impact.
Absence of competition hits efficiency
X-inefficiencies leads to higher unit costs
Less incentive to innovate/ loss of dynamic efficiency
Output quotas penalize firms who want to expand.
Reinforces the cartels monopoly power
Harder for new businesses to enter the market this reduces market contestability
What are X-inefficiencies?
X Inefficiency occurs when a firm lacks the incentive to control costs. This causes the average cost of production to be higher than necessary. When there is this lack of incentives, the firm will not be technically efficient.
What is dynamic efficiency?
Dynamic efficiency is concerned with the productive efficiency of a firm over a period of time.
A firm which is dynamically efficient will be reducing its cost curves by implementing new production processes. Dynamic efficiency will enable a reduction in both SRAC and LRAC.
What are the benefits to the economy of oligopoly cartels?
Possible increase in capital investment projects
Research and development leading to dynamic efficiency
Higher wages for employees-more consumption
What is a co-operative outcome?
An equilibrium in a game were the players agree to co-operate.
What is a dominant strategy?
A dominant strategy is one where a single strategy is best for a player regardless of what strategy other players in the game decide to use.
What is Nash equilibrium?
Any situation where all participants in a game are pursuing their best possible strategy given the strategies of all of the other participants.
What is Tacit collusion?
Where firms undertake actions that are likely to minimize a competitive response.
E.g. avoiding price-cutting or not attacking each other’s market.
What is whistle blowing?
When one or more agents in a collusive agreement report it to the authorities.
What is a zero sum game?
An economic transaction in which whatever is gained by one party must be lost by the other.
What is pareto efficiency/optimal?
Pareto efficiency is said to occur when it is impossible to make one party better off without making someone worse off.
What is pareto improvement?
A Pareto improvement is said to occur when at least one individual becomes better off without anyone becoming worse off.
What is break even pricing?
Break-even price is when the price of the good or service is equal to the average total cost.
What is cost plus pricing?
Where a firm fixes the price by adding a fixed percentage profit margin to the average cost of production.
What is limit pricing?
Limit pricing is a pricing by a firm to deter entry or the expansion of fringe firms. The limit price is below the short run profit maximizing price but above the competitive level.
What is peak pricing?
When a business raises its prices at a time when demand has reached a peak might be justified due to higher marginal costs of supply at peak times.
What is penetration pricing??
Pricing policy used to enter a new market usually by setting a low price.
What is predatory pricing?
Predatory pricing is a deliberate strategy of driving competitors out of the market by setting low prices or selling below average variable costs.
What is a contestable market?
A contestable market occurs when there is freedom of entry and exit into the market. In a contestable market, there will be low sunk costs.
What are sunk costs?
Costs which can’t be recovered when leaving the market
What are the conditions for a contestable market?
A pool of new businesses who are willing and ready to enter the market.
No significant entry or exit costs- this lowers the risk of market entry
Equal access to available industry technologies
Higher rates of customer switching (low brand loyalty)
What are some examples of Sunk costs?
Asset-write-offs
Project cancellation costs
The loss of business reputation and goodwill
What is efficiency?
Is about society making optimal use of scarce resources to help satisfy changing wants and needs.
What is allocative efficiency?
When no-one can be made better off without making someone else worse off.
Where production is at an output level where the price equals the Marginal Cost (MC) of production
What is productive efficiency?
Productive efficiency exists when producers minimize the wastage of resources. In the economy there can only be an increase in production of a good if there is a decrease in production of another.
Where is productive efficiency on a PPF?
When a firm operates at its PPF its productive efficient.
Where would productive efficiency be seen on a average cost curve?
The lowest point.
What is innovation?
Changes to products or production processes- innovation is important in delivering improvements to dynamic efficiency leading to better goods and services.
What is product innovation?
Small scale and frequent
What is process innovation?
Changes to the way in which production takes place or is organised.
Where is productive efficiency on a average cost curve?
Productive efficiency is when a firm is operating at the lowest point of their average cost curve.
What does X-inefficiency mean?
X Inefficiency occurs when a firm lacks the incentive to control costs. This causes the average cost of production to be higher than necessary. When there is this lack of incentives, the firm will not be technically efficient.
What can cause shifts in demand for labour?
A change in consumer demand
A change in the price of the product
A change in productivity of labour
Employment subsidy
A change in the cost of capital equipment
Wage rate
What is marginal revenue product of labour?
Is the extra revenue generated when an additional worker is employed.
If a firm is trying to maximize profits it should employ workers until?
Marginal revenue product of labour=Marginal cost labour
What does a elastic labour demand curve look like?
Less steep like a normal demand curve
What does a inelastic labour demand curve look like?
Steep demand curve.
What does elasticity of labour demand measure?
The responsiveness of demand when there is a change in the wage rate.
What does elasticity of labour demand depend on?
Labour costs as a percentage of the total costs of the firm. When labour expenses are a high percentage of total costs labour demand is more elastic.
Ease and cost of substitution: Labour demand is more elastic when a firm can substitute easily and cheaply between labour and capital inputs.
Price elasticity of demand for the product: If the product has inelastic demand then higher costs can be passed on.
Time period: In the long run is it easier for firms to switch factor inputs, e.g. bring more capital in perhaps replacing labour.
What is labour supply?
Hours that people are willing and able to supply at a given wage rate.
What factors are there that influence the supply of labour?
Real wage rate Extra pay Job risk Job security Career opportunities Anti social hours Generosity of occupational pensions Working conditions Quality of training Wages on offer in substitute occupation Barriers to entry (Degree) Non-Monetary characteristics of specific jobs(Job risk, need to work anti-social hours) Net migration of labour Demographic factors Peoples preferences.
What factors affect the elasticity of supply of labour?
Nature of skills and qualifications required to work
Specific skills and education requirements=More inelastic
Lengthy and costly training periods=more inelastic
Skill factor needed, low skill=more elastic
Time period:
in the SR supply curve tends to be inelastic
Takes time for people to respond to changes in wages
What is the equilibrium wage rate?
The equilibrium wage rate is at the intersection of the supply and demand for labour.
What is wage differentials?
The difference in wages between workers with different skills in the same industry, or between workers with comparable skills in different industries or localities.
What are some key causes of wage differentials in the labour market?
Compensating wage differentials
Different skill levels
Differences in labour productivity
Trade unions
Artificial barriers to labour supply
Employer discrimination
How can compensating wage differentials cause wage differentials?
When firms reward people for risk taking, working in poor conditions and during unsocial hours. These create wage differentials as employees whom do these things get paid more.
How can people having different skill levels cause wage differentials?
Market demand for skilled labour grows more quickly than for semi-skilled workers. This increased demand results in wage differentials as firms will pay more for these skilled laborers.
How can differences in labour productivity cause wage differentials?
Workers whose efficiency is high and generate revenue for a firm often have higher pay.
How can trade unions cause wage differentials?
Trade unions might use their collective bargaining power to achieve a markup on wages compared to non-union members.
How can employer discrimination to labour supply cause wage differentials?
Some employers will pay more to male employees causing wage differentials.
What are the arguments for a higher minimum wage?
Poverty reduction-Increases the pay to poorer workers
Training-Encourages firm to train workers that can lead to higher productivity.
Incentives-Will improve incentives for people to look for paid work rather than stay on benefits
Anti-discrimination-Minimum wage is a way of tackling discrimination that affects younger workers.
Equity justification
What are the arguments against a rise in the national minimum wage?
Loss of jobs-Higher MW adds to the cost of employing workers and might cause higher unemployment
Small businesses may struggle to make a profit- a risk of higher business closures
Competitiveness-Might make many UK businesses less competitive in some global markets
Inflation- Higher labour costs might cause higher inflation which then lowers real income for households.
What is the Living wage policy?
An optional alternative to the minimum wage.
What is the policy income tax reforms?
Cutting the basic rate of income tax or lifting the tax free allowance will improve work incentives
What is the policy benefit reforms?
Linking benefits to participation on work programs
What is the policy measures to raise labour productiviity?
Most important in the long run- higher productivity lifts wages and incomes.
The effects of a national minimum wage on employment, inflation and real incomes of those affected depend on?
Price elasticity of demand of the firms products, (Can they pass on higher costs and still sell their products)
The state of the economy, (Whether firms are sufficiently profitable to be able to absorb higher minimum wage)
Whether a higher minimum wage motivates workers to improve their productivity.
The magnitude of the change in the minimum wage and the time scale over which it happens.
What are causes of labour market failure?
Labour immobility
Disincentives to find/take work
Discrimination by employers
Monopsony power of employers
How does labour immobility cause labour market failure?
Occupational immobility-Barriers to moving easily between jobs
Geographical immobility- Barriers to changing local to find a new job
How does disincentives to find/take work cause labour market failure?
Unemployment trap where economic incentives to take a job are poor, leading to people staying unemployed
Poverty trap where there are disincentives to earn extra income.
How does discrimination by employers cause labour market failure?
This is part of explanation of the gender gap in pay and women in senior roles
Discrimination badly affects wages and employment for affected groups that can affect motivation.
How does Monopsony power of employers cause labour market failure?
They can use their buying power in labour market to drive down wages.
What are some examples of geographical immobility of labour?
Family ties
High cost of property
Migration controls-Caps on inward migration
Language barriers
What are the two types of factor immobility?
Geographical
Occupational
What is factor immobility?
Factor immobility occurs when it is difficult for factors of production (e.g. labour and capital) to move between different areas of the economy.
What is geographical immobility?
When it is difficult to move from one geographical area to another.
What is occupational immobility?
Difficultly to move from one type of work to another
What are causes of occupational immobility?
Skill gaps
Training gaps
Experience gaps
Confidence and motivation
How can skill gaps cause occupational immobility?
New jobs may require different skills from those that unemployed workers can offer.
How can training gaps cause occupational immobility?
Unemployed workers may not have access to affordable training schemes that would allow them to improve their human capital and employabilty.
How can experience gaps cause occupational immobility?
The long term structurally unemployed often have gaps in their CVs that make them less attractive to employers.
How can confidence and motivation cause occupational immobility?
The longer someone is unemployed the harder it is to find fresh work. Skills decline and so too does confidence and motivation to look for a job.
What can be done to reduce factor immobility?
Reducing occupational mobility-
Better funding for workplace training
Teaching new skills
An expansion of apprenticeships
Improving geographical mobility-
Rise in house-building will help to keep property prices lower and encourage more affordable rents.
Stimulate stronger work incentives
Higher minimum wage or living wage
Reductions in income tax/national insurance
Welfare reforms to reduce the risk of the povery trap
What is labour market discrimination?
Labour market discrimination occurs when an employer uses characteristics other than the measured productivity of a worker to judge their attractiveness for a job/role.
What are types of discrimination in the labour market?
Gender Ethnicity Faith Sexuality Age Height Social class
What are the reasons for a gender pay gap?
Career breaks to have children
Different choice of profession. – Women more likely to choose ‘caring’ professions which are lower paid.
The role of discrimination is hard to quantify, but, generous maternity pay has arguably created a disincentive to hire women.
Women more likely to do part time jobs. In 2010, some 88% of men work full-time, but only 58% of women worked full-time. Part-time work tends to be lower paid and have fewer opportunities for job promotion.
What is a monopsony in labour markets?
A monopsony occurs when there is one major employer and many workers seeking to gain employment.
If there is only one main employer of labour, then they have market power in setting wages and choosing how many workers to employ
What are the problems with monopsony in the labour markets?
Monopsony can lead to lower wages for workers. This increases inequality in society.
Workers are paid less than their marginal revenue product.
Firms with monopsony power often have a degree of monopoly selling power. This enables them to make high profits at the expense of consumers and workers.
Firms with monopsony power may also care less about working conditions because workers don’t have many alternatives to the main firm.
What is the profit maximising employment level for a monopsony employer?
When Marginal cost of labour is equal to the Marginal revenue of product labour.
What are two disincentives to being part of the labour market?
The poverty trap
The unemployment trap
What is the poverty trap?
The poverty trap affects people on low incomes. It creates disincentive to look for work or work longer hours because of the affects of the tax and benefits system.
What is the unemployment trap?
When the prospect of the loss of unemployment benefits dissuades those without work from taking a new job- this creates a disincentives problem in the labour market.
What are the key roles of trade unions?
Protecting and improving the real living standards/wages of their members
Protecting workers against unfair dismissal
Promoting improvements in working conditions
Promoting better workplace training and education
Protecting pension rights for members.
How can trade unions making employers pay above the normal competitive market wage affect the economy?
This might lead to an excess supply of labour and a contraction of total employment.
Will trade unions have better success raising wages for their members if the demand for labour is elastic or inelastic?
Inelastic as there will be less substitutes/alternatives available to the firm meaning that there is a greater chance of success.
Has trade union membership been increasing or decrease in recent years?
Decreasing.
What are the reasons behind the trade union decline?
Impact of legislation that has reduced many of their powers to engage in industrial action.
Rise in flexible labour markets
De-industrialization- fewer jobs in industries where unions tended to be stronger.
Globalisation which has reduced the bargaining power of employees
What is a Lorenz Curve?
The degree to which income is distributed unequally in an economy or population. Illustrated using a Lorenz Curve and measured using the Gini coefficient.
It shows the depth of income inequality in a given economy or population.
What are measures of income inequality?
Quintile Ratio
Palma ratio
Gini coefficient
S80/S20 ratio
What is the quintile ratio?
Ratio of the average income of the richest 20% of the population to the average income of the poorest 20% of the population.
What is the palma ratio?
Ratio of the richest 10% of the population’s share of the gross national income divided by the poorest 40%’s share.
What is the Gini coefficient?
Gini index of 0 represents perfect equality, while an index of 1 implies perfect inequality.
What is the S80/S20 ratio?
Ratio of the income of 80th percentile to income of the 20th percentile.
What are policies to reduce income inequality?
Minimum wage Living wage Universal Basic Income Higher top rate taxes Higher welfare spending Public and Merit goods Progressive taxes
What are different ways a government can intervene to regulate a monopoly?
Price capping RPI-X to limit price increases
Prevent mergers
Windfall tax on monopoly profit.
Investigating abuse of monopoly power, e.g. collusion.
What are the characteristics of a monopoly?
Dominant firm
High barriers to entry and exit
Supernormal profits in short and long run
How power to set prices however can be regulated
Low allocative efficiency
Productively efficient-econ of scale
Dynamic efficiency-depends on the use of profits
Potentially strong innovative behavior if profits fund research spending
What are characteristics of a competitive market?
Any number of firms usually many
Low barriers to entry
Absence of sunk costs
Threat of entry limits profits
Actual and potential competition limits pricing
More efficient as the market is highly contestable
Strong innovative behavior e.g. disruptive technology
Who are the Competition and Markets Authority?
The CMA has responsibility for carrying out investigations into mergers, markets and the regulated industries and enforcing competition and consumer law.
What are different ways the government can intervene in a market where they believe there is illegal or action against public interest taking place?
Price capping in a market Forced de-mergers Opening up a market via deregulation Better information for consumers Industry adjudicator for consumers
What are the benefits of price capping a industry?
A useful surrogate for competition
Holds price down- consumer welfare gains
Incentives for businesses to cut costs to maintain profits
What are the downsides of price capping a industry?
Reduces profits less money for capital investment
May dissuade new entrants
Firms might raise prices in other ways
What are the alternatives instead of price capping a industry?
Measures to reduce entry barriers in an industry
Higher taxes on monopoly profits e.g. a windfall tax.
Evaluate the effectiveness of price capping in an industry?
To be effective the capped price must be set by the regular below the normal profit maximizing price.
A price cap lowers the monopoly’s super-normal profit made by dominant firms in the market
May stimulate attempts to improve cost efficiency
In theory it leads to an improvement in allocative efficiency and consumer welfare
May also lead to the exit of some businesses from the industry which might actually reduce competition.
Why may the government regulate a industry?
Can create incentives for firms to control their costs
Can limit the impact of monopoly power on consumers
Can encourage new firms to enter an industry
Why may the government not regulate a industry?
Regulations increase costs that may hit small businesses
Always a risk of one or more unintended consequences
Regulations may be captured by powerful lobbying
What is lobbying?
Lobbying is when an individual or a group tries to persuade someone in Parliament to support a particular policy or campaign.
What are examples of anti competitive behavior?
Price fixing and market sharing
Predatory pricing
Charging excessively high prices
Discrimination
Patent misuse
What is the aims of competition policy?
To promote competition make markets work better and contribute towards improved efficiency in individual markets.
Anything that damages consumer welfare,
e.g. price fixing
What are types of legal collusion/business co-operation?
Joint ventures
Information sharing
Why are small businesses important?
Create competition Seed bed for innovation Create new jobs Create choice for consumers Source of exports Can be an agent for social change
How do small businesses survive?
Many smaller businesses act as a supplier to larger enterprises
Sell Niche products which can be sold at a higher profit margin
Avoid diseconomies of scale in the long run
Benefited from people willing to buy online the barriers to entry have come down because of digital technology.
What is privatisation?
Privatisation involves selling state-owned assets to the private sector.
What is the case for privatisation?
Private companies have a profit incentive to cut costs and be more efficient and raise productivity
Government gains revenue from sale of assets
If a state monopoly is replaced by a number of firms this will lead to lower prices and more competitiveness.
What is the case against privatisation?
Social objectives are given less importance
Government loses out on dividends from any future profits.
Often sold too cheaply
Case for state ownership?
Nationalized firms can target social objectives
Natural monopolies in the state sector can achieve economies of scale= gains in productive efficiency.
Can be used as a vehicle for macroeconomic aims
Case against state ownership?
Absence of shareholder pressure might lead to diseconomies of scale therefore higher prices
Lack of market competition can lead to X-inefficiency
Firms may lack an incentive to innovate- leading to a loss of dynamic efficiency
Losses of state owned firms are absorbed by tax payers.
What is a public utility?
A company that provides public services, such as power, water and telecommunications. It is regulated by government, but not necessarily state owned.
What is a regulated industry?
An industry that is closely controlled by the government.
What is a regulatory capture?
When industries under the control of a regulatory body appear to operate in favour of the vested interest of monopoly producers rather than consumers.
It is a form government failure.
What is deregulation?
The opening up of markets to competition by reducing one or more of the barriers to entry in an industry.
What is the aim of deregulation?
To increase market supply, stimulate competition and innovation and drive prices down for consumers.
What are the advantages of deregulation?
Opens up a market to fresh competition
Allows the free market to set prices
Stimulates investment into an industry
Lower prices as a monopoly power is cut
Opportunities for smaller more innovative businesses
What are the disadvantages of deregulation?
Social costs and benefits might be ignored
More choice for consumers might be compromised with reduced quality of service
Harder in industries with big investment/infrastructure needs.
