Econ plus dal micro notes year 2 in flashcards

Question 1

What is the law of diminishing returns?

Answer 1

It states that in the short run when variable FOPs are added to a stock of fixed FOP, total/marginal product will initially rise then fall

Question 2

What is the short run and long run?

Answer 2

Short run is when there is at least 1 fixed FOP
Long run is when all FOPs are variable

Question 3

What is the formula for marginal product?

Answer 3

Change in total products/Change in number of workers

Question 4

What is the formula for average product?

Answer 4

Total product/number of workers

Question 5

When is TP highest?

Answer 5

Total product being produced is highest when Marginal product is 0 (top of the curve)

Question 6

What does the different parts of MP curve look like?

Answer 6

The first rising part shows each extra worker brings in more output than the last. This means labor productivity is increasing.
The second part, after the curve has peaked is when the law of diminishing returns kicks in. Labour productivity decreases as fixed FOPS constrain production (not enough space or equipment for workers)

Question 7

What are explicit and implicit costs?

Answer 7

Explicit costs are things that require actual payment like fixed costs and variable costs
Implicit costs is just the opportunity cost

Question 8

Examples of fixed and variable costs?

Answer 8

Fixed costs - Rent, salaries, interest on loans, advertising, business rates
Variable costs - wages, utility bills, raw material costs, transport costs

Question 9

What is the formula for total fixed costs?

Answer 9

Total fixed costs = Total costs - Total variable costs
or it is the Average fixed cost x quantity

Question 10

What is the formula for average fixed costs?

Answer 10

Average fixed costs = Average costs - Average variable costs
or Total fixed costs / quantity

Question 11

What does a cost curve with TFC and AFC look like?

Answer 11

AFC looks like bottom left of circle and TFC is a straight horizontal line

Question 12

What does the average variable cost curve look like?

Answer 12

Normal U. Quadratic curve.
Axes are costs on the Y and output on the X

Question 13

How to calculate Marginal costs and Average costs?

Answer 13

Marginal cost = change in total cost / change in quantity
Average cost = Total costs / Quantity

Question 14

What does the MC and AC curve look like?

Answer 14

MC looks like a Nike tick. The first part is when labour productivity increases and Marginal cost decreases. This is due to specialisation and an underutilization of CELL. Second part is when labour productivity decreases and Marginal cost increases. This is as fixed FOPs become a constraint

Ac curve looks like a quadratic curve or a wide U

Question 15

What does total cost, Total variable cost and total fixed curves look like?

Answer 15

Total cost is above Total variable cost, however, they have the same shape which is like a whole tan interval.
The difference between the 2 lines is the total fixed cost
Total fixed cost is also the horizontal straight line

Question 16

What does the Long run average cost curve look like? LRAC

Answer 16

Shaped like a wide U and has 3 parts
Part 1 exists when there is economies of scale. There is an increasing returns to scale. This means the percentage increase in output is bigger than the percentage increase in input
Part 2 is when there is constant returns to scale. This means the percentage change in output is the same as percentage change in input
Part 3 is where diseconomies of scale occurs. There is a decreasing return to scale. This means the percentage increase in output is less than the percentage increase in input

Question 17

What is the minimum efficient scale and where is it on the LRAC curve?

Answer 17

It is at the end of section 1 and start of section 2.
It is the lowest level of output required to exploit full economies of scale.

Question 18

What is economies of scale?

Answer 18

It is a reduction in LRAC as output increases

Question 19

What is internal Economies of scale and what is required for it to occur? (Really fun mums try making pies)

Answer 19

This happens within a business.

Risk bearing - diversify and spread risk
Financial - lower rates of interest on large loans as lower risk
Managerial - specialist managers to boost productivity
Technological - better tech raises productivity
Marketing - bulk buy advertising
Purchasing - buy raw materials in bulk as firms get larger

Question 20

What is external economies of scale and what is required for it to occur?

Answer 20

It is when a business within an industry can benefit without doing anything
Better transport infrastructure, reduces costs on businesses
Component supplies move closer to you - this cuts costs of transportation
R and D firms move closer - improves tech and reduce costs

Question 20

What is diseconomies of scale and what are the causes? (CCCM)

Answer 20

It is when there is an increase in LRAC as output increases
Control - struggle to control huge work force
Communication - harder to spread messages to workers which wastes a lot of time
Coordination - becomes difficult as you get larger
Motivation - workers feel less valued which drops productivity

Question 21

How to calculate TR, MR and AR?

Answer 21

Total revenue = price x quantity
Average revenue = Price
Marginal revenue = Change in total revenue/Change in total quantity

Question 22

What does AR MR and TR look like on a grap?

Answer 22

AR=MR=D
Equal to the demand curve
Price/revenue on y axis
Quantity on x axis

Tr is a diagonal line from origin

Question 23

What is formula for profit?

Answer 23

Total revenue - Total costs(TFC TVC and opportunity cost)

Question 24

What is normal profit?

Answer 24

This is the minimum amount of profit required to keep FOP in their current use
Average revenue = Average cost

Question 25

What is supernormal profit?

Answer 25

This is when Average revenue > Average costs

Question 26

What is subnormal profit?

Answer 26

Average revenue < Average costs

Question 27

What are the objectives of firms?

Answer 27

Profit max, rev max and sales max.

Question 28

Why do we always assume objective of a firm is to prof max?

Answer 28

They can re invest - R&D
Dividends for shareholders - keeps the owners happy
Lower costs and lower prices for consumers
Rewards entrepreneurship

Question 29

What are reasons not to always maximise?

Answer 29

Avoid scrutiny (if you’re doing something dodgy)
Other objectives may be more appropriate like survival

Question 30

What is profit satisficing?

Answer 30

This is when a business sacrifice profit to satisfy as many key stakeholders as possible
Shareholders and managers are happy as they get bigger bonuses and dividends
Consumers don’t like it as it leads to excess price which gives a bad reputation
Workers don’t like it as wages are low due to cost cutting - can strike
Governments don’t like so they go investigate
Environmental groups don’t like it as pollution occurs - protests and social media attacks

Question 31

How can prof max be seen on a curve?

Answer 31

When MC = MR
When tick crosses with straight diagonal MR line

Question 32

Why do some firms choose revenue maximisation and what does this look like on a graph?

Answer 32

Revenue maximisation occurs when MR = 0. Go all the way up until you hit the AR=D curve and that is your price for revenue max

Why rev max?
Economies of scale benefits - revenue max quantity>prof max quantity. This means lower average costs so lower prices
Predatory pricing - When revenue max price < profit max price means dodgy tactics like PP can take place
Principle agent problem - Divorce between ownership (shareholders) and control (managers)

Question 33

Why do some firms sales max and what does it look like on a graph?

Answer 33

It occurs when AC=AR. Take this up and that’s the price. It is lower than prof max price and rev max price.

Why sales max?
Economies of scale benefits
Limit pricing (takes away incentive for new firms to enter the market)
Principle agent problem (divorce of ownership and control) - managers can use growth or sales as leverage to apply for perks and bonuses
Flood the market - lots of consumers become aware of your product

Question 34

What could be some other objectives of firms?

Answer 34

Survival - if entering a hyper competitive market - short run
Public sector organisations - Max societies interests / welfare so where D=S or P=MC
CSR’s - Corporate social responsibility through things like charity, sustainability and ethics

Question 35

What are barriers to entry? (LLoyds TSB)

Answer 35

Any obstacle that prevents a new firm from entering the market
Legal:
Patents, Licenses/permits, Red tape, Standards regulation, Insurance

Technical:
Start up costs, sunk costs, economies of scale, natural monopoly

Strategic:
Predatory pricing, limit pricing and heavy advertising

Brand loyalty

Question 36

What are barriers to exit?

Answer 36

Any obstacle that prevents a new firm from leaving a market

Under valuation of assets
Redundancy costs
Penalties for leaving contracts early
Sunk costs (all money spent on unrecoverable things)

Question 37

What does economic efficiency consist of?

Answer 37

Allocative, productive, X, dynamic efficiency

Question 38

What is allocative efficiency?

Answer 38

This is where resources follow consumer demand
This is where society surplus is maximised
This is where net social benefits is maximised
It occurs when P=MC, AR=MC, MSB = MSC and D=S

Question 39

What is productive efficiency?

Answer 39

This is when a firm is operating at their lowest point on the AC curve
There is full exploitation of all potential Economies of scale

Question 40

What is X efficiency?

Answer 40

It occurs when a business is minimising waste
It is when production is ON the AC curve
There would be X inefficiency when:
Monopolists lack competitive drive allowing for complacency
Public sector firms aren’t profit motivated, just want to max out social welfare

Question 41

What is dynamic efficiency?

Answer 41

The reinvestment of LR supernormal profits back into the business in the form of new and upgraded capital, technology, R&D, innovation etc
Lr supernormal profit

Question 42

What is static and dynamic efficency?

Answer 42

Static is allocative, productive and X. It occurs at 1 specific production point
Dynamic efficiency occurs over time

Question 43

Allocative efficiency analysis?

Answer 43

Definition - where D=S in a a market, society surplus is being maximised
Condition - occurs when P=MC
Consumer analysis - Resources are following consumer demand, Low prices (max of consumer surplus), High choice (what consumers desire), High quality
Producer analysis - It’s a way to retain or increase market share (stay ahead of rivals), increase profit by bringing more consumers to them

Question 44

Productive efficiency analysis?

Answer 44

Definition - maximisation of output at the lowest possible average cost, exploitation of economies of scale.
Condition - Min point of AC, MC=AC
Consumer analysis - Lower prices for consumers if the lower costs are passed on. Higher consumer surplus surplus due to the full exploitation of economies of scale
Producer analysis - More production at lower cost (higher profits), Lower prices and greater market share

Question 45

X efficiency analysis?

Answer 45

Definition - production with no waste
Conditions - Production takes place at any point on the AC curve
Consumer surplus - Lower costs which means higher profits
Producer surplus - Lower prices to pass on to consumer to increase market share to stay ahead of rivals

Question 45

Dynamic efficiency analysis?

Answer 45

Definition - reinvesting supernormal profits into innovation, R&D and new technology to lower LRAC over time
Conditions - supernormal profit is needed in the long run
Consumer analysis - New innovative products. Lower prices over time due to new tech, production processes. New entrants can push prices down which increases consumer surplus
Producer analysis - Long run prof maximisation is allowed. Lower costs over time. Retain/increase market share. A way to stay ahead of rivals which can help create monopoly power

Question 46

What is perfect competition and graphs?

Answer 46

There are many buyers and sellers
Homogenous good - firms are price takers
No barriers to entry/exit
Perfect info
Firms are profit maximisers (MC=MR) - Long run in perfect competition is when normal profit is being made

Look at paper for normal profit in Long run
Look at paper for supernormal profit in the short run
Look at graph for supernormal profit in the long run
Look at graph for subnormal profit in the short run

Question 47

Normal profit in long run

Answer 47

S and D lines. Then P1Q1 at equilibrium. Take it all the way across and on the new curve this will be p1 which is AR=MR=D.
Q2 arises from when MC=MR at the lowest point on the AC curve

Question 48

Supernormal profit in the short run

Answer 48

Normal S and D lines then take P1 across to make P1 for new graph. Profit maximisers so they produce at MC=MR. Mc cuts AC at lowest point. Average revenue > Average costs so SNP is being made. C1.

These SNP in the short run will attract new firms which compete away the SNP profits. This leads to supply shifting to the right and prices fall as a result.

Question 49

Supernormal profit in the Long run

Answer 49

S1 and S2 with D curve. Lower price at S2. Take it across to show lower price on next curve. Label it AR2=MR2=D2
Q4 is the new profit maximising position which shows normal profit now.
There is a tendency for new firms to enter until SNP are eroded away.

Question 50

Subnormal profits in the short run

Answer 50

AC curve is higher than AR curves. This means costs are more than revenues.
Supply curve shifts left which gives higher price too

Won’t last in the long run as firms will be incentivised to leave the market. They can leave as there are no barriers to exit. Supply shifts left, price goes up and that will keep happening until there is no incentive to leave (normal profit is attained)

Question 51

Efficiency analysis on perfect comp?

Answer 51

Allocative efficiency is when P=MC
Productive efficiency is when they are operating at lowest point on AC curve
X efficiency is when they are on the AC curve.
ALL 3 of these occur in perfect competition

Dynamic efficiency doesn’t occur as they don’t have SNP to reinvest back

Question 52

What are the characteristics of a monopoly?

Answer 52

One seller dominating the market (pure monopoly). Monopoly power is when one firms owns more than 25% of market)
Differentiated products which means the firm is a price maker
High barriers to entry/exit - SNP can persist over time
Imperfect info - keeps firms from entering
Firm is a profit maximiser which means MR=MC

Question 53

Monopoly efficiency analysis

Answer 53

Statically inefficient:

Not allocatively efficient as AR does not equal MC or P does not equal MC
Exploiting consumers as P>MC
Restricting output in order to make profits
Low quality due to lack of competition

Not productively efficient as they don’t produce at the minimum point of the AC curve

X inefficient as it occurs when monopolises produce above their AC curve allowing for wastage and excess costs. Monopolists get complacent. They don’t need to worry as they can just charge higher prices

They are Dynamically efficient as they make SNP in long run which they can re invest

Question 54

What is price discrimination?

Answer 54

This is where a firm charges different prices to different consumers for an identical good/service with no differences in cost of production

Question 55

What are the conditions necessary for price discrimination?

Answer 55

Need to have price making ability - monopoly power
Information to separate the markets - identify the marketts with inelastic demand so you can charge more
Prevent resale of the good (market seepage)

Question 56

What is 1st degree price discrimination?

Answer 56

Occurs when consumers are charged the exact price they are willing to pay for a good or service, eroding all consumer surplus and turning it into monopoly profit

Question 57

What is 2nd degree price discrimination?

Answer 57

It is called excess capacity pricing
For example, trains, cinemas and hotels - makes no sense leaving capacity available as they have fixed costs to pay. So they deal with this by last minute lowering of pricing - deals

Question 58

What is 3rd degree price discrimination?

Answer 58

Occurs when firms are able to segment the market into different PEDs. For example, rail companies. Inelastic are the commuters who need to get to work but elastic is leisure travellers

Question 59

What are the pros and cons of price discrimination?

Answer 59

Pros:
Dynamic efficiency which leads to greater profits
Greater economies of scale benefits with higher quantities which means lower price to consumers over time
Some consumers benefit from 2nd and 3rd degree. Through deals and being an elastic consumer
Cross subsidisation may occur - higher profits may be used to subsidise other loss making goods in a business

Cons:
Allocative inefficiency - exploiting consumers
Inequalities - if those consumers being discriminated against are on lower incomes, it can widen income inequality within society
Anti-competitive pricing - lower pricing can drive out other firms and we don’t want that as it would give them monopoly power

Question 60

What are the features of a natural monopoly?

Answer 60

Huge fixed costs
Enormous potential for economies of scale
Rational for only 1 firm to supply the market - competition is undesirable
Competition would result in a wasteful duplication of resources as the 1st firm into the market has the economies of scale advantage. This means the second firm will be priced out of the market which is just a wastage of resources and allocative and productive inefficiency

Look at paper for graph.
Downward sloping cost curve due to the huge economies of scale. It is deemed not good enough by regulators as they are charging very high prices for little quantity which means people can’t afford or have access to basic essential needs. The regulation point is where it is allocatively efficient. P=MC
However, it leaves no reason for firms to stay in the market as AC>AR which means sub normal profit is being made. You often see subsidies given by regulator to make sure the loss is covered.

Question 61

What are the pros cons and evaluation points of a monopoly?

Answer 61

Pros:
Dynamic efficiency occurs. This means you are able to reinvest SNP back into the business. This is good for consumers as you get innovative new products of better quality and better tech over time. Can beat rivals through the innovations over time.
Greater Economies of scale purely because of the size. Can charge lower prices and a higher quantity then a competitive firm trying to be allocatively efficient
A regulated natural economy gives desirable outcomes.
Monopolies can cross subsidise

Cons:
Allocatively inefficient. P>MC which means consumers are exploited, lower consumer surplus as a result. Can also be quality issues
Productively inefficient. Don’t minimise costs by being on the lowest point of the AC curve. Price is higher as a result, so consumers lose in that way too
X inefficiency
Inequalities in necessity markets - due to higher prices, the poor can suffer the most. Don’t want to see monopolies in necessity markets as it can lead to income inequalities.

Evaluation:
Can critique if dynamic efficiency will occur - they can pay off debts or pay shareholders instead
Economies of scale or diseconomies of scale?
Objective of monopoly may not be profit maximisation
Regulation - can help to reduce some inefficiencies
Price discrimination - exaggerate the -ves of monopolies
Competition? - rarely pure monopolies. Comp can keep monopolists honest and reduce inefficiencies
Natural monopolies are good
Depends on the type of good whether it is a necessity or a luxury

Question 62

Pros cons and evaluation of competitive markets

Answer 62

Pros:
Allocative efficiency - firms charge a price = marginal cost, lower prices for consumers, higher consumer surplus, resources follow consumer demand
Productively efficient - minimise AC and exploiting all Economies of scale and this pass on lower costs to consumer
X efficient - minimise waste and produce on their AC curve
Jobs can be created more in competitive markets - links to quality of life and standard of living due to derived demand

Cons:
Lack of dynamic efficiency due to no SNP
Lack of economies of scale as lots of small firms so they can’t build market share. Even if they’re productively efficient it is still lower Economies of scale than monopolies.
Cost cutting in dangerous areas? - wages, environment, health and safety
Creative destruction - new firms beat existing firms with lower costs of production or brand new products

Evaluation:
Still dynamic efficiency? Might have just enough profit
Level of Economies of scale
Natural monopoly?
Where is cost cutting taking place?
Role for regulation? Make sure society is protected
Static vs dynamic efficiency - which one is preferred in your market
Depends on the type of good/service made

Question 63

What are the characteristics of monopolistic markets and some examples?

Answer 63

Examples would be clothing markets, taxis, Fastfood/restaurants and hairdressers

Many buyers and sellers
Slightly differentiated goods - firms are price makers, price elastic demand
Low barriers to entry / exit
God info about market conditions
Non-price competitions - branding, advertising and quality
Firms are profit maximisers

Question 64

Short run and long run graphs for monopolistic competition

Answer 64

Look at paper

Long run, SNP gets eroded away due to low barriers of entry and exit + good information about the market

Question 65

Efficiency analysis of monopolistic comp

Answer 65

They are not allocatively efficient as in the long run P>MC
They are not productively efficient in the LR as they don’t produce on the lowest point of AC which is the reason for higher prices
They are not dynamically efficient as in the long run there is no SNP to be reinvested back into the economy

Question 66

Evaluation of monopolistic comp

Answer 66

Allocative efficiency:
The price making effect isn’t as bad as a monopoly as there is a good amount of competition in this market. The loss of consumer surplus is nowhere near as bad.
In perfect competition, there are homogenous goods, that’s not what consumers desire. Thus, differentiation in monopolistic comp is good, thus allocative efficiency isn’t that bad.

Productive efficiency:
PE compared to monopolies is nowhere near as bad as there are good substitutes in monopolistic markets.
In perfect comp, not very much economies of scale but in monopolistic comp there is which means prices can be lower than perfect comp. Our desire for variety can make it harder to exploit economies of scale

Dynamic efficiency:
If short run SNP are enough to reinvest
In a very competitive market we can still get dynamic efficiency, even if normal profits are being reinvested - sometimes it is a requirement in a market (clothing and phones to get ahead of rivals)

Question 67

How to calculate concentration ratios?

Answer 67

n:Total market share

Question 68

What is an oligopoly?

Answer 68

This is where few firms dominate the market - high conc ratio (roughly 70% for no more than 7 firms)
Differentiated goods - which allows them to be price makers
High barriers to entry/exit - start up costs, economies of scale, brand loyalty etc
Interdependence - firms make decisions based on the actions and reactions of rival firms - price rigidity
Non price competition - branding, advertising, quality of product/service
Prof maximisation is not necessarily the sole objective - pursue what gives them the most market share

Question 69

What are examples of an oligopoly?

Answer 69

Soft drink industry
Car industry
OPEC
Uk supermarket, energy, airline and bus industries

Question 70

What does the kinked demand curve look like and what are its features?

Answer 70

Lets assume equilibrium is at the point where the gradient of the demand curve changes

A raise in price means Q decreases proportionally more than a decrease in price. This is because of interdependence, other firms won’t follow the price rise by keeping price the same as they will gain market share. Firms that have raised their price will suffer, all other firms in the market will keep their price at p1, demand will drop off significantly and as a result, market share will decrease and total revenue will decrease

A fall in price means Q increases proportionally less than price. This is as the firm now moves to the price inelastic part of the demand curve. This is due to other firms and how they will react. Other firms will decide to follow and protect their market share which will lead to a price war. Total revenue will decrease and over time there will be no change in market share.

However, firms don’t want or need to change their price

Question 71

Conclusions from the kinked demand curve model

Answer 71

Could be price competition - they may still try to reduce price to gain market share even if it doesn’t make sense
There will be a lot of non price competition
There is a temptation to collude - this is because interdependence is annoying as firms are always worried about their rivals

Question 72

What is game theory?

Answer 72

It is the concept of what each firm does depends on the action of another firm

There is price rigidity at a certain price which means in order to compete you use non-price strategies
There is a temptation to collude to get most profit for both firms. They need to work together.
There is an incentive to cheat on collusive agreements as you can get more than the other if you go back on your word. Evaluation would be that collusion may not last in the long run

Question 73

What is overt and tacit collusion?

Answer 73

Overt is when people get together and decide
Tacit is when the collusion is informal or implied

Question 74

What are the factors promoting a competitive oligopoly and the factors promoting a collusive oligopoly?

Answer 74

Competitive oligopoly:
Large number of firms (less concentration) - organising collusion is then hard
New market entry possible? - if new market entry is possible then collusion isn’t as attractive as it encourages new firms to come and compete away SNP.
One firm with significant cost advantage (they won’t want to collude)
Homogenous good - don’t have price making powers to fix prices
Saturated market - a lot of price wars and competition, only way to get ahead is to snatch market share
Evaluate as if speaking about a competitive market - static efficiency benefits and lose economies of scale benefits and dynamic efficiencies

Factors promoting collusive oligopoly:
A small no of firms
Similar costs - collusion is easy
High entry barriers - SNP can be kept
Ineffective competition policy means you’re more likely to get away with it
Consumer loyalty and consumer inertia (don’t want to switch) - cheating is less likely to occur if there is consumer loyalty to your rivals.
Evaluate as if speaking about a monopoly - all static inefficiencies and dynamic gains and economies of scale gains

Question 75

What is a contestable market?

Answer 75

This is where there is a threat of competition

Question 76

What are factors that affect threat of entry?

Answer 76

Low barriers to entry and exit
Large pool of potential entrants
Good info of market conditions
Incumbent (large market share) firms are subject to hit and run competition (snatch SNP and then leave the market)

Question 77

How has technology affected the contestability of markets?`

Answer 77

Because of rise of tech - it has increased

Massively reduced barriers to entry/exit as businesses don’t have to be physical anymore (less start up and sunk costs). Eos and advertising easier
Increased pool of potential entrants through innovation to disrupt markets
Increased info - can find out things easier - better communication

Question 78

Can monopolies be contestable?

Answer 78

Yes they can as monopolies will move to normal profit point of AC=AR also knows as the break even point.
By limit pricing, and thus lowering profit margins, they are eliminating threat and taking away incentive for firms to enter. As long as you are making SNP there is incentive to enter.