Economics Stage 4

Question 1

What is the Market Structure of the Monopolistic Competition?

Answer 1

• Monopolistic competition is a market structure where:

▪ A large number of buyers and sellers are present (i.e. limited market power).

▪ Barriers to entry and exit are low (i.e. only normal profits are made in the long-run).

▪ Firms can differentiate their products (i.e. products are heterogenous).

▪ Firms compete on quality, price, and marketing.

Question 2

What is Product Differentiation in Monopolistic Competition?

Answer 2

• Firms in a monopolistic competition market have the ability to alter their products to make them different to the products offered by their competitors.
• A common approach is through branding.
• Brands can be purely symbolic (e.g. fashion labels) or attempt to communicate a non-visible feature (e.g. organic or fair trade).

Question 3

What 3 ways does Product Differentiation occur?

Answer 3

• This product differentiation allows firms to compete in three different ways:

▪ Quality Competition– firms may develop high quality products (e.g. more durable, reliable, and with better customer support).

▪ Price Competition– a firm producing a lower quality good may sell that product at a lower price than the market price.

▪ Marketing Competition– a firm producing a higher quality good may conduct marketing activities and alter its packaging to bring this to the attention of
consumers.

Question 4

How can Price Differentiation be observed?

Answer 4

• An example of a monopolistic competition
  market structure is that of prepared foods.
• Retailers stock a large range of crisps that are
  differentiated based on:

▪ Branding– Walkers and Kettle
▪ Ingredients– flavour
▪ Variation– crinkle cut and pringle
▪ Size– 35g and 150g
▪ Price– premium and basic

• This allows the market for prepared foods to
  display high levels of product differentiation

Question 5

How does Short-Run affect a Monopolistic Competition?

Answer 5

• Assume a firm in a monopolistic competition
  market introduces a new product variant.
• Initially, they are the sole provider of this new
  product variant.
• As a result of this, in the short-run the situation
  facing the firm is much the same as a monopoly.

Question 6

How does Short-Run affect Monopolistic Competition?

Answer 6

• As there are low barriers to entry in monopolistic
  competition, the short-run economic profit
  attracts new entrants.
• These new entrants mean that the firm’s demand
  curve reduces and shifts to the left with a
  corresponding shift in the MR curve.

This is done until all economic profit has been competed away.

Question 7

How does Monopolistic Competition benefit an economy?

Answer 7

• If products are changed to improve their
  features then the development cost incurred
  could represent a good investment.

▪ Firm earns economic profit in the short-run.

▪ Consumers get better and higher variety goods. Is product differentiation a good thing?

• If products are changed to improve their
  features then the development cost incurred
  could represent a good investment.

▪ Firm earns economic profit in the short-run.

▪ Consumers get better and higher variety goods.

• What about if a firm simply invests in
  advertising to create the illusion of a superior
  product?

▪ The fixed costs of the firm increases which also
increases its average total costs.

▪ If a firm can sell more due to advertising, it
could lower its ATC.

Question 8

How does a Monopolistic Competition damage the Economy?

Answer 8

• The capacity output of a firm is where the ATC is at
  its lowest point.
• An interpretation of this is that monopolistic
  competition markets are generally inefficient.
• These markets could be producing products at
  lower average prices if there was no product
  differentiation.
• However, consumers value variety and uniqueness.

Question 9

What is an Oligopoly Market?

Answer 9

• Oligopoly is a market structure where there are a few firms present.
• The products these firms sell can be homogenous or heterogenous.
• These small number of firms are linked in terms of their decision making.
• The price setting behaviour of a firm depends on their expectations regarding how their competitors will respond.
• There are broadly two traditional approaches to understanding the operation of oligopoly markets:

▪ Kinked-Demand Curve Model

▪ Dominant Firm Model

Question 10

What is a Kinked Demand Curve?

Answer 10

A kinked demand curve occurs when the demand curve is not a straight line but has a different elasticity for higher and lower prices.

• A firm is considering changing the price it charges but is conscious of the responses of its competitors.
• Firms in an oligopolistic market are encouraged not to change their prices– prices are stable.
• Firms in oligopolistic markets participate in non-price competition such as quality improvements and branding.

Question 11

What is a Dominant Firm Graph?

Answer 11

• Occurs when there is a large difference present in the size (i.e. level of output) of one of the firms within the oligopolistic market.
• The larger firm will likely have a significant cost advantage over its competitors.
• This is due to economies of scale, with the dominant firm operating at a lower point on the Long Run Average Cost Curve.
• In this situation:

▪ The dominant firm has the capability to set the market price for the product (i.e. they are the price leader).

▪ The competitors follow the price set by the dominant firm (i.e. they are price takers).

Question 12

What is the role of the Government?

Answer 12

• The duty of Government is to protect the interest of its citizens.
• Governments often intervene if they believe market failure is present.
• Market failure occurs when resources are not being efficiently allocated.
• This may occur in instances of:

▪ Public good provision

▪ Monopoly market control

▪ Market collusion

• Markets can be regulated in order to mitigate the effects of these three scenarios.
• Regulation involves the enforcement of rules by the government on such things as prices, standards, and market conditions.

Question 13

What is a Public Good?

Answer 13

• A public good is classified as a good that is:

▪ Non-Rivalrous – the consumption of the good be one consumer does not restrict consumption of the good by other consumers.

▪ Non-Excludable – it is not possible/practical for a producer to restrict the access of a good.

• Examples of public goods are street lights, ground water, and GPS systems.
• Due to these unique features of public goods it is difficult for firms to make a profit from providing them.

Question 14

What is the Free Rider Problem?

Answer 14

• A Free rider is a person who consumes a good without paying for it.
• This occurs because of two reasons:

▪ The non-payment by the free rider, by itself, does affect the provision of the good.

▪ The producer of the good finds it difficult to identify free riders and make them pay.

• For example GPS systems are public goods because a private firm would not be able to restrict access to their service.
• As a result of this, goods which suffer from free riders often must be provided by the government rather than private firms.

Question 15

What is the Tragedy of the Commons?

Answer 15

• This is a situation where a good, which is finite in nature (i.e. rivalrous), is made freely available for consumption (i.e. non-excludable).
• Consumers act in their own self interest which might be counter to the collective interest of all consumers.
• As no consumer has to pay to access the good, there is an incentive to expand consumption.
• If consumption exceeds the carrying capacity then the good will deteriorate.
• This concept was initially developed to describe the situation of open grazing of animals on public land.
• Examples are now present in different areas, notably human use of the:

▪ World Atmosphere

▪ Ground Water

Question 16

How does the World Atmosphere affect Economics?

Answer 16

• Mankind makes use of the world’s atmosphere as an
  environmental sink for waste products such as global and local air pollutants.
• This is often classified in economics as a negative
  externality.
• Negative externalities are present when the cost imposed through an economic action not accounted for.
• To overcome this , governments respond in various ways:

▪ Diplomacy – binding international commitments to reduce emissions.

▪ Regulation – standards on emissions producing activities.

▪ Markets – creation of markets for pollutants.

Question 17

What is Ground Water?

Answer 17

• Consumers sink wells into the water table to tap aquifers.
• As there is no usage charge, no incentive exists to make efficient use of the resource.
• This can promote over consumption, whereby extraction exceeds recharge.
• To overcome this , governments respond in various ways:

▪ Markets – assign property rights to the ground water.

▪ Regulation – monitor and restrict consumption through licenses.

Question 18

What are Regulators?

Answer 18

• Overseers of public interest in different economic sectors or to manage particular activates/resources, governments establish regulators:
• Regulators are bodies that are responsible for monitoring activities, developing
  and enforcing rules, and investigating questionable practices.
• Example of a regulators in the UK are:

▪ Office of Road and Rail – which regulates rail and road sectors of the UK (i.e. a monopoly market).

▪ Office of Gas and Electricity Markets - which regulates the electricity and gas sectors of the UK (i.e. an oligopolistic market).

Question 19

What is Monopoly Regulation?

Answer 19

• Monopolies can occur when one firm can supply the market at a lower cost than multiple firms (i.e. LRAC declines at all levels of output).
• Monopolies are capable of achieving economic profit in the long run due to high barriers to entry.
• This economic profit reduces the consumer surplus that would be received in an analogous perfectly competitive market.
• Regulators often intervene in such markets through price regulation.
• This can take the form of:

▪ Average Cost Pricing – where monopolies are required to set their prices where ATC = D (i.e. normal profits are received).

▪ Marginal Cost Pricing – where monopolies are required to set their prices where MC = D (i.e. economic loss is incurred).

Question 20

What is Oligopoly Collusion?

Answer 20

• When there are few firms in the market, an incentive exists for them to communicate in order to fix the market.
• This market fix usual represents an agreement to sell a specific quantity of product or charge a specific price.
• Such action is referred to as market collusion and is a form of anti-competitive behaviour.
• By acting in such a way, firms can form cartels and develop a situation whereby the market acts as a monopoly.
• This provides the cartel with the opportunity to make economic profit equivalent to a monopoly.

Question 21

What is Oligopoly Regulation?

Answer 21

• Cartels often control the market through output agreements, where each partner produces a specific quantity.
• These quantities are selected to maximise the economic profit that can be achieved across the partners.
• Governments can intervene by requiring firms operating in an oligopolistic market to produce set output quotas.
• These output quotas are selected to achieve an improved outcome for the consumer.
• Governments can also make collusion an illegal practice and levy fines when it is proven to have occurred.

Question 22

What is Regulatory Capture?

Answer 22

• Monopoly regulation requires the regulator to have accurate information regarding a monopoly’s costs.
• This might be difficult to achieve if managers within the monopoly either:

▪ Inflate the costs – spend more on production than is necessary.

▪ Mask the costs – fudge the numbers or make them difficult to unpack.

• To overcome this, there is often close working between regulators and monopolies with transfers of personnel.
• This can lead to situations where game keepers become poachers.

Question 23

What are the 4 types of Market Structure?

Answer 23

1. Perfect Competition: many buyers and sellers of a homogenous good, few barriers to entry or exit of the market, and perfect information is present about
   the market.
2. Monopoly: one large firm dominates the supply of a product and barriers to entry and exit are high.
3. Monopolistic Competition: many buyers and sellers of a heterogenous good and firms differentiate their products to develop short-run monopolies for variants.
4. Oligopoly: a small number of firms supply the market and firms tend to apply non-price competition strategies such as quality and marketing.

Question 24

Why is Macroeconomics studied?

Answer 24

• Macroeconomics represents the study of large scale economic systems.
• This type of study increased in prominence due to:

▪ The greater level of inter-dependence resulting from economic specialisation.

▪ The occurrence of economic depressions and the resulting implications for society.

• Economists began to study the national economic systems to understand:

▪ How they operate– what are the main components.

▪ How they can be measured– what are the key indicators.

▪ How they are linked– the occurrence of international trade.

▪ How they can be controlled– the application of government economic policy.

Question 25

How is Economic Output measured?

Answer 25

• A common method to measure a nation’s economic output is through Gross Domestic Product (GDP) is the Expenditure Approach.
• GDP is defined as the value of all goods and services produced in an economy.
• An expenditure approach can be taken to measure GDP, where:
• GDP = C + I + G + (X– M)

Question 26

What does GDP = C + I + G + (X– M) mean?

Answer 26

▪ GDP = National Income

▪ C = Consumption– the purchases made my households of goods and services produced in
the nation.

▪ I = Investment– the expenditure on capital equipment and buildings by firms and the
purchase of residential homes by households.

▪ G = Government Spending– the purchase of goods and services by government bodies.

▪ X = Exports– the expenditure of foreign economic agents on goods and services produced in the nation.

▪ M = Imports– the expenditure of national households, firms, and government bodies on
goods and services produced by foreign economic agents.

Question 27

What 3 methods can be used to calculate GDP?

Answer 27

Intermediate Goods and Services:

▪ These are outputs of one firm which another firms uses as inputs in their production process.

▪ Only goods and services that are destined for the final stage of consumption are included in the Expenditure Approach.

Second Hand Goods:

▪ The purchase of used goods is not included as these would have been recorded during their first sale.

Financial Securities:

▪ The purchase of stocks and bonds does not feature as the financial flows attributable to them are recorded as capital expenditure.

Question 28

How is Economic Growth recorded?

Answer 28

• Economic growth within an economy represents
  an expansion in the economy’s ability to produce
  goods and services.
• This is when the Production Possibility Frontier
  shifts rightward.
• This growth is measured though an expansion in
  GDP.
• GDP is often reported quarterly for an economy,
  while trends in GDP are usually evaluated annually.

Question 29

What is the Blue Book?

Answer 29

• In the UK, the Office of National Statistics
  publishes the Blue Book which reports on
  the health of the economy.

Question 30

What are Business Cycles?

Answer 30

A business cycle is a cycle of fluctuations in the Gross Domestic Product (GDP) around its long-term natural growth rate.

• The long-term trend in GDP is often referred to as potential GDP.
• Real GDP (i.e. observed) tends to fluctuate around this potential.
• This fluctuation is generally referred
  to as the business cycle.

▪ Peak– Real GDP’s highest point above
potential GDP.

▪ Trough– Real GDP’s lowest point below
potential GDP.

▪ Recession– two consecutive quarters of
Real GDP contraction.

▪ Depression– a prolonged recession.

▪ Expansion– a recovery in Real GDP.

Question 31

What are International Comparisons?

Answer 31

• Real GDP can be compared between
  countries to examine economic performance.
• This is often done by calculating GDP
  per capita (i.e. per person) to limit the
  impact of changes in population.
• Since the last recession in 2007, the
  Real GDP of countries within the EU
  have recovered at different rates.

▪ Different economic structures.

▪ Different levels of public debt.

Question 32

What is Employment?

Answer 32

• The number of jobs present within an economy is linked to the business cycle.
• Job numbers contract during a recession and expand during the recovery.
• How employment is evaluated within an economy depends on how the population is categorised.

Question 33

How is the population categorised in terms of employment?

Answer 33

• How employment is evaluated within an economy depends on how the population is categorised.

▪ Population– the total number of people resident within a county.

▪ Working Age Population– the total number of people aged between 16 and the state retirement age.

▪ Workforce– the total number of people that are economically active.

o Employed– the total number of people that are currently in paid full-time or part-time work.

o Unemployed– people not currently in paid work but are actively seeking employment (i.e. job seekers).

Question 34

How is the Unemployment Rate (UR) calculated?

Answer 34

UR = measures the proportion of the workforce that is out-of-work.

𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑝𝑒𝑜𝑝𝑙𝑒 𝑈𝑛𝑒𝑚𝑝𝑙𝑜𝑦𝑒𝑑
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑝𝑒𝑜𝑝𝑙𝑒 𝑖𝑛 𝑊𝑜𝑟𝑘𝑓𝑜𝑟𝑐𝑒 * 100

Question 35

How is the Unemployment Activity Rate (UAR) calculated?

Answer 35

EAR = measures the proportion of the working age population willing to work.

𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑝𝑒𝑜𝑝𝑙𝑒 𝑖𝑛 𝑊𝑜𝑟𝑘𝑓𝑜𝑟𝑐𝑒
𝑊𝑜𝑟𝑘𝑖𝑛𝑔 𝑎𝑔𝑒 𝑃𝑜𝑝𝑢𝑙𝑎𝑡𝑖𝑜𝑛 * 100

Question 36

How is the Employment to Population Rate (EPR) calculated?

Answer 36

EPR = measures the proportion of the working age population currently in work.

𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑝𝑒𝑜𝑝𝑙𝑒 𝐸𝑚𝑝𝑙𝑜𝑦𝑒𝑑
𝑊𝑜𝑟𝑘𝑖𝑛𝑔 𝑎𝑔𝑒 𝑃𝑜𝑝𝑢𝑙𝑎𝑡𝑖𝑜𝑛 * 100

Question 37

What are the Employment Types?

Answer 37

▪ Employed– an individual works for a firm and
receives an agreed compensation (e.g. a salary, an
hourly wage, or a wage-per-output).

▪ Self-Employed– an individual works for
themselves either as a sole trader or in a company
that employs other people.

▪ Full-Time– an individual supplies all of their usual
labour hours.

▪ Part-Time– an individual supplies a proportion of
their usual labour hours.

Question 38

What are the Unemployment Types?

Answer 38

▪ Job Losers– an individual that has been made
redundant/whose business ceased trading.

▪ Job Leavers– an individual that decides to hand in
their notice/close down their business.

▪ (Re)entrants– a school leaver who enters the
workforce/an individual that becomes economically
active again.

▪ Short Term Unemployed– an individual who is out
of work for less than 12 months.

▪ Long Term Unemployed– an individual who is out
of work for more than 12 months.

Question 39

What are the economic categories of Unemployment?

Answer 39

• Economists make use of three forms of unemployment to note how it connects to wider economic processes.

Frictional Unemployment:

• There is a background turnover in the labour market generated by entrants/leavers and business start-
  ups/close downs.
• This generates and ever present number of vacancies and unemployed job seekers.

Structural Unemployment:

• The industries that encompass a national economy change over time as technology develops, international competitors emerge, or consumer preferences change, leading to industry closure.
• The workers of these industries need to retrain or relocate, which generally prolongs unemployment.

Cyclical Unemployment:

• During a recession, firms shed jobs due to the contraction in economic activity.
• This is matched by job creating during economic expansions, whereby firms hire workers or individuals self employ to take advantage of increasing levels of demand.

Question 40

What is Full Employment?

Answer 40

• In a market economy, there will always be a degree of unemployment.
• This is referred to as the natural rate of unemployment (NRU).

NRU = Frictional Unemployment + Structural Unemployment

• The economic processes that lead to frictional and structural unemployment are a universal feature of market economies.
• If the unemployment rate within an economy is equal to the NRU, the economy is said to be in Full Employment.
• Another way to think about the concept of Full Employment is it occurs when
  there is no unemployment attributable to the business cycle (i.e. the occurrence
  of recessions).