EconPlusDal Micro Y2 Flashcards
What is the definition of short run?
A period of time when there is at least one fixed factor of production
What is the equation for marginal product?
The extra output gained or lost when adding one more unit of input.
Change in total product
/
Change in quantity of labour
What is the law of diminishing returns?
Law of diminishing returns states that in the short run when variable factors of production are added to a stock of fixed factors of production total/marginal product will initially rise and then fall
What is the equation for average product?
Total product
/
Quantity of labour
Why does labour productivity increase when adding a unit of labour?
Specialisation
- training from other workers
- more experience
Under utilisation of fixed FofP
Why does labour productivity start to decrease when adding to many units of labour?
Fixed FofP constrain production
- workers get in the way
- not enough materials
When is total product maximised, in relation to marginal product?
Total product maximised when marginal product = 0
What is long run vs short run?
Long run is when all factors of production are variable
Short run is when there is at least one fixed factor of production
What two types of costs are there in economics?
Explicit
Implicit
What are implicit costs?
Opportunity costs
What are explicit costs?
Fixed costs
- rent
- salaries
- interest on loans
Variable costs
- wages
- utility bills
- raw materials costs
What is the formula of total fixed costs?
total costs - total variable costs
average fixed costs x quantity
What is the formula for average fixed costs?
Total fixed costs
/
Quantity
or
Average costs - average variable costs
What shape is the average variable cost?
Smiley face ( U )
Assume wages are the only variable costs.
Law of diminishing returns causes AVC to rise.
What is the formula for average variable costs?
Total variable costs
/
Quantity
or
Average cost - Average FC
What is the formula for marginal cost?
Change in total costs
/
Change in quantity of output
What is the formula for average costs?
Total costs
/
Quantity of output
or
AFC + AVC
Marginal means what?
One more unit.
Marginal formulas will always be the same as average formulas but with changes in it.
What shape is the total variable cost curve?
~ (diagonally upwards)
The shallow part of the curve is when productive gains occur, specialisation and resources utilised.
Beginning steep curve there is under utilisation
End steep curve too much labour, not enough resources
What is scale?
When the business increases its factors of production, business is scaling up
What does the long run average cost curve look like?
U with an extended flat bottom, like a bucket
Long run is made up of many short runs
Beginning of U
- Increasing returns to scale
Bottom of U
- Constant of returns to scale
Upward U
- Decreasing returns to scale
What is increasing returns to scale?
% change output
>
% change input
Economies of scale
What is constant returns to scale?
% change output
% change input
What is decreasing returns to scale?
% change in output
<
% change in output
Diseconomies of scale
What is the minimum efficient scale?
The MES is the lowest level of output required to fully exploit economies of scale.
After this costs cannot become any less
What is economies of scale?
Economies of scale is a reduction in LRAC as output increases
What is internal economies of scale?
Really Fun Mums Try Making Pies
Risk bearing eos
Financial eos
Managerial eos
Technical eos
Marketing eos
Purchasing eos
Quantity produced is increasing much more than total costs
What is external economies of scale?
Business within an industry benefit from economies of scale due to external factors:
Better transport infrastructure
Component suppliers move closer
R&D firms move closer
What is diseconomies of scale? 3Cs and an M
Diseconomies of scale is an increase in LRAC as output increases
- Control as workforce increases, worse
- Communication as business grows, slows.
- Coordination harder as business grows
- Motivation, less valued as business grows
Total costs are increasing much faster than quantity
What is total revenue?
Price x quantity
What is average revenue?
Price
Total Revenue
/
Quantity
What is the formula for marginal revenue?
Change in total revenue
/
Change in quantity
What are the characteristics of perfect competition?
Hypothetical theory
- Many buyers and sellers
(infinite) - Homegenous goods
- Firms are price takers
- No barriers to entry/exit
- Perfect information
- MR = AR = D curve
- Positive diagonal Total Revenue curve
What are the characteristics of imperfect information?
- Few buyers and sellers
- Differentiated goods
- Firms are price makers
- High barriers to entry/exit
- Imperfect information
- AR = D, negative diagonal curve
- MR = twice as steep as AR
At imperfect competition when does total revenue peak?
When marginal revenue = 0
MR = 0
When marginal revenue becomes negative, total revenue will start fall.
When marginal revenue is positive, there is still room for revenue to be gained
What is the difference between economic profit and accounting profit?
Economic profit considers both implicit and explicit costs (physical costs & opportunity costs)
Accounting profit considers only explicit costs (physical costs)
What does each economic profit mean?
0 economic profit
- normal profits
- carry on with production
- AR = AC
> 0
- supernormal profits
- carry on with production
- AR > AC
<0
- subnormal profits
- produce the alternative
- AR < AC
What point on a graph is profit maximisation?
MC = MR
Why should firms profit maximise?
- Re-investment
- Dividends for shareholders
- Lower costs & lower prices for consumers
- Reward for entrepreneurship
Why would firms avoid profit maximisation?
- Knowledge of MC & MR
- Greater scrutiny
- Key stakeholders harmed (satisfice instead)
- Other objectives more appropriate
What is profit satisificing?
Sacrificing profit to satisfy as many key stakeholders as possible
What point on the graph does revenue maximisation occur?
MR = 0
Why would firms revenue maximise?
- Economies of scale
- Predatory pricing
- Principle agent problems
Divorce between ownership and control
What point on a graph does sales maximisation occur?
Break-even
AC = AR
Why may a firm sales maximise?
- Growth
- Economies of scale
- Limit pricing
- Divorce between ownership and control (principle agent problem)
- Flood the market
What will public sector organisations aim for on a graph?
P = MC
Demand = Supply
Allocative efficiency
Maximise society welfare
What objectives may firms have?
- Profit max
- Profit satsifice
- Revenue max
- Sales max
- Corporate Social Responsibility (CSR)
- Public sector organisations (P = MC, D = S, Allocative efficiency)
- Survival
What are barriers to entry?
Any obstacle that prevents a new firm entering a market
What legal barriers to entry is there?
- Patents
- Licenses/patents
- Red tape
- Standards vs regulations
- Insurance
What technical barriers to entry is there?
- Start up costs
- Sunk costs
- Economies of scale
- Natural monopoly
What nmeumonic is there to remember the types of barriers to entry?
Lloyds TSB
Legal
Technical
Strategic
Brand loyalty
What strategic barriers to entry is there?
- Predatory pricing
- Limit pricing
- Heavy advertising
What are sunk costs?
Sunk costs are costs that can’t be recovered
What barriers to exit is there?
- Under valuation of assets
- Redundancy costs
- Penalties for leaving contracts early
- Sunk costs
What are barriers to exit?
Barriers to exit are any obstacles that prevents a firm leaving a market
When does productive efficiency occur?
Productive efficiency occurs when a firm is operating at the lowest point on their AC curve
When does X-efficiency occur?
When a firm produces on the AC curve, minimising waste
What is dynamic efficiency?
Dynamic efficiency occurs when re-investment of LR supernormal profit
What is static efficiencies?
- Allocative
- Productive
- X-efficiency
What is the definition of allocative efficiency?
Where demand is equal to supply.
Maximising society surplus
P = MC
What does allocative efficiency mean for consumers?
- Resources follow consumer demand
- Low prices
- High choice
- High quality
What does allocative mean for producers?
- Retain or increase market share
- Stay ahead of rivals
- Increase profit
What is the definition of productive efficiency?
Maximising output at the lowest possible average cost.
Maximum exploitation of economies of scale.
Min. of AC curve
MC = AC
What does productive efficiency mean for consumers?
- Lower prices
- Higher consumer surplus
- Full exploitation of EOS
What does productive efficiency mean for producers?
- More production at lower AC
- Higher profit
- Lower prices and greater market share
What is the definition of dynamic efficiency?
Re-investment of supernormal profits into innovation, R&D & new tech to lower LRAC.
Supernormal profit in LR
What does dynamic efficiency mean for consumers?
- New innovative products
- Lower prices over time
- High consumer surplus
What does dynamic efficiency mean for producers?
- LR profit max.
- Lower costs over time
- Retain/increase market share
- Stay ahead of rivals
What is the definition of X-efficiency?
Production with no waste
Production on AC curve
What does x-efficiency mean for consumers?
- Low prices
- Higher consumer surplus
What does x-efficiency mean for producers?
- Lower costs
- Higher profit
- Lower prices & increased market share
What are the characteristics of a perfect competition market structure?
- Many buyers and sellers (infinite)
- Homogenous goods
- Price takers
- No barriers to entry/exit
- Perfect information
- Firms are profit maximisers
MC=MR
- Supernormal or Subnormal profit SR
- Normal profit LR
What efficiencies does perfect competition have?
Allocative
Productive
X-efficiency
Not dynamic efficiency as there is no profits in the long run
What is the shutdown condition?
PERFECT COMPETITION
AR = AVC
AR < AVC = shutdown
AR > AVC = continue for SR, firms will leave market and return to normal profit
What is the breakeven condition?
PERFECT COMPETITION
AR = AC
What are the characteristics of a monopoly market structure?
- One seller dominating the market
- Differentiated products
firm is a price maker - High barriers to entry/exit
- Imperfect information
- Firm is a profit maximiser
What is a pure monopoly?
Extreme theory
ONE single firm in market
What is a monopoly power?
Legal monopoly
When one firm owns 25% or more market share
What efficiencies does a monopoly market structure have?
Statically INEFFICIENT
ONLY dynamic efficiency
Higher prices lead to DWL for society and less quantity produced
What is the definition of price discrimination?
Where a firm charges different prices to different consumers for an identical good/service with no differences in costs of production
What conditions are necessary for price discrimination?
- Price making ability
legal monopoly - Information to separate the market
- Prevent re-sale (market seepage)
What is 1st degree price discrimination?
Consumer surplus turned into monopoly profit
What is 2nd degree price discrimination?
Consumer surplus occurs from last minute deals when price is reduced to increase quantity sold.
What is 3rd degree price discrimination?
Occurs when a firm can seperate elastic and inelastic demand and therefore charge different prices.
Inelastic demand = high price
What are the cons of price discrimination?
- No allocative efficiency
- Inequalities
- Anti-competitive pricing
What are the pros of price discrimination?
- Dynamic efficiency
- Economies of scale
- Some consumers benefit
2nd & 3rd degree (elastic) - Cross subsidisation
What are the characteristics of natural monopoly?
- Huge fixed costs
- Enormous potential for economies of scale
- Rational for 1 firm to supply the entire market
(competition is undesirable) - Competition would result in a waste, allocative productive inefficiency
(EOS not exploited)
Examples of natural monopolies?
Railways
Water supply
What are the cons of monopoly market structure?
- Allocative inefficiency
- Productive inefficiency
- X inefficiency
- Inequalities in necessity markets
What are the pros of monopoly market structure?
- Dynamic efficiency
- Greater EOS
- Natural monopoly
- Cross subsidisation
How can monopoly market structure be evaluated?
- Dynamic efficiency?
(not always likely) - EoS or DoS
- Objective dependent
- Regulation
- Price discrimination
- Competition or threat of
- Natural monopoly?
- Type of good or service, necessity or luxury?
What are the pros of competitive markets?
- Allocative efficiency
- Productive efficiency
- X-efficiency
- Jobs
What are the cons of competitive markets?
- Lack of dynamic efficiency
- Lack of economies of scale
- Cost cutting in dangerous areas
- Creative destruction, u/e and living standard problems
How can competitive markets be evaluated?
- Still dynamic efficiency?
- Level of EoS
- Natural monopoly
- Where is cost cutting taking place & role for regulation for safety
- Static vs Dynamic efficiency depends on type of good/service
What are the characteristics of a monopolistic competition market structure?
Competitive market with some characteristics of monopoly
- Many buyers & sellers
- Slightly differentiated goods
(firms are price makers)
(price elastic demand) - Low barriers to entry/exit
- Good information
- Non-price competition
- Firms are profit maximisers, MR = MC
Examples of monopolistic competition
- Taxis
- Bars & nightclubs
How is a monopolistic market structure diagram shown?
Normal profits in long run
1) AR & MR curves
2) MC curve
3) Profit Max, MC = MR
4) AC, touches quantity level and lowest point crosses MC
What efficiencies does monopolistic competition have?
NO efficiencies in theory
AE & PE Not as bad compared to monopoly
Potential dynamic efficiency, in long run re-investment may be a part of competition amongst firms even at normal profit levels
Example of how concentration ratio can be shown for 4 firms?
4:70
4 largest firms have 70%
What are the characteristics of an oligopoly competition market structure? Oli means few*
- Few firms dominate the market
(high conc. ratio) - Differentiated goods
(price makers) - High barriers to entry/exit
- INTERDEPENDENCE
(price rigidity) - Non-price competition
- Profit max. not sole objective, market share might be.
- Oligopoly is a dog fight for market share, firms react to others, interdependent
Examples of oligopolies?
UK airlines
UK supermarkets
UK fuel market
What does the kinked demand curve show for oligopolies?
- Firms don’t WANT to change price
- Firms don’t NEED to change price
Elastic demand
- Small increase in price will lead to big fall in quantity sold, affecting market share
Inelastic demand
- Large reduction in price will not greatly affect quantity sold in proportion, leads to a price war and in long run there is no market share change but a fall in revenue.
Therefore prices remain rigid at optimal point
MR has vertical gap, if MC is to then increase at same price level, then profit maximisation will ensure that same quantity will be sold.
Conclusions for oligopoly market structure?
- Price competition
- Non-price competition
- Temptation to collude amongst firms, act as cartel, fix prices, make supernormal profits.
- Incentive to cheat on a collusive agreement
- Prisoner dilemma
nash equilibrium, outcome over long term
dominant strategy, the option that firms will pick, not the best.
What factors promote competitive oligopoly?
- Large no. of firms
- New market entry possible
- One firm with significant cost advantages
- Homogenous goods
- Saturated market
How do competitive oligopolies compete?
Price
Non-price competition
How do collusive oligopolies compete?
Overt
Tacit (price leadership)
How can competitive oligopolies performance be evaluated?
Pros and Cons of competitive outcomes
How can collusive oligopolies performance be evaluated?
Pros and Cons of monopoly outcomes
What two types of oligopoly is there?
Competitive
Collusive
What are the factors promoting collusive oligopoly?
- Small no. of firms
- Similar costs
- High entry barriers
- Ineffective competition policy
- Consumer loyalty
- Consumer inertia
What is a contestable market?
When there is a threat of entry and contestability
What are the characteristics of contestable markets?
- Low barriers to entry/exit
- Large pool of potential entrants
- Good information
- Incumbent firms subject to hit and run competition
- Effects of technology
How has technology affected contestability and contestable markets?
- Lower barriers to entry and exit
- Increased pool of potential entrants
- Improved information
What are the pros of a contestable market?
- Allocative efficiency
- Productive efficiency
- X-efficiency
- Job creation
Why do contestable markets produce at AC=AR?
AC = AR = break-even point
Operate at normal profit and lower price, reduce incentives for new firms to enter market.
MC = MR profit max, supernormal profits, incentive for new firms.
What are the cons of contestable markets?
- Lack of dynamic efficiency
- Cost cutting in dangerous areas
- Creative destruction
- Anti-competitive strategies
What is the difference between contestable and competitive markets?
Contestable isn’t actual competition, just the potential.
How can contestable markets be evaluated?
- Length of contestability, how long is it contestable for?
- Role of technology, could reduce due to patents etc.
- Regulation, minimise the cons
- Dynamic efficiency
Who enacts competition policy?
Competition and markets authority (CMA)
European Competition Commission (EU)
Regulatory bodies:
- ORR
- CAA
- OFCOM
- OFWAT
- OFGEM
What are the aims of competition policy?
Act in public interest
- prevent excessive pricing
- promote competition
- ensure quality, standards and choice
- regulate natural monopolies, ensure effective privatisation
- promote technological innovation
When will competition authorities intervene?
- Antitrust & cartel agreements
- Investigate mergers
- Liberalise concentrated markets
- Monitor state aid control
What monopoly regulation is there?
- Price regulation
- Quality control/performance targets
- Profit control cover costs and adding % return on capital employed
- Windfall taxes on profit
- Merger policy
Promote competition:
- Privatisation
- Deregulation
- Reducing trade barriers
What is the issue with price regulation as a way of regulating monopolies?
- Cost
- Incentive to keep costs low
- Regulatory capture
What is the issue with quality control and performance targets?
- Unintended consequences
- ‘Game the system’
What is the issue with profit control covering costs and adding % return to capital employed?
- Asymmetric information
- Incentive to increase costs
- Incentive to over-employ capital
What is the issue with windfall taxes on monopoly regulation?
- Worsens monopoly outcomes
- Tax evasion/avoidance
- Less innovation
- Under-reporting of profit
How can monopoly regulation be evaulated?
- Level of information that regulation authorities have
- Costs vs benefits
- Regulatory capture
All leading to gov. failure, costs of intervention outweigh benefits
- Benefits of monopoly
What is regulatory capture?
When the firms being regulated dominate the regulating authorities
they are ‘captured’
What are the advantages of privatisation?
- Increased allocative efficiency
- X inefficiency falls
- Efficiency incentive which drives dynamic efficiency
What are the disadvantages of privatisation?
- Limited competition
(productive and allocative inefficiency) - Loss making services cut even if socially desirable
- Loss of natural monopoly and loss of economies of scale
(productive inefficiency)
What does the effectiveness of privatisation depend on?
- Level of competition post privatisation
- Level of government regulation
What is deregulation?
Deregulation is when governments reduce legal barriers to entry in given industries
What are the advantages of deregulation?
- More firms will increase consumer choice, incentive to be allocatively efficient
- Increased productive and x-efficiency
- Increased dynamic efficiency
What are the disadvantages of deregulation?
- Loss of natural monopoly
Increased average costs
Less productive efficiency - Wasteful duplication of resources, allocative inefficiency
- Formation of oligopolies and local monopolies
What does the effectiveness of deregulation depend on?
- Short run vs long run outcomes
- Height of other barriers to entry
- Level of government regulation to make sure there isn’t too many other barriers to entry
