last review of the book theme 3

Question 1

Explain what is meant by the divorce of ownership and control?

Answer 1

Where the owners of a company are unable to control the business directly (1 mark).
For example, shareholders own the company but appoint directors/managers to run the business on a day-to-day basis (1 mark).
This is an example of the principal–agent problem (1 mark).

Question 2

Outline one difference between a public sector and a private sector orginasiation

Answer 2

A public-sector organisation is owned and run by the government (or state) (1 mark), whereas a private-sector organisation is not/is run by individuals (1 mark).

Question 3

Reasons why a firm may undertake a demerger?

Answer 3

Lack of synergy (1 mark): firms do not gain the expected benefits from working as a larger company (1 mark).

Diseconomies of scale (1 mark): if the firm has grown too large, the long-run average costs may rise, such as due to poor communication/coordination (1 mark).

Loss of focus (1 mark): some businesses may be focused on too many markets and become less focused on their core business, which they predominantly get profits from (1 mark).

Selling off unprofitable businesses (1 mark): this could be to cut the losses of that business or to boost the share price of the remaining firm(s) (1 mark).

To raise finance (1 mark): this could then be used to reinvest into the remaining part of the business, such as product development (1 mark).

Question 4

Benefit of a demerger for consumers/

Answer 4

Improved product quality (1 mark):
e.g. due to improved focus/reinvesting funds from the demerger (1 mark).
e.g. due to greater competition as more firms in the market (1 mark).

Question 5

Why sales max another example?

Answer 5

Entry deterrence (1 mark): by only making normal profits (1 mark) there is less incentive for other firms to enter the market/may limit potential competition 
(1 mark).

Question 6

Two real life markets that closely resemble monopolistic comepetition?

Answer 6

Local hairdressers
Local takeaways
Taxi companies

Question 7

Define the terms/ difference between a pure and natural monopoly?

Answer 7

Pure monopoly (1 mark):
e.g. one firms controls the entire market
Natural monopoly
. an industry with one firm that exists as a result of significant economics of scale

Question 8

Pure monopoly (1 mark):

Answer 8

e.g. one firms controls the entire market

Question 9

Natural monopoly

Answer 9

. an industry with one firm that exists as a result of significant economics of scale

Question 10

Difference between monopolistic competition and a pure monopoly?

Answer 10

Low barriers to entry/exit (1 mark)
Large number of firms in the market (1 mark)
Each firm having a relatively small market share (1 mark)

Question 11

Sunk costs?

Answer 11

Sunk costs are costs that have already been incurred and cannot be recovered (1 mark), e.g. advertising (1 mark), R&D (1 mark), depreciation of capital equipment (1 mark).

Question 12

Explain why economics of scale is a significant barrier to entry?

Answer 12

Economies of scale are factors that cause long-run average cost to fall as output increases (1 mark).

Therefore, the existing firm can be more competitive on price than the entrant due to lower costs (1 mark).

Question 13

Explain why brand loyalty is a significant barrier to entry?

Answer 13

Brand loyalty is the tendency of customers to continue to buy the same brands rather than competing brands (1 mark).
Customers continue to trust the existing firm and continue to buy from it even when new entrants arrive (1 mark).

Question 14

Explain why patens are a significant barrier to entry

Answer 14

Patents are licences that give sole rights to producers for a set period of time (1 mark).
This means that the new firm will be unable to copy the products of the existing firm 
(1 mark).

Question 15

Explain the likely impact on a firms pricing of its market becoming more contestable?

Answer 15

Understanding of ‘more contestable’, i.e. lower barriers to entry and exit (1 mark).
Pricing will be reduced by the current firm (1 mark).

Reasons for lower prices:
Firms need to limit price as they face the threat of competition (1 mark) and to prevent hit-and-run competition occurring (1 mark).
Lower price will act as a barrier to entry for the current firm (1 mark) because entrants will not be able to enter profitably/only normal profits are being made (1 mark).

Question 16

Explain one reason why the collusive agreement between the two firms might have broken down

Answer 16

To gain short-term profits (i.e. by undercutting/reference to matrix).

To avoid fines (i.e. gaining immunity from being a whistleblower).

Question 17

Explanation of the benefit of monopsony, such as:

Answer 17

ability to negotiate better deals with suppliers (1 mark)
lower (variable) costs (1 mark) and higher profits (1 mark)
ability to lower prices to compete with rivals (1 mark)
maintaining profit margins even with lower prices (1 mark)

Question 18

Price discrimination eval

Answer 18

However, although many of the conditions for price discrimination hold for this example, the possibility of arbitrage may reduce the chance of making increased profits. For price discrimination to be successful it must not be possible for reselling to take place between the two markets (i.e. no arbitrage can take place). In this case it would mean medicinal drugs being bought at a low price in LEDCs and then resold at a price lower than set in the MEDCs. This can be highly profitable for firms to do given the scale of the pharmaceutical industry. In effect this would mean that the pharmaceutical companies would be selling all drugs at the lower price, as there would be no incentive for those in the MEDC to purchase at the higher price. Whilst measures could be put in place to stop this taking place, it would be hugely costly and almost impossible to ensure that no drugs were resold.

Question 19

Derived demand in terms of wages?

Answer 19

Definition (1 mark): when something is demanded only because it is needed for the production of other goods.
Application to builders (1 mark), e.g. builders demanded in order to build houses.

Question 20

Wage elastic supply

Answer 20

Definition (1 mark): where a change in the wage leads to a more than proportionate change in the quantity of labour supplied.
Application to builders (1 mark), e.g. easy for workers to join the building professions when builders’ wages rise.

Question 21

Explain the impact of a monopsony employer on builders wages?

Answer 21

Builders’ wages lower than under a perfectly competitive labour market (1 mark).
Application to diagram, i.e. wage falls from W1 to W2 (1 mark).
Reason for fall in wage (1 mark), e.g. monopsonist uses its buying power to exploit workers and lower wages as workers have few options for where to work.

Question 22

Number of builders employed?

Answer 22

Number of builders employed will be lower than under a perfectly competitive labour market (1 mark).
Application to diagram, i.e. employment falls from Q1 to Q2.
Reason why employment falls (1 mark), e.g. monopsonist lowering wage means it can employ fewer workers because there is less incentive to work at a lower wage (or they switch to another occupation).

Question 23

Explain why geographic immobility of labour can cause market failure in the labour market?

Answer 23

Market failure is where the price mechanism fails to allocate resources efficiently and leads to a misallocation of resources (1 mark).

Geographic immobility is the inability of workers to move areas to take available work 
(1 mark).

Example of cause of geographic immobility (1 mark), e.g. house price differentials/social ties/differences in cost of living.

Reason(s) why this is an example of market failure, such as:

It leads to structural unemployment because workers are unable to move to areas where jobs are available (1 mark) and leads to unemployed resources/inefficiency/operating inside the PPF (1 mark).
It can lead to rising inequality/poverty because workers are unable to find employment (1 mark), as well as between regions in the UK (1 mark).

Question 24

Geographic immobility and example

Answer 24

Geographic immobility is the inability of workers to move areas to take available work 
(1 mark).

Example of cause of geographic immobility (1 mark), e.g. house price differentials/social ties/differences in cost of living.

Question 25

Explain why an increase in the national minimum wage could leave wage levels unchanged for higher paid earners?

Answer 25

Identification that the national minimum wage is likely to be below the equilibrium wage/what the worker is currently earning in that profession (1 mark).

The high earners will still be paid the equilibrium wage as it will be above what the legal minimum is (1 mark).

Question 26

Explain one type of regulation that OFWAT could use to protect water consumers?

Answer 26

e.g. could improve allocative efficiency (1 mark) as the needs and wants of consumers are being met/consumer welfare promoted via targets, such as fewer leaks (1 mark)

Question 27

Price capping (1 mark):

Answer 27

e.g. could improve productive efficiency (1 mark) as firms have the incentive to minimise average cost to compensate for lower prices or an explanation via RPI – X formula (1 mark)
e.g. could improve allocative efficiency (1 mark) as firms are forced to reduce prices nearer to marginal cost or explanation via RPI – X formula (1 mark)
e.g. could improve dynamic efficiency (1 mark) if firms are allowed to increase prices and can then use profits to reinvest into better service or explanation via RPI + K formula (1 mark)

Question 28

Performance targeting (1 mark):

Answer 28

e.g. could improve allocative efficiency (1 mark) as the needs and wants of consumers are being met/consumer welfare promoted via targets, such as fewer leaks (1 mark)
e.g. could improve dynamic efficiency (1 mark) as targets could aim to improve consumer welfare in the long term, such as via investment in new infrastructure/water treatment (1 mark)

Question 29

Quality standards (

Answer 29

1 mark): e.g. water companies could be encouraged to be more allocatively efficient (1 mark) as they must provide water that meets quality standards, which are in the consumers’ interest (1 mark).

Question 30

Explain why the presence of regulatory capture could limit the efficetivemness of government intervention?

Answer 30

Regulatory capture means that the regulators are not aiming to promote the public interest 
(1 mark) but instead are trying to promote the interests of the industry they are regulating (1 mark).
This could happen due to regulators becoming too close to the industry they are regulating 
(1 mark).
Any example of a policy (1 mark), e.g. they may set less strict environmental regulations.

Question 31

Profit regulation (1 mark):

Answer 31

e.g. firms may have an incentive to be more allocatively efficient (1 mark) because there is less incentive to increase prices as profit/rate of return is capped by regulators (1 mark).

Question 32

Explain why asymmetric information may reduce the effectiveness of the competition and markets authority in preventing collusion?

Answer 32

The Competition and Markets Authority (CMA) aims to promote the public interest/promote competition (1 mark).

Collusion is where firms restrict competition in order to increase profits (1 mark).

Here there is asymmetric information because the CMA has less information (1 mark) than the firms that are colluding (1 mark) — this is because the firms know if they have colluded but the CMA does not (1 mark).

The CMA may be unable to detect evidence of collusion (1 mark), such as phone calls/e-mails (1 mark) and therefore cannot prove that collusion occurred (1 mark).

This is especially true if collusion is tacit because there will be no formal agreement to find (1 mark), and other evidence will be needed to prove that collusion has occurred (1 mark).