Micro Flashcards
ceteris paribus
assuming nothing changes; all other things held constant.
positive and normative statements
Positive Statements: statements can be proven true
Normative Statements: statements cannot be proven true
The Basic Economic Problem
needs and wants are infinite, resources are finite
Production Possibility Frontier (PPF)
a representation of all possible combinations of output for an economy assuming full employment
Opportunity cost
the value of the next best forgone alternative
capital and consumer goods
Capital Goods (owned by firms only): produced means of production
Consumer Goods (household only): goods used by households
Specialisation
when a labour focuses on one step of the production process.
Division of labour
dividing parts of the production process between the workers to increase efficiency.
Advantages of Division of labour
Increase output due to the repetitive task and higher productivity
Reduce price of products due to lower cost per unit, households then consume more
Increase employment rate as tasks are easy, little to no training required
Reduce training cost and time
Uniform/homogenous goods and services
Firms increase profit
Disadvantages of Division of labour (5)
Employees get bored, productivity and quality decreases
Workers are very replaceable due to less skills
Increase power dynamic of employees as the production line stops once a worker is missing
Employees have fewer transferable skills (less human capital)
Lack of innovation/variety
Functions of money
Medium of Exchange — acts as an intermediary between the buyer and the seller; widely accepted as a method of payment.
Measure of Value — the ruler by which other values are measured; acts as a common denominator and simplifies thinking about trade-offs
Store of Value — value that does not immediately need to be spent as its value will hold in the economy, even though it will inflate or deflate over time.
Method of Deferred Payment — if the money is usable today to make purchases, it must also be acceptable to make purchases to date that will be paid in the future.
Types of Economies
Free market Economies: economy where FoP are privately owned (e.g. Singapore)
Command/Planned Economies: economy where FoP are government owned (e.g. UK)
Mixed Economies: economic systems with features of both free markets and command economies (e.g. North Korea)
Transition economy
an economy goes from being command to a mixed economy
Demand
how many units of a good or service consumers are willing and able to buy at every price
Quantity demanded
how many units of a good or service consumers are willing and able to purchase at a given price
Latent and effective demand
Latent demand: when households are willing but unable to buy a good or service. E.g. Releasing news of a new product but not yet released to the market
Effective demand: when households are willing and able to buy a good or service.
Derived demand
demand that comes from the demand for something else
Factors shifting demand curve
Income, taste and preferences, price of related g/s, season and weather, market size, gov policies
Factors shifting supply curve
Weather
expectations of future prices
Technology
Price of related goods (joint/competitive supply)
Input price
Gov policy
Number of sellers in the market
Marginal utility
the benefit from consuming an additional unit of a G/S
Law of diminishing marginal utility
as consumption increases, utility gained from 1 additional unit of a G or S decreases.
Functions of Price Mechanism
Rationing
Signalling
Incentivising
Price Elasticity of Demand
how responsive QD is to a change in P
Always negative!!
Factors affecting PED
Availability and closeness of substitutes
Habit-forming good
Usefulness of good
Time to switch
Cost to switch
Income Elasticity of Demand (YED)
How responsive QD is to a change in income
YED categories
Normal luxury: income elastic, YED > 1
Normal Necessity: income inelastic, 0 < YED < 1
Inferior good: Negative YED
Cross-Price Elasticity of Demand (XED)
How responsive demand for one good is to a change in the price of another good
XED of complements, substitutes and unrelated goods
Complements: negative XED
Substitutes: positive XED
unrelated goods: XED = 0
Price Elasticity of Supply (PES)
How responsive QS is to a change in P
Factors affecting PES
Spare capacity of production
Stocks of components
Stocks of final products
Time to produce
Market failure
when a free market results in an undesirable outcome
Economists assume people consume up until (and including): ____ =____, but people actually consider ____ and ____ only
Marginal Cost (MC) = Marginal Benefit (MB)
MPB and MPC only
Deadweight loss
a decrease in total economic surplus
Externalities
when the consumption/production of a G or S imposes an additional cost/benefit on a third party.
Public goods
non-rivalrous and non-excludable
Non-rivalrous
one person’s consumption does not diminish another’s
Non-excludable
non-paying customers cannot be prevented from enjoying the benefits of the G or S
Private goods
rivalrous and excludable
Quasi-public goods
either non-rivalrous or non-excludable
Free-Rider Problem
because public goods are non-excludable, non-paying customers cannot be prevented from enjoying the benefits of the G or S. Consumers will therefore be unwilling to pay, and firms cannot make profit providing the G or S. (leading to total market failure)
Types of quasi public goods
Common goods (non-excludable and rivalrous)
Club goods (excludable and non-rivalrous)
Tragedy of the commons
Common public goods are quasi (rivalrous and non-excludable)
Everyone is incentivised to use the resource intensively to maximise their individual benefits
Leading to degraded, exhausted resources
Possible solutions to tragedy of the commons
impose quotas
Inspect the community to ensure everyone is following the laws
Tax/ entry fee/ licence
Ban/ create restricted areas
Community agreements (raised by Elinor Ostrom)
Information gaps
when one party knows more than the other
Adverse selection
when the buyer lacks information, they offer a middle price of value of the available goods. The seller of best quality products then leaves the market, causing a decrease in price the buyer offers. This continues until only bad quality products are left in the market
Ways to overcome adverse selection
Certifications
Rating/reviews
Guarantee/free trial/ free return
Warrantee/free fix
Advertising regulations
Moral hazard
when you don’t bear the full consequences of your actions, so you take more risks
Direct and indirect tax
Direct Tax: households pay directly to the government (eg. Income tax, vehicle tax, inheritance tax)
Indirect Tax: tax on firms, which is often passed on to customers (eg. VAT, alcohol tax, tobacco tax)
Consumer and producer incidence (tax diagram)
Consumer incidence: proportion of tax consumers pay.
Producer incidence: proportion of tax producers pay
Types of tax (progressive, regressive and proportional)
Progressive tax: higher-income families pay a larger percentage of their incomes
Regressive tax: lower-income families pay a larger percentage of their incomes
Proportional tax: everyone pay the same percentage of their incomes
eval for taxes
dep on gov objectives: raising tax revenue or reducing neg externalities?
consumer and producer subsidies
Consumer subsidy: government giving household money for the consumption of a good/service.
Producer subsidy: government giving firms money for the production of a good/service.
Problems with Subsidies
dependency
surpluses
political lobbying
opportunity cost
overproduction
who benefits and who pays
max and min price
Maximum Price (price ceiling): a price above which it is illegal to charge for a g/s
Minimum Price (price floor): a price below which it is illegal to sell a g/s
Government Failure
when a government intervention decreases total welfare, causes a new problem or makes a problem worse.
causes of government failure
political self interest
red tape
regulatory capture
information failure
disincentive effects
high enforcement costs
conflicting policy objectives
unintended consequences
regulatory capture
when the regulator acts in favour of the industry they are regulating
Trade pollution permits
Government gives firms right to have a certain amount of pollution (below equilibrium quantity)
Firms can trade the permit between them
advantages of trade pollution permits
Gives firms flexibility regarding when they switch to greener production processes
Disincentivise pollution
Reduce quantity to chosen level even if demand is inelastic
disadvantages of trade pollution permits
lower tax revenue (compared to pollution tax)
High enforcement cost (on monitoring)
Risk of government failure in setting amount to permit
eval for gov failure
Free markets : The role of the government
Hindsight: Looking back, there were obvious mistakes
info gaps
Alternatives: There may or may not be a better alternative method or this May already be better than not intervening at all
Special interests: May be influenced by lobbyists and partie
Behavioural Economics
an area of economics that challenges the assumption that people behave rationallly (by maximising utility)
Nudge
government policies that aim to subtly encourage consumers to make positive choices.
Advantages of a nudge
Not forceful (lower risk of political opposition)
Easier to implement
Low enforcement cost (no regulations)
disadvantages of a nudge
Unethical
Subject to social engineering
No tax revenue
Firms may use nudges in both ways
Homo Economicus
assumption in Economics that people always behave rationally.
Reasons why consumers might not behave rationally
Herd behaviour: influenced by choices of others (the majority cannot be wrong)
Habitual behaviour: make choices out of habit (NOT ADDICTIVE)
Computational difficulties: cost and benefits are too difficult to understand, the g/s is too complex.
Illusion of choices: decision fatigue, cognitively overloaded
Factors influencing demand for labour
Demand for final product
Employment tax
Relative cost of capital
availability of substitutes of labour (capital)
Labour productivity
Factors affecting elasticity of labour demand
% of labour cost in total costs
Ease and cost of factor substitution
PED for final product
Elasticity of labour demand
how responsive a change in QD of labour is to the change in wage rate
Supply of labour
how many people are willing and able to do a job at every wage rate
Factors influencing supply of labour
Extra pay
Wages in substitute occupations
Barriers to Entry (certifications/qualifications)
Net migration
Non-monetary job characteristics: benefits outside pay
Factors influencing Geographical mobility
Transport links
Cost to relocate
Familial links
Immigration laws
Housing availability
Language barrier
Cultural differences
Geographical mobility
ability of workers to move from one place to another
Policies to improve Geographical mobility
Relax immigration barriers
Subsidise language programmes
Increase spending on transportation
Increase spending on gov housing
Occupational mobility
ability of workers to switch from one type of work to another
Factors influencing Occupational mobility
Qualifications
Demand for labour
Training cost and time (Opportunity cost)
Natural talent
Health conditions
Policies to improve Occupational mobility
Subsidise training and education
Encourage online and night training
Impose max P on university fees
Apprenticeship schemes
Increase legal minimum education
Reasons to improve Mobility of Labour
Reduce structural unemployment
Reduce geographical inequality
Reduce frictional unemployment
Increase the efficiency of labour
Current labour market issues
Gender pay gap
Gig economy: short-term contracted work
Firms
a business organisation that sells goods and services with the aim of generating revenue and making a profit for the owners.
types of firms
Sole Trader: single owner with few to no employees
Partnership: multiple owners working in the firm
Private Limited Company: shareholders own the company, but shares cannot be sold easily
Public Limited Company: anyone can become a shareholder. Shares can be traded easily
Non-profit organisations
— run on a non-profit basis. Surplus income must be reinvested to further the organisation’s mission.
private and public sector
Private sector: firms owned by private investors
Public sector: organisations owned by the government
Reasons why businesses may want to stay small
Limited customer base: not much area to expand into
Difficulty in finding financial support
Main vision is not to grow large (eg. Quality over growth or want a life outside career)
Small-scale operation is the advantage of this niche market
Principal-Agent Problem
Due to asymmetric information, the agent and the principal have conflicting incentives.
Leads to moral hazard if the problem is not fixed and could further lead to adverse selection.
Types of Business Growth
Organic Growth (internal)
Forward Vertical Integration
Backward Vertical Integration
Horizontal Integration
Conglomerate Integration
Organic Growth (internal)
Growth within the firm (e. Marketing, hiring more workers, create new products, opening new branches)
Forward Vertical Integration
The firm acquires a firm at another stage in their industry closer to consumers
Backward Vertical Integration
The firm acquires a firm at another stage of their industry closer to raw materials
Horizontal Integration
The firm acquires a firm at the same stage of their industry
Conglomerate Integration
The firm acquires a firm in another industry altogether
advantages of organic growth
Less risky than external growth; can be financed through internal funds; grow at a more sensible rate
advantages of forward vertical integration
Better control over retail distribution channels
gain control over supply chain
advantages of organic growth
Growth is dependent on growth of the market; slow growth; franchises can be hard to monitor
disadvantages of forward vertical integration
new problems in communication and coordination
risk of attracting scrutiny from competition authorities
become complacent and rely less on external innovation
advantages of backward vertical integration
Improve access to raw materials
reduce unit cost
disadvantages of backward vertical integration
new problems in communication and coordination
risk of attracting scrutiny from competition authorities
become complacent and rely less on external innovation
Control raw materials, increase barriers to entry
advantages of horizontal integration
Exploit economies of scale
lower average costs
wider range of products
reduce competition
disadvantages of horizontal integration
Lower flexibility
risk of attracting scrutiny from competition authorities
risk of diseconomies of scale
Reasons for Mergers and Acquisitions
Diversification/Risk Reduction (conglomerate integration)
Economies of Scale (reduce cost of production through scaling up production)
Hold a larger market share in the industry (horizontal or vertical integration)
Grow the business
Create a more stable stream of revenue
Challenges of Mergers and Acquisitions
Different management styles
Diseconomies of scale
Loss of focus
Debt
Subject to monopoly prevention regulations
Reasons for Demergers
Falling revenue in the branch
Focus on a specific branch of the business
Raise cash for investments
Reduce risk of diseconomies of scale and reduce unit costs
fixed and variable costs
Fixed Costs (FC): costs that do not change in the short run
Variable Costs (VC): costs that changes with the firm’s output
Production and Productivity
Production measures the value of output of goods and services
Productivity measures the efficiency of factors of production (eg. output per labour)
The Law of Diminishing Returns
As more units of a variable input (eg. Labour) are added to the fixed input, after a certain point the marginal product of the variable input will begin to decrease.
Minimum efficient scale (MES)
the lowest quantity at which all economies of scale have been taken advantage of.
Types of internal Economies of Scale
technical
purchasing
risk-bearing
financial
marketing
managerial
types of External Economies of Scale
Locating in the same area as other firms in the same industry
Growth in the industry
Transfer of knowledge between firms
Causes of Diseconomies of Scale
Communication & coordination
Bureaucracy
Corporate Culture & Morale
Waste & Organisational Slack
The Shut-Down Condition
when revenue < AVC, the cost of staying in operation is greater than the benefits
profit maximisation
when MC = MR
sales maximisation
when AC = AR
revenue maximisation
when MR = 0
characteristics of a monopoly
1 seller only
No close substitutes
High barriers to entry
Firms are profit-maximising
legal monopoly
a firm that owns over 25% market share in an industry
Types of barriers to entry
Economies of Scale
Legal barriers: Intellectual Property (patent, copyright, trademarks)
Vertical Integration: controlling supply of materials
sunk costs
anti-competitive practices
Types of Anti-competitive practices
Limit pricing: selling at normal profit until rivals run out of business
Predatory pricing: selling at a loss to drive off rival firms
types of efficiencies
Productive efficiency: when AC is lowest (usually from economies of scale)
Allocative efficiency: when welfare is maximised –> AR = P = MC
X-inefficiency: when a firm operates above AC curve for a given level of output (due to lack of competition)
Dynamic efficiency: how supernormal profits improves output potential overtime through R&D
advantages of monopolies on consumers
if supernormal profits are reinvested, firms can afford R+D into improving and innovating products, providing more choice and better quality of goods
disadvantages of monopolies on consumers
higher price
lower consumer surplus
poorer quality
disadvantages of monopolies on employees
Loss of bargaining power (monopsony power)
Lower wages
Poorer conditions
Fewer job opportunities
advantages of monopolies on employees
can afford to pay higher wages
can afford to provide better working benefits
disadvantages of monopolies on suppliers
firms gain monopsony power: lower prices and could lead to exploitative conditions (eg. Delaying payments)
natural monopoly
Firm is most efficient when it is the only a single firm in the industry (ONLY economies of scale)
Characteristics of an industry with natural monopoly
High capital costs/sunk costs
High internal economies of scale
Price Discrimination
when a monopolist sells the same good or service to different consumers at different prices according to their willingness to pay in order to increase revenue and profit.
Types of price discrimination
Target audience (eg students, elderly people)
Time (eg on-peak, off-peak tickets)
Locations (eg Netflix subscription)
Conditions for successful price discrimination
Have monopoly power
Able to identify elastic/inelastic consumers
Able to limit the prices to the sub-market/prevent reselling
benefits of price discrimination on firms
Higher profits
More efficient use of fixed capital
Fixed costs divided between a larger cost so lower AC
benefits of price discrimination on consumers
Some get lower prices,
Peak/off-peak PD can reduce over-crowding
Firm profits may be reinvested to improve customer experience
costs of price discrimination on consumers
Some pay more and lose CS
unfair
costs of price discrimination on firms
may be hard to price discriminate consumers (splitting markets into sub-markets)
Cost to enforce non-arbitrage measures
characteristics of perfect competition
Many small buyers and sellers
No barriers to entry
Homogenous goods
Perfect information
Productive and allocative efficiencies of perfect competition in the long and short run
long run: productively and allocatively efficient
short run: allocatively efficient but productively inefficient
characteristics of monopolistic competition
Many firms
High degree of product differentiation (but still are substitutes)
Low barriers to entry & exit
types of non-price competition
Quality
Customer service/experience
Advertising & packaging
Branding that boosts brand loyalty
Collusion
when firms make agreements amongst themselves in order to restrict competition and maximise their collective profits
overt and tacit collusion
Overt collusion (usually illegal): firms make formal agreements to collude. The agreement is called a cartel
Tacit collusion: firms make no formal agreements but monitoring each other closely and abide by unwritten roles
Oligopoly
an imperfectly competitive market with high market concentration – a small number of large firms dominate the market.
characteristics of an oligopolistic market
Competitive/non-collusive
Interdependent – decision of one firm influences others
Why does an oligopolistic market tend to be competitive/non-collusive?
Large number of firms – so less likely to have a shared interest
Possible new market entry – hard to coordinate
There is one firm with significant cost advantages – this firm would be incentivised to cheat on agreements to max profit
Homogeneous goods – tending towards price competition
Saturated market – zero sum game where a firm gaining market share means another losing
Game theory – prediction of outcome of strategies
prediction of outcome of strategies
Nash equilibrium
a situation where a firm maximises their benefit depending on the behaviour of the other firm(s).
Contestability
a contestible market has LOW barriers to entry AND exit
Marginal Revenue Product of Labour
Extra revenue earned by employing an additional worker
characteristics of Perfectly competitive labour markets
Many firms and employees
Perfect information
Identical skills of workers
No collusion between employers and employees
Trade Unions
an association of workers in a firm or profession, formed to protect and further their rights and interests.
advantages of a trade union
Better working conditions
Higher job security
Solidarity and improved morale
disadvantages of a trade union
Higher costs for firms
Increase inefficiency of workers
eval for trade unions
If WR increase faster than productivity, firms experience higher costs so they would hire fewer workers, leading to fewer jobs available
Higher WR may incentivise workers to increase productivity when WR offered by a particular firm is greater than others in a perfectly competitive market as workers fear losing the job.
Bilateral Monopoly
when an industry consists of a monopoly employer and a monopoly trade union
Why governments institute a minimum wage
Increase incentives to work
Increase standard of living/reduce poverty
Reduce exploitation of workers
Incentivise productivity improvements through technology/automation and training
eval for min wage
Dep on PED of good
Dep on % of TC of min wage workers
Dep on how far min wage is higher than equilibrium price
Dep on extent of min wage: industry only or countrywide
Why might a labour market be monopsonistic?
Frictions in labour market: workers face a greater loss to lose a job than the employer losing a worker
Imperfect information
Employees are more dependent on labour income than the employers are on employees
Government intervention to control firms: Merger Control
to prevent firms from gaining too much market power (monopoly and/or monopsony)
Government intervention to control firms: price control
profit cap
RPI + X: % at which firms are allowed to raise their price by
RPI + K: % at which firms can make supernormal profit of
Public Sector Wage Setting: the government could manipulate wages in the public sector to achieve macroeconomic objectives
the government could manipulate wages in the public sector to achieve macroeconomic objectives
