MICRO Flashcards
Relationships between average values and marginal values.
As average values rise, marginal values are below the average values.
As average values fall, marginal values are above the average values.
If average values fall then rise, marginal values pass though the minimum point.
if average values rise then fall, marginal values pass through the maximum point.
The Law of Diminishing Returns
A short term law which states that as a variable factor of production is added to a fixed factor, eventually both the marginal and average return to the variable will begin to fall.
-total output is still rising but at a diminished rate.
Short Run
The time period in which at least one factor of production is fixed and can’t be varied.
Long run
the time period in which no factors of production are fixed and which all factor of production can be varied.
Total Returns of Labour
Total output produced by all the workers employed by the firm.
Average Returns of Labour
Total output divided by the total number of workers employed
Marginal Returns of Labour
The change in the quantity of total output resulting from the employment of one worker, holding all other factors of production fixed.
increasing return to scale
when an increasing factor input leads to a more than proportionate increasing in factor output
Decreasing Returns to Scale
increase in factor input leads to a less than proportionate increase in factor output
Constant Returns to Scale
increase in factor input leads to a proportionate increase in factor output.
Minimum Efficient Scale (MES)
lowest amount of output at which productive efficiency is achieved.–the higher the MES in an industry the greater the barriers to entry for firms.
Technological change
describes the overall effect of inventions, innovation and the spread of technology in the economy.
Technological change effects on method of production
- move from labour intensive to capital intensive
- increase in mechanisation and automation
- requires more resources.
- requires investment.
- less labour, though more skilled labour
- specialisation.
Productive efficiency
level of output at which average cost of production are minimised where more of one good can’t be made without producing less of another.
Allocative Efficiency
occurs when its impossible to improve overall economic welfare by re-allocating resources between markets;when the available economic resources are used to produce the combination of goods and services that best markets people’s tastes and preferences.
Dynamic Efficiency
occurs in the long run, leading to the development of new products and more efficient processes that improve productive efficiency.
Creative Destruction
Capitalism evolving and renewing itself overtime through new technology and innovations replacing older technologies and innovations
Rational Behaviour
acting in pursuit of self-interest, which for a consumer means attempting to maximise the welfare, satisfaction or utility gained from the good and services consumed.
utility
satisfaction or economic welfare an individual gains from consuming a good or service
marginal utility
the additional utility gained from consuming one extra unit of a good.
Internal economies of scale
- research and development
- technological
- financial
- managerial
External economies of scale
- education
- research and development
- infrastructure
- technological
Normal profit
minimum profit a firm must make to stay in business, which is insufficient to attract new firms into the markets.
Role of profit
- creation of business incentive
- creation of shareholder incentive
- profits and resources allocation
information gap
when people don’t process or they ignore relevant information leading them to make profit.
Asymmetric information
when one party possesses less information relevant to the a market transaction than the other.
why we have imperfect information
- misunderstanding the truth of costs/benefits if products.
- uncertainty about costs/benefits
- complex info
- inaccurate or misleading info
- addiction
- lack of awerness
Bounded rationality
when making decisions, an individual’s rationality is limited by the info they have, the limitations of their minds, and the finite amount of time available in which to make decisions.–leads to satisfaction rather than maximising choices
Bounded self-control
limited self controls in which individuals lack the self control to act what they see as their self-interest.
cognative bias
A mistake in reasoning or in some other mental thought process occurring as a result of, for example, using rule of thumb or holding onto one’s preferences and beliefs, regardless of contrary information
rules of thumb
a rough and practical method that can easily be applied when making decisions
anchoring
describes the tendency to rely too heavily on the first piece of info offered
availability
when individuals makes judgements about the likelihood of future events according to how easy it is to recall examples of similar events.
social norms
forms or patterns of behaviour considered acceptable by a society or group within that society
Choice Architecture
a framework setting out different ways in which choices can be presented to consumers, and the impact on consumer decision making.
framing
how something i presented influences the choices made.
nudges
tries to alter people’s behaviour in a predictable way without forbidding any option or significantly changing economic incentives–not legal.
Default choice
an option that is selected automatically unless an alternative is specified.
mandated choice
people are required by law to make a choice or decision.
Restricted choices
offering people a limited number of options so that they are not overwhelmed by the complexity of the situation. If there are too many choices, people might make a poorly thought out decision or not make any decision.
Features of Market Structures
entry barriers=barriers that make it hard for firms to enter the market.
exit barriers= barriers that make it hard for firms to leave (contractual barriers) (if research and development has been carried out that is stopping firms from leaving the market because it is money spent).
Natural barriers= barriers that result from inherent features of the industry e.g. fruits can’t grow in cold countries.
Sunk costs= costs that have already been incurred and can’t be recovered.
Artificial barriers= barriers by firms themselves
Perfect competition
- many small firms
- homogeneous goods.
- all firms are price takers
- perfect knowledge
- freedom of entry and exit
- factors of production are completely mobile.
What do we assume in economics
In economics we assume that firms are short term profit maximisers and they produce at MC=MR and are productively efficient at Q
Are perfectly competitive firms allocatively efficient?
Allocative efficiency occurs at P=MC.
If p is more than the marginal costs it is a signal to the firms to produce more.
if p is less than marginal costs then it is a signal to the firms to produce less.
Perfectly competitive firms statically efficient?
yes they are productively and allocatively efficient
Are perfectly competitive firms dynamically efficient?
no because they don’t have super-normal profits and therefore can’t carry out research and development and so can’t innovate to produce new product or more efficient methods of production.
Why can’t perfectly competitive firms make supernormal profits?
a firm lowers it’s prices to increase sales, revenue and make supernormal profits. This acts as an incentive to other firms to enter the market and use the same methods to increase supply and lower prices.
However, since firms in a perfectly competitive market are price takers then the market price falls and so firms can’t make supernormal profits.
Is a perfectly competitive market a desirable market structure?
Yes
- low prices due to competition- maximises consumer welfare (consumer surplus).
- there is static efficiency which means a good use of resources.
- there is choice .
no
- quality is all the same (won’t get better)
- dynamic inefficiency
- can’t maximise revenue or sales as it’s a small firm so tries to survive.’
Monopoly
Features of a Monopoly
- only one firm
- complete barriers to prevent entry and exit of firms.
- monopolist is a short run profit maximiser
- firms are price takers.
Are monopolists productively efficient?
Monopolists are not productively efficient. This is because firms are productively efficient when AC=MC and monopolists produce before that.
Are monopolists allocatively efficient?
Monopolists are not allocatively efficient. This is because firms are allocatively at P=MC and monopolist produce before that.
Are monopolists dynamically efficient?
Monopolists have means for dynamic efficiency. This is because they have means for supernormal profits in order to carry out research and development.
Though they don’t have the incentive for dynamic efficiency
Advantages of monopolists
- good for the firm
- Have the means for innovation (dynamic efficiency)
- internationally competitive
- benefit from economies of scale
- pass on savings to customers as low prices
- makes sense in the case of a natural monopoly (average cost always falls).
Disadvantages of monopolists
- no choice for the consumer
- quality can b poor (but nothing to compare to)
- consumer loses out on welfare (deadweight loss)
- no incentive for innovation
- can restrict supply
- keeps prices high
- Allocatively inefficient
- productively inefficient
- inequality.
Consumer surplus
a measure of the economic welfare enjoyed by consumers; surplus utility received over and above the price paid for a good- the difference between how much consumers pay and how much they’re willing to pay.
producer surplus
a measure of economic welfare enjoyed by firms or producers; the difference between the price of a firm succeeds in charging and the minimum price it would be prepared to accept.
Deadweight loss
the loss of economic welfare when the maximum attainable level of total welfare is not achieved.
Price discrimination
charging different prices to different customers for the same product or service, with the prices based on different willingness to pay.
Conditions necessary for price discrimination?
- Must be possible to identify different groups pf customers
- different customers must have different price elasticities of demand.
- Markets must be able to prevent resale.
- need to be price makers.
Methods of price discrimination
- geographical
- time
- age of customer
- quantity bought
Perfect price discrimination / first degree discrimination
when the discriminating firm can charge a separate price to each individual customer
- there is no consumer surplus as firms charge the maximum price that consumers are willing to pay=undesirable for consumers
- there is producer surplus as monopolists can make supernormal profits (they can then innovate and expand) = desirable for firms.
Second degree price discrimination
means charging a different price to different quantities such as quantity discount for bulk purchasing.
producer surplus decreases as consumer surplus increases as they get to buy more at a lower price.
Third degree price discrimination
when the discriminating firm can charge a separate price to different groups of customers
usually happens in the real world as firms try to increase sales and attract more consumers-e.g student discounts- consumer surplus increases as producer surplus decreases.
Price discrimination adv/disadv
advantages
- firms can maximise short run profits.
- producer surplus
- could lead to innovation
- equitable
- can increase sales which may lead to economies of scale
- lower prices for some consumers.
disadvantages
- consumer surplus replaced with producer surplus
- unequal.
Oligopoly
an oligopoly exists where a few large firms have the majority of the market share
e.g. the big 6 energy, supermarkets, mobile phones
features of oligopoly
- supply in the industry concentrated in the hands of relative few firms.
- firms must be interdependent- where actions by one firm will have an effect on the sales and revenue of other large firms in the market.
- there are high barriers to entry.
- non price competition.
Concentration ratio
the proportion of the market share held by dominant firms.
The Kinked demand curve explained
do firms raise prices?
- Above P the demand curve is elastic because there are substitute goods so consumers go to other competitors. A rise in price leads to a more than proportional fall in demand. Leads to revenue falling. so firms don’t have the incentive to raise prices.
The Kinked demand curve explained
do firms lower prices?
- At prices below P, other competitors follow which may lead to some consumers being attracted to the firm but not proportionally more than the fall in price-inelastic- and so revenue will fall. they have no incentive to lower prices.
Sticky prices?
In an oligopoly market prices are sticky and rigid as firms are unlikely to change prices of goods.
The Kinked demand curve explained
Marginal costs
when there is added marginal costs, the firms accept these costs without raising prices and passing it to consumers because if firms raise prices then they will lose revenue. So absorbs higher prices and lower profits per good as MC has to stay within the gap at Q.
Weaknesses with the kinked demand curve?
- firms are short run profit maximises and have to produce at Q- but some might want to increase their market share and so increase supply beyond Q.
- Diagram is based on how other firms act if the firm changes prices.
- Depends on what causes costs to change
- Depends if the firm is small (objective is to survive) or big (objective is to increase market share)–firms have different objectives.
- if there is bigger market share (84%) with more firms they act like this; though if market share is smaller (30%)with less firms then its more likely to be monopolistic competition.
- if products are homogeneous the oligopoly diagram will be more relevant and realistic.(supermarkets and energy).
-Diagram assumes that when prices are higher the consumers will switch–but consumers may choose not to as it is a long process.
=however there are price comparisons making it easier.
=though sometimes there is evidence of collision (which stop firms from exploiting workers).
-few economists now accept the kinked diagram
eval for oligopolies
advantages
- stable prices are good for consumers, businesses, inflation–this depends on the market and what they sell
- market cooperation can lead to improved health and safety, innovation, research and development–though they may not have the incentive and there may be cheating
disadvantages
- depend on if there is collusion
- the concentration ratio in the market
- the objectives of the firms
Interdependence
the action of one firm will have an affect on the sales and revenue of other large firms in the marker
-if one firms prices rise then another firm will gain sales
-if one firm spends money on research and development another firm may lose sales.
-this occurs where the diagram is kinked.
no interdependence in a monopoly because there is one firm
-no interdependence in competitive market because they can’t carry out research.
-interdependence may lead to uncertainty
-could use collusion to fix the problem
Collusive oligopolies
collusion is where firms cooperate in their pricing, marketing, research and development or output of policies.
its an attempt by firms to recognise their interdependence and act together rather than compete.
collusion removes the uncertainty that accompanies interdependence
work together to maximise joint profit
-diagram for this would be monopoly diagram because all firms work together and become a monopoly power (this is illegal because its anti-competitive)
it is hard to detect because firms can say that same prices are due to sticky prices– there is no evidence to prove they are collusive
cartel
a collusive formal agreement by firms usually to fix prices. Sometimes agreement to restrict output and to deter entry of new firms
price leadership
the setting of prices in the market usually by a dominant firm which is then followed by other firms in the same market.
formal collusion
- restrictive agreements
- price fixing
- dividing the market by area.
informal collusion
price leadership-big firms set prices
parallel pricing- the practise of following the pricing practises of other firms-same pricing as other firms
tacit collusion-firms undergo actions that are likely to minimise a response from another firm, e.g. avoiding the opportunity to price cut an opposition, –two firms agree to play a certain strategy without explicitly saying so.
problems facing collusion
- cheating has to be prevented
- potential competition must be restricted
- legislation
- as a result collusion is inherently unstable
not all collusion is bad
can lead to sticky prices and price rigidity which is good for consumers and inflation
oligopolists save money on marketing/ advertising and may pass along savings to consumers.
Monopolistic competition
this market structure in which firms have many competitors but each sells a slightly different product
e.g coffee stores and sandwich bars
Features of monopolistic comp
- large number of sellers and buyers act independently which lowers concentration ratio.
- In the long run there are no/low barriers to entry or exit.
- producers have some control over prices
- information is widely spread but is not perfect.
- firms produce differentiated or non homogeneous goods
similarities
like perfect competition
- large number of firms in the market
- in long run, no barriers to entry or exit.
like monopoly
- some price making ability especially in short run
- supernormal profit in the short run
evaluation for monopolistic competition
advantages
- there are no significant barriers to entry, in long run-are contestable
- high level of advertising, information, lower search costs
- differentiation creates diversity, choice and utility (every chain business manages to differentiate themselves). —–They are able to enter the market as they have an elastic demand curve.
Disadvantage
- some differentiation does not create utility but generates unnecessary waste e.g. excess packaging
- advertising is seen as waste
- inefficient and may lead to dead weight loss
- economies of scale is not maximised
- there is too much choice for consumer, increases search costs.
conglomerate integration
diversifying a firm into a different market e.g. shoe market to sweet shops
lateral integration
diversifying a firm into a similar firm e.g. shoes to shoe laces and socks
contestable market
where there is free entry and free exit for other firms.
features
- number of firms in the industry varies from one to many with no single firm having significant share of the markets
- freedom of entry and exit
- firms may produce homogeneous goods or provide branded goods
- there is perfect knowledge in the industry.
Hit and Run entry
where new firms enter the industry, cream off some of the supernormal profits of the incumbents and then exit.
So are contestable markets what create competition in monopolistic markets?
The threat imposed by the government to intervene by deregulation, breaking up monopolies ect, incentivises the monopoly to behave and lower its price by increasing supply. So the theory of contestability doesn’t increase competition.
the way they would act in response to the threat depends on their objectives
this is also how monopolies prevent competition as they prevent firms from entering the market–however if the monopoly makes less supernormal profit then it can disincentivise them to innovate, so the govt doesn’t intervene in markets such as medicine.
Govt interventions
Privatisation deregulation regulation subsidising the consumer nationalisation patents Windfall tax
Privatisation
the transfer of ownership, property or business from the govt to the private sector.
methods:
-assets sale
selling entire organisation via public auction to an investor.
-benefits
we assume that there would be an increase in efficiency as firms seek to maximise profits/ reduces govt interfere as govt doesn’t have direct control/ leads to innovation as firm finds new ways to compete.
-problems
if a firm is sold as a single firm then would lead to private monopoly which is bad for consumers/ govt would lose out profit from nationalised firms.
-how to avoid these problems
–selling the firm/ entity in parts to different buyers to encourage compete.
–introducing new regulative legislation to prevent anti- competitive practices.
share issue privatisation
-selling shares in a govt enterprise to the stock market
benefits
-increased efficiency as result of competition
-govt can keep some amount of control by retaining a percentage of the shares and appointing board members (though could still receive dividend problems.
problems
- if monopoly is sold as it is it will be private monopoly–so split it up before selling it.
contracting out
-production of goods or services by private firms under a govt contract.
benefits
-firms compete for the contract increasing efficiency.
-govt retains control.
-general problem with privatisation is that some services would not be provided as they are not profitable enough.e.g busses in rural areas.
Subsidising Consumers
Subsidising consumers would allow the good to be consumed at a cheaper optimal price. Govt encourages consumption from one firm rather than that with holds largest market share. Subsidies are desirable as they allow consumers to posses a large consumer surplus.
however,
- may be inefficient as the govt have to ensure that the consumer spends the money on what the govt want.
- but the govt can do ensure this by giving coupons, vouchers which can only be spent on the right thing.
- though this will increase govt spending and some economists may argue that intervening may lead to unforeseen complications which would lead to market failure.
Deregulation
when the government reduces or completely eliminates any regulations of industries where any government regulation has taken place. This would increase competition and improve business operations.
deregulation leads to competition which provides incentive to higher quality products, greater productive efficiency within firms which can result in lower prices for customers.
– saves money as govt doesn’t intervene
however
- hard to create competition in markets with a natural monopoly and high barriers to entry as it is hard for firms to enter the market as there are high start up costs, it’ll take time and some consumers are loyal to brands. Also, without govt supervision it may allow firms to hold up their ethical standards.
e. g. in 2007 any licensed operator was allowed to deliver postal packages to business or individual households creating more competition in the postal market.
Regulation
the imposition of rules by govt backed by the use of penalties that are intended specifically to modify the economic behaviour of individuals and firms in the private sector.
they regulate to
-discourage high prices
-ensure quality of service
promote competition
METHODS
price caps- imposed limit on the price charge for a product.this is usually restricted to the utility industry for example OFGEM (gas and electricity markets) and OFWAT (tap water)
this reduces abuse of monopoly power and price increase can be set depending on the firm.
However, regulation is costly. There may also be a regulatory capture, which is when the regulator ends up helping the firm more than the consumer.
- Regulation of the quality of the sevice
- merging policy= monopolies who merge and could create monopoly power are investigated
- breaking up a monopoly when the firm becomes too powerful.
Nationalisation
the process of converting private assets into public ones by bringing them to be under state control. This transaction can happen with or without compensating the owner of the firm.
why is it good
- publicly owned firms are non-profit so prices are set according to supply and demand market mechanism.
- there is more coordinated supply of goods and services
- failing public firms have access to economies of scale, which a smaller privately owned firm would otherwise not have.
why is it bad
- publicly owned non-profit organisations can’t be dynamically efficient as they don’t have super normal profit.
- (a non-profit organisation could have more inelastic supply).
- privately owned firms can be more competitive in the industry and this competition could lower prices in a business in order to be more competitive. Something a publicly owned company can not do.
- a the industry is protected from competition there is no incentive to be efficient or improve quality of goods and services.
Patents
this is granted to the inventor, giving the inventor the right to stop others from making, using or selling the invention without their permission. patent is available for limited time-full patent can last for 20 years.
- this encourages innovation= if firms didn’t patent new innovations then firm would have a less incentive to spend the money on research and development– firm might have to spend millions on technology though if this technology was available to all firms, the market would be more competitive and wouldn’t make enough money to cover the costs of investment.
- investment for innovation is payed for using retained profits that arise from supernormal profits made by he firm that sells a unique good allowing them to restrict supply and increase the price. e.g industry or drugs uses profits to fund future innovations.
advantages
- helps to develop competitive advantage through unique product.
- barriers to entry allows firm to retain supernormal profits in the long run
- may be dynamic efficiency as money made could be used to improving product or production system which reduces costs which could be passed to consumers leading to lower prices.
- r&d could lead to environmental and health benefits.
disadvantage
- patents allow supernormal profits to be made and passed to highly-profitable monopolies.
- may prevent competition and innovation by others
- may cause x-inefficiency due to lack of contestability in the market. as AC would be higher than in a competitive market and so patent acts as barrier to entry.
- there is dead weight loss
Windfall tax
this is tax levied on unforeseen or unexpectedly large profit, esp on one that is regarded to be excessive or unfairly obtained.
- windfall tax can incentivise monopolies to reinvest their high profits– beneficial to smaller firms or can lead to innovation.
- monopolies can also lessen the amount of supply and increase supply so their costs and revenue raises but their profits don’t seem excessive so can’t be taxed.
However,
-it is unlikely that a monopolistic firm would ever give some of their profits to help other firms. Therefore windfall tax would not be an effective intervention because it may encourage monopolies to hide their profits within the monopoly and giving them more profit thus increasing the market failure.
Tragedy of the commons
Theory of a situation within a shared resource system where individual users act independently according to their own self interests, behave contrary to the common good of all users by depleting or spoiling that resource through their collective actions
Property rights
the exclusive authority to determine how a resource is used. In the case of a private good right, the owner of private property has the right to prevent other people from consuming the good unless they are prepared to pay a price to the owner.
Environmental pollution
How property rights deals with pollution?
if firms take ownership of a resource, they can charge consumers to use it and therefore internalise the externality (producers will have the incentive to care for the good and make sure it is at capacity.)
problems with extending property rights?
- policing property rights is difficult
- some places or properties have more value, so not all regions are of the same value.
- dispute between countries (e.g. overseas)
- no world government to do this
- pollution in the environment can cross boarders (e.g. deforestation in Brazil can lead to global warming in the UK).
- Difference between finite and renewable resources.
Pollution permits
- The environment is a quasi- public good
- Free rider public good= those who benefit from using public goods as they don’t have to pay for them.
-can lead to:
missing markets, state provision, over consumption, tragedy of the commons.
pollution permits- how the government intervenes?
- tax -privatisation
- subsidy - closing intervention gap
- fines - regulation
- pollution permits
The Labour Market
Theory of marginal productivity of labour
this states that the demand for workers depends on their marginal revenue product (MRP).
what does the Marginal productivity theory assumes:
- workers are homogeneous
- firms have no buying power
- trade unions have no impact on the available labour supply
- the physical productivity of each worker can be accurately and objectively measured by the labour force calculated.
- the industry supply of labour is assumed to be perfectly elastic. Workers are occupationally and geographically mobile and can be hired at a constant wage rate.
Marginal physical product
the change in total output arising from hiring one more worker
marginal revenue product
the value of the physical addition to total output arising from hiring one extra unit of labour.
shifts in demand for labour
- availability of machines / price of machines
- level of skill will affect productivity of workers (change in labour productivity)
- A change in demands for the final product
- a change in technology.’
Elasticity demand of Labour
the responsiveness of quantity of labour demanded to a change in the wage rate.
Factors affecting this
- time
- availability of substitutes
- necessity/ luxury
- proportion of income
Factors determining supply of labour to a particular occupation:
- monetary factors= the financial rewards to a particular occupation
- non monetary factors= the non- financial rewards to a particular occupation (convenience, flexibility holiday ect.)
Factors determining supply of labour to a particular firm
- time
- opportunities for full-time work.
Participation rate/ activity rate
- the percentage of the population of working age currently in work or actively seeking work
- calculated as a percentage of the population of working age that is economically active.
Determinants of supply of labour
- changes in income (which way it shifts depends on the person)
- changes in population
- changes in expectations.
Elasticity of labour
the responsiveness of quantity of labour supplied to a change in wage rate.
Elasticity of labour depends on-
- skills and qualifications required in the job. elasticity of labour supply lower for skilled jobs.
- length of training period= jobs with long training periods have low elasticity of labour supply.
- sense of vacation= jobs where the reward for work is not wholly financial tends to have inelastic demand.
- time period= in the long run supply of labour will tend to be more elastic.
Perfectly competitive labour market Assumptions
- perfect knowledge
- perfect mobility of labour
- all workers and employers are wage takers
- no barriers which prevent wages rising and falling with change in supply and demand.
- firms aim to maximise profit and workers aim to maximise wages
- large number of small firms hiring large numbers of individual workers.
what is average cost of Labour
this is the total wage costs divided by the number of workers employed
what is marginal cost of labour
this is the addition to a firms total cost of production resulting from employing one more worker. cdonals
How wages are determined in perfectly competitive labour markets
- each employer would have to accept the ruling market wage rate- as they are not wage setters.
- the ruling wage rate is the perfectly elastic supply curve of labour facing each of the firms in the market– this is also the AC of labour and MC of labour.
- At the ruling wage each firm would be a passive price-taker, able to hire as many workers as it wished as all wages would be the same, BUT unable to influence the ruling wage by its own actions.
How would firms maximise profit by selling output produced by labour in perf comp labour market
- To maximise profit when selling the output n=by labour, each firm would have to demand labour up to a point where :
the addition to sales revenue resulting from employment would equal the addition to production costs resulting from the employment of an extra worker. - MRPL=MCL
What occurs at MRCL=W
The marginal revenue product of labour would be the marginal benefit accruing to the employer when hiring extra workers.
- Marginal cost of labour would be the marginal private cost incurred by each firm.
- Since, in a perf comp labour market, the marginal cost of labour would be equal to the wage paid to the worker, the firm’s level of employment or demand for labour at each wage rate would be MRCL=W.
what happens if MRPL>W ?
what happened if MRPL
- if MPRL> W more workers should be hired
- if MRPL< W fewer workers should be employed
- If MRP= W he firm is employing the number of workers consistent with profit maximisation
How realistic is the model of perfect competition in labour markets?– EVAL
- In practice, it is difficult for workers to shift between employers.
- There are significant costs and immobilities to moving between jobs.
- Firms have a degree of monopsony power which enables them to pay wages lower than a competitive equilibrium
- Existence of unemployment gives firms more monopsony power
- Some workers have only a limited choice of employer. For example nurses, firemen, train-drivers will face one main employer (monopsony power).
What is a Monopsony?
Where there is only one buyer in the market; Have the ability to reduce wages and lower employment
What is monospony power?
the market power exercised in a market by the buyer of a good or the services of factor production such as labour, even though the firm is not a pure monopsonist?
What is an imperfectly competitive labour market?
-An imperfectly competitive labour market is one whee either the firm is a dominant or monopoly buyer of labour.
Diagram from firm in imperfectly comp market explained?
- Demand curve is downwards sloping due to law of diminishing returns— This states that if a firm employs more of a variable factor, such as labour, assuming one factor remains fixed, the additional return to extra workers will begin to diminish.
- supply curve is upwards sloping because in order to attract labour, wages have to be high.
- Firm produce at Q where MRPL-MCL as they are profit maximisers.
- If firm employed above Q, then labour would be supplied with higher wages– when the firm decided to employ more labour they would have to raise wages to attract more labour, but this would lead to all employees demanding higher wages– would lead to a rise in marginal cost and average cost
- however, as its imperfect comp there is imperfect knowledge and so other workers would not know.
what is occupational immobility of labour
this is when workers are unwilling or unable to move from one type of job to another e.g because different skills are needed.
what is geographical immobility of labour
when workers are unwilling or unable to move from one area to another in search of work.
what are trade unions?
these are organisations of workers who join together to further the interests of it memebers
what is collective bargaining
the process of negotiating on wages, pensions, working conditions.
these improve working conditions and protect against unfair working conditions.Sometimes the market wage rate is determined though the bargaining process, with the employers deciding the wage rate.
what affects trade unions
- stages of the economic cycle
- public support- the more there is the stronger the union
- union density
- legislation
Trade unions in perf competitive markets?
- it is unlikely for trade unions to occur in per comp labour markets because all workers are price takers, who have perfect comp with other workers, so there is no barriers to entry and workers are easily replaced– all unskilled.
- as they’re equally productive with same wages there are no trade unions as they are undesirable.
-Although if trade unions did attempt to raise wages it would be at the expense of jobs– some argue that if trade unions are interested in reducing unemployment then they should accept wage cuts.
But why do some economists disagree with this view that trade unions have no effect in perf comp labour markets?
- believe that it is unrealistic to assume that conditions of demand for labour are unchanged– by agreeing to accept technical progress, by working with new capital equipment and new methods of organising work and by improving skilled of their members, unions can ensure that the MRPL curve of labour shifts to the right.
- Increased productivity creates scope for both increased improvements in productivity to pay the higher wages but some unions may resist the changes in working practices that lead to increased productivity.
- Also, both wages and employment can rise when a union negotiates higher wages in a firm producing in an expanding good market– here, increased demand for output creates increased demand for labour to produce the output– rising real wages throughout the economy are likely to increase AD for the output of all firms producing consumer goods because wages are most important source of consumption expenditure.
The effects of a trade union into a monopsony labour market? explained by diagram
- W2 is the trade union negotiated wage– its flat because it is a min wage (price floor).
- This isn’t as high in a competitive market because that is when D=S but it is higher than a monopsony.
- monopsony employs at Q where MCL=MRPL
- though it is not completely flat because some workers would not work for W1 so higher prices would attract these workers.
- There’s a kink in the supply curve at W2.
- Firms would have employed at MCL=MRPL and wages would have been lower at W1 as we read of supply curve.
- monopsony can employ lower quantity at lower wages
- At W2– S=A=MC as the line is horizontal
- when marginal cost goes up the marginal revenue must go up and so firms have to employ more labour at Q2.
- W2 is high because of high density power
- this way trade unions correct market failure of a monopsonist but are unlikely to fix complete market failure.
what is high union density?
what is low union density?
high union density involves public sector support and represents workers such as actos.
low union density includes the self employed and unskilled workers.
Why is there a decline in union power?
- Changing patterns of employment:
change in structure away from strong union sectors (engineering, coal mining, textiles ect) towards service sector, jobs in private sector where union density is low. - Market competitors:
effects of increased competition in product markets- nearly every domestic market for goods and services, greater competition than there was a few years ago. - Employment Laws:
Employment legislation has outlawed illegal strikes, given employers the right to seek compensation for effects of certain forms of industrial action and requires all unions to hold secret ballots of their members before strikes permitted.
What is national minimum wage?
-A national minimum wage sets the minimum hourly wage rate that is acceptable in law. A national minimum wage has been law in the UK since 1999, when the adult hourly rate was set at £3.60.
The aims of a national minimum wage?
The long-term aim of a minimum wage is to remove the problem of poverty pay, which exists when the earnings from paid work do not result in a living wage and fail to push people out of poverty.
Low pay can result from a number of labour market failures, including:
Lack of access to the labour market, as a result of barriers to entry including discrimination.
Lack of bargaining power by individuals in uncompetitive labour markets, such as where there is one employer, a monopsonist. In this case the employer can adopt a ‘take it or leave it’ attitude.
Lack of skills leading to very elastic demand for labour, so that a ‘higher’ wage would reduce demand, hence workers have to accept this wage, or remain unemployed.
Inward migration from low-pay countries, where workers are prepared to accept extremely low wages, for often short periods of time, which this drives down the wages for indigenous employees.
Effects of a National Minimum Wage?
If the NMW is higher than market clearing wage for a particular job, then demand will contract and supply extend. The contraction of demand is the result of a combined income and substitution effect in response to the higher wage rate. In other words, at a higher wage rate the firm’s income, its profits, will, ceteris paribus, fall and the firm will reduce demand, hence the income effect. The substitution effect implies that at a high wage rate firms will look to substitute workers when they can, for other workers or with capital. One reason the minimum wage is fixed for all workers is to reduce the substitution effect, and make demand for labour more inelastic.
On the supply side the higher wage will encourage existing employees to supply more labour, or it will encourage workers out of voluntary unemployment. The effect can be demonstrated in the following diagram.
The advantages of a national minimum wage?
- Greater equity will be achieved, and the distribution of income between the high paid and the low pay may be narrowed.
- Poverty may be reduced as the low paid gain more income and the unemployed may be encouraged to join the labour market. In this case the higher wage is an incentive for individuals to supply their labour.
- Less worker exploitation by labour market monopsonists, who are single employers is able to pay below the market equilibrium.
The disadvantages of a national minimum wage?
A high minimum wage can cause price inflation as firms pass on the higher wages in higher prices.
Falling employment, as demand contracts, and rising unemployment as supply extends.
The competitiveness of UK goods abroad can suffer compared with low wage economies, such as China and India.
Inward investment may be deterred, as foreign investors will look to avoid high wage economies.
The labour market may become inflexible in response to changes in the rest of the economy.
Workers and employers may be driven into the ‘unofficial’ labour market.
The full impact depends upon:
The level of the minimum wage, and;
The elasticity of demand for and supply of labour
what is discrimination?
where groups of workers are treated differently to other workers in the same job regarding pay and employment.
what is positive discrimination?
when a group of workers are treated more favourably than others
what is negative discrimination?
when a group of workers are treated less favourably than a group of others.
Problems of discrimination?
- Discrimination leads to deadweight welfare loss. Certain groups of workers may be out of work or have a wage less than their marginal revenue product.
- If firms have monopoly/monopsony power, discrimination enables firms to cut costs and receive more profits (at the expense of workers).
- However, in competitive markets, firms will tend to experience higher costs as a result of discrimination – leading to higher prices for consumers.
- Discrimination causes a sense of alienation, frustration and injustice. It can lead to social disorder with those discriminated on going on strike for better conditions.
How Market forces can work against discrimination?
- If a company wanted to employ only white workers, it would push up the wages for white workers and increase its cost of production.
- However, the company would then be vulnerable to another firm entering the market and employing ethnic minorities. If ethnic minorities have been discriminated against, their average wages would be lower.
- The new company could then pay lower wages than the discriminatory firm and undercut its rival.
- The firm who discriminates against ethnic minorities is, therefore, penalising itself. Market forces would put pressure on the discriminatory employers to cut wages and employ all workers.
- In theory, this should put downward pressure on wages for ‘preferred’ groups of white workers and lead to equalising pressures.
Distribution of income and wealth
what does income mean
a flow of money to a factor of production e.g wages
what is marketable wealth?
what is non-marketable wealth?
marketable wealth is wealth that can be transferred to others
non-marketable wealth is wealth that cannot be transferred to others
what is the Gini coefficient
a statistical measure of the degree of inequality of income and wealth.
- Gini distribution is the ratio of the area between 45 degrees line and lorenze curve divided by total area below the 45 degrees.
a/ a+b
- when the ratio is equal to zero, there is perfect income equality
- when the ratio is equal to 1 here is complete unequal income distribution.
Nations of equity
what is equity
- equity is about fairness- requires a value judgement
- equity is a normative concept and it can’t be measured
- Horizontal equity means identical treating
- vertical equity means different treatments of individuals or groups
The problems of poverty?
- market failure
- inefficient allocation of resources
- costs money to care for the poor-
- poverty leads to crime, health care strains (ect)
- means high unemployment–further from PPF capacity
causes of poverty?
- unemployment
- low wages
- sickness and disabilities
- old age
- poverty trap
- imperfect information
What is the poverty trap?
- When individuals or householders are no better off following a pay increase because tax paid increases and benefits are withdrawn– made worse if person is on minimum wage, has children to care for- can’t work long hours, or may have to pay for child care.
- any intervention that the govt does should make sure people are not stuck on the poverty line.
Policies to alleviate poverty.
- incentivise working– e.g by lowering benefits
- raise benefits
- education and training
- free school meals
- legislation to protect lowest paid workers.
Relative poverty
Relative poverty is the condition in which people lack the minimum amount of income needed in order to maintain the average standard of living in the society in which they live.
Absolute poverty
absolute poverty is ‘…being unable to subsist…’ that is, unable to eat, drink, have shelter and clothing. A common universal measure of extreme poverty is .receiving less than $2.50 a day. Extreme poverty is defined as not being able to buy enough food to survive.
How does national minimum wage alleviate poverty?
The government could increase the national minimum wage. This is an effective way of increasing the incomes of the low paid and therefore reducing wage inequality. A related concept is the Voluntary Living Wage – an attempt to encourage firms to pay higher wages.
However, the problem is that it may cause unemployment because firms may not be able to afford the workers. If it does cause unemployment, poverty could worsen. However, if firms have monopsony power, then they will be able to afford higher wages.
pros
- increases income on low paid workers
- improves labour productivity as labourers are more motivated
- firms have more incentive to invest in labour productivity
- NMW can offset the impact on monopsony employers
- increases incentives to take up jobs.
cons
- can cause unemployment in competitive markets
- could encourage the use of black markets
- some firms can not afford wages
- regional imbalances in wages reduces the effectiveness.
how do Progressive Taxes alleviate poverty
Increasing progressive taxes, such as the higher rate of income tax from 40% to 50%, will take more income from those on high-income levels. This enables cuts in regressive taxes (e.g. VAT/Sales tax) and increased welfare benefits which help increase the income of the poor. This can be an effective way for reducing relative poverty.
However,
critics argue higher income taxes create a disincentive to work., leading to less output. This is because higher tax makes work less attractive and reduces the opportunity cost of leisure. Therefore people work less and enjoy more leisure. This is known as the substitution effect.
Similarly higher corporation tax may discourage investment in the UK
However, higher tax reduces incomes and this may encourage people to work more, to maintain their income. (This is known as the income effect)
Evidence suggests that higher income tax has little incentive on the supply of labour, suggesting labour supply is relatively inelastic.
However, it also depends at what level income tax is set. There is certainly a level where higher income tax will reduce incentives to work.
Other problems with increasing income tax, include encouragement of tax evasion (illegally avoiding to pay tax) and the fact firms may adjust wages to compensate for the higher taxes.
Macroeconomic stability alleviate poverty?
-The trickle down effect
lower tax; more revenue/ profit; expand; more labour employed- like multiplier effect; govt can tax more labourers; more revenue and money to spend on unemployed
increase pensions alleviate poverty?
old people, proportionately, tend to be poorer, increasing pension will provide them with more money, can pay for care homes (ect) – could mean less family members can go to work and not look after them, more tax can be taken by govt, more govt revenue, more money spent on poor.
Increase spending on education and training alleviate poverty?
more education= more skilled= better paid jobs
however this doesn’t address relative poverty and requires more spending- opportunity cost.
Reduce Unemployment to alleviate poverty?
Unemployment is a major cause of poverty because the unemployed have little income, relying on state benefits. Unemployment can be reduced through supply-side policies, such as free training schemes for those who are structurally unemployed.
Poverty and unemployment are often geographical problems, with depressed areas seeing higher levels of poverty. Policies to overcome geographical poverty could include government subsidies for firms to set up in depressed areas. Also building better infrastructure (transport and communication) in depressed areas can provide an economic stimulus to create new jobs.
Sustained economic growth to alleviate poverty?
The argument is that promoting economic growth increases total income in society, creating more jobs and income which could be redistributed. In the past 100 years, economic growth has been a major factor in reducing the levels of poverty which were seen in pre-war Britain and the US.
However, it is not necessarily the case that income and wealth will trickle down to the poorest. There is a concern that economic growth could widen relative poverty because it benefits the highly skilled wealthy classes more than those at the bottom.
what are Means-tested welfare benefits
unemployment benefit, food stamps, income support and housing benefit.
why is distinguishing between absolute poverty and relative poverty useful when investigating poverty in the UK and in less developing countries?
- in less developed countries the circumstances are such that survival is an issue in a way which it is not in richer countries– this makes an absolute measure more relevant than a relative measure.
- In richer countries unequal ‘living standards’ might be dysfunctional but are not an immediate matter of life and death– though they are a matter of long term life chances.
- Definitions of poverty are bound to be arbitrary e.g. terms like severe deprivation mean different things to different people.
- absolute poverty indicates a lack of basic needs while relative poverty indicates inequality– it is possible for a country to have no absolute poverty but there will be relative poverty if there is inequality.
- we would not expect people in more developed to nations to be poor enough to not have access to basic needs e.g less than $2.50 a day.
x-inefficiency
this is when there is a lack of contestability in the market, lack of competition, and high barriers to entry as AC curve is higher than it would be in competitive market.
