Microeconomics Flashcards
started at video 11
Define allocative efficiency
-where society surplus is maximised (maximum consumer and producer surplus)
occurs at D = S on a supply and demand diagram
occurs at MSB = MSC on an externality diagram
occurs at P = MC on a monopoly diagram
Define Productive efficiency
-when a firm is operating at the lowest point on their AC curve -> by full exploitation of economies of scale
(show on monopoly diagram)
Define X-efficiency
when a firm is minimising their waste -> not large enough to exploit economies of scale and get to the lowest point on the AC curve -> done a little bit to the left on the AC curve
doing this minimises waste + minimises costs by achieving x-efficiency
how could X-inefficiency occur
a monopolist lacks a competitive drive -> could be due to e.g. lack of firms in the market to compete -> no incentive to minimise costs
monopolies are also profit maximisers -> doesn’t make much sense to allow waste to creep in -> however is very unpopular as to reduce it e.g. take away wages, reduce staff perks etc.
Public firms could lead to x-inefficiency -> they are not driven by profit -> not incentivised to reduce costs -> waste creeps in as a result
define dynamic efficiency
Re-investment of long run supernormal profit back into the business
could be in the form of new capital, upgraded capital, new technology, innovation in R and D
you show the money that goes into dynamic efficiency on a monopoly diagram as supernormal profit
what does static efficiency consist of
allocative, productive and x-efficiency
all efficiencies that occur at one specific production point
i.e. P = MC for allocative efficiency
productive efficiency at bottom of AC curve
x-efficiency to the left a bit on the AC curve
Define allocative efficiency, give the condition, consumer analysis points and producer analysis points
Where D = S maximising society surplus
Consumer analysis:
-Resources follow consumer demand -> consumers get what they want at the quantity they want
-Low prices -> Maximisation of CS
-High choice
-High quality -> quality has to stay high to stay ahead of their rivals
Producer analysis:
retain or increase market share
stay ahead of rivals
increase profit
Define productive efficiency, give the condition, consumer analysis points and producer analysis points
Maximising output at the lowest possible average cost -> full exploitation of economies of scale
occurs at the min of AC
Consumer analysis:
lower prices -> lower average costs are passed onto consumers -> high consumer surplus -> full exploitation of EOS
Producer analysis:
More production at lower AC -> higher profit -> lower prices and greater market share
Define dynamic efficiency, give the condition, consumer analysis points and producer analysis points
Re-investment of supernormal profits into innovation, R + D, new tech -> decreases LRAC
Condition is supernormal profit in LR
Consumer analysis:
New innovation products -> lower prices over time -> high consumer surplus
producer analysis:
LR profit max -> lower costs over time -> retain/increase market share -> stay ahead of rivals
Define x efficiency, give the condition, consumer analysis points and producer analysis points
Production with no waste
Condition is production on AC curve
Consumer analysis:
Lower prices-> higher consumer surplus
Producer analysis:
Lower costs -> higher profit -> lower prices and increased market share
define the conditions of perfect competition
Many buyers and sellers in the market
Homogenous goods -> firms are therefore price takers
No barriers to entry/exit
perfect information of all goods in the market
firms are profit maximisers
Draw the supernormal profit diagram for perfect competition in the SR and explain why it will only last in the SR
video to check - https://www.youtube.com/watch?v=2BqFpSN4IsE&list=PLWeicFreBUYDwmBZ0AiJwhCNSCb0di9eI&index=14
supernormal profit incentivises firms to enter the market -> are able to do this as a perfectly competitive market has no barriers to entry + perfect information of market conditions
Draw a perfect competition diagram in the LR showing that supernormal profit has been competed away
also give conclusions from the diagram
video to check - https://www.youtube.com/watch?v=2BqFpSN4IsE&list=PLWeicFreBUYDwmBZ0AiJwhCNSCb0di9eI&index=14
makes normal profit in the LR ( AC=AR) as profits are competed away -> show in the firm diagram as the supply of firms in the industry shift right
conclusions:
-allocative efficiency is being achieved -> explain further
-productive efficiency is being achieved -> explain further
-x efficiency is occurring -> explain further
-no supernormal profit in LR -> cannot be dynamically efficient
draw a perfectly competitive market for subnormal profit in the SR and explain why it wont last in the LR
video to check - https://www.youtube.com/watch?v=2BqFpSN4IsE&list=PLWeicFreBUYDwmBZ0AiJwhCNSCb0di9eI&index=14
subnormal profit shown in the firm diagram as AC > AR
firms will be incentivised to leave the market -> costless to leave market as perfect competition
draw the LR perfectly competitive subnormal profit diagram showing that the market is now operating at normal profit
video -https://www.youtube.com/watch?v=2BqFpSN4IsE&list=PLWeicFreBUYDwmBZ0AiJwhCNSCb0di9eI&index=14
what are the shutdown conditions of a perfectly competitive firm
define the characteristics of a monopoly
one firm dominating the market:
can either be a :
-pure monopoly
-Monopoly power (can act like a monopoly, has 25% or more market share)
differentiated products -> firm is a price maker
high barriers to entry/exit -> supernormal profits can persist over time for this firm
imperfect information -> keeps firms out of the market
is where MC = MR
draw the supernormal profit monopoly diagram and apply conclusions
diagram - https://www.youtube.com/watch?v=UXC51iTDEJI&list=PLWeicFreBUYDwmBZ0AiJwhCNSCb0di9eI&index=16
conclusions:
allocative inefficiency -> charging higher than MC -> exploiting consumers -> high prices -> low consumer surplus
not productively efficient -> not producing at the bottom of AC
X-inefficiency -> monopolists are producing above their AC curve -> allowing waste to creep in -> as they become complacent with a lack of competitive drive
dynamically efficient -> can use the supernormal profits made in the LR as no firms will enter due to the high barriers to entry -> reinvest back into company in the form of e.g. new tech, innovative new products from R + D
define price discrimination and describe the conditions needed for it to happen
when a firm charges different prices to different consumers for an identical good or service with no differences in cost of production
the conditions:
-price making ability
-information to separate the market
-prevent re-sale (market seepage)
what are the three different types of price discrimination, draw diagrams and describe each
1st degree price discrimination - when the consumer is charged the exact price they are willing and able to pay for a good or service -> eroding all consumer surplus in the market -> turning it into monopoly profit
diagram for 1st degree - https://www.youtube.com/watch?v=bNyqPR4ch70&list=PLWeicFreBUYDwmBZ0AiJwhCNSCb0di9eI&index=18
2nd degree price discrimination - excess capacity pricing -> e.g. fixed number of seats need filling -> doesn’t make sense to leave idle as the companies have fixed costs to pay -> lower their prices last minute -> fill that capacity + contribute towards fixed costs
diagram for 2nd degree -
youtube.com/watch?v=bNyqPR4ch70&list=PLWeicFreBUYDwmBZ0AiJwhCNSCb0di9eI&index=18
consumers gain cs for paying for the last minute deal
3rd degree price discrimination:
segments the market into different groups (e.g. age, income, time) all with different PED -> charge different prices to those different groups (e.g. charging more for peak train journeys)
diagram for 3rd degree -
https://www.youtube.com/watch?v=bNyqPR4ch70&list=PLWeicFreBUYDwmBZ0AiJwhCNSCb0di9eI&index=18
name the pros and cons of price discrimination
Cons:
Allocative inefficiency -> charging prices way beyond marginal cost -> exploiting consumers
inequalities -> from first degree + 3rd degree inelastic discrimination -> can widen inequality if people buying are low income
anti-competitive pricing -> mainly 3rd degree when very elastic -> could drive out competitors and leave the firm with monopoly power
pros:
Dynamic efficiency -> from greater profits made by price discrimination
greater quantity (in 2nd and 3rd degree) -> greater economies of scale benefits
some consumers might benefit -> those in 2nd and 3rd degree when elastic
what are the characteristics of a natural monopoly and draw it showing the minimum efficient scale
they have huge fixed costs e.g. railroad track, pipes for water distribution etc. -> very high total costs -> to minimise average costs it will take a huge quantity of output -> huge potential for economies of scale
diagram - https://www.youtube.com/watch?v=jmtUbKeDiuE&list=PLWeicFreBUYDwmBZ0AiJwhCNSCb0di9eI&index=19
one firm dominating the market -> results in allocative efficiency + productive efficiency -> as long as the natural monopolist is regulated
diagram - https://www.youtube.com/watch?v=jmtUbKeDiuE&list=PLWeicFreBUYDwmBZ0AiJwhCNSCb0di9eI&index=20
why is it rational for one firm to supply the entire market
competition would cause a wasteful duplication of resources -> because the first mover into the market has got the EOS advantage -> other firms entering after wont have the same advantage and will therefore be priced out of the market
when they are priced out -> their resources will be left idle -> waste of duplication of resources and non exploitation of full economies of scale -> allocative and productive inefficiency
What are the pros and cons of monopoly (highly concentrated market)
cons:
Allocative inefficiency -> prices are higher than MC -> consumers are exploited to pay more -> reduction in consumer surplus
diagram - (one on left) https://www.youtube.com/watch?v=GgsDqQ2IU4Y&list=PLWeicFreBUYDwmBZ0AiJwhCNSCb0di9eI&index=20
productively inefficient -> forego economies of scale -> don’t operate at the bottom of the AC curve -> costs are higher -> prices are higher as a result
pros:
dynamic efficiency -> reinvest supernormal profit back into business -> innovative products, higher quality, better technology in LR -> can patent these new technologies and keep earning those profits over time
evaluation of monopolies
Dynamic efficiency -> profits can be used elsewhere e.g. give to shareholders via dividends, owners, save it etc. -> not a guarantee it will be used to reinvest
are EOS or DOS more likely -> depends on the size of the firm
objective of the monopolist -> could be other things than profit e.g. sales maximisation (AC=AR)
a regulative monopoly can be used to reduce inefficiencies
could prevent major inefficiencies if market is competitive still (legal monopoly) e.g. tesco -> or could prevent the inefficiencies by the threat of competition (market contestability)
type of good -> bad news if it is a necessity -> may not be bad news if a luxury good e.g. electronics -> because constant reinvestment from dynamic efficiency as a result
Pros and cons of competitive markets
https://youtu.be/Ybw4Y71CXoM
what are the characteristics of monopolistic competition
many buyers and sellers
slightly differentiated goods -> firms are price makers but only slightly as there is price elastic demand (lots of substitutes available) -> firms cant raise price too significantly exploiting their price making power
low barriers to entry and exit
good information of market conditions
as firms cant raise prices significantly to make supernormal profits -> lots of non-price competition instead (branding, advertising, quality of goods/service)
firms are profit maximisers MC = MR
draw a monopolistically competitive market in the SR
selling slightly differentiated goods -> profit maximise -> monopoly diagram making supernormal profit
diagram (SR at top) - https://www.youtube.com/watch?v=DHgSBazfTEk&list=PLWeicFreBUYDwmBZ0AiJwhCNSCb0di9eI&index=22
why will profits be eroded away in a monopolistically competitive market in the LR
new firms enter the market attracted by the supernormal profit -> can enter due to low barriers to entry and good market information -> erodes supernormal profit as a result so all firms now make normal profit AC=AR
diagram (LR at bottom)- https://www.youtube.com/watch?v=DHgSBazfTEk&list=PLWeicFreBUYDwmBZ0AiJwhCNSCb0di9eI&index=22
what are the conclusions made from monopolistic competition
Allocative efficiency not achieved in LR -> consumers are exploited -> prices are greater than costs -> output is restricted + consumer choice is restricted as a result
productive inefficiency in LR -> not at lowest point on AC so foregoing economies of scale -> another reason for higher prices as costs are not being minimised
dynamically inefficient in LR -> no long run supernormal profit being made -> not enough profit to be reinvested back into the company
evaluation points for monopolistic competition
decent competition in market -> price making ability of monopolistic firms are much lower than e.g. monopoly -> loss of consumer surplus is nowhere near as bad
in perfect competition there is productive efficiency -> might not be very many economies of scale in perfect competition whereas in monopolistic competition there is -> any economies of scale being exploited might be to a greater extent in perfect competition -> prices then might still be lower in perfect competition
may be dynamic efficiency if short-run supernormal profits are enough to be reinvest
in a very competitive market -> still dynamic efficiency even if normal profits are being reinvested -> could be just part of competition in the market for firms to have to reinvest e.g. if clothing firms don’t reinvest and bring in new fashion lines as new seasons come along they will fall behind significantly
what is a concentration ratio
the collective market share of the largest firms in an industry
concentration ratio:
n:total market share
4 firms: 70% market share
4 : 70
ignore if there is an others% value
what are the characteristics of an oligopoly
few firms dominate the market -> high concentration ratio
differentiated goods -> firms are price makers
high barriers to entry/exit
interdependence (make decisions based on the actions or reactions of rival firms) -> price rigidity -> firms compete in non-price competition instead
profit max not sole objective
draw a kinked demand curve diagram to show price rigidity and explain why this is
diagram - https://www.youtube.com/watch?v=Ec19ljjvlCI&list=PLWeicFreBUYDwmBZ0AiJwhCNSCb0di9eI&index=24
firms don’t want to change their price -> with a price rise other firms wont follow and output will fall for that firm -> decreasing price will only increase quantity output very slightly as the curve is inelastic -> firms don’t want to risk causing a price war so avoid lowering price
what are the conclusions made from a kinked demand curve
there may still be price competition although it doesn’t make sense -> firms may want to try and reduce price in order to gain market share and out compete rivals (price war)
Non-price competition -> if firms agree to keep the prices rigid/sticky -> more non-price competition (branding, advertising, quality etc.) e.g. like soft drink industry
temptation for firms to collude -> formal (agreement with other firms to collude, is illegal. Or tacit, happens without any kind of agreement, its in the best interest of firms to not compete
in what situation would a competitive oligopoly occur
when there is a large number of firms -> colluding with a large number of firms is much more difficult
if new market entry is possible -> colluding to make large supernormal profit is not as attractive -> encourage new firms to enter the market and take the supernormal profits away
one firm with significant cost advantages -> makes it very difficult to organise and fix a price or quantity to produce at in collusion
Homogenous goods -> firms don’t have the price making power to fix prices
saturated market (lots of price wars and competition) -> can only get ahead of firms is by snatching market share away
in what situation would a collusive oligopoly occur
when there is a small number of firms -> easier for firms to get together and organise
similar costs -> easier to decide a price and level of output to collude at
high entry barriers -> no risk of colluding and other firms entering the market to compete the supernormal profits away
ineffective competition policy -> likely to get away with colluding together
eval point of oligopolies
all it takes is one firm to undercut the others who have agreed to collude -> to gain market share -> other firms follow and triggers a price war as a result
define a contestable market and the conditions of one
where there is a threat of competition but not necessarily actual competition -> the threat however could be enough to change the behaviour of incumbent firms -> to disincentivise new firms from entering the market as a result
conditions:
low barriers to entry/exit
large pool of potential entrants
good information -> new firms looking to join must know about costs + technology so if they were to join they could complete on a level playing field
incumbent firms are subject to hit and run competition -> when new firms enter the market quickly, snatch some supernormal profit and leave before incumbent firms can react and lower their profit margins
how has technology increased contestability in markets
-technology has massively reduced barriers to entry and exit -> as businesses dont have to be physical anymore -> reducing start up costs, sunk costs, firms dont need to hire as many workers (therefore dont need to meet as many regulations)
economies of scale are easier to achieve (e.g. technical)
advertising is easier -> easier to overcome brand loyalty
technology has increased innovation -> increased the pool of firms that can enter the market with something brand new to disrupt the market e.g. Uber, AirBNB
Technology has allowed firms to find cheaper ways of producing things -> can disrupt the market in this way rather than having something brand new to offer
Increased information due to the internet -> firms can find out easier about costs and technology in the market
Draw a diagram of a supernormal profit monopoly market that is being contested and explain what it is doing
Diagram - https://www.youtube.com/watch?v=UxTbiVOW9bU&list=PLWeicFreBUYDwmBZ0AiJwhCNSCb0di9eI&index=27
if contestable -> firms will shift towards where AC=AR where firms it will make normal profit (limit price) -> lowers profit margins to take away incentive for firms to enter market -> attempts to eliminate threat
if firm does enter however -> ready to compete with lower prices and higher quantities
Pros and cons of a contestable market
as the diagram is moving towards the limit price -> it is moving towards these efficiencies
pros:
allocative efficiency -> lower prices -> higher consumer surplus for consumers
productive efficiency -> implies greater exploitation of EOS -> lower prices for consumers
X-efficiency -> minimising waste
getting these competitive outcomes as the firm is getting ready for competition
job creation -> higher quantity in the market -> increased derived demand for labour
Cons:
lack of dynamic efficiency -> eval. however if new firms come in with innovative ideas, that itself is the benefit of dynamic efficiency
cost cutting in dangerous areas -> e.g. wages, product safety, environmental standards etc.
creative destruction -> the creativity of new firms coming into the market destroys firms -> job losses
evaluation of contestable markets
if new firms coming in can patent ideas -> market will not be contestable over time
technology provide consumer data to firms -> firms can practise price discrimination (1st and 3rd degree)
dynamic efficiency -> new firms come in with innovative ideas, that itself is the benefit of dynamic efficiency
who enacts competition policy
Competition and markets authority
they have regulatory bodies beneath them that look over and regulate specific industries and the firms within them
What are the aims of competition policy
to ensure the public interest is protected
aims:
to prevent excessive pricing by firms -> e.g. monopolists, oligopolists
promote competition
ensure quality, standards and choice
regulate natural monopolies
ensure effective privatisation of natural monopolies
promote technological innovation -> e.g. supernormal profits made by monopolies are being used in the public interest rather than being given to shareholders
when will competition authorities intervene?
anti trust + cartel agreements
mergers
liberalise concentrated markets
monitor state aid control
COMPETITION POLICY Y2 28
make notes
what is privatisation, what will it do to the firm
when state run organisations are sold off to the private sector -> idea being when the private sector is in charge of these organisations it will run much more efficiently -> as they will have a profit motive + more competition allowed to occur in the market -> lowering costs + increasing efficiency
draw a deregulation diagram
diagram - https://www.youtube.com/watch?v=9jvz6sSWzQA&list=PLWeicFreBUYDwmBZ0AiJwhCNSCb0di9eI&index=30
what are the advantages of privatisation
leads to increased allocative efficiency as there is an increased drive to become more efficient in competitive markets-> lower prices -> increased consumer surplus
profit motive incentivises firms to be as efficient as possible -> dynamic efficiency gains that occur over time
what are the disadvantages of privatisation
limited competition -> productive and allocative inefficiency
loss making services cut even if socially desirable
loss of economies of scale -> increased average costs -> increased costs to consumer
what is deregulation and show a diagram showing this
when governments reduce the legal barriers to entry in industries -> reduces barriers to entry -> incentivises firms to enter the market as barriers to entry are now reduced -> promote competition -> promote efficiencies (allocative, productive, x-efficiency)
diagram - https://www.youtube.com/watch?v=3jeKA4V30kk&list=PLWeicFreBUYDwmBZ0AiJwhCNSCb0di9eI&index=31
DEREGULATION LESSON 30
make notes
what is nationalisation
the process of taking an industry into public ownership
arguments in favour of nationalisation
-greater economies of scale -> productive efficiency gains -> lower average costs -> potentially lower prices
more focus on service provision as government aim is to maximise social welfare and fulfil the needs and wants of society
less likely to be market failure arising from externalities -> because governments intend to maximise social welfare
arguments against nationalisation
state run natural monopoly is huge -> risk of diseconomies of scale
lack of incentive to minimise costs -> risk of complacency and wasteful production creeping into the production process -> static inefficiency (allocative, productive x-efficiency)
lack of supernormal profit -> dynamic inefficiency -> no massive R + D gains
high taxpayer burden -> increased risk of moral hazard (i.e. taxpayers pay the risk of reckless decisions made by the firm)
evaluation points for nationalisation
Public Private Partnerships -> i.e. private sector pays for the construction and maintenance of a project and the public sector prays on this to rent and uses it e.g. school buildings. -> best of both as efficiency gains from private sector + maintaining of public services to make sure service quality is high
may not need to nationalise the industry -> strong regulation of private industries
competition in private sector -> has better outcomes than
Moral hazard
Big taxpayer burden