Theme 3: Business Behaviour and the Labour Market Flashcards
What are some reasons for why a firm would want to grow
1) To experience economies of scale and reduce costs
2) To gain a greater market share to influence prrices
3) More security and access to finance
What is the principle agent problem
Separation of ownership (who want to profit maximise) and leadership ( who may want to maximise their own benefits)
Also has an element of mroal hazard e.g. risky investment banker
What are the costs of the principle agent problem and issues linked to it
1) Agency costs-Principles may not be aware of how much a contract has been fufiled
2) Inefficiency - Enables agents to produce sub-optimal cost work
3) Cost of monitoring/incentives - solutions to overcome principle agent problem cost money
Salaries linked to revenue/growth. Lack of accountability. Info assymetry
What are some ways to overcome the principle agent problem
1) Tipping; reliance on tips may make waiters more aligned with owners
2) Share options part of salary; workers also benefit if company does well
3) Partner progression; workers are incentivised to align with shareholders to join company and also want to maintain company growth
What is Profit satisficing
- Owners set a minimum acceptable level of revenue and profit
What are cooperatives
- Co-ops are owned and run by their members, who can be customers, employees or groups of businesses
What is CSR
Coporate Social Responsibility
Why would a firm embrace CSR
- Altruism - being a good citizen
- Contracting Benefits - helps recruit,motivate and retain employees
- Customer related motivation - attract customers; brand postioning
- Lower production costs - packaging, energy useage
- Risk management - address potential legal/regulatory capture
Improved access to capital
What is outsourcing of public sector
Private sector businesses used to provide public sector work
What are arguments for out-sourcing
- competition can save the tax payer money
- Private sector businesses more likely to achieve efficiency improvemments and costs savings
- Also might be more innovative, less heirarchical and less prone to suffering from DEoS
What are arguments against out sourcing
- Business bidding to win contracts may sacrifice quality of service as a way of loweing their costs
- Doubts about some employmeny practices of service companies
- Contracting-out/outsourcing requires proper monitoring which itself invovles extra spending
What are the 2 main types of growth
organic and integration
What are advantages and disadvantages of Organic Growth
Advantages:
● Integration is expensive, time-consuming and high risk , with evidence suggesting that the long-term share price of the company falls following integration. Firms often pay too much for takeovers and integration is often poorly managed with many key workers tending to leave after the change.
● The firm is able to keep control over their business.
Disadvantages:
● Sometimes another firm has a market or an asset which the company would be unable to gain through organic growth. For example, integration would allow a European company to expand into the Asian market which it has no expertise in.
● Organic growth may be too slow for directors who wish to maximise their salaries.
● It will be more difficult for firms to get new ideas.
What are the 2 types of vertical integration
Forward and backward integration
What is vertical integration
Vertical integration is the integration of firms in the same industry but at different stages in the production process
What is the difference between vertical forward and backward integration
If the merger takes the firm back towards the supplier of a good, it is backwards integration.
Forward integration is when the firm is moving towards the eventual consumer of a good.
What are the advantages and disadvatages of forward and backward vertical integration
Advantages:
● There is increased potential for profit as the firm takes the potential profit from a larger part of the chain of production.
● There will be less risks as both can be reliable
● With backward integration, businesses can control the quality, delivery and price
● Forward integration secures retail outlets and can restrict access to these outlets for competitors.
Disadvantages:
● Firms may have no expertise in the industry they took over
What is horizontal integration
This is where firms in the same industry at the same stage of production integrate.
What are the advantages and disadvantages of horizontal integration
Advantages:
● This helps to reduce competition as a competitor is taken out and increases market share, giving firms more power to influence markets.
● Firms will be able to specialise and rationalise , reducing the areas of the businesses which are duplicated.
● The business is able to grow in a market where it already has expertise , which is more likely to make the merger successful.
Disadvantages:
● The problem is that it will increase risk for the business as if that particular market fails, they have nothing to fall back on and will have invested a lot of money into that area. They are ‘placing all their eggs in one basket’.
What is a conglomerate integration
This is where firms in different industries with no obvious connections integrate. They can sometimes be linked by common raw materials/technology/outlets.
What are the advantages and disadavantages of congolomerate integration
Advantages:
● It is useful for firms where there may be no room for growth in the present market.
● The range of products reduces the risk for firms
● finance can be easily obtained and managers can be transferred from company to company within the firm.
Disadvantages:
● The problem with this is that firms are going into markets in which they have no expertise.
What are the constraints of business growth
● Size of the market: A market is limited to a certain size
● Access to finance: Firms use two main ways to finance growth: retained profits and loans.
● Owner objectives: Some owners may not want their business to grow any further
● Regulation: In some markets, the government may introduce regulation which prevents businesses from growing.
What are joint ventures
- Joint ventures occur when businesses join together to pursue a common project
- The businesses remain separate in legal terms
An example might be joint-research projects to share the fixed costs
Why do many mergers fail
- Huge financial costs of funding takeovers including deals that have relied on loan finance - this leaves a big debt overhang after the deal
- Integrating systems – companies might have very different technology systems that are expensive or impossible to marry e.g. eBay & Skype
- Share price: The need to raise fresh equity through a rights issue to fund a deal which can have a negative impact on a company’s share price
- Many mergers fail to enhance shareholder value because of clashes of corporate cultures, priorities and key personalities
- The enlarged business may suffer a loss of customers and also some of their most skilled workers post acquisition (a loss of human capital)
- Paying too much: With the benefit of hindsight we see the ‘winners curse’ - i.e. companies paying over the odds to take control of a business – this is particularly the case with takeovers driven by management ego
- Bad timing – mergers and takeovers that take place towards the end of a sustained boom can often turn out to be damaging for both businesses
What is a demerger
A demerger is a business strategy in which a single business is broken into two or more components
What are reasons for demergers
● Lack of synergies : managers are splitting their time between areas which are so different it could lead to diseconomies of scale
● Value of the company/share price: e the value of the separate parts of the company is worth more than the company combined.
● Focused companies: . By focusing on one area, managers can improve their skills and knowledge and become more successful.
What is the impact of demergers on workers
firms may need their own managers and leaders so people could get a promotion.
However, the goal of making the firm more efficient may result in job losses.
What is the impact of a demergers on business
a smaller core business may enable it to be more efficient and then lead to more innovation and surviving higher competition.
However, the smaller size of the business could lead to a loss of economies of scale and access to finance
What is the impact of demergers on consumers
may gain from innovation and efficiency, leading to better products and cheaper prices .
demerged firms may be less efficient through loss of economies of scale or raise prices/reduce quality or range of goods as they become motivated by profits.
What is profit maximisation and why would firms aim this
● Neo-classical economics assumes that the interests of owners or shareholders are the most important and therefore the goal of firms is to profit maximise
● This is at MC=MR
What is revenue maximisation and why would firms do this
● Baumol suggested managers are most interested in their level of revenue since this is what their salary depended on.
● Revenue maximisation is at MR=0
What is sales maximisation and why would firms do this
● Robin Marris suggested that managers aim to maximise the growth of their company above any other objective.
● Size is often linked to security
● Growth will also increase market share, and may push other firms out of business
- Sales maximisation is AC=AR
What are the limitations of profit maximisation
In the real world it is not so easy to know exactly your marginal revenue and marginal cost of last goods sold.
Many firms may have to seek profit maximisation through trial and error.
It is difficult to isolate the effect of changing price on demand. Demand may change due to many other factors apart from price.
Firms may also have other objectives and considerations.
What is revenue
Revenue is the money earned from the sale of goods and services
What is total revenue
● Total revenue (TR): The total amount of money coming into the business through the sale of goods and services. quantity x price
What is average revenue
Average revenue (AR): Demand is equal to AR: total revenue/output
What is marginal revenue
Marginal revenue (MR): The extra revenue that the firm earns from selling one more unit of production: total revenue from ‘N’ goods- total revenue from (N-1) goods OR change in total revenue change in output
How does a perfectly elastic demand curve affect revenue
price received by the firm for the good is constant and so MR=AR=D. Their demand curve is horizontal. The TR curve is upward sloping because prices are constant and so the more goods that are sold, the higher the revenue made.
With imperfect competition, how do revenues change
D = AR
MR is 1/2 of Gradient of AR
and TR is dependent on MR elasticity
● If marginal revenue is positive , when the firm sells the product at a lower price (or when they increase output), total revenue still grows and so the demand curve is elastic.
● If MR is negative , TR decreases as price decreases (or output increases) and so the demand curve is inelastic. After output Q, the demand curve is inelastic.
● When MR=0, TR is maximised and the demand curve is unitary elastic
What is seasonal revenues
Seasonality refers to fluctuations in output and sales revenue related to the seasonal of the year.
For most products there will be seasonal peaks and troughs in production and/or sales
What are fixed costs
Business expense that does not vary directly with the level of output
Examples:
* Business insurance
* Consulting fees
Rental fees
What are variable costs
costs that relate directly to the production or sale of a product
Examples:
Energy and fuel costs
Component parts
Packaging costs
What is TC (total cost) and TFC (Total fixed cost) and TVC (Total Variable Cost)
● Total cost (TC): The cost of producing a given level of output: fixed + variable costs
● Total fixed cost (TFC) : Costs that do not change with output and remain constant e.g. rent, machinery
● Total variable cost (TVC): Costs that change directly with output e.g. materials
What is ATC (Average Total Cost), AFC (Average Fixed Costs) and AVC (Average Variable Cost)
● Average (total) cost (ATC): total costs/ output
● Average fixed cost (AFC): total fixed cost/ output
● Average variable cost (AVC): total variable cost /output
What is marginal cost
Marginal cost (MC): The extra cost of producing one extra unit of a good
What is the short and long run
The short run is the length of time when at least one factor of production is fixed and cannot be changed; this varies massively with different types of production. The long run is when all factors of production become variable.
What is diminishing marginal productivity
● Diminishing marginal productivity means that if a variable factor is increased when another factor is fixed
there will come a point when each extra unit of the variable factor will produce less extra output than the previous unit.
● Marginal output will decrease as more inputs are added in the short run. This will mean that the marginal cost of production will rise.
What is the shape of the AFC
● The average fixed cost curve (AFC) starts high because the whole fixed costs are being divided by a small output. As output is increased, AFC falls as the same amount is divided by a larger number.
What is the shape of ATC
● The average total cost curve (AC/ATC) is U-Shaped due to the law of diminishing marginal productivity.
Costs initially fall as machinery is used more efficiently but as production continues to expand, efficiency falls as machinery is overused.
How is the AVC shaped
The average variable cost curve (AVC) is also U-Shaped, but it gets closer to ATC as output increases since AFC gets smaller.
How is MC curve shaped
● The marginal cost (MC) will also be U-Shaped due to the law of diminishing marginal productivity.
It will initially fall as the machines are used more efficiently but will rise as production continues to rise
Where does MC cut AC
The marginal cost line will always cut the AC line at the lowest point on the AC curve
if MC is below AC, then AC will continue to fall since producing one more costs less than the average so the average falls; but if MC is above AC, then AC will rise.
Marginal costs can be rising whilst AC is still falling, as long as MC is still below AC.
Draw MC ATC AVC and AFC with imperfect competition
Why are SRAC and LRAC U shaped
Short run average cost (SRAC) curves because of the law of diminishing returns
Log run average cost (LRAC) curves because of economies and diseconomies of scale.
How are LRAC and SRAC related
LRAC is the envelope ffor all associated SRAC curves because the LRAC is either equal to or below the relevant SRAC
Draw SRAC’s and LRAC curves and explain the shape
Short run curves get diminishing marginal returns as some factors fixed
Long run curves all factors become variable and so the SRAC curve can be shifted, new SRAC curve will be lower since the firm can have economies of scale
This continues until the firm experiences constant returns to scale and eventually diseconomies of scale
What is the LRAC a boundary for
The long run average cost curve is a boundary representing the minimum level of average costs attainable at any given level of output.
Points below the LRAC are unattainable and producing above the LRAC is inefficient.
What is the LRAC a boundary for
The long run average cost curve is a boundary representing the minimum level of average costs attainable at any given level of output.
Points below the LRAC are unattainable and producing above the LRAC is inefficient.
What causes a movement or a shift along the LRAC curve
**Movement along the LRAC **is due to a change in output which changes the average cost of production due to internal economies/diseconomies of scale.
A shift can occur due to external economies/diseconomies, taxes or technology, which affects the cost of production for a given level of output.
What is the Minimum Efficient Scale
- the minimum level of output needed for a business to fully exploit economies of scale. It is the point where the LRAC curve first levels off and when constant returns to scale is first met.
What are economies of scale
Economies of scale are the advantages of large scale production that enable a large business to produce at a lower average cost than a smaller business
What are diseconomies of scale
the disadvantages that arise in large businesses that reduce efficiency and cause average costs to rise
What are constant returns to scale
firms increase inputs and receive an increase in output by the same percentage
What are internal economies of scale
an advantage that a firm is able to enjoy because of a growth in the firm, independent of anything happening to other firms or the industry in general.
What are the 5 types of internal economies of scale
- Technical Economies
- Financial Economies
- Risk Bearing Economies
- Managerial Economies
- Marketing and purchasing economies
What are technical economies and some examples
- Economies that arise from improvements in the production process
- Specialisation
- Increased dimensiones; if you double the size of a container you increase the amount it can carry by more than double
- Indivisibilty of Capital; spme processes require huge capital
- Research and Development
What are financial economies
● Large firms have greater security because they have more assets so it is easier for them to obtain finance and interest rates will be lower due to lower risk. This makes investment more accessible.
What are risk bearing economies
● Large companies are able to operate in a range of different markets, producing different products which means that if one area of business fails, their whole business will not collapse.
What are managerial economies
● Large companies can afford to appoint specialist managers in every field, who are specialised and so have greater knowledge and are able to do their job better.
Staff represent an indivisibility and so small firms cannot employ specialist staff.
What are marketing and purchasing economies and some types
● Buying in bulk
● Specialisation: Like other areas, businesses can afford to take on specialist buyers and sellers who could be more efficient due to the extra time and knowledge.
●Distribution: Large firms are able to enjoy preferential rates from transport companies because they offer the company a lot of businesses.
What are external economies of scale
an advantage which arises from the growth of the industry within which the firm operates, independent to the firm itself. These cause the LRAC curve to shift downwards.
What are the types of external economies of scale
- Labour
- Support Services
- Subsidies
Cluster effect
Transport links
Supportive legislation
How is labour an external economies of scale
● Businesses established in an area with other successful firms from the same industry find that labour tends to come to that area if they want a job in that industry, for example Silicon Valley. This reduces the cost and time take to recruit.
● Another advantage for large industries is that local education and training providers are more likely to develop courses to prepare people to take up jobs in these businesses.
● Firms will be able to hire staff who have been trained by other businesses , which is cheaper and more efficient for the firm than training the workers themselves.
How is support services an external economy of scale
● Businesses who provide products or services for large businesses will naturally move to the area where those businesses are based, which reduces transport cost/time delays for the business.
What are some types of diseconomies of scale
- Workers
- Geography
- Change
- Price of materials
- Management
How can workers be a diseconomy of scale
- In a large business, people can think their efforts go unnoticed and have less chance of promotion so lose motivation and work less hard.
- They can also lose their sense of belonging and have less personal commitment and identification with the business.
How can geography be a diseconomy of scale
● A firm may have to transport finished products huge distances and firms may find it harder to control parts of the business which is miles away.
How can change be a diseconomy of scale
● It takes much longer and is much more difficult for a large firm to respond to change.
How can the price of materials be a diseconomy of scale
● an increase in demand can cause prices to rise and therefore increase production costs. This could also occur if the whole industry increases and so firms bid up prices.
How can management be a diseconomy of scale
● Coordination and control: As a business grows, it will become progressively more difficult to coordinate and keep control of all the different parts of the business.
● Communication: Within a large business, communication can be slow and also can lose accuracy
What are learning economies of scale
- Industry experience reduces LRAC
○ Workers may become more adapt and Managers schedule the production process more effectively.
What is Agglomeration economies
Businesses in similar industries tend to cluster together and attract an influx of skilled talent which then provides human capital to expanding businesses.
What are economies of scope
Economies of scope happen when it is cheaper to produce a range of products rather than specialize in a limited number……Amazon
How would you evaluate economies of scale
- The nature of production / technology requirements will influence the size of MES relative to market demand
- Economies of scale may run out at a certain point but constant returns to scale means that unit cost will be stable
- Many economies depend on businesses achieving a high rate of capacity utilisation – this lowers the fixed cost per unit
What are the conditions for profit maximisation
- Profit is maximised when TR and TC are furthest apart (TR>TC)
- Also occurs at MC=MR
What happens if MR crosses MC twice
Sometimes, MR and MC may cross at two points and thus the profit maximising point is where marginal cost rises as it crosses the MR line.
What is normal profit and where does it occur
● Normal profit is the return that is sufficient to keep the factors of production committed to the business .
In economics, costs include the level of profit needed to keep the producer in the market and to cover the opportunity cost. Therefore, if the firm covers its costs it earns normal profit.
This is at the point where** AC=AR or TC=TR. **
Where does a loss occur in economics
AR<AC
If a business is making a loss in the short run, when should it shut down
When AVC>AR as producing more goods will increase the loss
If AVC<AR then firms should continue production as each good produces a revenue to help cover the loss
If a business is making a loss in the long run when should it shut down
Firm must make at least normal profits of AC=AR
(also cover fixed costs)
What is the short run shut down price
AVC=AR
(don’t need to cover fixed costs in short run)
Should this firm keep producing in short run, and long run
- AVC cost is only C2 so AR>AVC so can produce in SR
- IN LR needs AC=AR so will have to shut down
What is the evaluation of profit maximisation
- In the real world it is more difficult to maximise profits because firms do not have access to costs and MR data easily; ends up being prediction
- Principle agent problem; profit satisficing
- ESG considerations, other strategies
What is the evaluation of the shutdown price
- The firm may not close down at price of less than shutdown
- if they expect the** fall in demand to be temporary** and they are hopeful they can cut costs. A firm will try to avoid shutting down because it will lose market share and long term customers
What are factors that affect profitability
- Market Share
- Brand Image
- Competition
- Costs
- Exchange rate
- Economic Growth
Allocative efficiency
When resources are allocated to the best interests of society, when
there is maximum social welfare and maximum utility; P=MC
Asymmetric
information
Where one party has more information than the other, leading to
market failure and causing problems for regulators
Average cost/average
total cost (AC/ATC)
The cost of production per unit
total costs/
quantity produced
Average revenue (AR)
The price each unit is sold for
TR/quantity sold
Bilateral monopoly
Where there is only one buyer and one seller in the market
Cartels
A formal collusive agreement where firms enter into an agreement to
mutually set prices
Collusion
Occurs when firms agree to work together, for example by setting a
price or fixing the quantity they produce
Competition policy
Government action to increase competition in markets
Competitive tendering
When the government contracts out the provision of a good or service
and invites firms to bid for the contract
Conglomerate
integration
The merger of firms with no common connection
Constant returns to
scale
Output increases by the same proportion that the inputs increase by
Contestable market
When there is the threat of new entrants into the market, forcing firms to be efficient
Decreasing returns to
scale
An increase in inputs by a certain proportion will lead to output
increasing by a smaller proportion
Demergers
A single business is broken into two or more businesses to operate on
their own, to be sold or to be dissolved
Deregulation
The removal of legal barriers to allow private enterprises to compete
in a previously protected market
Derived demand
The demand for one good is linked to the demand for a related good
Diminishing marginal
productivity
If a variable factor is increased when another factor is fixed, there will
come a point when each extra unit of the variable factor will produce less extra output than the previous unit; after a certain point, marginal
output falls
Diseconomies of scale
The disadvantages that arise in large businesses that reduce
efficiency and cause average costs to rise
Divorce of ownership
from control
Firms are owned by shareholders, who have little say in the day to
day running of the business, and controlled by managers; this leads to the principal-agent problem
Dynamic efficiency
Efficiency in the long run; concerned with new technology and
increases in productivity which causes efficiency to increase over a
period of time
Economies of scale
The advantages of large scale production that enable a large
business to produce at a lower average cost than a smaller business
External economies of
scale
An advantage which arises from the growth of the industry within
which the firm operates, independent of the firm itself
Fixed cost
constant costs whatever the amount of goods produced
For-profit business
A business whose main aim is to make money
Game theory
Used to predict the outcome of a decision made by one firm, when it
has incomplete information about the other firm
Geographical mobility
of labour
The ease and speed at which labour can move from one area to
another
Horizontal integration
The merger of firms in the same industry at the same stage of
production
Increasing returns to
scale
An increase in inputs by a certain proportion will lead to an increase in
output by a larger proportion
Interdependent
The actions of one firm directly affects another firm
Internal economies of
scale
An advantage that a firm is able to enjoy because of growth in the
firm, independent of anything happening to other firms or the industry in general
Limit pricing
When firms set prices low in order to prevent new entrants; used in
contestable markets
Loss
When revenue does not cover costs
Marginal cost
The additional cost of producing one extra unit of good
Marginal revenue
The additional revenue gained by selling one extra unit of good
Maximum wage
A ceiling wage which people cannot earn above
Minimum efficient
scale
The lowest level of output necessary to fully exploit economies of
scale
Minimum wage
A floor wage which people cannot earn below
Monopolistic
competition
Where there are a large number of buyers and sellers who are
relatively small and act independently, selling non-homogeneous
goods
Monopoly
A single seller in the market
Monopsony
A single buyer in the market
N-firm concentration
ratio
The percentage of market share held by the ‘n’ biggest firms
Nationalisation
When a private sector company or industry is brought under state
control, to be owned and managed by the government
Natural monopoly
Where economies of scale are so large that not even a single
producer is able to fully exploit them; it is more efficient for there to be a monopoly than many sellers
Non-collusive
oligopoly
When firms in an oligopoly compete against each other, rather than
making agreements to reduce competition
Non-price competition
When firms compete on factors other than price, for example
customer service or quality; they aim to increase the loyalty to the
brand which makes demand more inelastic
Normal profit
The minimum reward required to keep entrepreneurs supplying their
enterprise, the return sufficient to keep the factors of production
committed to the business; TC=TR
Not-for-profit business
Where firms are run in order to maximise social welfare and help
individuals and groups; any profit they do make is used to support
their aims
Occupational mobility
of labour
The ease and speed at which labour can move from one type of job to
another
Oligopoly
Where a few firms dominate the market and have the majority of
market share, they act interdependently
Organic growth
Where firms grow by increasing their output
Overt collusion
Collusion where firms come to a formal agreement, for example a
cartel
Perfect competition
A market with many buyers and sellers selling homogenous goods
with perfect information and freedom of entry and exit
Perfectly contestable
market
A market with no barriers to entry, where a new firm can easily enter
and compete against incumbent firms completely equally
Predatory pricing
When a large, established firm is threatened by new entrants so sets
such a low price that other firms make losses and are driven out the
market
Price leadership
Where one firm sets prices and other firms tend to follow this firm as they are fearful of engaging in a price war
Price wars
Where firms continuously drive prices down to the point where they
are frequently making losses and firms are forced to leave
Principal-agent
problem
Where the agent makes decisions on behalf of the principal; the agent
should maximise the benefits of the principal but have the temptation
of maximising their own benefits
Private sector
The part of the economy that is owned and run by individuals or
groups of individuals
Privatisation
The sale of government equity in nationalised industries or other firms to private investors
Productive efficiency
When resources are used to give the maximum possible output at the
lowest possible cost; MC=AC
Profit maximisation
When firms produce at a point which derives the greatest profit;
MC=MR
Profit satisficing
When a firm earn just enough profit to keep its shareholders happy
Public sector
The part of the economy that is owned or controlled by local or central government
Regulatory capture
When regulators become more empathetic and are able to ‘see things from the firm’s perspective’, which removes impartiality and weakens their ability to regulate
Revenue maximisation
When firms produce at a point which derives the greatest revenue;
MR=0
Sales maximisation
When firms produce at a point where they sell as many of their goods
and services as possible without making a loss; AR=AC
Static efficiency
The level of efficiency at one point in time
Sunk cost
Costs that cannot be recovered once they have been spent
Supernormal profit
The profit above normal profit, TR>TC
Tacit collusion
Collusion where there is no formal agreement, such as price
leadership
Third degree price
discrimination
When monopolists charge different prices to different groups for the
same good or service
Total cost
The cost to produce a given level of output
total variable costs+total fixed costs
Total revenue
Revenue generated from the sale of a given level of output
price x quantity sold
Variable cost
Costs which change with output
Vertical integration
When a firm merges or takes over another firm in the same industry,
but at a different stage of production
What is **allocative efficiency **
when the value to society from consumption is equal to the marginal cost of production, where P=MC.
What is productive efficiency
firms produce at the bottom of the AC curve, in the short run this is where MC=AC, has to be technically efficient
What is **dynamic efficiency **
his is achieved when resources are allocated efficiently over time. It is concerned with investment,will be achieved in markets where competition encourages innovation but where there are differences in products and copyright/patent laws.
Supernormal profit is required to provide firms with the incentive to invest and the ability to do so.
What is static efficiency
oncerned with the most efficient combination of existing resources at a given point in time.
Allocative + prod effieiencies
What is a x-inefficiency
If a firm fails to minimise its average costs at a given level of output, it is X-inefficient and there is organisational slack. It often occurs where there is a lack of competition so firms have little incentive to cut costs.
What are the 2 types of dynamic efficiency
- Cost Reducing Innovation
- Creative Destruction
What makes up cost reducing innovation
* Product innovation
○ Small-scale and frequent subtle changes to the characteristics and performance of a good or a service
* Process innovation
○ Changes to the way in which production takes place or is organised
○ Changes in business models and pricing strategies
Innovation has demand and supply-side effects in markets and the economy as a whole
What is social efficiency
- The socially efficient level of output and/or consumption occurs when marginal social benefit (MSB) = marginal social cost (MSC)
What are the impacts of Monopoly allocative inefficiency
- The monopolist will seek to extract a price from consumers above the cost of resources used in making the product.
Higher prices mean that consumers’ needs and wants are not being satisfied, as the product is being under-consumed.
Higher prices cause a loss of consumer surplus & welfare and will disproportionately affect lower income families.
What effiencies does Perfect Competition have
- Allocative efficiency: In both the short and long run, price is equal to marginal cost (P=MC)
- Productive efficiency: in the long run
so static efficiency
Dynamic efficiency: no room to innovate because homogeneity or enough for R+D
● Competition should keep costs, and therefore prices, low. However, firms will be unable to benefit from economies of scale and this may mean costs are higher than they otherwise could be.
What efficiencies does Monopolistic Competition have
- Prices are above marginal cost – meaning that the equilibrium is not allocatively efficient
- Saturation of the market may lead to businesses being unable to exploit fully economies of scale - causing average cost to be higher – therefore not productively efficient
- Debate over the social costs of packaging and negative externalities is linked to monopolistic competition
Monopolistic competition associated with extensive consumer choice and innovation – good for dynamic efficiency
Do takeovers boost economic efficiency
- Economies of scale from horizontal integration (productive efficiency)
- Higher supernormal profits leads to increased R&D spending and more innovation (dynamic efficiency)
Firms with monopoly power still face competition in contestable markets (allocatively efficient prices)
Do takeovers boost economic efficiency
- Increased market power can lead to X-inefficiency (managerial slack, waste)
- Risks of diseconomies of scale (rising long run AC)
- Many takeovers fail to achieve forecast cost gains
Growing number of de-mergers points to limited impact of takeovers on overall economic efficiency
Economic case against monopolies
- Prices are higher than under competitive conditions
Leads to a loss of allocative efficiency (price > MC)
**Regressive effects **on lower-income households - Absence of genuine market competition may lead to production inefficiencies
○ X-Inefficiencies such as wasteful production and advertising spending
○ Higher prices can limit the final output in a market and lead to fewer economies of scale being exploited - Protected markets – perhaps less drive to innovate
Monopoly may get too big – diseconomies of scale
What is the economic case for monopoly
High market concentration does not always signal absence of competition; can reflect the success of firms in providing better-quality products, more efficiently, than their rivals.
- Profits used to fund investment & research
- Natural monopoly – economies of scale
- Domestic monopoly faces global competition
- Monopolistic firms can be regulated – i.e. industry regulator acting as a proxy consumer
- Price discrimination may help some consumers (cross-subsidisation)
What did Schumpeter argue about monopolies and creative destruction
· Schumpeter argued that firms have a very real incentive to invest in R and D,
· He stated that firms would fear Creative Destruction. Where new firms enter the market with technological advancement a force out existing firms. Incumbents fear this.
* They invest therefore in R and D and this is likely to come in the **form of the product/process. **
What does investment in the product result in (quality)
· Scarce resources are effectively allocated to meet consumer needs and wants.
· Consumers utility is met/improved and although consumers may face higher prices one could argue this level of product development and meeting the consumers’ needs is not possible in a competitive market due the absence of abnormal profit in the long run.
What does investment in the process result in (cost)
Investment in production-invention or innovation.
Investment in process is an example of technological EOS and the impact of tech improvement will drive down average and marginal cost. This can be shown. (see diagram)
What are the 4 key characteristics of a perfectly competitive market
1.There must be many buyers and sellers. This means that no one will be able to influence the market
2. freedom of entry and exit from the industry
3. There must be** perfect knowledge**
4. Homogenous products
Why must there be freedom of entry and exit for a perfectly competitive market
when a business is making profits anyone can enter that market and start producing that product for themselves.
As a result, business are unable to make SNP in the long run and if they are making losses they are able to leave. In the long run, they make normal profits.
Why must there be perfect information for a perfectly competitive market
This enables firms to know when other firms are making profits which will attract them to join the market. Moreover, all firms have the same costs as they can use the same production techniques.
It also means that any attempt to raise prices above the level determined by the market will lead to no sales, as customers will be aware they can buy the same good for a lower price and firms know there is no point lowering the price as they will sell all their goods at the higher price determined by the market.
Why must there be homogeneity for a perfectly competitive market
it means if a firm raises it price above the competitors’ no one will buy it and they will not gain from lowering their price because they can sell all of your product at the same price as everyone else.
What possibilities are there for perfectly competitive firms in the short run
Firms are assumed to short run profit maximise and so the firm will produce at MC=MR. In the short run, it is possible for the firm to make a normal profit, a supernormal profit or a loss
What possibilities are there for perfectly competitive firms in the long run
Only normal profits :0
How do PC firms go from SR SNP to LR NP
SR SNP signals to other firms to enter the market (perfect competition + no barriers) so they enter causing a shift out in supply of the industry so firms have to sell at a lower and lower price (price-taker) until SNP disappears
How do PC firms go from SR subnormal profits (loss) to LR NP
PC firms will know they are making a loss and leave to produce their opportunity cost (no barriers to exit). This causes a shift in of supply in the firm causing firms to increase their price ( price taker ) until there is no loss and normal profit is left
When drawing PC market structures what do you always have to includes
The market (s+d diagram) because firms are price takers
How would you evaluate the PC model
- Most firms have some amount of price-setting power – they are price makers not price takers!
- Dominance in real world markets of differentiated / branded products
- Highly complex products, there always information gaps facing
consumers - Impossible to avoid search costs even with the spread of digital/web technology
- Patents, control of intellectual property, control of key inputs are all ignored by the competitive model
- Rare for entry and exit in an industry to be costless
What are the characteristics of Monopolistic Competition
● There must be a large number of small, independent buyers so no one buyer or seller has a large price setting power.
● There are no barriers to entry or exit
● The difference is that in monopolistic competition firms produce differentiated, non-homogenous goods or services.
* The entrepreneur has a more significant role than in firms that are perfectly competitive because of the increased risks associated with decision making.
How do MC profit maximise in the short-run
Firms are assumed to be short run profit maximisers
As a result, they produce Q1 at MC=MR and make a supernormal profit
Why do MC produce normal profits in the long run
new firms will enter the industry as they know that supernormal profits are being earnt.
This will cause demand for the individual firm to decrease and therefore the AR and MR curves will shift to the lift and so the firm is making normal profits.
If the firm was making a loss, firms would leave the industry and thus demand for the individual firm would increase as they had less competition. This would lead to normal profits in the long run.
What are the limitations of the MC model
- that information may be imperfect and so firms will not enter the market as predicted as they are unaware of the existence of abnormal profits.
- firms are likely to be different in their size and cost structure as well as in their products, which may allow some firms to maintain supernormal profits because firms cannot compete on equal terms.
What are the efficiencies of the MC model
● Since they can only make normal profit in the long run, AC=AR and since they profit maximise, MR=MC. Therefore, the firm will not be allocatively or productively efficient, as MR does not equal AR so AC cannot equal MC and AC cannot equal MR.
● They are** likely to be dynamically efficient** since there are differentiated products and so know that innovative products will give them an edge over their competitors and enable them to make supernormal profits in the short run.
However, since the firms are small they may struggle to receive finance or have the retained profits necessary to invest.
● In monopolistic competition compared to perfect competition, less is sold at a higher price and firms may not necessarily be producing at the lowest cost. However, the market will offer greater variety and may be able to enjoy some degree of economies of scale.
What are some advantages of monopolistic competition
· There are no significant barriers to entry; therefore markets are relatively contestable.
· Differentiation creates diversity, choice and utility.
The market is more efficient than monopoly but less efficient than perfect competition - less allocatively and less productively efficient.
What are the disadvantages of monopolistic competition
· Some differentiation does not create utility but generates unnecessary waste, such as excess packaging. Advertising may also be considered wasteful, though most is informative rather than persuasive.
· there is allocative inefficiency in both the long and short run. This is because price is above marginal cost in both cases.
In the long run the firm is less allocatively inefficient, but it is still inefficient.
There may be a lack of dynamic efficiency in the long run due to the absence of long run abnormal profit
Why is there a tendency for excess capacity in MC
- There is a tendency for excess capacity because firms can never fully exploit their fixed factors because mass production is difficult. This means they are productively inefficient in both the long and short run.
What are the characteristics of an oligopoly
- products are generally differentiated
- supply in the industry must be concentrated in the hands of a relatively small number of firms
- firms must be interdependent so the actions of one firm will directly affect another
- there are barriers to entry.
Explain the kinked demand curve theory
· At P1 if one firm increased their price, other firms would not follow suits. Consumers would buy from the other firms therefore the firms raising price would face a PED elastic response on the AR curve would lose a large share of the market, revenue and likely profit
· If one firms cut price then they could gain a big increase in market share, however it is unlikely that firms will allow this. Therefore, other firms follow suit and cut price as well. Therefore demand will only increase by a small amount: Demand is inelastic for a price cut and revenue would fall for all firms
· This model suggests price will be rigid because there is no incentive for firms to change the price, they are risk averse.
What are the limitations of the kinked demand theory
- It assumes there is an intial price set
- It does explain why prices tend to be stable
What was the n-firm conc. ratio
total sales of n firms x100 /total size of market
What is collusion
- Collusion is when firms make collective agreements that reduce competition .
- When firms don’t collude, this is a competitive oligopoly.
What are the advantages of collusion
● if they work together, they could maximise industry profits.
● Collusion reduces the uncertainty firms face and reduces the fear of engaging in competitive price cutting or advertising, which will reduce industry profits.
What are the disavantages of collusion
● collusion is illegal and due to the risks of collusion , such as other firms breaking the cartel or prices being set where they don’t want it.
● A firm with a strong business model and something that sets it apart from other firms will not want to collude if they feel they can increase market share and/or charge higher prices than competitors.
When does collusion work best
there are a few firms which are all well known to each other
the firms are not secretive about costs and production methods and the costs and production methods are similar
they produce similar products
there is a dominant firm which the others are happy to follow
the market is relatively stable; and there are high barriers to entry.
What are the 2 types of collusion
overt and tacit collusion.
Overt collusion is when firms come to a formal agreement whilst tacit collusion means there is no formal agreement.
What is a cartel
A formal collusive agreement is called a cartel, which is a group of firms who enter into agreement to mutually set prices.
The rules will be laid out in a formal document which may be legally enforced and fines will be charged for firms who break these rules.
What are the 2 ways a cartel can operate
1) agree on a price for the goods and then compete freely using non-price competition to maximise their market share
2) agree to divide up the market according to the present market share of each business.
What are the problems with cartels
● there is constant temptation to break the cartel. The more successful the cartel, the greater the incentive to break it; it is important for firms to be the first to break it and not the firm who is left to deal with the after effects.
● Since collusion is illegal, firms may be involved in tacit collusion such as price leadership and barometric firm.
What is price leadership
Price leadership is where one firm has advantages due to its size or costs and becomes the dominant firm to set the price
Other firms will tend to follow this firm because they would be fearful of taking on the firm on in any form of price war.
What is barometric price leadership
● Barometric firm price leadership is where a firm develops a reputation for being good at predicting the next move in the industry and other firms decide to follow their leader.
What are 2 strategies a firm can take
- MaxiMin Policy - firms working out the strategy where the worst possible outcome is the least bad (minimising losses)
- MaxiMax Policy - firms working out the policy with the best possible outcome.
If Minimax policy and Maximax policy are the same what is this strategy
Dominant Strategy
What is a Nash Equilibrium
where neither player is able to improve their position and has optimised their outcome based on the other players expected decision.
They have no incentive to change behaviour, unless someone else changes theirs.
Use a Game Theory matrix to explain why oligopolies have stable prices
What does the prisoners dilema show about the Nash Equilibrium
What are the types of price competition
- Price Wars
- Predatory Pricing
- Limit Pricing
What are price wars and when do they occur
● These occur in markets where non-price competition is weak ; where goods have weak brands and consumers are price conscious. They also occur when it is difficult to collude.
● A price war will drive prices down to levels where firms are frequently making losses. In the short term, firms will continue to produce if their AVC is below AR but in the long run, they will leave the market and prices will have to rise since supply falls.
● It lowers industry profits.
What is predatory pricing
●Threat of Competition means Firms sets such a lower price so firms are unable to make a profit
● This is illegal and only works when one firm is large enough to be able to have low prices and sustain losses.
What is **limit pricing **
● In order to prevent new entrants, firms will set prices at AC=AR to ensure normal profits
● The greater the barriers to entry, the higher the limit price. It is mainly used in contestable markets.
● The drawback of this is that it means firms cannot make profits as high as they would be otherwise be able to.
What is cost plus pricing
`
Firms add on a percentage increase to their average costs; doesn’t consider the market
What is pychological pricing
Firms utilising non-rounded prices to given an impression that the price is cheaper than it is
What is market led pricing
Firms follow pricing set by other firms; ignores cost
What is price skimming
new products can have high prices to cover R+D and supress demand
This can be lowered over time
What is penetration pricing
New products at low price so people get used to it and gain brand loyaly so firm can increase price
e,g, BOLT
(opposite of price skimming)
What are common examples of non-price competition
- Advertising/ Branding; lower PED
- Loyalty Cards
- Quality
- Customer Service
- R+D
What is the issue with non-price competition
They are often expensive and so firms need the money before they are able to undertake the competition
What efficiencies do oligopolies have
● Firms will be statically inefficient, since they are not productively or allocative efficient.
● They are likely to be dynamically efficient; SNP + threat of comeptition incentivies DE
● They will be able to exploit economies of scale, lowering costs.
Draw a Cartel Firm’s SNP when staying within the quota of output
Draw the incentive to cheat shown by a Cartel Firm’s SNP
What are the costs of collusive behaviour
1) Damages consumer welfare
○ Higher prices / lost consumer surplus ○ Loss of allocative efficiency ○ Hits lower income families – i.e. has a regressive impact lack of choice due to high conc. 2) Absence of competition hits efficiency ○ X-inefficiencies leads to higher unit costs ○ Less incentive to innovate / loss of dynamic efficiency * Output quotas penalise firms who want to expand
3) Reinforces the cartel’s monopoly power
Harder for new businesses to enter the market – this reduces market contestability
What are the potential consumer gains from collusive behaviour
- Period of relative price stability
- A reduction of some of the wasteful costs of advertising and marketing if producers co-operate rather than compete with each-other
- Guaranteed supply from the producer cartel
What are the potential producer gains of collusive behaviour
- Producer cartels may be successful in raising the price of exported commodities
○ May help to fund higher levels of capital investment
Boost to export revenues for countries with a high dependency on exports of primary commodities
What does the discontinued MR curve illustrate
As long as the Firms MC curve lies in this area MC=MR this will be the best strategy for the individual firm
What are the limitations of the kinked demand curve
· No explanation of how the original price was arrived at.
· The theory only deals with price competition not non price competition
· It ignores certain practices such as interest free credit
· In a recession competition may increase
What are the limitations of the kinked demand curve
· No explanation of how the original price was arrived at.
· The theory only deals with price competition not non price competition
· It ignores certain practices such as interest free credit
· In a recession competition may increase
When are Cartels more likely to survive and occur
· Barriers to entry are high
· Govt regulation is weak
· Demand is stable
Price and output are easily monitored
how do you work out N-Firm conc. ratios
using the formula: total sales of N firms / total size of market
Whatt is CMA (Competition and Markets Authority) and its role
The CMA is now the UK’s key competition regulator, combining the competition elements of the OFT and Competition commission.
- Investigate mergers which could restrict competition where there may be breaches of UK or EU law against anti-competitive agreements and abuses of dominant positions
- Bring criminal proceedings against individuals who commit a cartel offence
- Cooperate with sector regulators (such as Ofcom) and encouraging them to use their competition powers considering regulatory references and appeals
What is regulatory capture and the issues associated with it
where the regulator is captured or hijacked by the regulated.
the regulated develop a deep understanding of the details of the regulation and can learn how to ‘play the system’ OR increased exposure of regulators to the regulated encourages them to ‘see things from their perspective’
How did Pfizer and Flynn Pharma collude illegaly
Aug 2015: Pfizer and a UK company called Flynn Pharma found to have charged “excessive and unfair prices” for an anti-epilepsy drug — phenytoin sodium — inflating the annual NHS drugs bill by tens of millions of pounds
What is the cheating of the RBS and Barclays Cartel
RBS admitted that staff involved in making loans to big law and accounting firms had illegally given pricing data to corresponding staff at Barclays.
** RBS fined £28 million**
**No action is to be taken against Barclays, **as a reward for having acted as an informant within the industry, voluntarily disclosing its part in the affair to the competition authorities.
What is the difference between overt and tacit collusion
- Overt is illegal and a fomal agreement
- Tacit is legally grey and an unwritten agreement
In what forms does tacit collusion come in
· Price leadership where the dominant firm in the industry changes its prices and all others follow
· Firms monitoring each others behaviour closely and** unwritten rules developing**. Eg all following certain principles
· Barometric price leadership
What is collaboration
· Firms working together, perhaps even encouraged by the government.
· There could be significant benefits to society of such sharing of info and ideas. (+externalities of improved medical treatments)
· There is a danger though that collusion may be the result and also monopoly power
What are the various methods of collusion
- Monopsony pricing – where retailers collude to reduce the amount paid to suppliers.
- Collusion between existing firms in an industry to exclude new firms from deals
- Sticking to output quotas and higher prices.
- Collusive tendering. For example, ‘cover prices’ for competitive tendering in bidding for public construction contracts.
How do people justify collusion in bad conditons
collusion may be a way to try to save the industry and prevent firms from going out of business, which would not be in the long-term consumer interest.
Dairy suppliers tried to use this justification in 2002/03 after problems from foot and mouth disease led to a decline in farm incomes.
What is an example of cover pricing - collusive tendering
Firms would decide which contracts they wanted, and rivals would bid purposefully high price. This is a practice known as “Cover pricing”. Successful companies would often reward rivals with a secret payment for avoiding competition.
During the investigation, the OFT found 199 offences where the 103 companies artificially inflated £200m worth of work. Companies were fined a total of £129.5m by the OFT.
How are Australian Supermarkets an oligopoly
90% market share in the hands of just four supermarkets so farmers are presssured by extreme barganing power meant farmers’ margins have been squeezed
Regulators have failed to curb this excessive power.
In the long term, consumers will be worse off through less choice and innovation in products, less efficiency and productivity
What is limit pricing
● In order to prevent new entrants, firms will set prices low (the limit price). The price needs to be high enough for them to make at least normal profit but low enough to discourage any other firm from entering the market.
● The greater the barriers to entry, the higher the limit price. It is mainly used in contestable markets.
● The drawback of this is that it means firms cannot make profits as high as they would be otherwise be able to.
What is a good example of lobbying in regulation : Australian Banks
Bank lobbyists are seeking to water down a new Financial Accountability Regime proposed by Australia’s Treasury, which includes A$1m fine for executives who breach accountability obligations.
What is the Quebec Maple Syrup Cartel and what does it show about the weaknesses of oligopolies
Federation of Quebec Maple Syrup Producers (FPAQ) produce 70% of world supply of maple
insist that the majority of members benefit from quotas, a 2016 study by the independent Montreal Economic Institute disagreed. Quebec sold 78% of the world’s maple syrup, that percentage has already fallen to 69% due to it giving price stability to it’s competitors
How does OFGEM show regulatory failure
many suppliers lacked the financial resilience to deal with the six-fold increase in wholesale prices seen last year, the NAO said.
“By allowing so many suppliers with weak finances to enter the market, and by failing to imagine that there could be a long period of volatility in energy prices, Ofgem allowed a market to develop that was vulnerable to large-scale shocks,” said Gareth Davies, head of the NAO.
What is a pure monopolist
a single supplier that dominates the entire market – the market has 100% concentration
What is a working monopoly
A working monopoly is any firm with greater than 25% of the industries’ total sales
What is a dominant firm
A dominant firm is a firm that has at least 40% market share
Draw a monopoly market
What is third degree price discrimination
This is when monopolists charge different prices to different people for the same good or service
What are the conditions for price discrimination
- the firm must be able to clearly separate the market into groups of buyers
- the customers must have different elasticities of demand
- they must be able to control supply and prevent resale
Draw a diagram for 3rd degree price discrimination based on separation by PED
The diagram shows the seperate markets for separate groups: those with inelastic demand and those with elastic demand. Assumption of constant cost
This shows that by price discriminating and having two separate markets, the inelastic market and the elastic market, rather than a combined market, the firm can make higher profits. The orange area plus the purple area is larger than the yellow area.
Draw a diagram for 3rd degree price discrimination based on separation by PED
The diagram shows the seperate markets for separate groups: those with inelastic demand and those with elastic demand. Assumption of constant cost
This shows that by price discriminating and having two separate markets, the inelastic market and the elastic market, rather than a combined market, the firm can make higher profits. The orange area plus the purple area is larger than the yellow area.
What is a natural monopoly
the economies of scale are so large that even a single producer is not able to fully exploit all of them (decreasing cost industries)
when the most efficient number of firms in the industry is one.
A natural monopoly will typically have very high fixed costs meaning that it is impractical to have more than one firm producing the good.
Draw a natural monopoly
Why is it pointless to encourage competition in natural monopolies
It would be pointless to encourage competition since it would raise average costs for the industry. If any new firm enters the market, they will be easily priced out as their costs will be so much higher.
● Natural monopolies tend to be found in industries with very high fixed costs , such as railways.
What are the costs and benefits of monpolies on firms
● Monopolists have the potential to make huge profits for their shareholders through profit maximisation.
● The existence of supernormal profits so finance for investments and will be able to build up reserves to overcome short term difficulties.
● Large firms will be able to maximise economies of scale, reducing costs and increasing profit further.
● However, firms may not always choose to profit maximise because of X-inefficiencies, sales or revenue maximising, profit satisficing or contestability leading to limit pricing.
In the long run, the lack of competition may mean that firms become complacent and so they may not make maximum profits.
What are the costs and benefits of monopolies on employees
● Monopolists produce at lower outputs, so will employ fewer workers.
● However, the inefficiency of the monopoly may mean employees receive higher wages, particularly directors and senior managers. Profit satisficing or sales/revenue maximising may mean output is higher and so more employees are employed.
What are the costs and benefits of monopolies on suppliers
depend on the extent to which the monopolist is also a monopsonist. If the monopolist buys all or most of the suppliers’ goods (so is a monopsonist), it will reduce the suppliers’ profits as the monopolist will decrease prices.
What are the costs and benefits of monopolies on consumers
● With a natural monopoly, consumers tend to be better off than if there was competition.
● When firms enjoy economies of scale = higher consumer surplus
● Monopolists may produce more choice due to **cross subsidisation. **
● The use of price discrimination will allow for survival of a product or service , and benefits some customers (those in the cheap market) whilst is negative for others. For example, it is said that economy class flights are funded by business class flights
● Consumers may pay higher prices and see a poorer quality service , due to a lack of competition.
● There is less choice for consumers, since there is only one firm producing the good.
What efficiencies does a monopoly have
● A monopoly is productively inefficient, since they don’t produce at MC=AC. They are also not allocative efficient as P>MC.
● Since a monopolist is likely to make supernormal profits, they will be dynamically efficient. However, if there is no competition, they may have no incentive to invest.
Draw the Williamson trade off and describe the areas of DWL, falls in consumer surplus, gains in producer surplus
What is the Williamson trade off
A diagram that shows the effect of a monopolist compared to perfect compeittion; assumed that industry is a constant cost where AC=MC
Analyse this diagram
- As a profit maximiser the monopoly will restrict output to Q1 in order to achieve MC=MR.
- Consumers suffer through a lack of choice but also high prices reducing surplus to [5,6,7].
- Producer benefits by capturing surplus from the consumer, a transfer in welfare [1,2,11,12]. Total producer surplus is now [1,2,13,14].
- The monopoly is not allocatively efficient as P≠MC, This creates a welfare loss of [8,9,10] made up of lost consumer and producer surplus.
- The firm is not productively efficient it doesn’t not produce at the lowest point of the AC curve
- there is likely to be a degree of x-inefficiency. This results in higher AC, higher prices and poor service.
- The monopoly does not fully exploit its EoS on the graph as it does not produce at the MES point since it restricts output.
What are the general disadvantgaes of a monopoly
· lower consumper surplus and restricted choice for consumers.
· Allocative and productively inefficient.
· Welfare loss leads to a market failure.
· Likely to be** x-inefficient **due to a lack of competition.
· Not fully exploiting Economies of Scale as not producing at the MES point.
· Protected by high barriers to entry, could lead to a lack of dynamic efficiency (no incentive to innovate).
· They may suffer from Dis-economies of scale and higher AC.
Price discrimination can lead to some consumers having to pay more than others
What are the advantages of a monopoly
· A monopoly will be able to use its size to benefit from Economies of Scale so lower average costs which could be passed onto consumers.
· Dynamic efficiency will benefit consumes in the long-run, more so than perfect competition.
Monopolies can compete on an international scale due to their EoS. This benefits the economy on a macro-level with output, employment, exports, tax revenue etc.
On a micro-level, in a local community suppliers and local shops benefit and there are positive externalities of employment.
What di Schumpeter argue about monopolies
- Firms would fear Creative Destruction, where new firms enter the market with technological advancement a force out existing firms.
- They invest therefore in R and D and this is likely to come in the form of the product/process.
What is the dynamic efficiency of the product
The product:
· Scarce resources are effectively allocated to meet consumer needs and wants.
· Consumers utility is met/improved and although consumers may face higher prices
· This is to the benefit of consumers compared to competitive markets.
What is dynamic efficiency of the process
The process:
Investment in production-invention or innovation.
Investment in process is an example of technological EOS and the impact of tech improvement will **drive down average and marginal cost. **
What is price discrimination and how many types are there
3 (only need to know 3rd)
This involves charging different prices for different groups of consumers for the same good or service, for reasons not associated with cost.
What are the conditions necessary for price discrimination
- Monopoly Power
- The ability to prevent market seepage (second hand arbitrage/resale).
- Ability to split the market into segments through PED. This is usually done through time or geography.
What is 1st Degree Price Discrimination (Perfect Price Discrimination)
- Each consumer in theory is charged the maximum they individually are willing to pay so extracts all consumer surplus.
- In reality, this is an unrealistic theory as consumers are unlikely to reveal their true preferences
What is second degree price discrimination
- Excess capacity pricing exists when sellers try to off-load their spare output to buyers
- This involves charging different prices depending upon the choices of consumer. For example quantity, time period, collecting coupons
e.g. · Early Bird Discount – Creates cash flow, and ensures they can run the flight
Buying in Bulk – e.g. if you buy 100 units then they are £10 each, if you buy 500 units then they are £8 each. Diagram:
What is third degree price discrimination (direct price discrimination)
This involves charging different prices to different groups of people
What are the advantages for consumers for price discrimination
· Cross Subsidisation
o This is where unprofitable routes are subsided and ran because of the profitable routes which are engaging in price discrimination.
Some consumers benefit from lower prices,
Some consumers have access to services which they otherwise would not be able to afford. These last minute deals are second degree price discrimination.
What are the **disadvantages ** for consumers for price discrimination
· Certain consumers will pay higher prices, due to the extraction of consumer surplus by firms.
· Some groups, for example graduates travelling to work, are particularly penalised.
· As monopoly power is needed for price discrimination to be possible, monopoly arguments can be used here too
x-inefficiency. This leads to higher costs/inertia-consumers may suffer
Dis. EOS – higher average costs, meaning higher final prices for the consumer.
What are the advantages for producers for price discrimination
· In first/third degree, producer surplus is increased so higher SNP
· Dynamic efficiency means that barriers to entry for potential entrants to the market increase.
· Economies of scale provide barriers to entry for the monopoly.
Provides profits to engage in anti-competitive strategies– for example predatory pricing.
What are the disadvantages for producers from price discrimination
· Monopoly inertia
· Creative destruction
Dis EOS harms producers as well as consumers
What is the evaluation for price discrimination
· The key word in the question is “always”.
o Price discrimination is not bad for all consumers
o It is also not always good for producers, due to government regulation and monopoly inertia.
· There may be an asymmetric impact between regions, some being cheaper and some more expensive.
· Dynamic efficiency – does the monopoly invest in R + D, or do profits go into ‘back pocket’?
Analyse this diagram
- As a profit maximiser the monopoly will restrict output to Q1 in order to achieve MC=MR.
- Consumers suffer through a lack of choice but also high prices reducing surplus to [5,6,7].
- Producer benefits by capturing surplus from the consumer, a transfer in welfare [1,2,11,12]. Total producer surplus is now [1,2,13,14].
- The monopoly is not allocatively efficient as P≠MC, This creates a welfare loss of [8,9,10] made up of lost consumer and producer surplus.
- The firm is not productively efficient it doesn’t not produce at the lowest point of the AC curve
- there is likely to be a degree of x-inefficiency. This results in higher AC, higher prices and poor service.
- The monopoly does not fully exploit its EoS on the graph as it does not produce at the MES point since it restricts output.
What are the general disadvantgaes of a monopoly
· lower consumper surplus and restricted choice for consumers.
· Allocative and productively inefficient.
· Welfare loss leads to a market failure.
· Likely to be** x-inefficient **due to a lack of competition.
· Not fully exploiting Economies of Scale as not producing at the MES point.
· Protected by high barriers to entry, could lead to a lack of dynamic efficiency (no incentive to innovate).
· They may suffer from Dis-economies of scale and higher AC.
Price discrimination can lead to some consumers having to pay more than others
What are the advantages of a monopoly
· A monopoly will be able to use its size to benefit from Economies of Scale so lower average costs which could be passed onto consumers.
· Dynamic efficiency will benefit consumes in the long-run, more so than perfect competition.
Monopolies can compete on an international scale due to their EoS. This benefits the economy on a macro-level with output, employment, exports, tax revenue etc.
On a micro-level, in a local community suppliers and local shops benefit and there are positive externalities of employment.
What di Schumpeter argue about monopolies
- Firms would fear Creative Destruction, where new firms enter the market with technological advancement a force out existing firms.
- They invest therefore in R and D and this is likely to come in the form of the product/process.
What is the dynamic efficiency of the product
The product:
· Scarce resources are effectively allocated to meet consumer needs and wants.
· Consumers utility is met/improved and although consumers may face higher prices
· This is to the benefit of consumers compared to competitive markets.
What is dynamic efficiency of the process
The process:
Investment in production-invention or innovation.
Investment in process is an example of technological EOS and the impact of tech improvement will **drive down average and marginal cost. **
What is price discrimination and how many types are there
3 (only need to know 3rd)
This involves charging different prices for different groups of consumers for the same good or service, for reasons not associated with cost.
What are the conditions necessary for price discrimination
- Monopoly Power
- The ability to prevent market seepage (second hand arbitrage/resale).
- Ability to split the market into segments through PED. This is usually done through time or geography.
What is 1st Degree Price Discrimination (Perfect Price Discrimination)
- Each consumer in theory is charged the maximum they individually are willing to pay so extracts all consumer surplus.
- In reality, this is an unrealistic theory as consumers are unlikely to reveal their true preferences
What is second degree price discrimination
- Excess capacity pricing exists when sellers try to off-load their spare output to buyers
- This involves charging different prices depending upon the choices of consumer. For example quantity, time period, collecting coupons
e.g. · Early Bird Discount – Creates cash flow, and ensures they can run the flight
Buying in Bulk – e.g. if you buy 100 units then they are £10 each, if you buy 500 units then they are £8 each. Diagram:
What is third degree price discrimination (direct price discrimination)
This involves charging different prices to different groups of people
What are the advantages for consumers for price discrimination
· Cross Subsidisation
o This is where unprofitable routes are subsided and ran because of the profitable routes which are engaging in price discrimination.
Some consumers benefit from lower prices,
Some consumers have access to services which they otherwise would not be able to afford. These last minute deals are second degree price discrimination.
What are the **disadvantages ** for consumers for price discrimination
· Certain consumers will pay higher prices, due to the extraction of consumer surplus by firms.
· Some groups, for example graduates travelling to work, are particularly penalised.
· As monopoly power is needed for price discrimination to be possible, monopoly arguments can be used here too
x-inefficiency. This leads to higher costs/inertia-consumers may suffer
Dis. EOS – higher average costs, meaning higher final prices for the consumer.
What are the advantages for producers for price discrimination
· In first/third degree, producer surplus is increased so higher SNP
· Dynamic efficiency means that barriers to entry for potential entrants to the market increase.
· Economies of scale provide barriers to entry for the monopoly.
Provides profits to engage in anti-competitive strategies– for example predatory pricing.
What are the disadvantages for producers from price discrimination
· Monopoly inertia
· Creative destruction
Dis EOS harms producers as well as consumers
What is the evaluation for price discrimination
· The key word in the question is “always”.
o Price discrimination is not bad for all consumers
o It is also not always good for producers, due to government regulation and monopoly inertia.
· There may be an asymmetric impact between regions, some being cheaper and some more expensive.
· Dynamic efficiency – does the monopoly invest in R + D, or do profits go into ‘back pocket’?
What is the importance of marginal cost in price discrimination
In markets where the marginal cost of an extra passenger is very low, the firm has an incentive to use price discrimination to sell all the tickets.
Draw a predatory pricing diagram
What is an example of predatory pricing in the Darlington Bus War
Busways a new entrant into the deregulated bus markets, offered free bus travel to try and force the rival Darlington Bus company out of business.
The result was that Darlington Transport Company (DTC) went out of business leading to monopoly power for the remaining Busways Company.
“It was the combination of Busways’ actions in recruiting so many of DTC’s drivers so quickly, registering services on all its routes and running free services which caused DTC’s final collapse. We find these actions to be predatory, deplorable and against the public interest.”
Since bus deregulation, bus use in Darlington has fallen from 10 million journeys a year (2001) to 6.6 million (2014).
Draw a limit pricing diagram
Evaluate limit pricing
- A large multinational may be willing to enter a market – even if it is unprofitable in the short-term.
- Limit pricing will be more effective in industries with substantial economies of scale
For industries, with few economies of scale, such as restaurants and bars, limit pricing will not be effective
What is a monopsony
This is where there is only one buyer of labour or products in the market,
How does the NHS use monospony power
One example could be the NHS, who pay less for cancer drugs than a number of other high-income countries.
How do monopsonies use their buying power in product markets
They will pay their suppliers the lowest price possible to minimise their costs and make the most of their position as the only buyer.
e.g. Requiring suppliers to cover costs such as delivery
Forcing suppliers to make lump sum payments to the monopsonist, for example, for access to particular positions in stores and outlets
Delaying payments to suppliers to improve the monopsonist’s cash flow.
Draw a monopsony diagram
They will produce where the cost to them (MC) is equal to the value they get (AR). Hence, they will produce where MC=D.
What are the costs and benefits to firms from monopsony power
● The monopsony gains higher profits by being able to buy at lower prices.
● They achieve purchasing economies of scale, which will lower costs and increase profits.
●More investment and DE
What are the costs and benefits to consumers from monopsony power
● Customers may gain from lower prices as reduced costs are passed on.
● It could lead to a fall in supply, since the business buys fewer inputs. Dependent on PES of supplier
● They may act as a** counter-weight to monopolists. **
● There may be a** fall in quality** as prices are driven down
What are the costs and benefits to employees from monopsony power
● The supplier will sell less goods and so employ less people whilst the monopsonist may employ fewer, more or the same amount of people since they have less inputs to use for production but their costs are also lower.
● Monopsonists** may pay higher wages** as they are making higher profits.
What are the costs and benefits to suppliers from monopsony power
● Suppliers will lose out as they will receive lower prices ; less will be supplied leading to some firms leaving the market
What are government attempts to control monopsony power
- Setting up a specific regulator to monitor the activities of firms with monopsony power, such as the UK’s Groceries Code Adjudicator (GCA).
- Controlling prices paid to suppliers – such as setting minimum prices.
- Subsidising suppliers who are adversely affected by the exertion of monopsony power.
- Legislate against late payments.
- Prevent further monopsony power by blocking mergers or by forcing firms to divest outlets or divisions of their business.
- encourage new entrants into the industry.
How do suppliers combat monospony power
- Establishing **producer cooperatives **as a counter-balance to monopsony buyers
- Using technology for suppliers to sell directly to consumers
What are some examples of producer cooperatives
Arla Foods is a global dairy company and cooperative owned by 9,700 dairy farmers with 2,100 of whom are British.
- Ormoia Coffee Union in Ethiopia over 20,000 farmers.
What are the characteristics of a contestable market
· This means there are no barriers to entry and no barriers to exit, such as sunk costs, economies of scale and contractual agreements.
· No brand loyalty
· Perfect information.
What are the implications of a contestable market
● Hit and run competition; only way to prevent this is by using limit pricing, which reduces the incentive for firms to enter the market.
● In a perfectly contestable market, firms will only be able to make normal profits and produce where AC=AR
● Firms are likely to be productive and allocative efficient.
- The threat of contestability is sufficient for economic efficiency, all markets may be efficient provided there is contestability.· Potential competition may be as important as actual competition for economic efficiency.
· It shifts the emphasis of govt policy away from the number of firms to barriers to entry.
· The absence of competition does not necessarily mean a lack of contestability.
· Nobody entering the market may just be out of fear for the incumbent’s efficiency
What are some innocent entry barriers (natural barriers)
- Economies of Scale of existing firms
- Network effect
- High r+d costs
- High set-up costs
- Ownership of key resources or raw materials
What are some Artificial (Strategic) barriers to entry
- Predatory pricing, as well as an acquisition.
- Limit pricing
- Advertising and brand
- Contracts, patents, and licenses
- Loyalty schemes
- Switching costs discourage new entrants
What are the barriers to entry for all the 4 market structures
Perfect competition: Zero barriers to entry
Monopolistic competition: Medium barriers to entry
Oligopoly: High barriers to entry
Monopoly: Very high to absolute barriers to entry
What are barriers to exit
obstacles or impediments that prevent a company from exiting a market in which it is considering cessation of operations, or from which it wishes to separate.
What are some barriers to exit
highly specialized assets, which may be difficult to sell or relocate, and high exit costs, such as asset write-offs and closure costs. A common barrier to exit can also be the loss of customer goodwill.
- Highly specialised assets that are hard to sell off
- Tax breaks and regulation
- Costly Equipment
- Impact on the Enviroment
How can high barriers to exit be an opportunity for new entrants
A new company could buy up the assets of a company wishing to exit at a favourable price. Or a competitor could do this
What is a sunk cost
A sunk cost is a fixed cost that a business cannot recover if it leaves the industry
How is the degree of contestability measured
Etent to which the gains from market entry for a firm exceed the costs of entering the market, A market with no sunk costs and no barriers to entry and exit is a perfectly contestable market
What are reasons for increasing contestability nowadays
- Deregulation of markets allowed for a reduction of barriers to entry
- Competition policy means firms can no longer use predatory pricing/cartels
- Globalisation has allowed for more firms to enter
- Technology (internet shopping) reduced entry capital costs
What are policies to increase contestability
- Deregulation of an industry
- Open up networks of monopolies
- Tough rules on predatory pricing
- Encouraging international trade
What is hit and run competition
When a business enters an industry to take advantage of temporarily high (supernormal) market profits.
Draw the effect of contestability
· There is downward pressure on prices because high prices and profits act as incentives for new producers to compete away monopoly profit.
· Normal profit will occur AC=AR (link to alternative objectives)
· An improvement in c/s and welfare will occur.
What are some criticisms of the theory of contestability
- Sunk costs are extremely high even with transferable capital
- Contestability requires specific technical inowledge necessary to operate to be freely avaliable however patents iin the drugs industry last for 20 years
What are sone examples of contestable market
- the taxi industry, with the introduction of Uber
- the hotel market, with AirBnB
- Ocado, who are set to replace M&S in the FTSE 100 (2018), showing the new replacing the old.
How has globalisation led to greater contestability (synoptic point)
- Greater access to relecommuncations had reduced barriers to entry and incrased information
- European single market has opened up new market for firms and so these firms can enter into the market easily
What is MRPL (Marginal Revenue Product of Labour)
MRPL = marginal physical product * marginal revenue
What does the demand curve for labour show
how many workers will be hired of any given wage rate over a given period of time
What is demad for labour derived demand of
The need to expand output to satisfy demand; goods need workers to make
What is the optimal wage rate
MC (marginal cost) = MRP (marginal revenue product)
How does the diminishing marginal returns affect MRPL
As workers increase, ceteris paribus, MRP will increase at first then decline
Why is the demand for labour assumed to be downward curve
- Short run fixed levels of capital so diminshing marginal returns means adding extra workers gives a lower return so they are woth a lower wage rate
- Long run, all factors of prod. vary, high wage rates will encourage businesses to use machinery instead of workers
What are the 6 main factors influencing demand for labour
- Wage Rates
- Demand for the product
- Price of other factors of production
- Wages in other countries
- Technology
- Regulation
How do wage rates influence demand for labour
same influence on demand for labour as price has on the demand for a product
Higher wage means contraction of demand
How does demand for the product influence demand for labour
if there is no demand for the product, there is no demand for the labour.
How does prices of other factors of production influence demand for labour
If machinery and equipment becomes cheap, people will switch machinery for labour and therefore the demand for labour will fall.
How do wages in other countries influence demand for labour
people will be employed in other countries as it represents a lower cost for businesses. This means that demand in the UK is low.
How does technology influence demand for labour
less demand for labour, but demand for labour in technological based industries is increasing. By 2040, about 47% of jobs could be lost to technology.
How does regulation influence demand for labour
High regulation within the labour market is likely to discourage firms from hiring since it can be very costly and time-consuming so this will reduce demand for labour in these areas
What is price elasticity of demand for labour
responsiveness of the quantity demanded of labour to the wage rate
% change in quantity demanded for labour/ % change in the wage rate
What are some factors affecting PED of labour
- PED of product
- Propotion of wages to the total cost of production
- Subsitutes
- Time
How does PED of the product affect PED of labour
If the good is elastic, then a rise in wages and hence a rise in prices for consumers will have a large impact on the quantity the business sells. This will mean that the business will reduce the number of people it employs, in order to help it make a profit.
direct correlation
How does the proprtion of wages to total costs affect PED of labour
- if wages are a huge proportion of costs, then an increase in wages will increase costs massively and so there will be a large fall in demand for labour hence it will be elastic.
direct correlation
How do substitues affect PED of labour
substitutes, such as machinery and labour in other countries, then the demand will be elastic.
This means high skilled jobs tend to be more inelastic than low skilled jobs as the labour cannot be easily replaced.
How does time affect PED of labour
In the long run, it is more elastic as machinery can be developed and jobs can be moved whilst
in the short run firms have to employ workers and redundancy payments can be expensive.
What is does the supply of labour curve represent
The labour supply is the the ability and willingness of people to make themselves available to work at different wage rates.
What are the 7 main factors affecting the supply of labour
- Wages
- Population/distribution of age
- Non-monetary benefits
- Education
- Trade unions and barriers to entry
- Wages and conditions of other jobs
- Legislation
How do wages influence the supply of labour
- Through either offering more hours or getting new workers, higher wagese wil incentivise more workers
How do population/distribution of ages influence the supply of labour
- High population ensures large supply
- Distribution of age is important to also ensure this
- Migration rienforces working force (75% of child-bearing age) and boost young people
How does non-monetary benefits influence the supply of labour
- Supply will increase from high job satisfaction
- this may be due to being close to family or offer perks like free healthcare/ flexible hours
How does education influence the supply of labour
More educated workers means a higher supply of workers in skilled labour or just generally being able to overcome barriers to enter
How do trade unions and barriers to entry influence the supply of labour
- Can increase job satisfaction through security and higher wages
- Restrict supply of labour by introducing barriers e.g. need degree to teach
How do wages and conditions of other jobs influence the supply of labour
If many jobs in a local area are considered to be unpleasant and offer low wages, then supply for alternatives will be higher.
How does legislation influence the supply of labour
The government rules can affect supply of labour, for example school leaving age and the retirement age.
What is occupational immobility
workers find it difficult to move from one job to another because of a lack of transferable skills.
It is particularly difficult in the short term when workers need to get new training but in the long run it may only be possible at a high cost
What is geographical immobility
they find it difficult to move from one place to another due to the cost of movement, family etc.
Those on lower incomes are more geographically immobile.
How does labour immobiliy cause distortions in the market
mmobility can mean that there can be excess supply of labour in one area/occupation and excess demand in another.
Even if wages are higher where there is excess demand, people will be unable to leave where there is excess supply to get a job in that area/occupation because of their immobility.
Explain the UK skill shortage
The UK suffers from a severe skills shortage and this could cost £90bn a year following Brexit.
There are four million too few high skilled people but six million too many low skilled people. Engineering is one industry suffering particularly badly from skills shortages.
Define elasticity of supply of labour
responsiveness of supply to a change in wage rates.
What is elasticity of supply of labour based on
● Higher skill requirement reduces elasticity
● Similarly, it can depend upon the availability of suitable labour in other industries , for example if a company can ‘poach’ workers from other industries, then it will be more elastic
● Moreover, it depends on time as in the long run supply of labour will be more elastic as people will have time to train. If the job is vocational, it will be inelastic since even if wages fall people won’t leave the job.
What are the 2 assumptions to why the labour supply curve is upwards
- Workers may be attracted into industry from related jobs
- Workers previously employed in this occupation may be attracted back e.g. they decided to end a period of economic inactivity
What causes ana outward shift in labour supply
- Net inward migration of suitable qualified / experienced workers
- Fall in relative pay/earnings in substitute occupations
- **Lower entry barriers **to this particular job such as minimum professional qualifications
- Demographic factors causing a rise in the active labour supply
What causes ana outward shift in labour supply
- Net inward migration of suitable qualified / experienced workers
- Fall in relative pay/earnings in substitute occupations
- **Lower entry barriers **to this particular job such as minimum professional qualifications
- Demographic factors causing a rise in the active labour supply
What causes an inward shift in labour supply
- Brain drain effects – an economy loses skilled workers overseas
- Decline in non-monetary rewards associated with the job e.g. job dissatisfaction / stress
- Fall in relative pay in this occupation compared to other jobs / rise in min qualifications
What is the income effect in wages
Positive income effect: Higher wages –> incentivise to work more hours (to reach a target income)
Negative income effect: Target income reaches so higher wages –> incentivises working less hours
What is the substitution effect in wages
- A rise in the real wage increases the opportunity cost of leisure
- Therefore higher wages will always cause people to be incentivized to work longer hours via the substitution effect
But the income effect may work in the opposite direction
Draw the effect of both the substitution effect and the income effect
Backwards bending supply curve
How does the average and marginal cost of labour interact with employment
f a firm can employ each additional worker at the same wage rate, then the average and marginal cost of labour will be the same
If the firm has to pay higher wages to attract more workers, then the average cost of labour rises and the marginal cost of labour will be above ACL. This is since raising wages for one worker means raising wages for workers
What is occupational immobility and structural unemployment
when there are barriers to the mobility of factors of production between different industries leading to these factors remaining unemployed, or being used inefficiently
structural UE is when applied to a whole industry
What is geographical immobility
Geographical immobility refers to barriers people moving from one area to another to find work.
What are reasons for occupational and geographical immobility
- Family and social ties – older people more reluctant to move
- Financial costs involved in moving home; no affordable housing, differences in costs
- Migration controls e.g. possible caps on inward migration
- Cultural and language barriers to living and working overseas
What are Policies to improve occupational mobility
- Better funding for and more effective workplace training
- Teaching new skills e.g. Computing skills
- An expansion of apprenticeship / internship programmes
What are policies to improve geographical mobility
- Rise in house-building will help to keep property prices lower and encourage more affordable rents
- Active regional policy to create new jobs and businesses
What policies stimulate stronger work incentives
- Higher minimum wage or a living wage
- Reductions in income tax / national insurance
- Welfare reforms to reduce the risk of the poverty trap
What causes wage rates to differ in an occupation
- age
- education
- training
- work experience
- skill/talent/ability to perform tasks
- sex
- ethnic background.
What is illegal to discriminate wages by
sex and ethnic background
How does the immobility of labour impact wages
excess supply in one area/occupation, causing low wages, and not enough workers in another, meaning high wages
What is a perfectly competitive labour market
- Same assumptions as perfect competition in products
- Therefore, wages are determined purely by demand and supply and all workers are paid the same.
- If workers were not paid the same, they would simply move somewhere else where the wage rate in the industry was higher.
*
What is a monopsony labour market
there is only one buyer of labour
How does a monopsony employ workers
They will employ to where:
Cost of employment (MC) = Value of worker to company (MRP/D)
At this quantity they will then use their monospony power to push the wages down to a wage determined by the Supply curve
Compared to a perfectly competitive market they employ less people at a lower wage
What is a monpoly in the labour market and how do they arise
- Only seller of labour
- existence of trade unions through a process of collective bargaining.
How do monopolies in labour markets (TUs) increase wages
1) They could set **barriers of entry **which would reduce supply. Teachers’ unions lobbied for a rule which means that all teachers must have degrees .
2) Alternatively, they could set wages at a specific wage and ensure workers are not prepared to work for less, creating a kinked supply curve as seen in the diagram (the grey line). Supply is perfectly elastic up to output of QS and if the company wanted to employ more than this, they would have to increase wages further.
The firm will employ where supply is equal to demand, at QDW2. Both of these methods will lead to higher wages but cause a fall in employment from the perfectly competitive equilibrium of Q1W1.
How did the Government reduce the power of Trade Unions
The government has introduced postal ballots, outlawed secondary picketing, restricted the size of the picket line and forced unions to provide 14 days’ notice of action.
The Trade Union Act 2016 clause saying that at least 50% of people must vote in the ballot
What is a bilateral monopoly
both monospony and monopoly in the labour market
Explain the steps to arrive at a wage rate and draw a diagram for a bilateral monopoly
- The firm is a monopsonist and wants to employ at Q2W2.
- However, the union may decide to set a minimum wage at W1 and ensure that there is no one willing to work below this price, creating a kinked supply curve. The new MC and AC curves are the purple curves.
- The wage that is set will depend on the relative bargaining strength of both .
- In a time of economic recession and unemployment the unions may have less bargaining power and wage is most likely to be down at W1. In times of full employment, they may have the power to influence and wages could be at W3 .
What are the positive effects of a biliateral monopoly
they are able to increase wages to W3 without negatively impacting the number of workers. This increase in wages and employment is able to make the economy more efficient.
even at W1 that increases employment rather than decrease
What are the 7 main labour market issues
- Skills Shortage
- Young Workers
- Retirement
- Wage Inequality
- Zero-hour contracts
- The ‘Gig Economy’
- Migration
Explain the labour market issue of a ‘skills shortage’
Occupational and geographical issues mean there are a lack of engineers
shortfall of roughly 59,000 engineers every year.
Explain the labour market issue of ‘retirement’
Rising life expectancy and demographic shift as ‘baby boomers’ reach retirement
Retirement age will have to rise and pensioners makeup over 50% of welfare spending
Explain the labour market issue of ‘Wage Inequality’
Over time, those on the highest wages have seen their wages grow by a bigger percentage than those on the lowest wages.
wealthiest 100 people in the UK have as much money as the poorest 18 million people, according to the Equality Trust.
Explain the labour market issue of ‘Zero-Hour contracts’
Nearly half (48%) of employers of zero-hours workers said that they do not compensate workers for shifts that are cancelled with less than 24 hours’ notice.
incentivises a lack of capital investment
Explain the labour market issue of ‘Zero-Hour contracts’
Nearly half (48%) of employers of zero-hours workers said that they do not compensate workers for shifts that are cancelled with less than 24 hours’ notice.
incentivises a lack of capital investment
Explain the labour market issue of the ‘Gig Economy
Many more people are now self-employed and undertake short term contracts, working for companies such as Uber and Deliveroo.
There are concerns over the rights of these workers and the unreliability of their pay each week.
What is the labour market issue of ‘migration’
people suggest that migration causes a fall in wages
With Brexit, drivers are also choosing not to return to the UK, as large numbers of them now prefer “EU stability” and the perspective of higher salaries working in France or Germany.
100,000 shortage in crucial HGV drivers in Septmeber 2022
What is the national minimum wage
a legally enforced lowest salary possible
What is the current minimum wage
What are arguments for the national minimum wage
- Reduces poverty and inequality
- Reduces gender wage differentials
- More content workforce makes the business more productive
- Prevents unemployment trap
What is the unemployment trap
benefits are higher than the wage people would otherwise receive.
What are some arguments against the national minimum wage
- Classical UE aka Real Wage Inflexibility; dependent on elasticity of supply and demand
- Cost-push inflation/ lower profits so lower R+D
- No consideration of regional differences
- Dependent wether it is above or below current wage
What is efficiency wage theory and draw the graph
increasing wages can lead to increased labour productivity because workers feel more motivated to work with higher pay.
Therefore if firms increase wages – some or all of the higher wage costs will be recouped through increased staff retention and higher labour productivity.
What are reasons for efficiency wage theory
- Fear of losing jobs – “Shirking model”
- Loyalty
- Labour market ‘Gift Exchange’
- Lower costs of supervision
- Attract higher quality labour
- Nutritional +healthcare
How does the Shapiro and Stigliz’s shirking model contribute to efficiency wage theory
if workers are paid a relaatively higher wage, they have more to lose from being made redundant.
Shapiro and Stiglitz posited that workers with a higher wage will work at an effort level which involves no shirking. This wage is above market-clearing levels.
How does Akerlof’s Gift Exchange model contribute to the efficiency wage theory
labour market has a ‘gift exchange’ where good labour relations depended on goodwill. FIrms could pay wages above market-clearing levels, and in return, workers would take on more responsibility and initiative.
How does Rebitzer’s supervision argument contribute to efficiency wage theory
Rebitzer noted that lower wages were associated with higher levels of supervision. Workers receiving higher wages were more motivated and therefore needed less managerial supervision
What is the best example of minimum efficiency wages
in 1914 when Henry Ford introduced a five dollar day. Ford paid well above the market-clearing rate. He wanted to pay higher wages in order to:
- Ban unions. A condition for high pay was no trade unions
- Compensate for boring work on his efficient assembly lines. Ford increased productivity by the revolutionary use of assembly lines, but was worried a low wage, workers would get bored and stop working.
Raff and Summers (1986) concluded that Ford’s five dollar day was consistent with what was expected of efficiency wage theories.
“There is vivid evidence that the five-dollar day resulted in substantial queues for Ford jobs. Finally, significant increases in productivity and profits at Ford accompanied the introduction of the five-dollar day
What are the limits of the efficiency wage theory
- In practice, many factors determine worker morale and productivity, wages are just one of them. Often other factors are more important such as work conditions, management
- Wages are relative to similar positions by other firms
Firms with monopsony power may not need to pay higher wages to create the threat of workers losing their jobs.
What are maximum wages
A legally enforced limit on a wage
What are the positive and negative impacts of maximum wages
- Help to reduce inequality; max pay ratio to lowest earners
- Dependent on elasticities; chief executives are v inelastic so no effect
- Excess demand within industry –> loss of most productive workers
How do public wages and private wages vary in the short run and long run
SR:
* Gov. can make whatver wage it decideds e.g. 2010-15 pay freeze
LR:
* To incentivise workers to stay have to stay in line with private sector wage rises
How does monopsony theory apply in real life
Even if a firm is not a pure monopsony, it may have a degree of monopsony power, due to geographical and occupational immobility’s
They will also often have a degree of monopoly selling power
What are examples of monpsony in product markets
· Supermarkets have monopsony power in buying food from farmers. If farmers don’t sell to the big supermarkets, there are few alternatives.
· Amazon.com is one of the biggest purchases of books. If publishers don’t sell to Amazon at a discounted price, they will miss out on selling to the biggest distributor of books.
What did Thatcher do to Trade Unions
Thatcher banned wildcat strikes (instant strikes) and secondary picketing (sympathy strikes) and introduced secret ballots to remove intimidation to get workers to strike.
TU action can still consist of:
- Announced Strikes
- Introducing overtime ban
- Work to rule (working to the contract and no extra)
How do Trade Unions negotiate higher wages
- Will likely neogitate productivity deal; changing working practices, training and capital to increase MRP of the workforce
Draw the effect of a productivity deal
Diagram shows that as MRP rises, more workers could now be employed at the TU wage, contrary to the opinion that the TU will increase wage rate at the expense of employment.
This should protect against redundancy
Explain why MC=AC=Ls
TU now enters a monopsony market and through collective bargaining now raises the wage to w/pTU.
The agreed wage becomes the standard for the industry/firm, therefore MC = AC = LS.
This is because the cost of employing the next worker is the same as the previous, meaning MC is constant and so is AC.
Explain why the firm won’t employ past Q(tu)
At this wage, QTU workers are prepared to work and the monopsony is happy to employ as MC is below MRP. If the monopsony wished to employ beyond the LS curve kink, a higher wage would have to be offered.
In offering a higher wage, all previous workers would have to be paid more and MC would discontinue and go above MRP. Therefore, the firm would not employ beyond QTU.
When is a merger investigated
A merger is investigated if it will result in market share greater than 25% or if it meets the turnover test of a combined turnover of £70 million or more.
How are mergers assessed by the CMA
whether there will be a substantial lessening of competition (SLC).
The CMA will consider the likely competitive situation if the merger goes ahead compared to if it does not, and the merger will be approved if its potential benefits are greater than its cost.
What is an example of a merger recently blocked by the CMA
The merger between Activision Blizzard and Microsoft due to it’s potential monopoly in the cloud-gaming market
What are the potential disadvantages of mergers that lead to a significant increase in market share
- Higher prices –> fall in allocative efficiency and consumer surplus
- X-Inefficiency
- Less competition –> less dynamic efficiency
- Less choice for consumers
- May suffer from DEoS
- Impetus may come from high-achieving employees e.g. ABN Amro
What are the potential advantages of mergers
- Economies of scale (esp. for natural monopolies)
- Help compete internationally
- Greater dynamic efficiency through more R+D
Evaluate mergers
- Is there a scope for economies of scale? Are fixed costs high enough?
- Will there be a significant reduction in competition (magnitude)
- Is the market still contestable (force limit pricing)
- Other factors: need for financial sector e.g. First Republic and JP Morgan
What are 8 potential methods for governments to control monopolies
- Price Regulation
- Profit Regulation
- Quality Standards
- Performance Targets
- Windfall Taxes
- Breaking them up
- Subsidies
- Self-Regulation
What is RPI-X price controls
Regulators set price controls to force monopolists to charge below MC=MR
X Reprents the expected efficiency gains of the firms and the aim is ot ensurte firms pass on those gains to consumers since if firms can reduce costs more than X than they enjoy increased profits
What is RPI-X+K price controls
Same as RPI-X but K represents the level of investment
In which industry was RPI-X+K used successfully for investment
Water industry, it allowed ro investment of £130bn
What are the advantages of RPI-X regulation
- Incentive for efficiency gains through profit
- Stability can help for some forward planning; esp if regulated for long time
- System is flexible
- Independent and Specialist Regulator –> more likely to set prices closer to MC
What has been the effect of RPI-X regulation on real prices of telephones and electricity since the system started in 1984
Significant cuts in real prices of telephones and electricity
What are the disadvantages of RPI-X regulation
- Assymetric information leading to too weak or too strong regulation
- Regulatory Capture
- If too strict –> Hampers investment (‘UK is closed for Business’)
- may be fewer incentives to cut costs because, if they do increase efficiency, the regulator may just increase the value of x. e.g. Five Year Plan targets
- Performance/Quality more important than price
What is profit regulation
Prices set to allow covering of operating costs and to earn a ‘fair’ rate of return on invested capital, based on returns in a competiitiive market
Thus encouraging investment and prevents firms setting high prices
What are the advantages of profit regulation
- There is substantial incentives to invest in R and D and capital as this could allow for greater future return. This can lead to greater long run dynamic efficiency.
- Consumers are protected from price hikes above inflation etc as there is very little incentive to raise prices. This effectives waters down price making power and creates a more allocative efficient environment.
What are the disadvantages of profit regulation
- There are incentives to over investas the more capital employed can mean the industry/firm can attain more profit. This is inefficient spending and is not useful for consumers or industry in the long run
- Assymetric information - firms overreport capital employed and costs for greater profit
- There is very little incentive to cut costs as greater profitability is not allowed. This can lead to a lack of productive efficiency and more x inefficiency (diagram)
How do quality standards control monopolies
Introduce quality standards to ensure sufficieny investment of profits to benefit the consumer
e.g. Post Office has to deliver letters on a daily basis to all areas despite the loss incurred
How do performance targets control monopolies
‘Yardstick Competition’ by setting puntuality targets for companies based on the best-performing
Can be targets on price,quality, consumer choice or cost
e.g. Train companies subject to close scrutiny on punctuality, safety records and win franchieses based on level of service
Evaluate the use of performance targets to control monopolies
- Targets may be too weak and have little deterrence for failure e.g. Ambulances have 8 minute target but often don’t make it
- Unintended Consequences e.g. GPs may not do proper diagnoses
- May cheat to meet targets e.g. train comppanies change timetables to give themselves more time to arrive
- Regulatory Capture
How can windfall taxes control monopolies
Discourage monopolists from making excessive profits and/or encourage htem to reinvest them
e.g. UK Windfall tax had a tax break through investment
what are the disadvantages of a windfall tax
- Disincentive for investment e.g. TotalEnergies leaving
- High profit may be due to an efficient firm
- Short-term solution and firms may start to underreport profits
What are the costs and benefits of breaking up a monopolyfor controlling monopolies
- Split Monopoly into competing units to lead to lower profits and prices as well as greaterr consumer choice
but
- May also have loss of EoS leading to higher prices
- Lobby groups may make it unfeasible1
How do subsidies control monopolies and what are the issues with this
- Beneficial for producing at allocatively efficient point when unprofitable otherwise (natural monopoly)
BUT
- Assymetric information
- Dynamic Market means MC can change a lot
- Politically unpopular –> large opportunity cost
How does self regulation control monopolies and what are the issues with it
- Monopolies may have a profit motive to self-regulate properly to avoid worse side effects ( financial crises ) or greater regulation
But
- There always exists a profit motive and they will take actions that minimisse change and to maximise profit
e.g. (SVB)
How can the government intervene to promote competition and contestability
- Promotion of small businesses
- Deregulation
- Competitive Tendering
- Privatisation
How does the promotion of small business promote competition and contestability
- Training and grants to new entrepreneurs
- Increases incumbents fear of creative destruction
What is the Seed Enterpise Investment Scheme
provide tax relief for people who buy shares in small companies to help them grow.
Evaluate the effects of promoting small business on competition and contestability
- Small firms will lack EoS
- Depends also on quality and success of business
- Assymetric information of gov. grant size
What is outsourcing of public sector
Private sector businesses used to provide public sector work
What are arguments for out-sourcing
- competition can save the tax payer money
- Private sector businesses more likely to achieve efficiency improvemments and costs savings
- Also might be more innovative, less heirarchical and less prone to suffering from DEoS
What are arguments against out sourcing
- Business bidding to win contracts may sacrifice quality of service as a way of loweing their costs
- Doubts about some employmeny practices of service companies
- Contracting-out/outsourcing requires proper monitoring which itself invovles extra spending
What are arguments against out-sourcing/competitive tendering
- It gives firms a private monopoly; danger that the private firm will increase prices, or cut back on service.
- It requires the government to monitor the quality of service provided and
to make sure they don’t take shortcuts to boost profit. - Because the contract is short-term, it may discourage long-term
investment e.g. Railway firms not taking 7 year contracts - Costs involved in the bidding process.
- Private Firms may collude in cover pricing e.g. construction £200m
How does deregulation help promote competition and contestability
- Allows greater competition by reducing legal barriers to entry and thus more efficiency e.g. Royal Mail
- Reduce regulation costs e.g. Red Tape Challenge
effective in increasing competition in the retail of electricitty and gas
Evaluate the effects of deregulation on promoting competition and contestability
- More competition may mean less profit and less DE
- Unable to benefit from EoS therefore never reach MES
- Some industries require regulation e.g. Gas, Financial
- Doesn’t work in Natural Monopolies
What are the advantages of deregulation in general
· Increased choice
· Increased competition mean firms will cut costs and a decrease in x inefficiency as firms look to offer lower prices through productivity gains
· Regulation often involves costs of bureaucracy and therefore deregulation should help relieve the burden to the taxpayer.
Lesser regulation can help reduce the effects of regulatory capture
Evaluate the idea of deregulation
· Alternatives to deregulation
· Ideal in theory but how good is deregulation in practice.
· is there an optimal level of regulation?
· S/R vs. L/R effects
· Greater allocative and productive efficiency (greater static efficiency) but may be less long run efficiency in terms of dynamic efficiency
What are the benefits of privatisation
- Reduced government short-terminism
- Remove borrowing limits
- Private Companies are more efficient from profit motive
- Improved public finances
- Increased comeptition –> AE, better quality
What are the potential problems of privatisation
- Barriers to Entry make it hard to increase competition
- Public Services should be run in the public interest
- Positive Externalities of industries like rail
- Revenue is one off
- Privatised businesses close off essential unprofitable parts and so services worsen
- Lack of investment or improvement e.g. Water Companies £18.2 billion in dividends
How can government intervention protect suppliers and employees
- Restrictions on monopsony power of firms
- Nationalisation
- Workers Rights
How can restrictions on monopsony power of firms protect suppliers and employees
- Monopolists exploit suppliers/employees by reducing prices/wages
- Governments can introduce an independent regulator and make such practices illegal
- Minimum prices can also be introduced
But
* Regulatory Capture
* Assymetric information
How can workers rights protect employees
- Health and safety laws, employment contracts, redundancy processes, maximum hours at work and the right to be in a trade union
BUT
* If workers rights are too strong than employers will be unwillling to take on new workers due to the extra cost of employiing these workers
What are the advantages of nationalisation
- Providing essential services to the consumer (equity) - Natural Monopoly
- Need for strategic control e.g. Arms, Finance
- Private companies only do short-term investment
- Positive Externalities
- Profit shared with tax revenue
- Better protection of employees
What are the disadvantages of nationalisation
- Principle Agent Problem - loss covered by gov.
- No profit motive/ competition –> X-Inefficiency
- Influenced by government short-terminist as based on budget
- Worsening public finances –> higher debt
e.g. NHS lack of funcing/compeititon leads to ppoor quality as well as uncertainity with each government.
Why was the Just Eat acquisition of Hungryhouse allowed in 2017 despite giving Just eat 70% market share
As Hungryhouse was less dynamic and loss making
How is government intervention in market structures limited
- Regulatory Capture
- Assymetric Information
How does regulatory capture limit government intervention
- Regulators see things from the firms perspective rather than the consumers which damages the ability to regulate
- Regulators often have personal links with the coporation
e.g. HMRC alledged capture by vodafone who negotiated their tax of £7bn to be reduced to £1bn
