Theme 3: Business behaviour and the labour market Flashcards
What is business growth and organic growth (3.1) (2)
-Business growth is when the business reaches the point for expansion, and seeks additional options to generate more profit
-Organic growth is when a business grows internally either from reinvesting profits or borrowing from the bank
What are the key motivations for business growth (3.1) (7)
-Profit motives - increased growth can provide better returns to shareholders
-Cost motives - economies of scale help reduce average costs
-Market power motives - large firms can take advantage of large market share and gain from monopoly power
-Managerial motives - Managers may prioritise long run growth over short term profit maximisation
-Risk motives - Diversification can help reduce investor risk
-Reduces risk of hostile takeover
-Synergies - the idea that the valuation of 2 businesses combined is greater than both individually
Why might firms want to grow organically (3.1) (5)
-Increase market share
-Develop new, innovative products
-Find new markets to sell existing products
-Getting existing customers to buy more products through advertising
-Investing in new technology to expand production
What are the pros & cons of organic growth (3.1) (5,5)
-Can maintain current management style, culture, ethics
-Less risk financed with profit and expanding what they’re good at
-Easy to manage/control internal growth
-Less disruption = increased worker morale and productivity
-Able to keep a brand/name viewed positively by consumers
-Can take longer to grow internally
-Can take a while to adapt to big market changes
-Business ,ay miss out on opportunities for more ambitious growth
-If market not growing, business’ restricted to increased market share or new markets
-Market size not affected by organic growth
What are the pros/cons of horizontal integration (3.1) (5,4)
-Economies of scale attainable
-Spreading risk
-Reducing competition
-Increasing market share
-Easier to buy a brand than grow one
-Clash of cultures
-Diseconomies of scale
-Synergies not occuring may damage shareholder values
-Risk of attracting investigation from the CMA
What are the pros and cons of Vodafone and Threes merger (3.1) (5,5)
-Offered to freeze prices for UK consumers for 5 years
-Pledge to invest £11 billion into the UK
-Greater quality goods (5G)
-Pooled R&D can lead to greater innovation
-Increased economies of scale = lower AC = higher profits or lower prices
-Increased market share = increased prices (new company has 27 million userbase)
-Concerns of foreign joint ownership over a key national asset
-Hike peoples bills and cause job losses
-Diseconomies of scale
-Decreased choice
What are the types of business growth (3.1) (5)
-Organic growth - where a business grows internally by reinvesting (Subway, Iceland growing through adverts)
-Horizontal integration - when two businesses in the same stage of production merge (Vodafone and Threes proposed merger)
-Forwards vertical integration - when one firm integrates with a firm in a stage of production closer to the consumer (Pepsi buying KFC)
-Backwards vertical integration - when a business merges with another in a stage of production further from the consumer (Tesco buying a farm)
-Conglomerate integration - where two businesses in different industries merge (Amazon and Whole Foods)
What are some examples of horizontal integration (3.1) (3,3,3)
-Facebook and Instagram
-In 2012, Facebook bought Instagram for $1 billion, Instagram being valued at $100 billion in 2018
-Facebook bought Instagram to unlock new audiences and to reduce competition
-Disney and Pixar
-In 2006, Disney bought Pixar for $7.4 billion
-This integration allowed Disney access to Pixars high quality tech, a factor which is thought to have reanimated Disney
-Exxon Mobil
-In 1998, Exxon bought Mobil in a deal worth $75.3 billion, the largest merger in US history (then)
-This merger allowed the two to pool resources (sharing gas stations), as well as streamlining of resources and higher efficiency
What are some examples of vertical integration (3.1) (3,3,3)
-Ikea
-Ikea bought Romanian forestland in 2015, and Alabama forestland in 2018
-This allowed IKEA to control the production, manufacturing and final retail of their goods
-Netflix
-In 2013, Netflix entered the production business
-This allowed Netflix to differentiate from competitors and choose what shows to have on (Netflix originals)
-Zara
-Zara is vertically integrated with their designers and manufactorers
-This helps Zara increase efficiency in stock management as well as quickly reacting to trends
What are the pros and cons of vertical integration (3.1) (5,4)
+Greater reliability: Greater cooperation leads to quick deliveries, better service…
+Power of suppliers/buyers: Firms can dictate prices over who they own
+Economies of Scale: Firms can benefit from lower unit costs through higher output from suppliers
+Flexibility: Easy transmission of feedback allows both firms to act independent
+Lower consumer prices: assuming vertical integration leads to increased competitive advantage
-Higher costs: Financial, time and effort costs of purchasing/integrating a firm
-Management difficulties: People may not want to be dictated by someone with little experience in that field
-Loss of focus: Firms may lose focus on other parts of the business, focusing on integrating
-Reduced flexibilities: Firms may nor rely on a single supplier, instead of having multiple, making it harder to move production
What is the difference between an acquisition and a merger (3.1) (2)
-An acquisition is where one company buys another outright
-A merger is the combination of two firms, which subsequently form a new legal entity under the banner of one corporate name
What are the pros and cons of conglomerate merger (3.1) (5,4)
+Diversification: They can reduce risk by acting in different markets
+Synergies: Mergers may lead to a much higher stock market valuation
+Improved consumer base: Consumers from one firm may now check out/use the other
+Economies of Scale: Higher growth leads to economies of scale (However, different industries have different limits)
+Utilisation of human resources: Greater workforce, can pool together two firms labour
-No prior experience: A firm doesn’t know how the other industry works
-Shift in focus: May ignore other issues to focus on merging
-Complication: Can be complicated sharing resources/gaining EOS
-Government issues: regulators may dislike the mergers
What are constraints on business growth (3.1) (4)
-Size of the market - No firm can be bigger than the market they’re in
-Owner objectives - Short term profit or long term growth
-Limited access to finance - Not being able to take out loans may means firms have to grow via profit, which takes longer
-Regulators - Regulators may try to limit a firms growth, to stop them becoming too powerful
Who are the CMA (3.1) (3)
-The Competition and Markets Authority look into mergers
-They look into anti competitive behaviour by firms
-They work in the interest of workers, consumers and other stakeholders
What is the principle-agent problem (3.1) (3)
-The principal-agent problem is when the agent makes decisions for the principal, but acts in their own interests, rather than the principles
-A manager and a shareholder may have different objectives which may conflict, resulting in short term profit > long term dividends
-When a firms owner sells shares, they lose control they had over the firm, resulting in conflicting objectives between different stakeholders
What is a demerger, and what are the reasons for them (3.1) (2,6)
-A demerger is when a single business is broken into two or more businesses, to operate on their own, to be sold, or dissolved
-Paypal splitting from Ebay in 2014
Reasons:
-Lack of synergies - without synergies, firms are likely to demerge since they’d be worth more
-Growth - Faster growing sections may be split up from other parts of a firm with different growth rates
-Diseconomies of scale - If a firm is so large that average costs rise with output, they may split
-Focus - focusing on fewer markets could allow firms to grow faster than if they spread out
-Resources - a firm may sell of part of the firm if they haven’t got the resources to sustain production in all faucets
-Finance - Selling off parts of the firm can raise finance for more profitable parts
What are the impacts of demergers on businesses, workers and consumers (3.1) (4,2,3)
Businesses-
-Eliminate diseconomies of scale, through greater control and coordination
-Make a profit off part of a firm, which can be used as a source of finance for investment
-Dispose of underperforming/loss making parts
-New, demerged firm can focus on their unique market instead of having to spread
Workers-
-Potential job cuts
-Confusion as roles shift between demerged and parent firms
Consumers-
-Removal of diseconomies of scale = lower price
-Increased choice and competition, only if the two demerged firms are in the same industry
-Net welfare gain if the demerger leads to higher efficiency
Who are different people who could have control over a firms objectives (3.2) (6)
-Owners/shareholders
-Managers/directors
-Workers/unions
-State
-Consumers
-Pressure groups
What are the assumptions made about profit maximising, and what do firms gain by profit maximising (3.2) (3,5)
Assumptions:
-Neoclassical economists assume it is all firms’ sole objective to profit maximise
-The entepreneur is the owner/director
-That profit maximisation can be attained, through the marginalist principle of MR=MC
Benefits:
-Can invest in R&D, to increase the quality of technology
-Lower costs
-Can gain greater funds for reinvesting and expanding
-Pay out greater dividends to shareholders
-Reward enterpreneurship
What is profit maximisation, and how is it graphically represented (3.2) (3,1)
-Profit maximisation is when MR=MC
-If MR>MC, output can be further increased without increasing costs greater than revenue, so profit rises
-If MR<MC, total profits are reducing as costs are rising faster than revenue
-Find the point in the cost/revenue graphs where MR=MC, draw up from that to the AC and AR curves, than that square area is the supernormal profit
What is revenue maximisation, and how is it graphically represented (3.2) (3,1)
-Revenue maximisation is when MR = 0
-Revenue maximisation occurs at the top of the total revenue curve
-Revenue maximisation is a theoretical objective in which the goal is to maximise sales revenue
-You find the point where MR cuts the x axis and draw up to the AR and AC curves, achieving a higher quantity but lower price than the profit maximising point
What are the reasons for revenue maximisation, and how may you evaluate it (3.2) (4,3)
Reasons:
-Economies of scale -> Higher output = higher EOS = Lower AC’s
-Predatory pricing -> Firms could drive out competitors with lower prices
-Principle-agent problem -> Divorce between ownership and control could lead to managers settling for revenue maximisation, easier than profit max
-Brand loyalty -> Cut prices = increased exposure, loyalty and market share
Evaluate:
-Some firms (newspapers) are not profit motivated, but motivated by influence and exposure
-Revenue max can have greater costs and may lead to firms making a loss when they could make profits
-In theory, the Office of Fair Trading protects consumers from predatory pricing and firms seeking unfair competition (drive out competitors)
What are the reasons/evaluation for sales maximisation (3.2) (3,3)
Reasons:
-Economies of scale would lead to future profit
-Limit pricing, where at break even there’s no incentive for new firms to join the market
-To flood the market with a firms goods, increasing market share
Evaluation:
-Predatory pricing limited by the OFT
-Greater costs may lead to a loss
-Some firms are motivated by exposure, not profit (newspapers)
What is sales maximisation, and how can this be graphically represented (3.2) (2)
-Sales maximisation is supplying the largest output possible consistent with earning at least normal profits where AR=AC
-Sales maximisation on a graph is where AR=AC, a higher quantity than Qpm and a lower price than Ppm
What is profit satisficing (3.2) (3)
-Profit satisficing occurs where owners of a business set a minimum acceptable level of achievement in terms of profit/return
-This occurs when there is separation between ownership & management, and it is an acceptable rather than a perfect amount
-Firms may profit satisfice whilst setting other objectives
What is economic costs, imputed costs and opportunity costs of production (3.3) (3)
-Economic cost is the value that could’ve been generated had the resources been employed in their next best use (EC = Actual COP + Imputed COP)
-Imputed cost is the opportunity cost incurred during the period when an asset is employed for a particular use, rather than a different use
-The opportunity cost of production for financial capital is the income which could’ve been generated by investing elsewhere
What are fixed costs, variable costs and total costs (3.3) (4)
-Fixed costs are costs that do not vary with the level of output (AFC = FC/O)
-Variable costs are costs that do vary with the level of output (AVC = VC/O)
-Total costs are the costs of producing at a given level of output (AC = TC/O)
-AC = AFV + AVC = TC/O = P
How to show total costs and average costs on a diagram (3.3) (2)
-TVC and TC have an upwards wave-esque curved line, the difference between the two being TFC, a flat line
-AC and AVC are 2 quadratic-esque curves with positive coefficents, the difference between them being AFC, a curve closening to the x-axis
(TC/AC > TVC/AVC)
What are marginal costs and semi variable costs (3.3) (2)
-Marginal cost is the additional cost of producing one more unit of output
-Semi variable costs are costs which contain within them a fixed cost element and a variable cost element
What is the law of diminishing returns, average product, marginal product (3.3) (4)
-The law of diminishing returns states that in the short run, when variable factors of production (usually labour) are added to a stock of fixed factors of production, total/marginal product will initially rise then fall
-Average product = total product / input
-Marginal product = change in total product/change in input
-Firms may experience diminishing returns as firms are unable to increase their fixed factors of production, so variable FOP’s become the limiting factor
What does an AC + MC graph look like (3.3) (4)
-AFC is a downwards sloping curve
-AVC is an upwards sloping curve which initially falls
-AC is a U shaped curve
-MC initially falls then rises, and crosses through the lowest points of AVC and AC
What are some rules regarding the AC and MC curves (3.3) (5)
(first four also apply to AVC)
-AC>MC when AC is falling
-AC<MC when AC is rising
-AC=MC at all stages of production where AC is constant
-AC=MC at the lowest point of the AC curve
-Lowest pooint on the MC & AVC curves shows the law of diminishing marginal returns kick in
How does the AC/MC curves adapt to changes in costs (3.3) (2)
-When fixed costs rise, AC rises
-When variable costs rise, AC and MC rise
How do you draw a LRAC curve + its shifts (3.3) (1,2)
-LRAC is a U shaped curve, with a flat bottom, which is the productive efficiency, and the first Quantity at productive efficiency is the minimum efficient scale
-Higher FOP price = LRAC shifts up
-Lower FOP price = LRAC shifts down
What are economies of scale, internal economies of scale and external economies of scale (3.3) (3)
-Economies of scale are the long run average cost advantages a firm gains through increasing the scale of production, causing LRAC to fall
-Internal EOS are a result of the growth of the firm itself, leading to cost saving and a fall in LRAC’S
-External EOS occur when a whole industry grows larger, and firms benefit from lower average costs
What are technical, dimensional, purchasing and division of labour econommies of scale (3.3) (2,2,2,2)
-Technical economies of scale are when larger firms can buy better equipment, leading to greater efficiency and lower LRAC
-However, will these greater firms have the labour required to utilise the tech
-Dimensional economies of scale are when shipping (for example) dimensions are labelled, leading to a 4x price but an 8x volume, where the volume of what can be shipped has risen the most, reducing overall LRAC’s
-However, external factors (shipping limits) may limit how big these containers can be
-Purchasing economies of scale are when the more a firm purchases a specific raw material, the more negotiating power they have, allowing them to lower LRAC’s in the process
-However, this can be quite unethical, and can harm suppliers
-Division of labour economies of scale are when a greater sized firm can spread their labour out, allowing for specialisation, greater efficiency and lower LRAC’s
-However, if one part of the production process fails, specialised labour will be unable to fill this role
What are financial, managerial, marketing, risk bearing and R&D economies of scale (3.3) (2,2,2,2,2)
Financial:
-Banks more willing to give out better loans to bigger firms
-However, this depends on the state of the economy, willingness of bank to lend, and the increase cost of a higher loan
Managerial:
-Larger firms can employ specialist managers to maximise efficiency
-However, these managers can lead to less cohesion, less of a family feel and lower motivation to work
Marketing:
-Larger firms can spend more on adverts, and can offset more advertising costs
-However, there is no guarantee that the adverts will have the desired outcome on demand
Risk bearing:
-Larger firms are able to diversify, and take more risks, falling back on other parts of the firm if one fails
-However, a risk not paying off can lead to funds being diverted from more successful sections of the firm, increasing AC’s
R&D:
-Larger firms can afford entire R&D departments, to increase innovation
-However, there is no guarantee that these R&D departments will innovate anything
What are some examples of external economies of scale (3.3) (2,2,2,2)
Transport:
-Better transport will enable firms to reach a wider audience at lower costs
-However, this depends on what transport links firms already have, and what links they need
Education:
-Being close to a university/higher education will give firms a higher pool of skilled labour
-However, there is a time lag as the students go through the education, and it depend son what they do
Concentration:
-If more firms are concentrated in an area, it is more likely the supplier will move to the area, leading to lower delivery costs
-However, other firms may compete for the supplier
Reputation:
-If an area has a high reputation (silicon valley) is more likely to have workers go there
-However, reputation changes quickly
What are the advantages of firms growing in size for firms and consumers (3.3) (2,2)
-Efficiency in production makes firms more competitive in markets
-Firms can now gain higher profits, or lower prices to attract consumers and increase market share
-Consumers get lower prices
-Consumers get high quality/highly innovative goods
What are diseconomies of scale + types (3.3) (1,5)
-Diseconomies of scale are when the expansion of a firms output comes with increasing average costs
-Poor communication: in a large firm, it is harder to communicate an idea to everyone
-Alienation: in a highly specialised assembly line, workers may feel bored and lack motivation
-Lack of control: in a large firm there is greater separation between management and labour., meaning individual workers can get away with doing less
-Overcrowding: too many workers may mean some get in eachothers way, reducing efficiency
-Motivation: people feel less connected, and feel less of a personal incentive to work hard, decreasing productivity
How may firms be able to overcome diseconomies of scale (3.3) (5)
-Poor communication: divide the work process into separate groups, and get these groups to communicate within themselves
-Alienation: have incentives (worker of the month) to encourage people to work hard
-Lack of control: have separate managers for separate portions of the production process
-Overcrowding: let people work from home, or have multiple workplaces
-Motivation: have schemes (days out, pay incentives) to ensure people remain motivated
How do you draw an AR, MR and TR curve, assuming firms receive the same price per good (3.3) (1)
-AR = MR as a straight horizontal line, and TR is a upwards diagonal straight line, all 3 starting from the same point
(Revenue on Y axis, Q of sales on X axis)
How do you draw TR, AR and MR assuming firms recieve a lower price as Q of sales increases (3.3) (2)
-AR and MR are straight lines which fall diagonally, MR being twice as steep as AR
-TR is a negative curve, rising at first when demand is elastic, peaking when MR=0, then falling when demand is inelastic
What is revenue, TR, AR & MR (3.3) (2,2,2,2)
-Revenue is the money recieved from the sale of a good/service over time
-Firms usually calculate weekly, monthly … revenues
-Total revenue is the total money recieved from the sale of a good/service at a given level of output
-TR = P x Q
-Average revenue is the average revenue per unit of good/service sold
-AR = TR/Q = P = D
-Marginal revenue is the additional revenue gained from the sale of one more unit of output
-MR = change in TR/change in Q
What are some real life applications of microeconomic theory (6)
-Royal dutch shell acquired BG group for £47 billion in 2015 (acquisitions)
-Tech advances have led to decreased demand for restaurant dining, since competitiors such as uber eats/deliveroo have improved (demand)
-Electricity and water have inelastic demand, as there are very few natural alternatives (inelastic demand)
-Brexit (31st Dec 2020) has led to increased costs of production all over, such as increased fruit and veg prices for supermarkets (COP’s)
-Housing in prime locations (central london0 may have perfectly inelastic supply, since there’s no space to build houses (inelastic supply)
-Energy price cap rose 54% in April 2022 (£693py), the new cap of £1971 (max prices)
What are market structures, and the main characteristics focused on (3.4) (1,6)
-Market structures are the characteristics of a market which determine firms’ behaviour
Main characteristics:
-Number of firms in market and their relative size
-Number of firms which may enter/leave market
-Ease of difficulty of new firms entering/leaving market
-extent to which all goods/services are siilar
-Extent to which all firms share the same information/knowledge
-Extent to which 1 firms actions impact others
What are the types of efficiency (3.4) (4,2)
-Allocative efficiency = distributing resources according to consumer preference (p=mc)
-Productive efficiency = producing for the lowest cost (AC = MC)
-Dynamic efficiency = producing efficiently over time
-X-efficiency = producing at the lowest costs at any given level of output
-Efficiency of scale - achieving economies of scale
-Social efficiency - taking into account external pros/cons
What is allocative efficiency (3.4) (3,1)
-Allocative efficiency is when resources are used to produce goods/services which consumers want and value most highly, and social welfare is maximised
-Allocative efficiency is at an output level where marginal benefits = marginal costs (p=mc)
-Price is the same as the marginal utility a consumer gets from each additional good/service consumed
-On a diagram, allocative efficiency is where S=D, where MC = MR, or P = MC
What is productive efficiency (3.4) (2,1)
-Productive efficiency is when MC=AC, when the maximum possible output is achieved with the lowest possible average costs
-Productive efficiency can only occur with technical efficiencies, where the maximum output is produced with the given available factor imputs
-On a diagram, productive efficiency occurs when MC=AC, the lowest point of AC
What is x-efficiency/inefficiency (3.4) (2,2)
-X-efficiency occurs when a firm is producing at the lowest possible cost for a given level of output
-When the firm is at any point on the AC curve
-X-inefficiency is a specific type of productive inefficiency, when a firm is not producing at the lowest possible cost for a given level of output
-Also known as organisational slack, and is present when a firm is operating within its average cost curves, and not the boundary
What is dynamic efficiency (3.4) (2,1)
-Dynamic efficiency is efficiency in the long run
-When all resources are allocated efficiently over time, with high productivity, innovation, and technology
-The market is dynamically efficient if consumers needs/wants are met as time goes
What is perfect competition, and the assumptions/characteristics of perfect competition (3.4) (1,8)
-Perfect competition is a theoretical market structure with no monopolies, where a large number of small buyers and sellers sell homogenous goods
-Homogenous products
-All firms have the same access to factors of production
-Large number of small firms
-Free barriers to entry/exit
-Profit maximisation is a key business objective for firms
-Perfect knowledge
-Price taking firms
-Perfectly elastic demand curve
How to graphically represent perfect competition in the long run (3.4) (2)
-Originally, the market equilibrium (S=D) leads to individual firms making a SNP, as their horizontal AR=MR=P curves > AC
-This SNP leads firms to join the market, leading to market supply shifting outwards to S1=D, where now AR1 = AC = normal profits
What are the pros/cons of perfect competition (3.4) (3,3)
+Since firms produce at lower price P=MC, it is allocatively efficient
+Since firms produce at the bottom of their AC curves, it is productively efficient
+Short run supernormal profits can allow firms to reinvest, being dynamically efficient
-Small firms = little/no economies of scale
-Lack of long run SNP increases dynamic inefficiency
-Assumptions rarely hold up, perfect competition near impossible to find
What is a monopolistic market, and assumptions/characteristics of one (3.4) (1,6)
-A monopolistic market is an industry in which many firms offer products or services that are similar, but not perfect, substitutes
Assumptions/Characteristics:
-Large number of small firms
-Low barriers to entry/exit
-Firms produce similar, but differentiated products (adverts, branding, quality)
-Firms have price setting power, due to their differentiated products
-Firms set profit maximising as their objective
-Goods have a high elasticity of demand
How can we diagramatically show firms in a monopolistically competitive market making normal profit in the long run (3.4) (3d)
-Draw a firm with downwards sloping AR and MR curves making supernormal profit
-Firms see the SNP and enter the market, and this leads to higher competition, and lower demand
-This lower demand leads to AR and MR shifting inwards, to the point where normal profit is being made (AR tangent to AC)
-DRAW NORMAL PROFITS FIRST AND THEN SNP
What different efficiencies apply to monopolistic competition (3.4) (4)
-Isn’t productively efficient, as MC isn’t equal to AC
-Isn’t allocatively efficient, as P isn’t equal to MC
-Can be dynamically efficient, as firms have profits to reinvest and expand
-Is X-efficient, as firms face competitive pressures to cut costs
What are the pros and cons of monopolistic competition for firms (3.4) (5,4)
+Market differentiation = higher prices, consumer loyalty
+Flexibility in prices, due to product differentiation
+Innovation, due to pressures to stay ahead
+Consumer choices, as firms can cater to different preferences
+Firms have the opportunity to make economic (SNP) profit
-High competition leads to lower market share and profit
-Advertising costs high to differentiate
-Product differentiation costs are expensive
-Price sensitivity, challenging to raise prices without losing consumers
What are the pros and cons of monopolistic competition for consumers (3.4) (5,4)
+Product diversity leads to higher choice
+Innovation and improvement in goods
+Non-price competition (higher quality, more services)
+Firms responsive to consumer preferences
+Brnding and quality insurance
-Higher prices, as firms differentiate
-Confusing choices between similar but not same goods
-Potentially lower quality, as firms seek lower costs
-Limited bargaining power
What is an oligopoly/characteristics of an oligopoly (3.4) (2,4)
-An oligopoly is when a few large firms dominate the market, and have majority market share (5-firm concentration ratio > 50%)
-An example would be the supermarket industry (74%)
Characteristics:
-Products are generally differentiated
-Firms are interdependent (actions of one firm will affect eachother)
-Supply in the industry is concentrated in the hands of a relatively small number of firms, with a high concentration ratio
-High barriers to entry
What is a concentration ratio (3.4) (3,5)
-Concentration ratios are the percentage of market share taken up by the largest firms
-N-firm concentration ratio = %market share of n largest firms
-Market share % = (company sales/total market sales) x100
-If the 5-firm concentration ratio > 50%, the market is a monopoly/oligopoly
-UK supermarkets 5-firm CR = 74%
-UK legal monopoly = 1 firm CR > 25%
-If the 3 firm CR > 80%, there is scope for collusion, lower competition and higher prices, and the government may need a regulator
-Government regulators for electricity (5-firm CR = 90%), gas, railways
What is interdependence, and how might firms compete (3.4) (3,5)
-Interdependence is when firms don’t make decisions independently, rather making actions based on the action/reactions of other firms
-Interdependence leads to price rigidity/stickiness
-Interdependence in oligopoly’s leads to non-price competition
Firms compete on:
-Price
-Quality
-Branding
-Advertising
-Additional services
What is the kinked demand curve, and how does it show price rigidity (3.4) (d+2)
-The kinked demand curve is a demand curve which is elastic above price equilibrium, and inelastic below price equilibrium
-Firms don’t want to increase prices, as the higher price is less than the lower quantity, as other firms gain market share at their expense
-Firms don’t want to lower prices, as the higher quantity is less than the lower price, as this action starts a price war, so everyone loses out on profits
What is collusion (3.4) (1,2,3)
-Collusion in an oligopoly refers to an agreement or understanding, among a small number of competing firms to coordinate their actions, typically with the aim of influencing market conditions in their favour
-Horizontal collusion is collusion in the same industry at the same stage of production
-Vertical collusion is collusion in the same industry at different stages of production
-Explicit collusion is obvious and open collusion
-Tacit collusion is under the table agreements between firms
-Tacit collusion includes price leadership, sticking to output quotas, bid rigging
What are the key aspects/impacts of collusion in an oligopoly (3.4) (5,3)
Aspects:
-Price fixing: firms may agree to set a common higher price
-Output quotas: Firms may restrict supply, to increase scarcity and drive up prices
-Market sharing: Firms may decide to split the market amongst themself, with each firm with a designated market share
-Bid rigging: Firms may coordinate which firm will set the lowest bid to gain contracting rights from the government (government pays)
-Coordinated advertising/promotions: To avoid aggressive competition
Impacts:
-Higher prices for consumers
-New firms may be discouraged from entering the market
-Easy profits can make firms lazy
What is the UK’s legal position on collusion (3.4) (1,2,3)
-Collusion is often illegal, due to potential negative impacts on consumers and competition
-1998 Competition Act prohibits agreements, practices and conduct that may have an anti-competitive effect in the UK
-2008 Enterprise Act strengthened the legal framework for competition enforcement
-The CMA is the primary authority in the UK for investigating and enforcing competition laws
-The CMA has the power to conduct investigations, impose fines and take legal action
-In 2016, the CMA fined several pharmaceutical companies £45mill, including GSK, for increasing costs and delaying entry of generic versions of an antidepressant drug
What is a payoff matrix (3.4) (d+1)
-A payoff matrix is a 2 by 2 square, which show if 2 firms collude they make more money than if two firms compete
-Game theory can be used to illustrate tacit collusion in an oligopoly
What are the pros and cons of oligopolys for consumers, and what these depend on (3.4) (3,3,3)
+Price wars in a competitive oligopoly lead to higher consumer surplus
+Greater non-price competition leads to higher R&D, increasing dynamic efficiency
+Dominant firms can take advantage of EOS for lower AC’s and lower prices
-Tacit collusion may lead to firms setting higher prices, reducing allocative efficiency
-High concentration ratio’s lead to lower consumer choice, and high barriers to entry deter new firms from entering the market
-Persuasive advertising can manipulate preferences
Depends on:
-Contestability of the market
-Objectives of business
-Effectiveness of industry regulation
What is a monopoly + dominant firm (3.4) (4,2)
-A monopoly in its purest form is when one firm dominates the market
-The UK’s CMA defines a working monopoly as when one firm has >25% of industry sales
-A near pure monopoly is when one firm has >90% of market share
-The monopoly power enjoyed by firms is dependant on the definition of the market. Some firms have local monopolies, others have regional/national
-A dominant firm is one which accounts for a significant share of a market and has a significantly larger market share than its next rival
-Dominant firms typically have >40% market share
What are the key characteristics of monopoly’s and reasons for monopoly’s forming (3.4) (5,4)
Characteristics:
-Firms are profit maximisers
-Firms have market power/price setting power
-Economies of scale are available to large producers
-Barriers to entry high, enabling firms to maintain long run profits
-Few close substitutes reduces the cross elasticity of demand
Reasons:
-Firms having exclusive ownership of a scarce resource (Microsoft owning Windows OS)
-Governments may grant firms monopoly status (post office until 2006)
-Producers may have patents over designs or copyright over ideas
-A monopoly could be created following the merger of 2 or more firms
What is price discrimination, and conditions needed for third degree price discrimination (3.4) (3,3)
-First-degree/pure price discrimination is where the firm can charge different prices for every unit of the good/service sold, eliminating all consumer surplus (impossible in reality due to the information requires)
-Second-degree price discrimination is charging a different price for different quantities of a good sold, such as bulk discounts
-Third-degree price discrimination is charging different prices to different groups for the same G/S
for third degree price discrimination to occur:
-Firms must be able to separate the market into groups of different buyers
-Customers must have different elasticities of demand
-Firms must be able to control supply and separate the different prices
How to to diagramatically represent third degree price discrimination (3.4) (3d,2)
-We assume the industry contains constant costs at MR=MC (can also illustrate on combined)
-By price discriminating and separating the markts, firms can make higher profits
-On one diagram should be an inelastic AR and MR curves and the subsequent SNP with a constant AC=MC
-One another diagram should be elastic AC=MC curves, and the subsequent SNP with a constant AC=MC
-One a third diagram should be a combined, with an elastic curve kinking into an inelastic AR and MR curve, Mr=MC being on the inelastic section, and the subsequent SNP
What are the pros/cons of third degree price discrimination (3.4) (5,4)
+Firms can benefit, as they can increase their profits and reinvest more, increasing dynamic efficiency
+Some consumers can now afford g/s they previously couldn’t, reducing inequality
+Some firms may go out of business if they couldn’t set higher prices
+Allows firms to regulate services (on peak vs off peak crowds)
+Those in the elastic market gain consumer surplus, paying a lower price
-Some consumers lose consumer surplus and have to pay higher prices
-Firms need to spend administration costs ensuring the price boundarys are respected
-Could go not well for firms if they do not have proper price information
-Can create unfairness in society, depending what factors are used to divide (old and rich vs young and poor)
What is a contestable market (3.4) (3+d)
-A contestable market is one where firms can freely enter/exit the market
-In a contestable market, there will be low sunk costs (costs that cannot be recovered when exiting the market)
-In contestable markets, firms are threatened by firms’ ease to enter the market, and thus keep prices close to a competitive equilibrium and profits low
-In a contestable market, firms are more likely to produce at the lower price and normal profits (AC=AR) than higher priced supernormal profit (MR=MC)
What are some criteria price discrimination can occur on (3.4) (6)
Price discrimination can occur based on:
-Demographics (age)
-Time (on vs off beak, month of the year for holidays)
-Income (low income discounts)
-Quantity (bulk buy)
-Location (postcode specific)
-Geography (location/country based pricing)
How can you illustrate why firms price discriminate (3.4) (3d)
All three diagrams are horizontal to each other
-On the first diagram show where MC = kinked MR
-On the second diagram show SNP with inelastic AR and MR curves, with a higher price
-On the third diagram, show SNP with elastic AR and MR curves, with a lower price
What is a contestable market (3.4) (3+d)
-A contestable market occurs when there is freedom of entry/exit in the market
-In a contestable market, there will be low sunk costs (costs that cannot be recovered when entering the market)
-Threat of firms entering the market freely keeps prices close to a competitive equilibrium and profits low
-In a contestable market, firms produce at sales maximisation AR=AC, keeping normal profits at a lower price and higher quantity
What factors determine the contestability of a market (3.4) (4)
-Sunk costs: high sunk costs make it difficult for new firms to enter/exit the market, making it less contestable (adverts, R&D)
-Advertising/brand loyalty: if an established brand has significant brand loyalty (coca cola), new firms will have to pay a lot on adverts to disrupt loyalties
-Vertical integration: if a firm doesn’t have access to the supply of a good, the market will be less contestable (oil firms limiting petrol supply, government regulation allowing access to the national electricity grid)
-Access to technology/skilled labour: less contestable in markets if it’s hard to gain access to the labour/capital required (google pays software engineers well, has a 26 acre silicon valley HQ worth $1 billion
What are some methods to increase the contestability of a market (3.4) (5)
-Removing legal barriers to entry: royal mail was a 360 year legal monopoly, but now other firms can enter the market for delivering letters/parcels
-Force firms to allow competitors to use its network: when BT was privatised, the OFTEL (office for telecommunications) forced BT to allow other firms to use its network. This has also happened on the national grid
-Legislation against predatory pricing: if firms can’t engage in predatory pricing they can’t force new firms out of the market, making it more contestable
-OFT can legislate against abuse of monopoly power: can ensure firms don’t restrict supply to certain firms
-Government firm: as a last resort in banking, the government has toyed with making its own firm, to increase competition
Why is banking contestable/not contestable (3.4) (2,3)
+Internet has reduced setup costs and enabled new firs to enter the online banking market
+Government is trying to introduce regulation to reduce the time/effort needed to switch accounts
-High sunk costs in getting a network of banks set up
-Brand loyalty to existing banks is high
-High profits for banks indicate that hit and run profits aren’t possible
What is a monopsony, and the characteristics of a monopsony in a labour market (3.4) (2,2,1)
-A monopsony is when a single buyer controls the market for a good/service, in essence setting price and quantity
-Without that buyer, there would not be sufficient demand for the product
-It often refers to monopsony employers, who have market power in hiring workers
-Examples of dominant employers in the UK include the NHS, army and firefighters
-Monopsonists in labour markets are wage setters, as they are the sole employer of labour, and therefore can offer whatever wage rates/quantity they feel
How can we illustrate where labour market monopsonists hire (3.4) (d+3)
-On the diagram with x axis Q, and y axis WR, you have a downwards sloping D=MRP, and starting from 0 you have two upwards sloping curves, an S=ACL and a higher MCL curve, and go down from where MCL=MRP to ACL to find WR
-Profit maximisers hire where the Marginal Cost of Labour = Marginal Revenue Product
-Monopsonists will maximise revenue (MRP) workers produce in comparison to cost (MCL), maximising profit
-Wage and quantity are lower in a monopsony (Wm + Qm) then in a competitive labour market (Wc and Qc)
What are the pros and cons of a monopsony (3.4) (4,4)
+Firms can hire workers at lower wage rates, maximising profit
+Lower COP’s for firms can lead to lower prices/higher quality for consumers, increasing allocative and dynamic efficiency
+Workers get a stable employer of labour
+Suppliers get a stable purchaser of supply
-Suppliers may cut corners to stay profitable, leading to lower quality for firms
-Workers striking for wages/conditions could impact consumers
-Employees get lower wages, with no alternative employer
-Suppliers get exploited my monopsonist and lower prices/quantities
What is a natural monopoly (3.4) (3)
-A natural monopoly arises when there are high fixed costs, usually in the form of infrastructure
-The costs of infrastructure (water pipes) are high sunk costs, thus increasing barriers to entry/exit
-It is considered inefficient to try and increase competition through duplicating this infastructure, as this would mean that there is the same infrastructure twice, wasting resources
What are the pros and cons of a monopoly (3.4) (5,5)
+Monopolies can exploit economies of scale for lower average costs
+High profits can be taxed for government revenue
+Monopolies’ significant SNP’s allow for R&D, innovation and dynamic efficiency
+With a natural monopoly, it is more efficient to let them be the sole producer
+Monopolies are more likely to innovate if they can protect their ideas
-High prices and profits leads to misallocation of resources and inefficiency
-Monopolies could exploit the consumer, charging a higher price and reducing allocative efficiency
-Monopolies have no incentive to become more efficient
-Losses in consumer surplus and gains in producer surplus
-Little choice for consumers
What is the difference between a product market and a factor market, and what is the labour market (3.5) (2,1)
-A product market is where final goods/services are sold from producers to consumers for consumption
-A factor market is where factors of production are sold from one producer to another for use in producing a final good
-The labour market is a factor market where labour is bought/sold
What is the demand for labour + elasticity (3.5) (3,1,3)
-The demand for labour represents the willingness and ability of firms to employ workers at a given wage rate at a given point in time
-Demand for labour is a derived demand for the product labour is used to produce
-The DoL curve is inverse, since firms will switch production to capital as wages rise (automation)
-The elasticity of labour demand measures the responsiveness of labour demand o a change in wage rates
Factors affecting labour demand elasticity include:
-Labour costs as a % of total costs
-PED of final goods
-Ease/Cost/Quality of factor substitution
What factors impact the demand for labour (3.5) (5)
-Higher demand for product = higher demand for labour
-Higher productivity of labour = higher demand for labour
-Higher quality/quantity of labour substituted = lower demand for labour
-Higher firm profitability = higher demand for labour
-Higher number of firms in the market = higher demand for labour
What is the supply of labour, elasticity of supply and factors influencing elasticity (3.5) (2,1,4)
-The supply of labour represents the willingness and ability of people to make themselves available to work at given wage rates at given points in time
-The Supply of Labour curve is upwards sloping, as more workers will work at higher wages
-The elasticity of supply of labour is the responsiveness of supply to a change in wage rates
Factors influencing elasticity include:
-Level of training/qualification required
-Time
-Availability of suitable labour in other industries
-Levels of unemployment
What factors influence the supply of labour (3.5) (7)
-Wages: for an industry, wages cause movements on the upwards sloping curves
-Population/age: higher WORKING AGE population leads to a higher supply of labour (migration has more of an impact than birth/death rates)
-Non-monetary benefits: holidays, flexibility, hours, job satisfaction, area
-Education/training: occupations which need higher levels of education will have lower, more elastic supplied of labour (also higher E&T = higher SoL)
-Alternatives: supply of labour for a firm depends on other available firms
-Legislation: government rules (school leaving age, retirement) can impact supply of labour
-Trade unions: unions may be able to restrict supply of labour (teachers union made it so you have to have a degree to teach)
What is the individual supply of labour curve (3.5) (d+3)
-An individual’s supply of labour curve is a backwards bending C, with hours on the x axis, and wage rate on the y axis
-Below equilibrium (max hours), the substitution effect>income effect, and above equilibrium the income effect>substitution effect
-The substitution effect is giving work greater value then labour, due to higher wages
-The income effect is when higher wages mean workers work less to achieve a set income
What is labour immobility, types and consequences (3.5) (1,1,2,2,2)
-Labour immobility refers to the difficulty of workers to move from one location to another, or from one occupation to another
-Labour can suffer either from occupational or geographical immobility
-Occupational immobility is when workers struggle to move from one job to another, due to a lack of transferable skills
-This is particularly challenging in the short run, but in the long run workers can get training (but, expensive)
-Geographical immobility is where people find it difficult to move from one place to another
-Housing, expenses to travel to interviews, commute, all hurting low-income people more
-Immobility leads to excess/shortages of labour in certain occupations/areas
-Uk suffers from a skills shortage, costing £90 billion annually as there are 4 million too few skilled workers in areas such as engineering
What is the impact of unions on jobs/wages (3.5) (d+1)
-Shifting supply inwards, the lost wage income from contraction in employment is change in quantity x original wage rate, and the gained wage income from collective bargaining is the change in wage rate x new quantity
-Union bargaining strength depends on the proportion of workers in an industry in a union
What is a national minimum wage (3.5) (3+d)
-A national minimum wage sets the minimum hourly rate that is acceptable in law
-A national minimum wage aims to remove the problem of poverty pay, where the earnings from work don’t result in a living wage, and fail to push people out of poverty
-A national minimum wage has been in the law since 1999, where the hourly wage rate was at £3.60, and is now £6.40 for <18yr olds, and the national living wage is £11.44 for >21yr olds
-On a SL and DL curve, a price level set above market equilibrium
What are the pros and cons of a minimum wage (3.5) (3,5)
+Greater equity achieved, and the distribution of income is narrowed
+Poverty reduced, as the low paid gain more income and the unemployed join the labour market
+Less worker exploitation by labour market monopsonists, who can pay below-market equilibrium
-Price inflation, as firms pass on higher costs
-Falling employment and rising employment leads to demand contracting
-Workers/employers may be driven to unofficial labour markets
-Inward investment + FDI deterred to avoid expensive labour
-Competitiveness of UK goods abroad suffer compared to low wage economies
How may unions graphically impact wage determination (3.5) (2d)
-On a regular supply and demand diagram, the union wage will be perfectly elastic supply until the supply curve, above market equilibrium
-On a labour monopsony and monopoly diagram, the union wage will be perfectly elastic until D = AC, then rise up
What are some labour market issues (3.5) (7)
-Skills shortage: the UK suffers from geographical and occupational immobility
-Young workers: youth unemployment (12% for 16-24 vs 3.8% overall), as firms in recession don’t hire new workers, and lower lifetime earnings follow
-Retirement: higher life expectancy = higher strain on government budget and a higher retirement age (pensioners make 50% of welfare spending)
-Wage inequality: higher wage inequality raises questions on relative poverty and redistributive measures (UK gini coefficient 0.28 in 1960, 0.38 now)
-Zero hour contracts: 75% rise over the last 10 years, employees don’t know what they’ll make and have little notice of when
-Gig economy: short term, unreliable self employed contracts
-Migration: causes fall in wages, but helps fill skills shortages (visas for doctors)
Who are the CMA + what do they do (3.6) (2,3)
-The CMA in the UK enforce competition and consumer law and take action to prevent anti-competitive behaviour and unfair business practices
-The CMA protects consumer rights by investigating infringements, imposing fines and sanctions and taking action against companies
-The CMA fined 4 pharmaceutical firms £35 mill in 2022, Focus receiving a £15.5m fine, for limiting the supply of an anti0-nasuea dug, causing its price to rise 700%
-The CMA investigates mergers if the result is market share > 25%, or >£70m turnover, aiming to prevent a worsening competitive position
-The CMA can encourage competition through forcing others to use its infrastructure network, setting price controls at RPI - X (X = efficiency gains, ensuring firms pass efficiency gains to consumers), or RPI-X+K ( K = investment, incentivising £130b in water industries)
How can the government intervene to control mergers + examples (3.6) (4,2)
-In the UK, mergers are investigated case-to-case, on whether there’ll be a substantial lessening of competition (SLC), and if the pros outweigh the cons
-A merger will be investigated if it’ll result in market share of >25%, or if the merged firm passes the turnover test of >£70 million
-The aim is to prevent 2 large companies merging, which could then exploit consumers for higher prices and lower quantities
-However, very few mergers are investigated per year, the CMA suffering form regulatory capture (regulators being sympathetic)
-Tesco’s takeover of Booker (2017, £3.7b) was allowed to to the competitive nature of supermarkets
-The European Commission blocked the merger of Ryanair and Aerlingus in 2010, as they’d control >80% of all european flights from ireland
How can the government intervene to control monopolies (3.6) (9)
-Price regulation ensures firms don’t price too high
-Profit regulation incentivises reinvestment, and disincentivises high prices
-Quality standards ensure firms don’t produce low quality goods/services
-Performance targets help firms reach a certain level of quality of a number of factors
-Windfall taxes are high taxes which are placed after a certain event has occured
-Lowering barriers to entry and merger policy could help increase competition
-Breaking up the monopolist into competing units
-Subsidies could incentivise firms to lower prices
-Self regulation could ensure firms follow their own codes of conduct
How might price and profit regulation be methods of controlling monopolies (3.6) ((4,2)(2,1))
Price:
-Regulators can set a price control to charge a price below profit maximising
-One price control is ‘RPI - X’, X being expected efficiency gains which therefore are transferred to consumers
-Another price control is ‘RPI-X+K’, K being the level of investment, this contro allowing for £130 billion investment in the water industry
-These price controls disincentive high prices and incentivise innovation
However:
-However, it is difficult to know where to set X, due to asymmetric information and rapid changes in technology levels
-It is also difficult for governments to know the allocatively efficient price, whilst increasing dynamic inefficiency
Profit:
-In the US, ‘rate of return’ regulation is used, setting prices to allow for costs and a ‘fair’ rate of return
-This encourages investment and prevents higher prices
However:
-There is little incentive for efficiency gains, as firms on’t win from cutting costs rather from overinvesting in too much capital
How might quality standards and performance targets be used to control monopolies (3.6) ((2,1)(3,3))
Quality standards:
-The government can introduce quality standards, to ensure firm don’t cut quality as a measure to increase profits
-Electricity generators are forced to have enough capacity to prevent blackouts
However:
-This requires political will and understanding
Performance targets:
-Regulators can introduce yardstick competition, such as setting train punctuality targets based on the best performing operators
-Regulators can also split a service into a number of regional sectors, and compare performance in each (water industry)
-Targets can be set on price, quality, costs of production and consumer choice
However:
-Requires political will and understanding, as firms will actively oppose setting targets
-Enforcable punishments will need to be in place if firms don’t meet targets
-Attempting to meet targets could have adverse effects (NHS time targets led to low quality)
How may government intervention promote competition and contestability (3.6) (2,3,5,1)
-The promotion of small businesses increases innovation and efficiency, as new firms will provide goods and old firms will be forced to compete
-Government can give out training, grants, tax incentives and subsidies to entrepreneurs
-Deregulation is the removal of legal barriers to entry, increasing efficiency through allowing higher competition
-Privatisation can also be used to increase competition in the market
-However, these will have negative effects of poor business behaviour
-Competitive tendering is when the private sector produces goods to be bought out by the public sector
-Government can contract out the provision of a good/service to private companies
-Competition can be introduced, inviting private firms to bid for contracts to supply, the lowest contract wins
-This helps minimise costs and ensure efficiency
-However, private sector firms may cut quality in an attempt to cut costs to be able to afford lower contracts
-Government can prevent firms taking anti-competitive behaviour
How may government intervention protect suppliers and employees (3.6) (2,2)
Restrictions on monopsony power:
-Government’s can pass anti-monopsony laws, introducing independent regulators who force monopsonists to buy fairly
-Fines can be implemented, minimum prices may be introduced, self regulation could be used but is weak
Workers rights:
-Government protects employees through health and safety laws, employment contracts, rights to be in a union
-However, if workers rights are too strong, firms will be unwilling to take on new workers, due to higher costs
What is privatisation, and the pros/cons of privatisation (3.6) (1,4,4)
-Privatisation is the sale of government equity in nationalised industries, or other firms to private industries, to revitalise inefficient industries
+Encourages greater competition, reducing x-inefficiency and prices
+Reduces government interference, and firms can invest with greater competition
+Managers become more accountable and there are higher incentives for higher quality
+1997 Railway privatisation lead to higher passenger satisfaction and investment
-Privatised natural monopolies may abuse their monopoly power
-Makes sense for the government to coordinate key industrys
-Problems over externalities and inequality, as firms focus on profit
-Since 1997, railway standard single fairs have risen 200%
What is nationalisation, and the pros/cons of nationalisation (3.6) (1,4,4)
-Nationalisation is when a private sector company/industry is brought under state control, to be owned/managed by the government
+Government will hold more of a long-run view then shareholders
+Government will consider externalities and inequality
+Government will provide a minimum level of service, not being profit motivated
+Government should control key national assets for security
-Will be x-inefficient and can lead to opportunity cost
-Nationalised industries suffer from the principal agent problem
-Government may not have the funds to properly invest
-NHS suffers from lack of funding, lack of uncertainty (different governments) and a lack of competition
What are the impacts of government intervention on prices, profit and efficiency (3.6) (3,3,3)
Prices:
-Government can force businesses with monopoly power to cap prices
-This is useful for essential utilities, such as electricity, gas and water
-However, low prices might force businesses out, reducing choice
Profit:
-Businesses will be limited in profits, due to being limited in price
-Therefore firms will have to cut costs to maintain profits
-Firms may be forced to reinvest profits
Efficiency:
-As quality standards are set, reductions in cost will have to come from efficiency
-Firms may increase productive efficiency as they aim to lower costs
-Firms may also become more allocatively efficient, forced to produce at AR = MC
What are the impacts of government intervention on quality and choice (3.6) (3,2)
-As governments set minimum quality standards, firms must meet these or be punished
-Therefore acceptable standards are likely to be maintained
-Quality may be lowered as the government is x-inefficient
-By limiting monopoly power/barriers to entry, government creates choice and markets become more contestable
-However, nationalisation will lead to reduced choice
What are some limits to government intervention (3.6) (4,5)
-Regulatory capture occurs when an organisation set up to protect the interests of the public instead defends the interests of the industry
-Government failure occurs, as businesses are organised to negate government policy
-Businesses will invest in market research, leaning how to play the system
-Vodafone negotiated a tax reduction from £7billion to £1billion in 2010
-Asymmetric information might occur where the government makes poor decisions
-Industries may provide inaccurate or limited information to their regulator
-Regulators have to use the information provided by firms, so the wrong measures will be set
-Government information can be inaccurate, due to poor research or future fails
-This’ll deliver the wrong signals to markets, meaning decision making is flawed
