Theme 4 Flashcards
What are the characteristics of a market with perfect competition?
- Many competitors
- Homogenous products
- Firms are price takers
- Profits for firms likely to be small due to small market share
What are the characteristics of a market with Monopolistic competition?
- Many small, independent firms with small market share
- Differentiated products
- Imperfect information for buyers and sellers
- Compete using non-price competition
What are the characteristics of an Oligopoly?
- Dominated by a small number of firms, each with a large market share
- Product differentiation
- Compete using non-price competition
- High barriers to entry
- Firms are interdependent
What are the characteristics of a Monopoly?
- Only seller in the market
- Price maker
- Price discrimination
- Profit maximisation (firms make supernormal profits in both the short and long run)
How do you calculate Total Costs?
Total Costs = Total Variable Costs - Total Fixed Costs
What are fixed costs?
Do not vary with output e.g. rent, advertising, capital good
What are variable costs?
- All factor inputs can change in the long run
- Change with output
- e.g. cost of raw materials increase as output increases
How do you calculate Total Revenue?
Price x quantity sold
How do you calculate Average Revenue (AKA price per unit)?
Total Revenue / Quantity sold
What is the Marginal Revenue?
The extra revenue earned from the sale of one extra unit
How do you calculate Profit?
Total Revenue - Total Costs
What is break-even?
Where TR = TC
What are some facts about the UK rail industry?
- Contribute £10bn per annum to GDP
- Employs 216,000 people
- £4.2bn in government subsidies
- 1.73bn passenger journeys per year
What are some arguments for nationalisation of the UK rail industry?
- Rail network is considered to be a natural monopoly suited to state control to achieve EOS
- Rail fares can be controlled to improve affordability
- Profits flow to the taxpayer rather than to shareholders of private train companies
What are some arguments against the nationalisation of the UK rail industry?
- State-controlled monopoly might experience diseconomies of scale due to lack of competition
- nearly 1/2 of all passenger fares are already regulated in the UK
What are some arguments for privatisation of the UK rail industry?
- Competition on lines is more important than who owns the railway
- Private sector firms are more likely to improve dynamic efficiency
- Possible to regulate more fares on services run by private train operating companies (no need to change ownership)
What are some arguments against privatisation of the UK rail industry?
- Rail system in the UK is close to full capacity
- Franchise has a monopoly (can increase price to yield consumer surplus)
- Even with regulation, rail fares have increased by more than 120% since 1995
What may happen if there was nothing was done to improve the efficiency of the rail system?
- Negative externalities (more traffic, more use of cars, more pollution, less tourism, less productive economy due to less transport for workers)
What are the reasons for government intervention?
- Correct percieved market failure
- Achieve a more equitable distribution of income and wealth
- Improve the short and long-term performance of the economy
How do the government intervene in markets?
- Regulating the Market
- Taxes and subsidies
- State ownership/funding and provision
- Maximum and Minimum prices
What is the definition of market failure?
When the price mechanism is distorted and causes a misallocation of scarce resources causing society to suffer
What is an externality?
The effects that producing or consuming a good or service has on 3rd parties
What are withdrawals in the circular flow of income?
- Savings (by consumers)
- Taxes
- Imports
What are injections into the circular flow of income?
- Investment (by firms)
- more government spending
- exports
When is the economy in equilibrium?
When the rate of injections = rate of withdrawals
What are the components of Aggregate Demand?
AD = C + I + G + (X-M)
What % of GDP is Consumer Spending, and what affects it?
- 60% (largest)
- Interest rates (lower I.R. = more spending)
- Consumer confidence
- levels of unemployment
- levels of personal taxation
What % of GDP is Investment, and what affects it?
- 15% of GDP (smallest)
- Business expectations and confidence
- Interest rates (lower I.R. = more investing)
- levels of corporation tax
What % of GDP is Government spending, and what affects it?
- 18-20% of GDP
- Government priorities and macroeconomic objectives
- Stage in economic cycle
- Fiscal policy
What affects the balance of trade? (X-M)
- 2nd largest % of GDP
- Exchange rate (SPICED/WPIDEC)
- International competitiveness
- Stage of global economy
- Protectionism
What causes an outward shift of the AD curve?
- If there’s a rise in C/I/G/X
What is the trade-off for having a strong currency?
A strong currency = exports are more expensive and imports are cheaper, so there will be a fall in net exports (reduction in AD).
What is the effect the multiplier effect on aggregate demand?
Injections into the economy = AD curve shifts to the right
What is an absolute advantage?
A country will have an absolute advantage when its output of a product is greater per unit of resource used than any other country.
What is a comparative advantage?
A country has a comparative advantage if the opportunity cost of producing a good is lower than the opportunity cost for other countries.
What would cause a shift in the LRAS curve?
- Technological advancements
- Changes in Education and skills
- Changes in government regulation
- Demographic changes and migration
- Increased competition
What causes cost-push inflation?
When there are increases in the costs of production e.g. minimum wage
What is full capacity output?
The maximum amount of goods and services in the economy that can produce when all of its resources are employed
What causes demand-pull inflation?
When aggregate demand outplaces aggregate supply (means firms are more willing to charge more for their goods/services)
What does a Strong Pound mean?
- Imports are cheaper
- Exports are smaller
- AD curve shifts to the left
What does a Weak Pound mean?
- Imports are smaller
- Exports are cheaper
- AD curve shifts to the right
What are the main economic objectives of the UK?
- Low unemployment (less than 5%)
- Economic growth
- Low and stable rate of inflation (2%
- Current account equilibrium
What are the demand-side policies?
Monetary and Fiscal policy
What is monetary policy?
- Conducted by BofE and MPC (Monetary policy committee)
- Controls supply of money in the economy using interest rates and QE
What is fiscal policy?
- Conducted by the government
- Uses government spending and revenues from taxation to influence AD
What is inflationary fiscal policy?
- Makes economies grow and shifts AD to the right
- Needed during recession
What is deflationary fiscal policy?
- Increases interest rates
- moves AD2 to AD (back to equilibrium)
- Prevents hyperinflation
What are the types of UK tax?
- Income tax (direct)
- Council tax (direct)
- Corporation tax (20%) (direct)
- Inheritance tax (direct)
- VAT (indirect)
Where does the UK government spend the tax revenue?
- Pensions
- Welfare
- Health
- Education etc.
What are the limitations of fiscal policy?
- Imperfect information about the economy
- Time lag
- Size of multiplier
- High interest rates (mean fiscal policy may not be effective at increasing demand)
What is Quantitative Easing?
- Increases the money supply so firms and consumers can spend more
- Used to stimulate AD when interest rates are already low
- Involves the BofE ‘creating new money’
What are the benefits of QE?
- Brings up the rate of inflation (rather than decreasing interest rates) means the currency will be kept weak which increases the competitiveness of UK firms and boosts exports
- Should boost confidence in and economy during recession
What is the trade-off between the environment and competitiveness?
- If a firm wants to be more competitive, they may build more factories (to benefit from EOS) = causes more pollution.
- If a firm wants to be more environmentally friendly, their costs of production would increase = may increase price of goods
What is the trade-off between progressive taxes and inflation?
- Progressive taxation would tax the richer so should decrease inequality
- Reducing inequality could lead to higher I.R. so higher inflation
- E.g. higher VAT rate increases the price of goods for firms and consumers
What is the trade-off between Low interest rates and inequality?
- Low I.R. = cheaper loans + may reduce inequality
- Low I.R. = savers only receive a small return on their savings (more inequality)
What is the definition of supply-side policies?
All measures that can increase the total productive capacity of the economy.
What is the difference between market-based and interventionist policies?
- Market-based policies limit the intervention of the government and allow the free market to eliminate imbalances. The forces of supply and demand are used.
- Interventionist policies rely on the government intervening in the market.
What are some market-based policies?
- Increase incentives = reduce income and corporation tax
- Promote competition =deregulate or privatise
- Reform labour market = remove NMW to allow free market forces to allocate wages
What are some interventionist policies?
- Improve competition = competition law
- Reform labour market = improve the geographical mobility of labour by subsidising the relocation of workers and improving the availability of job vacancy information.
- Improve skills of labour force = subsidise training, spend more on education and healthcare.
What is the impact of BREXIT (a risk)?
- The outcome of leaving the EU is unpredictable
- UK exporters may face higher tariffs in European countries = sales fall = AD shifts left
- firms may have to make employees redundant
- less exports = exchange rate will depreciate
- exports become cheaper = more competitive
What is the definition of a shock?
Unexpected event that has a major effect on the national economy
What is a forward market?
Make it possible to buy a foreign currency at a price agreed today for delivery on a specific future day (insurance against an unfavourable change in the exchange rate)
What are the pros for using forward markets?
- Removes uncertainty
- Gives firms certainty over how much capital they can have
What are the cons of using forward markets?
Potentially costly as firms could have saved if they waited
What is money?
A medium of exchange that acts as a measure of value and is the standard of deferred payment.
- Inflation can make it less effective
What are the characteristics of money?
- Acceptable
- Portable
- Durable
- Divisible
- Limited in supply
- Difficult to forge
What is liquidity?
The ease at which money can be transferred into cash
What is the money market?
Where financial assets are bought and sold and where IOU’s are less than or equal to a year.
Why do the Bank of England control the supply of money?
To meet their inflation target of 2%
How do reserve requirements affect the supply of money?
Reducing the reserve supply to lower interest rates and increase money supply in economy (theoretical in UK but used in USA)
How does the discount or bank rate affect the supply of money?
- The rate at which commercial banks borrow from the BofE or each other is 0.5%.
- If BofE reduces the discount rate, then it’s cheaper to borrow from BofE so less money is being sucked out of the money supply.
How do open market operations affect the supply of money?
- Buy bonds which replaces paper with cash to increase money supply (reduces I.R.)
- Selling bonds replaces cash with paper (decreases money supply + increases I.R.)
What is the role of the central bank?
- implement monetary policy
- act as a banker to the government
- act as a lender of last resort to the banks
- regulate the financial system
Why is financial stability crucial for confidence in the financial system to remain high?
Prevents a run on the banks
What is a moral hazard?
When people take risks because they won’t suffer the consequences themselves if things go wrong.
Who regulates the UK banking industry?
- Prudential Regulation Authority (PRA): promotes the safety and stability of banks, building societies, investment firms and credit unions, and ensures policyholders are protected.
- Financial Conduct Authority (FCA): regulates financial firms to ensure they are being honest to consumers and promotes competition.
What are some unintended consequences of a ban on market rigging?
- Could use tacit collusion
- Could raise prices
What are some unintended consequences of preventing the sale of unsuitable products?
- People might sell illegally
- Rise in black markets
What are some unintended consequences of deregulation?
- Market failure
- A systemic crisis + bank run
- Consumers have less confidence (reduces AD)
What is regulatory capture?
Firms covered by regulatory bodies, such as utility companies, can sometimes influence the decisions of the regulator to ensure that the outcomes favour the companies and not the consumers.
E.g. a regulated industry might pressurise their regulatory body into making decisions that benefit them.
What is asymmetric information?
When one party knows more than the other
What is the current UK interest rate?
0.5%
Where in the world are there high-interest rates?
USA = 1.75% Argentina = 40%
Where in the world is there high consumer confidence?
- USA
- Eurozone
- due to low unemployment
Where in the world is there low consumer confidence?
- Japan and China due to trump’s protectionism
- UK due to BREXIT
Where in the world is there a weak exchange rate?
- US dollar (uncertainty due to Trump)
- Pound (due to BREXIT)
