econ

What is economics?Economics is a social science that studies how humans make decisions when they face scarcity. What does scarcity mean?Scarcity means that our wants and needs are greater than the amount of available resources. Economic agents make decisions based on- Political Judgement - Short term outcomes - Moral Judgement - Normative Statements What is a positive statement? They are objective statements that can be proved by referring to evidence What is a normative statement?They are statements of opinion that contain a value judgement What is a value judgement?They are judgements about society that cannot be quantified and tested, found within a normative statement. e.g the homelessness problem in Oxford needs to be addressed and funds should be redistributed to do this. What does ceteris paribus mean?all other things kept equal. How is economics Similar to other sciences?- Develop theories and make models - Use economic models to make predictions How is economics different to natural sciences?- Controlled approaches experiments cannot be conducted - economist use the assumption ceteris paribus What is the basic economic problem?"There are not enough resources on earth to satisfy humans' unlimited wants and needs." What are the 3 foundations to economics decisions?What to produce? How to produce? Who to produce for? What is a need?something necessary for survival e.g food, water, shelter What is a want?Things people can live without but desire e.g luxury cars, designer clothes What are the 4 factors of production?land, labor, capital, enterprise What is meant by land?Finite and non-finite resources found on the planet, including animals, water and natural materials. What is meant by labour? (2 things) Human capital - the value human labour brings to the production process Labour force - the population that can work. What is meant by capital?Human made resources: technology machinery What is meant by enterprise?The entrepreneurs who take a risk to make a profit by creating things from the other factors of production. What are the 3 main economics agents? What are their roles?- Producers: supply goods/services - Consumers: purchase goods/services - Governments: Establish rules in an economy What decisions does a producer make?Producers must decide what products to make and the selling price of products. What decisions does a consumer make?Consumers decide what products to purchase and how much they want to spend on products. What is an opportunity cost? The loss of potential gain from other alternatives when one alternative is chosen. What are some problems with opportunity cost?- Not all factors have alternatives - Some alternatives are unknown - Agents may lack information on alternatives What is a trade-off?sacrificing one good or service to purchase or produce another Traditionally, what is the main incentive that firms base their decisions on?Profit What is a PPF curve?"A curve which shows the maximum amount of two goods or services an economy can produce. -it explains the constraints experienced by society. <img src=""img1689932503619275370.png""> " How is opportunity cost shown on the PPF curve?As you move along the curve, to produce good X you have to sacrifise production of good Y. Why is the PPF curved?The law of diminishing returns: - As we increase the production of Good X the more of Good Y has to be sacrificed What do points on, inside and outside the PPF mean?"On = Productively efficient, all factors are being fully utilised Inside = Under utilisation of factors of production Outside = Not currently possible to produce at this point. <img src=""img1811489654136270945.png""> " What cause an outwards shift in the PPF?"Economic growth: - Improvements in labour and technology - Increased resources (increase in total number of workers) <img src=""img8576229197286606330.gif"">" What causes an inwards shift in the PPF?"Negative economic growth: - A loss of resources (e.g. natural disaster) - Migration <img src=""img6014986108953329409.jpg"">" What is static efficiency?Refers to the efficiency at any point in time and can be separated into allocative and productive. What is productive efficiency?Any point on the PPF, when all resources are being used as efficiently as possible. Products are produced at a level where average costs are at their lowest What does a linear PPF show?"Opportunity costs are constant <img src=""img5453081833373180549.jpg"">" How does the specialisation of factors of production change along the PPF curve?Towards any end of the PPF, factors of production are specialised for the production of the good of the opposite end. This is because your opportunity cost is greater towards the end of the PPF What can cause a PPF to shift out in one direction?"- When improvements in capital/labour can only benefit one good. <img src=""img1103936549790112995.png"">" What is demand?the willingness and ability of buyers to purchase goods at a given price within a particular time period. What is price?Price is what the buyer pays for a specific good or service. What is the income effect?a change in quantity demanded caused by a change in consumer income What is the substitution effect?When demand for the cheaper good increases demand for the costlier good decreases. What is a complement good?Goods that are often used together; when price increases both demands fall (PS4 and PS4 games) What is a substitute good? (Competitive Demand)"Goods that are alternatives to eachother. An increase in price of good A would cause a rise in demand for good B and a fall for good A (McDonald's Vs KFC)" What is a demand curve?"a curve that shows the relationship between the price of a product and the quantity of the product demanded <img src=""img5587489380207263463.png"">" What causes a contraction and extension in demand?"Change in price Rise in price = Contraction Fall in price = Extension <img src=""img3910725000981070628.webp"">" What factors can cause a shift in the demand curve?P - Population I - Income R - Related goods (subs and complements) A - Advertisement T - Tastes E - Expectations (future price change) S - Season What effect does increased income have on the demand curve for normal goods vs inferior goods?For normal goods, increased income will lead to increase in quantity demanded (Cars) For inferior goods, increased increased income will lead to a fall in quantity demanded (Rice) What is a Giffin good? How does its demand curve look?- A Giffin good is one for which as price increases demand increases e.g. necessities for low income earners - Upwards sloping demand curve. What is a Veblen good? How does its demand curve look?- A Veblen good is one for which as price increases, demand increases e.g. expensive goods for celebrities - Upwards sloping demand curve. What is elasticity?Elasticity measures the responsiveness of one variable to the change in another variable What is the equation for percentage change?(X2 - X1)/X1 What is Price elasticity of demand (PED)? What is the equation for it?"PED is a measure of how quantity demanded responds to a change in price. <img src=""img8035115767666611203.jpg"">" What is elastic demand?"Elastic demand is when PED > 1. This means a % change in price will lead to a larger % change in quantity demanded. <img src=""img6303206145670147781.jpg"">" What is inelastic demand?"Inelastic demand is where the 0 < PED < 1. This means a % change in price will lead to a smaller % change in demand. <img src=""img7043773398645607826.webp"">" What does unit elastic mean?"Unitary elasticity is where the PED = 1. % change in price will lead to an equal % change in quantity demanded. <img src=""img620573249808296175.jpg"">" What is perfectly elastic demand?"PED = ± infinity Any price increase will cause demand to drop to zero. <img src=""img769947550926017679.webp"">" What happens when you increase and decrease price when PED is perfectly elastic?- Increasing price means nobody is willing or able to purchase - Decreasing price means firms are unable to cover costs. What is perfectly inelastic demand?"PED = 0 Any price change won't affect demand. <img src=""img5926468649616482216.webp""> " Why is PED always negative?Because price and demand have an inverse relationship What is income elasticity of demand (YED)? What is the equation for it?"YED measures how much demand changes with a change in real income. <img src=""img4810774502390360453.jpg"">" What is the YED for normal necessitiy goods?- Normal necessity goods have a positive income elasticity, - 0 < YED < 1 - (income rises, demand increases). What is the YED for inferior goods?Inferior goods have negative income elasticity, YED < 0 (income rises; demand decreases). What is cross elasticity of demand (XED)? What is the formula for it?"XED is a measure of how the quantity demanded of one good responds to a change in the price of another good. <img src=""img7786290430502096900.jpg"">" What is the XED for substitute goods?XED is positive for substitutes (XED > 0) What is the XED for complementary goods?XED is negative for complementary goods (XED < 0) What is the XED for independent goods?XED = 0, as independent goods are not related to each other. What is total revenue?"Price per unit x Quantity <img src=""img5847715300449311193.jpg"">" If a product is price elastic, what does increasing and decreasing the price do?Decreasing price = increases total revenue. Increasing price = decreases total revenue. If a product is price inelastic, what does increasing and decreasing the price do to total revenue?Decreasing price = decreases total revenue. Increasing price = increases total revenue. How does the burden of an indirect tax differ when PED is elastic vs inelastic?"- When PED is inelastic, most of the burden is passed onto consumers, since a change in price doesnt really affect demand - When PED is elastic the firms will take up the burden, since increasing the price will cause a large fall in demand <img src=""img1776414113710185732.webp"">" What factors influence PED? (6)- NASBIT - Necessity Goods - Addictive habit forming goods - Substitutes - Brand Loyalty - Income % spent - Time (SR vs LR) What happens to PED when there are more substitutes?Becomes more price elastic What is PED like for cheap goods vs expensive goods?Expensive - Price elastic Cheap - Price inelastic What is PED like in the long run?Price elastic, as you have more time to find alternatives How does elasticity change along a demand curve?"At zero demand/high price : price elastic At midpoint : unit elastic At zero price/high quantity : price inelastic PED of ± 1 = maximised total revenue. <img src=""img3243499843804827519.jpg""> " What is supply?Supply is the quantity of a good or services that producers are willing and able to produce at a given price at a particular time. What is a supply curve?"A curve that shows the relationship between the price of a product and the quantity of the product supplied. <img src=""img7510907630251701355.jpg"">" What is the law of supply?as price increases, quantity supplied increases all other factors constant. What causes an extension and contraction in a supply curve?"Increase price - extension Decrease price - contraction <img src=""img5823340370908815230.jpg"">" Why does a rise in price lead to an increase supply of that good?The increase in price incentivises firms to increase output to make more profits. When does the supply curve shift?"When the quantity supplied increases/decreases at every price level. <img src=""img2675272866966910495.jpg"">" What factors cause a shift in the supply curve?P - Productivity I - Indirect taxes N - Number of firms T - Technology S - Subsidies W - Weather C - Costs of production OR A change in the cost, quality or quantity of factors of production. What is price elasticity of supply (PES)? What is the formula for it?"Price elasticity of supply measures how the quantity supplied of a good response to a change in its price. <img src=""img8480556314312061887.jpg"">" What is elastic supply?"PES > 1. A percentage change in price will lead to a greater percentage change in quantity supplied. <img src=""img6769350752902145490.jpg"">" What is inelastic supply?"0 < PES < 1. A percentage change in price will lead to a smaller percentage change in quantity supplied <img src=""img970199180985421529.jpg"">" What is unit elastic supply?"PES = 1. Percentage change in price will lead to and equal percentage change in quantity supplied. <img src=""img1511982558170106911.jpg"">" What is perfectly elastic supply?"PES = ± Infinity. Any quantity demanded can be met without changing price, but if price changes quantity supplied falls to 0 <img src=""img5289247050006208272.webp"">" What is perfectly inelastic supply?"PES = 0. Supply is fixed regardless of any change in price. Change in demand cannot be met easily. <img src=""img2787352277437101856.webp"">" Why is a high PES important to firms?A high PES means firms are able to respond quickly to any changes in price and demand What can a firm to do make their supply elastic?- Spare production capacity - Improve technology - Flexible working patterns What is the short run? Refers to a period of time in when at least one factor of production is fixed, usually capital. What is the long run?Refers to a period of time when all factors of production can be variable What is the elasticity of supply like in the short run vs the long run?Short run = Inelastic. Capital is fixed and it takes time to increase factors of production, making it it difficult to react to changes in price. Long run = Elastic. Firms can increase capacity as all factors are variable and have longer to react. What factors effect PES? (5 factors)- Levels of stock - Spare production capacity - Artifcial Limits - Factor mobility - Time Why do we see an elastic supply during Recessionary periods?because if a firm tried to expand their production, they would have a larger pool of labour to hire. Their ability to attract this labour is also high as people need jobs. What is market equilibrium?- Supply = Demand - This is the only price where the amount consumers want to buy is equal to the amount producers want to sell. What is disequilibrium?Disequilibrium is when the market supply and demand is not equal. What happens when the market is not at equilibrium?Functions of the price mechanism will ration away excess supply/demand How does disequilibrium occur?When there is excess supply or demand What happens when there is excess supply?"Excess supply will force producers to cut the price. Supply would contract and demand would extend until the equilibrium price is reached again. <img src=""img1449904620318890753.jpg"">" What happens when there is excess demand?"Excess demand will signal to producers that they can generate more profit by raising the price, and will do so. Demand will contract and supply will extend until the equilibrium price is reached again. <img src=""img3324761830742601074.jpg"">" What 3 assumptions does the equilibrium model have?- Ceteris Paribus - Supply and demand are independent from each other - All markets are perfectly competitive What does market forces mean?The free interaction of supply and demand What effect will a shift in the demand curve (but not in the supply curve) have on equilibrium?"- An increase in demand will cause an increase in price. Supply will extend and form a new equilibrium. - A decrease in demand will cause the price to fall. Supply will contract and form a new equilibrium. <img src=""img4098913574845696890.jpg"">" What effect will a shift in the supply curve (but not in the demand curve) have on equilibrium?"- An increase in supply will cause a decrease in price. Demand will extend and form a new equilibrium. - A decrease in supply will cause an increase in price. Demand will contract and form a new equilibrium. <img src=""img151987725010197873.jpg"">" If PED/PES is inelastic, what do shifts in the demand/supply curve have the greatest impact on?Price If PED/PES is elastic, what do shifts in the demand/supply curve have the greatest impact on?Quantity How do the functions of the price mechanism change equilibrium in a free market?1. Signal to firms price is to high/low 2. Firms incentivesed to change price 3. Rations away excess demand/supply 4 Allocates resources effectively What is joint demand?two goods are in joint demand if they are complementary e.g. ps4 and ps4 games What is derived demand?When the demand for one good leads to the demand for another e.g. an office and office furniture What is composite demand?Goods that have a number of uses in the production process. e.g. steel What is joint supply?A production process that can yeild 2 or more outputs e.g. cows milk and beef What does productivity measure?Productivity measures the output efficiency of firms and economies. What does input mean?The 4 factors of production: - Land - Labour - Capital - Enterprise What is the equation for labour productivity?Output produced in a given time ÷ total number of workers/total hours worked. How can labour be improved?- Better technology - More training - More education What is meant by division of labour?Division of labour involves dividing the workforce and allocating specific individuals to specific tasks. What is specialisation? Is when workers/firms focus on specific tasks to gain a greater degree of efficiency What are the advantages of specialisation?- Leads to economies of scale which can reduce long run average costs - Reduce cost of training - Increase labour productivity What are the disadvantages of specialisation?- lack of flexible labour (immoblie workers) - bored workers - over reliant on 1 firm What is the law of diminishing returns?If one variable factor of production is increased while the others stay fixed marginal product will initially rise then fall. What is marginal product(returns)?The extra output from adding one extra factor input What is total product(returns)?The total output from all factor inputs What is average product(returns)?Total product / number of inputs Why does the law of diminishing returns only apply in the short run?Because at least one factor of production stays fixed, usually capital. Explain what happens when MP initially rise then falls. (4 steps)"- Rises initially because of specialisation/utilisation of capital - then falls because fixed factors of production constrain production - for example a pizza shop with 5 ovens wouldn't benefit from from adding 6 or 7 or 8 workers - this all happens because of the law of diminishing returns" Why is total product maximised when marginal product = 0?"- If MP is positive, each factor input employed increases output, if MP is negative each factor employed decreases output. - Total product is maximised when adding an extra factor input doesn't change output in any way" How can productivity be improved? - Better training - Better management - Improved technology What is the relationship between MP and MC?When MC rises, MP is falling When MC falls, MP is rising What is marginal costs (MC) and the equation for it?Marginal costs is the extra cost of producing one more unit of output MC = change in TC ÷ change in quantity Why is the marginal cost curve U-shaped?"Law of diminishing returns <img src=""img3472408298566189405.jpg"">" How does marginal cost affect average costs?"When marginal cost < average cost = average cost is decreasing. When marginal cost > average cost = average cost is increasing. <img src=""img2489108578593737029.jpg"">" Why does MC cut AC at its lowest point?When marginal cost < average cost, average cost is decreasing. When marginal cost > average cost, average cost is increasing. So MC can only cut AC when the AC is neither increasing or decreasing, the lowest point. (MC=AC - Productive efficiency) What is the difference between fixed and variable cost?- Fixed cost do not vary with output - Variable cost vary with output How is average cost calculated?AC = TC ÷ Q Why is the AC curve U shaped?"1. AC is AFC + AVC 2. Initially AFC is falling as TFC is spread across more output and AVC is falling as workers specialise and begin to take advantage of underutilised capital 3. When LoDM kicks in my AVC rises as fixed factor cause a contraint to my variable factors 4. This will offset the effects of my AFC falling and cause AC to rise, explaining why it is 'U' shaped <img src=""img667583300437106892.webp""> " Why are AFC always falling?"Total fixed cost can be spread across greater output So you dividing a constant number by a number that is always increasing <img src=""img946850713666769322.jpg"">" What is economies of scale?economies of scale is a reduction in average cost due to operating on a larger scale (cost benefits of operating on a larger scale) What is purchasing economies of scale?- Large firms have bargaing power with suppliers and can gain discounts for buying in bulk What is risk-bearing economies of scale?- When a firm becomes larger, they can expand their production range so they can spread the cost of uncertainty. - If one part is not successful, they have other parts to fall back on. can help lower average costs What is managerial economies of scale? - Large firms are able to employ specialist managers who can make better decisions and have more experience What is marketing economies of scale?- Larger firms can divide their marketing budgets across larger outputs, so the average cost of advertising per unit is less than that of a smaller firm. What is financial economies of scale?- large firms can often borrow more money at a lower rate of interest as they are seen as less risky What is technical economies of scale?- Large firms can afford to invest in specialist equipment which can help to reduce average cost What is external economies of scale? A reduction in average unit costs because of activity not controlled by the firm What are examples of external economies of scale?- Local colleges with Qualifications - New roads that improve transport What is diseconomies of scale?An increase in average costs as a result of operating on a large scale What are some internal diseconomies of scale? - Wastage and loss can increase, as materials may seem in plentiful supply. - Communication becomes more difficult, with an increasing number of staff - Managers may be less able to control as workforce increases How can external diseconomies of scale occur?- If a whole industry becomes bigger the price of raw materials may increase since demand will be greater How could economies of scale lead to monopolies forming?- If average costs keep decrease firms can pass these reduced costs on to consumers in the form of lower prices undercutting competition and gaining a bigger market share - This can force other firms out of business and cause a monopoly What is returns to scale?Returns to scale describes the effect on increasing the scale of production/output What is increasing returns to scale?- When % change in output > % change in input. - Increasing all factors of production leads to a more than proportional increase in output. What is decreasing returns to scale?- When % change in output < % change in input - increasing all factors of production leads to a less than proportional increase in output What is constant returns to scale?- When % change in output = % change in input - Increasing factors of production will lead to a proportional increase in output What is the link between economies of scale and returns to scale?"- Increasing returns to scale contributes to economies of scale - Decreasing returns to scale contributes to diseconomies of scale <img src=""img5605404170017592788.jpg"">" What is the minimum efficient scale of production (MES)?- MES is the lowest level of output needed to be productively efficient - This is the lowest level of output where full EoS can be exploited and after this point a firm no longer receives EoS What is a LRAC curve? (Envelope Curve)"- A curve thats shows the minimum possible average cost at each level of output. <img src=""img5602766515918271933.webp"">" Why is the LRAC curve made up of multiple SRAC curves?- Initially a firm is confined by fixed factors of production - Eventually they can increase their factors of production until they are confined again by a fixed level of factors of production - this continue and makes multiple SRAC curves which make up the LRAC curve What can cause an upward / downward shift in the LRAC curve?"External economies and diseconomies of scale. <img src=""img3864074281812956257.jpg"">" "Why do some economists argue the LRAC curve is 'L' shaped?""- They argue although diseconomies of scale will occur with increasing output this will be offset with continued reduction in average costs. <img src=""img1401433065074578515.jpg"">" Why is the LRAC curve U-shaped?"- In the long run all factors are variable so a firm is able to increase all its factors, reducing average costs. - However as they continue to increase factors of production become harder to manage and coordinate properly, so average costs increase <img src=""img2120047021767060662.jpg"">" Why is the LRAC curve only below or equal to the SRAC curve?- For a firm to operate on its LRAC curve it must be using the most appropriate mix of factors of production - So in the short run cost can be reduced to this minimum level as some factors are fixed What is TR and the equation for it?Total amount from a firms sales TR = Q x P What is AR and the equation for it?revenue per unit sold AR = TR ÷ Q What is MR and the equation for it? Extra revenue incurred from selling an additional unit of a good MR = change in TR ÷ change in Q Why does AR = Price ?AR = TR ÷ Q = P x Q ÷ Q = P How do the curves for AR and MR look when there is perfect competition?AR = MR = D - The curve is horizontal when there is perfect competition as the firm is a price taker so demand is perfectly elastic - The firm must take the price set by the market and any increase in price will cause quantity sold to drop to 0 How does TR look when there is perfect competition?- TR is a diagonal straight line going from bottom left to top right - So when AR is constant TR increases proportionally with sales. Why does AR = D ?- Average revenue is Total Revenue ÷ Quantity - total Revenue = Price x quantity of output - each point on the curve represents the price of the product in the market. - Price determines the demand for a product, hence average revenue curve is also demand curve. Why is MR twice as steep as AR?- When a firm drops its prices is not just dropping its prices for the next unit sold but all the units its selling, even the units its already sold so MR will drop twice as fast as AR Why is MR = 0 when TR is maximised?- When MR is positive every additional sale bring additional revenue so TR increasing - When MR is negative every additional sale brings less revenue so TR is decreasing - TR can only be maxed when MR is neither increasing or decreasing so it is maxed when MR = 0 What is normal profit and when does it occur?Normal profit is the minimum level of profit required to keep opperating in the long run, but not enough to attract other firms into the market Normal profit is when AC = AR (0 opportunity cost) What is subnormal profit and when does it occur?Any economic profit below normal profit AC > AR In a perfectly competitive industry, what type of profit can be made?Only normal profit can be made In the long run, what type of profit is required for a business be sustainable?Normal profit at the very minimum What does the existence of supernormal profits signal?Signals to other firms to enter the market, but barriers to entry and competition must be considered What is the profit equation?Profit = Total Revenue - Total Cost What is supernormal profit?Any economic profit above normal profit and represents that a firm is making more money than in its next best alternative market AR > AC When is profit maximised? Why is this- when MC=MR - If marginal cost is less than marginal revenue, the firm could increase profit by expanding production. - If marginal cost is greater than marginal revenue, the firm could increase profit by reducing output. How is economic profit different to accounting profit?Economic profit cosiders both explicit (FC VC) and implicit (opportunity costs) costs Accounting profit only considers explicit costs. Price takers can only make what type of profit in the long run?"Normal <img src=""img1564509063683078393.jpg"">" What is key about a price making firm?"Supernormal profits can be made <img src=""img8838440790300988565.jpg"">" Why are no supernormal profits made in perfect competition in the long run?- Although in the short run supernormal profits can be made, this will signal to firms to enter the market, so these supernormal profits will be shared among multiple firms In the long run why will a firm shut down?If it cant make a normal profit Why wont a loss making firm close immediately in the short run?"- In the short run firms have fixed cost to pay even if they don't produce and cannot sell assets - so they will continue to produce with prices below AC as long as they cover AVC so fixed cost can start to be payed off" When will production be ceased immediately and why?"If in the short run the market price doesn't cover variable costs as this will only increase debts" What is the difference between an invention and innovation?- An invention is an advancement in knowledge. - An innovation involves putting that advancement to use in a new product or service. What is creative destruction?When Markets are destroyed and new ones created because of technological innovations What decisions does a government make?Governments decide how much they should intervene in the production and consumption process. What is the law of demand?The law of demand states that there is an inverse relationship between price and quantity demanded, all other factors constant. What is YED for normal luxury goods?- Normal luxury goods have a positive income elasticity - YED > 1 Why does MP cross AP at its highest point?"If marginal product is less than average product, then average product declines. If marginal product is greater than average product, then average product rises. <img src=""img7391846333707170734.png"">" In simple terms what does PES mean?How well can demand be met The less number of substitutes a good has, the more[...] its demand will be.The less number of substitutes a good has, the more inelastic its demand will be. Higher brand loyalty means that a good will have more price [...]demandHigher brand loyalty means that a good will have more price Inelastic demand Longer time to make purchasing decisions maked demand more price [...]Longer time to make purchasing decisions maked demand more price elastic A higher % of income speant on a good means that its demand is more price [...].A higher % of income speant on a good means that its demand is more price elastic. Why does MR=AR in perfect competition?MR = AR because each extra unit sold brings the same revenue as all the others At the point where PED is unitary TR [...] At the point where PED is unitary TR is maximised Prove using calculus that MR is twice as steep as ARlet AR be P = A - BQ TR = P x Q = Q(A-BQ) = AQ - BQ^2 MR = ChangeTR/ChangeQ DTR/DQ respect to q = a-2bq, which is twice the gradient as p - Consumer surplus is [...] - This is based on [...]- Consumer surplus is the difference between the price the consumer is willing and able to pay and the price they actually pay. - This is based on what the consumer perceives their private benefit will be from consuming the good. Diagrammatically, the area of consumer surplus can be seen [...] "Diagrammatically, the area of consumer surplus can be seen above the equilibrium price and below the demand curve <img src=""img3710889018252515332.jpg""> " - Producer surplus is the [...] - In other words, [...]- Producer surplus is the difference between the price the producer is willing to charge and the price they actually charge. - In other words, it is the private benefit gained by the producer, measured by profit. Diagrammatically the area of producer surplus can be seen [...]"Diagrammatically the area of producer surplus can be seen below the equilibrium price and above the supply curve <img src=""img5768504749359712057.png""> " What is a deadweight loss? How can this be shown on a diagram?"- is a measure of lost economic efficiency when the socially optimal quantity of a good or a service is not produced. <img src=""img5461689531415887129.png"">" What are some examples of ways firms can extract consumer surplus from consumers?- Monopolies: high prices redue consumer surplus - Price discrimination - Creating a more inelastic demand An increase in supply is likely to have what impact on consumer surplus?- Consumer surplus increases A decrease in supply is likely to have what impact on consumer surplus?- Consumer surplus decreases An increase in demand is likely to have what impact on producer surplus?- Producer surplus increases A decrease in demand is likely to have what impact on producer surplus?- Producer surplus decreases "How can the change in consumer surplus be represented on the diagram? <img src=""img9023504287027577768.jpg"">""By shading the region P1,F,E,Pe <img src=""img6550428132157467325.jpg"">" "How can the change in producer surplus be shown on the diagram? <img src=""img3973678062494168726.jpg"">""By shading the region P1,Y,Z,Pe <img src=""img5558682466536885179.jpg"">" The more elastic a good/service is, the [...] consumer surplus is gainedThe more elastic a good/service is, the less consumer surplus is gained The more elastic the supply of a good/service is the [...] producer surplus is gainedThe more elastic the supply of a good/service is the less producer surplus is gained The more inelastic a good/service is the [...] consumer surplus is gainedThe more inelastic a good/service is the more consumer surplus is gained The more inelastic the supply of a good/service is the [...] producer surplus is gainedThe more inelastic the supply of a good/service is the more producer surplus is gained If demand for a good is perfectly elastic what will consumer surplus be? Why?When the demand for a good or service is perfectly elastic, consumer surplus is zero because the price that people pay matches exactly what they are willing to pay. When demand is perfectly inelastic, consumer surplus is [...]. When demand is perfectly inelastic, consumer surplus is infinite. What is meant by market failure?- When the price mechanism leads to a misallocation of resources. - This means the price mechanism leads to a price and quantity that isnt best for society. What are the 7 reasons for market failures from the AQA spec?" <img src=""img2857214114580253126.jpg""> M\(^2\)PIIE" What is the difference between a complete and partial market failure?- A complete market failure occurs when a market simply does not supply products at all and we end up with missing products e.g. streetlights - A partial market failure occurs when a market supplies a good, but at the wrong quantity and/or the wrong price e.g. education What is a public good? What is the key distinction between public goods and other goods?- They are goods that are provided by the government - The are non-excludable & non-rival What is meant by non-excludable?- You cannot exclude or stop someone from consuming a good - e.g. if I pay to use a streetlight, I cant stop someone walking behind me from using it aswell What is meant by non-rival?- The quanitiy of the good does not diminish apon consupmtion - e.g. if I pay to use a beach, it doesnt reduce the quantity available to others What is the free rider problem? What happens as a result of the free rider problem?- Since consumers are all waiting for someone to buy the public good so they can use it for free, nobody actually demands the goods, so producers dont supply them as they wont make any profit - This could lead to a complete market failure as the market would not provide the public good A pure public good is [...] Examples include [...]A pure public good is always non-excludable, non-rival Examples include flood defence barriers, streetlights, fireworks What is a quasi-public good?Public goods that show some characteristics of privates goods How can some goods posses characteristics of private and public goods?- Roads can be non-excludable, but if toll booths are put in making people pay to use the roads they can be excludable - If there is alot of traffic on a road it can become rival as the road has been used by the other drivers What are some examples of quasi-public goods?- Roads - Parks - Beaches What is tragedy of the commons?- Private producers will act according to their self interest and unsutainably keep exploiting common access resources, leading to a depletion of that resource What is a natural public good (common access resource/commons)?Natural resources for which no private ownership has been established Private goods are [...]Private goods are excludable, rival and rejectable Explain the tragedy of the commons using an example"- For example in the 1960's English and French fishermen would travel to the east coast of canada to fish for cod. Since they couldnt be stopped and fish were reproducing faster than they were fishing the fish could be considered as non-excludable non-rival goods. - Then when the American and Canadians developed new boats that allowed them to carry more fish, the amount of fish they caught was greater than the rate that the fish were reproducing - Today there is only 1% of the total cod that there was in the 70's" Why should the government not provide public goods? (Evaluation points)- Lack of competition + no profit motive means poor quality of services e.g. bin collectors - If the government are the only providers this reduces choice and quanitity, which can result in productive, allocative and dynamic inefficiency leading to government failure - Vast opportunity cost the government suffer Why should the government provide public goods? (Evaluation points)- Government can provide goods on a much larger scale compared to the private sector + they have the lowest borrowing rates, which can allow them to gain economies of scale benefits and achieve productive efficiency - They make sure that essential public goods such as healthcare and education are provided as they provide positive externalities. The free market may struggle to provide these goods due to the free rider problem leading to a market failure - Helps develop long term growth and economic development through the provision of infastructure What are negative externalities?Costs which affect third-parties outside the price mechanism What is a negative consumption externality?A negative affect on a third party as a result of consuming a good What is a negative production externality?A negative affect on a third party as a result of producing a good Why is demand = marginal benefit?Its because the demand curve tells you the highest a consumer would be willing and able to pay for a good and that price is equal to MB since you wouldnt pay more than the benefit you get from something Why is supply = marginal cost?It because the supply curve tells you the lowest price a producer would be willing and able to supply a good for, and that lowest price is equal to marginal cost since you woudnt sell a good for less than what is cost to produce Negative production externalities are the same thing as [...]Negative production externalities are the same thing as external cost What is a social cost? What is the formula for social costs?The cost experienced by the whole of society Social costs = Private costs + External cost What is social benefits? What is the formula for social benefits?The benefits experienced by society as a whole Social benefits = Private benefits + External benefits How is net welfare worked out?Net welfare = Social benefits - Social costs Draw a negative externalities in production diagram, showing overproduction and a welfare loss"<img src=""img3827803497698823574.png"">" "What is the difference between these 2 curves? <img src=""img1093703584483273496.jpg"">"On the left external costs are the same for each unit produced On the right external costs are increasing for each unit produed "This red circle is know as the ............ <img src=""img2500713263985881972.jpg"">"Socially effecient equilibrium Draw a negative externalities in consumption diagram, showing overconsumption and a welfare loss"<img src=""img7804501332618387217.jpg"">" If the governemnt is to set an indirect tax to tackle production externalities, it will only be effective if [...]If the governemnt is to set an indirect tax to tackle production externalities, it will only be effective if the size of the tax is equal to the external cost When the government fix a negative production externality, we can say that it has been [...]When the government fix a negative production externality, we can say that it has been internalised How can regulation solve negative externalities market failures?- Completley ban certain goods that have high external costs e.g. class A drugs, guns - Reduce consumption of goods by having legal ages e.g. alchol, smoking - Reduce production of goods if they do not meet certain criteria e.g. cars What are positive externalities?Benefits which affect third parties outside the price mechanism Examples of negative externalities (consumption and production) include [...]Examples of negative externalities (consumption and production) include smoking, alchohol and pollution What is a positive consumption externality?Benefits to a third party as a result of a consumption of a good What is a positive production externality?Benefits to a third party as a result of the production of a good Draw a positive consumption externalities diagram, showing underconsumption and the potential welfare gain"<img src=""img4458275496469255451.jpg"">" Draw a positive production externality diagram showing underproduction and the potential welfare gain"<img src=""img8705298517613302169.png"">" Some ways to solve negative externality market failures include [...]Some ways to solve negative externality market failures include TPPS, Indirect taxes, Minimum prices and regulation Some ways to solve positive externality market failures include [...]Some ways to solve positive externality market failures include subsidies maximum prices What is a merit good?Merit goods are goods which are underconsumed because of either positive externalities or information gap . Examples of merit goods include [...]Examples of merit goods include education healthcare and healthy food What is a demerit good?Demerit goods are goods which are overconsumed or over-consumed because of either negative externalities or information gap . Examples of demerit goods include [...]Examples of demerit goods include alchol cigarettes surgary drinks Wether a good can be considered a merit or demerit goods depends on a [...]Wether a good can be considered a merit or demerit goods depends on a value judgement The 3 examples of market imperfections include [...]The 3 examples of market imperfections include monopolies, information failure and immobile factors of production What are the 2 types of information failure?- Incomplete information (Overconsumption and underconsumption) - Asymmetric information What is incomplete information?Incomplete information is when someone doesn’t have full information about the benefits or costs of their decisions. Why can incomplete information lead to overconsumption?- Consumers will be unaware of the full costs that consuming certain goods may have e.g. smoking, alchol, fizzy drinks Why can incomplete information lead to underconsumption?- Consumers will be unaware of the full benefits that consuming certain goods may have e.g. education, healthy food What is asymmetric information?When one party knows more than the other in a transaction What does symmetric information mean?All parties know as much as eachother in a transaction How can asymmetric information lead to market failures?If one knows more than the other in a transaction, they can easily be exploited, leading to a misallocation of their resources What are some examples of markets where there is a high presence of asymmetric information?- Used car markets - Used phones - Private healthcare How can monopoly power lead to market failure?Monopolies charge higher prices and produce lower quantities, exploiting consumers and leading to a misallocation of resources Why might a monpoly not lead to market failures?Since monopolies make long run supernormal profits, they can reinvest into R&D and new tech. If this outways the high prices consumers pay in the short run there will be no marlet failure. Factor immobility can be seperated into 2 types, [...] and [...]Factor immobility can be seperated into 2 types, geographical and occupational What is occupational immobility? Why can it lead to market failure?- Occupational immobility is when workers cant move between different jobs because they lack the skills needed - Occupational immobility leads to structual unemployment, which can cause a labour market failure How can the government intervene to prevent occupational immobility?- Subsidising education and apprentiships What is geographical immobility? Why can it lead to market failures?- Geographical immobility is when wokers struggle to move to the area where the jobs are located. - Without government intervention it can lead to unemployment, a labour market failure How can the government intervene to prevent geographical immobility?- Relocation subsidies - Improving transport What is regulation?Imposition of rules by the government backed by penalties that are intended to modify the behaviour of economic agents Examples of government regulations include [...]Examples of government regulations include speed limits smoking bans and legal drinking ages What is the price mechanism? - The interaction of supply and demand to determine prices. What are the 3 functions of the price mechanism?- Signalling - Incentivising - Rationing Explain how the price mechanism works1) Signals are sent to producers that their prices are too high/low 2) There are incentives to increase/decrease supply depending on if there is excess demand/supply 3) This increase/decrease in supply will ration away excess demad/supply taking us back to equilibrium What are some advantages of the price mechanism?- Can result in allocative effeciency as producers are supplying what consumers demand - Can opperate without the cost of people to regulate it - Prices are kept low as resources are used as effeciently as possible What are some disadvatages of the price mechanism?- Under provision of public goods - Inequality in incomes and wealth as only those with purchasing power benefit from the price mechanism *add to this Who are the CMA?The Competition and Markets Authority is a non-ministerial government department, responsible for strengthening business competition and preventing and reducing anti-competitive activities. What are the 4 key types of regulation the the CMA use?- Merger policy - Price regulation - Profit regulation - Performance targets and quality standards What is meger policy? How does it work?- When the CMA block merging that might give firms too much market power - The CMA will carry out an investigation if a firm merging gives 25% or more market share or £70 Million in revenue. They will only be blocked from mergeing if they think they will negatively harm consumers What is price regulation? What are the 2 types of price regulation?- A limit to how much firms can increase their prices - RPI + K & RPI - X What is the difference between RPI + K & RPI - X?- RPI + K allows for firms to increase their prices by the rate of inflation + k which is an additional amount so they can increase their supernormal profits - RPI - X allows for firms to increase their prices by the rate of inflation - x which is used to punish firms if they think they can be more effecient What is regulatory capture? What are examples of this?When regulators begin to favour the companies that they are regulating e.g. setting quality standards too low or allowing firms to increase prices by too much What is profit regulation? What are the benefits of this?- When the government can take 100% of a firms profit in taxes after they reach a certain profit limit - This can encourage firms to reinvest in new capital since then they cannot be taxed What are some examples of performance targets and quality standards?- Performance targets include, ScotRail, who have the performance target of 91.3% of its trains running on time and the NHS, each hospital has the performance target of responding to accident and emergency patients in less than 4 hours. - The Food Standards Agency (FSA) give out a quality standard as do the British Standards Institute (BSI) (childrens toys). What are ways that the CMA can promote contestability to tackle monpolistic firms? (4)- Deregulation - Privitisation - Helping small firms grow - Stopping anti competitive practises How can deregulation and privitisation lead to more contestable markets?- When regulation are removed they can lower barries to entry. This can lead to more firms entering the market which forces existing firms to lower prices, improve customer services and increase effeciency in order to survive - By privitising firms the government create more competiton as now there is incentive form firms to make profit, forcing them to be effecient What is competitive tendering? How does it work?- Competitive tendering is when the government outsources specific job contracts to the private sector. - Private sector firms bid to win the contract, by offering the best deal - the highest quality for the lowest cost. The government then chooses the firm which offers the best value for money - and awards them the contract! What are the types of anti competitive practises the CMA can prevent? What do they each mean?- Predatory pricing, when firms charge aggresivly below AVC to cut their competiton out of the market - Vertical intergration (forwards or backwards) is when firms take over other firms at different stages of the supply chain of the same product. By firms doing this they can create barriers to entry whereby other firms may struggle to access suppliers or retailers - Price collusion, when 2 or more firms agree to restrict competiton What are the 3 main ways that the government helps small businesses to grow?- Access to loans - R&D tax breaks - Subsidies What is privitisation?- The transfer of the ownership of a firm from the public sector to the private sector What are some advantages of privitisation?- Government revenue from selling firms - Increased competiton means improved efficiency and reduces x-inefefficiency - Competiton may result in lower prices for consumers What are some disadvantages of privitisation?- Natural monopolies: Sometimes it makes sense for one firm to be the sole supplier of a good. Privitising these types of firms can lead to undesired competition and wasteful duplication of resources - Government lose out on potential dividends since most privitised firms are often profitable - Regulation to stop private monopolies Privitisation may depend on? (Evaluation points)- The type of industry: healthcare education VS Telecoms - Quality of regulation - If the market is contestable and competitive What is nationalisation?The process of taking assets from private to public ownership. "In the 1980's firms like [...] were all privitised""In the 1980's firms like BT BP and British Airways were all privitised " Firms that were nationalised include [...]Firms that were nationalised include the coal industry and the national railway What are some advantages of nationalisation?- Greater economies of scale potential since the government can produce more output than the private sector, which can lead to productive effeciency - Public sector is more likely to focus on welfare and provision of services - Less likely to be market failures that arise from externalties What are some disadvantages of nationalisation?- Lack of supernoramal profits + Higher prices due to low competiton - Complacent and wasteful production = X-ineffeciency - Expensive to run state companies and therfore there is a burden on tax payers - Moral Hazard What is moral hazard? How is it a disadvantage of nationalisation?- Moral hazard is the idea that when someone pays for you problems your likely to take less care to avoid those problems - Politicians who make the decisions to nationalise firms will not suffer the burden if something goes wrong, taxpayers will Nationalisation depends on (Evaluation points)- Are PPPs (public private partnerships) or competitve tendering better alternatives - If there is good regulation of private sector industries - Level of competition: Nationalisation may not be needed if there is high levels of competition  What are some advantages of deregulation?- Reduced barriers to entry mean more competition is promoted = more choice for consumers = allocative effeciency - Higher incentive to minimise cost with more competition created, which leads to productive and X effeceincy What are some disadvantages of deregulation?- If there is a natural monopoly then deregualtion allows for more firms to enter the market which can lead to a loss of the natural monopoly, increasing average costs and leading to productive ineffeciency - Formation of oligopolies and local monopolies Deregulation depends on? (Evaluation points) - Short run VS Long run outcomes: If deregulation leads to local monopolies and oligopolies then in the long run this reduces contestability - Just because legal barriers to entry are removed doesnt always make a market more contestable > consider strategic and technical barriers - Levels of regulation on anti competitive behaviour What is governent failure?Government failure is when the government intervenes to correct a market failure but makes the allocation of resources even worse than before What are the 4 main causes of government failure?- Law of unintended consequences - Information gaps - Distortion of the price mechanism - Administration cost Explain how distortion of the price mechanism can lead to government failure (maximum price)E.g. In the New York housing market maximum prices are set so that homes are affordable to consumers. However these lower prices reduces the incentive for producers to supply which lead to excess demand and a shortage of houses. Explain how distortion of the price mechanism can lead to government failure (minimum price)"E.g in the 1970's the EU introduced minimum prices on argicultural foods to incentivise farmers to produce more but this only lead to excess supply and a contraction in demand. This resulted in food being wasted and disposed of creating pollution and damaging agricultrual soils" Give examples of how law of unitended consequences can lead to government failure- Speed bumps: they intend to slow traffic down but ambulance need to be places fast. It is estimated for every person that is save by a speed bump 85 die as a result of ambulances not being quick enough - Illegalising goods creates black markets What is the law of unintended cosequences?All government interventions have some unintended consequences Explain how information gaps can lead to government failuree.g. Rio Olympics; the government run £1.6 Billion over because they didnt have full information about the costs - In 2002 the government wanted to make an NHS online database to improve effeciency, but 9 years later they didnt complete it because they lacked full information on the costs and technology. They ended up scrapping the project altogether wasting £11 billion in tax payers money How can administration costs lead to government failure?"When the government impose laws and policies there are also costs of regulating. If these costs exceed the benefits of government intervention this can lead to government failure e.g. £21 Billion makes up the NHS's admin costs and it is estimated that 750 extra lives could be save every month if they could afford more medical supplies, despite a £150 billion budget " What are some disadvantages of regulation?- Encourages black markets and law breaking - Reduces innovation and dynamic effeciency - Regulatory costs What are some advantages of regulation?- Quick to implement and can reduce negative externalities e.g smoking bans, age limits on drinking - Effective for inelastic goods - Government regulations are generally imposed to benefit the greater society = allocative effeciency and welfare gains What is the effect of minimum prices to solving market failures? Show this on a diagram."- Increase the price of goods that may have negative externalities in consumption. Demand will contract as a result <img src=""img5654642700295930313.jpg"">" What are some negatives to using minimum prices? (2)- Not effective if demand is price inelastic - Consumers may turn to black markets Minimum pricing depends on (evaluation points)- Does it affect everybody equally (inequitable/regressive) - How effective is the minimum price (50p per unit of alchol) What is the effect of maximum prices to solving market failures? Show this on a diagram."- Reduces the price of goods which have positive externalities in consumption. This causes demand to extend and supply to contract <img src=""img5301143649953313490.jpg"">" What are some problems that arise from maximum prices?- Creates a shortage of goods with excess demand = government failure - Black markets where consumers may be exploited by paying higher prices - Low prices may mean lower quality goods - Enforcement costs What are the advantages of maximum prices?- Can be a cause for merit goods to become cheaper - Stops monopolies from exploiting consumers - Increase in consumer surplus Maximum prices may depend on? (Evaluation points)- Are alternatives better? (Subsidies) - Are they going to impact everyone equally (equitable) What are the disadvantages of indirect taxes to solve market failures?- Not effective for price inelastic goods - Regressive on lower income earning families - Black markets/Tax evasion What are the advantages of indirect taxes to solve market failures?- Often on everyday goods, which can significantly increase government revenue - Increases the price of demerit goods, which discourages their consumption - Encourages firms to change their behaviour e.g. making less sugary drinks How to you work out the revenue gained by an indirect tax/cost of a subsidy to the government?"Go to the new equilibrium, find the vertical distance and create a box from there <img src=""img268523123171110618.jpg""> " How do the diagrams of an indirect tax differ when the tax is specific VS Ad Valorem?"Specific Tax = Parallel shift Ad Valorem Tax = Pivotal shift <img src=""img3885059448636249019.jpg"">" What are some disadvantages of using subsidies to solve market failures? (2)- High cost which means there is a huge opportunity cost - Moral hazard: firms might get complacent and wasteful What are some advantages of using subsidies for solving market failures?- Reduces cost of merit goods = Increases welfare in society - Subsidies encourage investment = diverse products for consumers - Prices are kept low for consumers "Explain how TPP's work?"1) The governemt sets a cap of how much pollution can be emmited in a given year 2) Government allocate permits based on the size of firm (Larger firm = more permits) 3) Will distibute permits until 10% of permits remain, which are then auctioned of to other firms 4) A firm must now either become more eco friendly or buy permits of other firms "What are the disadvantages of TPP's?"- High costs of regulation - Pollution can be hard to measure = pollution cap may be wrong - Relocation of firms to countries with low pollution regulation "What are the advantages of using TPP's?"- Incentives firms to reduce pollution (so they can potentially sell permits) - Market based = effecient allcation of permits - Equitable for firms as it allows them to make choices Draw the short run shutdown diagrams for a firm that should leave and stay in the market"<img src=""img8600014298472539602.jpg"">" Draw the shutdown diagram for a firm that should close in the long run"<img src=""img1186770536488800913.jpg"">" What is a monopoly?A single firm that has full control of the market What is the difference between a legal monopoly and a pure monopoly?"Pure monopoly = A theoretical extreme whereby 1 firm has 100% market share Legal monopoly = When a firm has 25% or more market share on there own and has the 'power' to act like a monopoly" What assumptions does the monopoly market structure have? (5)- Firms profit maximise - High barriers to entry/exit - Imperfect information - Differentiated product - Firms are price makers<div>(Delete)</div> When modelling monopolies we assume there is [...] firm in the marketWhen modelling monopolies we assume there is 1 firm in the market Draw a monopoly diagram"<img src=""img6898289896842042185.jpg"">" What efficiency conclusions can be derived from monopoly? Productively inefficeint Allocatively inefficeint X-inefficeint Dynamically efficient What are some disadvantages of monopoly?- Allocative inefficiency: consumers have less choice with monopoly and pay high prices leading to reduced consumer surplus and a deadweight welfare loss - Productive inefficiency: they do not produce where MC=AC either due to a lack of competitive drive meaning they dont necessarily have to, or diseconomies of scale whereby a monopoly grows too large - X-inefficiency: complacent and wasteful production due to a lack of competitive drive - Inequalities that arise in neccesity markets What are some advantages of monopoly?- Dynamic efficiency = supernormal profits made in the long run which can be reinvested into r&d and new tech which can bring about benefits for consumers - Greater economies of scale potential as monopolies are larger in size and as result we may see lower prices than in competitve outcomes - Natural monopoly = If natural monopoly markets are regulated then they give society more desirable outcomes than if there was competition since it makes sence for that firm to dominate the market What are some evaluation points for monopoly?- Does dynamic efficiency really hold in the real world: profits may be spent by owners, payed to shared holders and workers rather than reinvested - Objective of the firm = The theory states that the monopoly will profit maximise but what if they have other objectives that intend to bring about welfare in society - Type of good/service = Necessity goods will have more extreme consequences if sold by a monopolist Draw a diagram comparing monopoly outcomes and competitive outcomes"<img src=""img5591804011053357517.jpg"">" Draw a diagram showing the economies of scale potential a monopoly has compared to competitve firms"<img src=""img8057859059869571641.jpg"">" What is a natural monopoly?a natural monopoly is when it is most efficient for 1 firm to be in the market e.g. TFL have 100% market share of London transport What is the argument for natural monopolies?- High sunk costs (for TFL estimated £129 billion pounds) - Huge economies of scale + first movers advantage Any firms entering these markets would create undesired competition and a wasteful duplication of scare resources Draw a natural monopoly diagram"<img src=""img4314841123883798443.jpg"">" When does productive efficiency occur?MC=AC When does allocative efficiency occur?When welfare in society is maximised MC = AR When does x-inefficiency occur?For a given level of output a firm is opperating above its average cost curve When does dynamic efficiency occur?When firms make long run supernormal profits What are legal barriers to entry?Any patents, copyrights or trademarks that stop new firms using ideas from an incumbent firm What are sunk costs?Costs which cannot be recovered when a firms leaves the market How does economies of scale create barries to entry?New smaller firms will be unable to compete with larger firms with economies of scale advantages as they will have much lower costs How does brand loyalty create barries to entry?New firms will unable to make sales as consumers will stay loyal to incumbent firms What are the 5 types of barries to entry? (Uplearn)"LEBAS <img src=""img5924565520628523679.jpg"">" What is meant by a constestable market?Contestable markets are markets where there are potential threats of competition (may not be actual competition) What is hit and run competition?"This occurs when new firm hit the market by undercutting incumbent firms and stealing their supernormal profits Then the incumbent firm will set it price to AC so only normal profit is made causing the new firm to 'run' and leave the market" What are examples of barriers to exit?- High redundancy costs = costs payed to workers as a reuslt of shutting down - Sunk costs - Penalties for leaving contracts early Why is it important to look a theoretical extreme markets like perfect competition?By looking at these types of markets it helps us undertsand what is wrong with real life markets when they have undesirable outcomes What are the features of a perfectly competitve market? (5)- 0 Barriers to entry/exit - Firm is a profit maximiser - Many buyers and sellers (infinite) - Perfect information of market conditions - Homogenous goods Draw the market and firm for a perfectly competitive market (short run)"<img src=""img5511213238341895255.jpg""> " In perfect competition firms are price [...]In perfect competition firms are price takers Why cant supernormal profits be made in the long run in perfect competition?Supernormal profits signal to firms that they should enter the market and since there are no barriers to entry and exit they will do so until only normal profits are made Draw the market for a perfectly competitve firm (Long run)"<img src=""img2470137083846071888.jpg"">" What efficiency conclusions can be made about perfect competition?- Static efficiency (productive and allocative) - X-efficiency - Dynamically inefficient What are the characteristics of contestable markets?- Low barriers to entry /exit - Large pool of potential entrants to the market - Good information of market conditions - Incumbent firms are subject to hit and run competition How has technology increased contestability?- Lowers barriers to entry/exit e.g. businesses moving online reducing start up costs - Increases the pool of potential entrants: firms can created new products and services disrupting current markets (uber, air bnb) - Increased information : this allows for firms to learn about costs and market conditions Why will a monopoly reduce their prices in contestable markets?- By reducing price they take away any incentive for new firms to join the market What are some advantages of contestable markets?- Movement towards static efficiency + x-inefficiency as contestable markets move firms towards competitve outcomes - Creation of jobs What are some negatives of contestable markets?- Cost cutting in dangerous areas e.g. environmental standards, health and safety, wages - Creative destruction: new firms destroy old markets due to advancements in technology leading to job loss - Anti competitve strategies may aries reducing contestability What are some evaluation points for contestable markets?- How long is the market contestable for? - Role of technology (will it be used for good or bad, say to collect data on consumers which allows firms to practise price discrimination) - Regulation What are the characteristics of oligopoly markets?Dominated by a few large firms (3-7) High barriers to entry/exit Interdependence Non-Price competition Differentiated goods (Similar but slightly different) What are some examples of sunk costs?- Advertisements - R&D What is price collusion?When 2 or more firms agree to limit competition What is the difference between overt collusion and tacit collusionOvert collusion is when 2 firms formally agree to limit competition e.g. contracts, spoken agreements and happens as a result of price agreements Tacit collusion is when firms limit competition without directly stating or formally agreeing and happens as a result of price leadership Why has the CMA blocked overt and tacit collusion?Overt collusion generally leads to higher prices which reduce consumer surplus and negatively harm consumers e.g. BA & Virgin Atlantic What are 3 ways that firms will compete on price?- Price wars = when firms try to undercut each other with lower prices to steal the other firms’ consumers - Predatory pricing = charging way below AVC to force other firms out of the market - Limit pricing = when an incumbent firm sets prices so that other firms do not enter the market What are some ways firms will compete based on non-price competition?- Advertising - Loyalty Cards (Tesco clubcard, Nandos Card) - Branding - Quality Why is uncertainty significant in oligopoly markets?- Decisions by one firm in the industry impact all of the other firms. Since it is hard to predict the decisions of other firms, this can lead to considerable uncertainty. What distiguishes collusive and non-collusive oligopolies?- Non-Collusive = Will comptete with eachother - Collusive = Will agree to restrict competition What is the difference between collusion and cooperation?Collusion is illegal whereas cooperation is allowed Describe the shape and elasticities of the kinked demand curve"- On the top section demand in elastic. This is because if a firm raises is price demand will fall sigificatlly as consumers will switch to cheaper substitutes. - On the bottom section demand is inelastic. This is because if a firm lowers its price competitors will also match them hence demand doesnt change that much <img src=""img2796228612905145851.jpg""> " Draw a complete kinked demand curve"<img src=""img5368730155590676841.jpg"">" In oligopolies when the market is in equilibrium this is due to price [...]In oligopolies when the market is in equilibrium this is due to price regidity Model a theoretical payoff maytrix for coca-cola and pepsi (game theory)"<img src=""img6219591159277847537.jpg""> " When the prisoners dilema has been solved the market is said to be in [...]. This is the dominant strategyWhen the prisoners dilema has been solved the market is said to be in nash equilibrium. This is the dominant strategy How are n-concentration ratios calculated?"Adding up the market share of 'n' number of firms. " The higher the concentration ratio the [...]The higher the concentration ratio the less competition there is in the market as few firms make up a larger bulk of the maret share What are some advantages of oligopoly markets? (2)- Cooperation in oligopolies may lead to improvements in industry standards - Oligopolies make supernormal profits which may mean they reinvest in R&D which can yield positive externalities What are some disadvantages of oligopolies?- The kinked demand suggests that there is high prices and low output which could lead to a misallocation of resources - When firms collude it may lead to a loss of consumers welfare since prices are raised and output is reduced - The absence of competition could mean that there is a loss of efficiency gains What is the difference between natural (technical) and artificial (stategic and legal) barriers to entry?Natural barriers are naturally present and cannot be circumvented e.g. EoS (MES), start up costs, sunk costs Artificial barries are created by the incumbent firm in order to reduce competition into the market e.g. predatory pricing, limit pricing vertical intergration What are the characteristics of monopolistic competition?- Many small buyers and sellers - Slightly differentiated goods (some price making power) - Good information of market conditions - Low Barriers to entry/exit In the short run the diagram for monopolistic competition will look the exact same as [...]In the short run the diagram for monopolistic competition will look the exact same as the monopoly diagram What does the long run position look like on a diagram for monpolistic competition and why?"In the long run, with low barriers to entry and firm attracted by supernormal profits, they will enter the market and compete the profits away until there is only normal profit to be made <img src=""img3793562258532194447.jpg"">" What are some advantages of monopolistic competition?- Models a more realistic market compared to perfect competition - Consumers get a wide variety of choice + competition drives prices low - Short run supernormal profits may be enough to reinvest and bring small dynamic effeciency gains What is the main disadvantages of monopolistic competition?- In the long run no efficiency gains are achieved How can we evaluate monpolistic competition?- Although the theory states that allocative effeciency is not achieved, high levels of competition could lead to lower prices which can increase consumer surplus - Although dynamic effeciency is not achieved in the long run, high levels of competition may mean that normal profits are reinvested in order to survive What is meant by efficiency?Efficiency considers how well we use inputs to achieve outputs Why may a firm choose to profit maximise?- Reinvest - Dividends for shareholders - Reward for entreprenership A firms business objectives are influenced by what 4 key stakeholders?"- Consumers - Workers - Managers/CEO's - Shareholders" Why may a firm not profit maximise?- Lack of knowledge of MR=MC - To avoid scrutiny by regulators, market authorities - Key stakeholder is harmed as a result What is profit satisficing?Sacrifising profit to satisfy as many key stakeholders as possible. Other than profit maximising, what are some other objectives firms may have?- Revenue Max - Sales Max - Profit satisficing Why may a firm choose to reveue max?- Economies of scale potential is greater than at the profit max quantity - Increase market share, since market share is measured by revenue - Principle agent problem What is the divorce of ownership and control and how does this lead to the principle agent problem?- As firms grow bigger, owners will sell shares to raise finances but in turn end up loosing majority of ownership in their company. - This can lead to the principle agent problem when the agent (e.g. the manager who runs and controls the business) pursues different objectives to the principal (e.g. the shareholders who own the business) - Generally shareholders will want to profit max while owners will want to revenue/sales max for bigger bonuses and to control a larger firm When does sales max occur? Why may a firm choose to sales max?AC=AR is when sales max occurs without making losses - Limit pricing / Loss leader - Economies of scale - Principle agent problem - Flood the market (develop loyalty then raise prices) What is price discrimination?When a firm charges different prices to different consumers for an identical good/service with no differences in costs of production What are the 3 conditions necesarry for price discrimination?- Price making ability (monopoly power) - Information to seperate the market into elastic and inelastic consumers - Prevention of resales (market seepage) What is the difference between first second and third degree price discrimination?1st = When consumers are charged the exact price they are willing to pay, and all consumer surplus is converted into monopoly profit 2nd = Firms charge lower prices when larger quantities are bought of the exact good 3rd = When the market is segmented into elastic and inelastic consumers Draw a diagram to represent first degree price discrimintation"<img src=""img5603400390279171833.jpg"">" Draw a diagram to represent second degree price discrimintation"<img src=""img7578989766821910321.jpg"">" Draw a diagram to represent third degree price discrimintation"<img src=""img2952672984289074428.jpg"">" What are the disadvantages of price discrimination?- Allocative inefficiency - Inequalities - Anti competitve practises What are the advantages of price discrimination?- Dynamic efficiency - Economies of scale - Some consumers benefit (2nd 3rd degree) What is significant about the point where AP and MP meet?- This is the point where AP is maximised - This is also productive efficiency What is marginal revenue product (MRP)? How is it calculated?How much extra revenue an extra worker will bring to a firm MR x MP (MPP) In labour markets why is demand = MRP?A rational profit maximising firm will demand labour based on how high MRP is What is the difference between goods markets and labour markets?- In goods markets, firms supply goods and we demand goods from firms - In labour markets, we supply labour, and firms demand our labour Why is the labour market supply curve upwards sloping?When wages go up people realise that they can make more money, so more people will be willing to work increasing the quantity supplied of labour Describe what happens when wages are above equilibrium and explain how the market will correct itself- When there are higher wages firms will demand less labour at the same time more workers will be willing to supply their labour - This will lead to an excess supply of labour aka unemployment - For those unemployed they will have no choice but to accept lower wages so that they can remain in work - So wages will decrease, quantity supplied of labour will fall, quantity demand for labour will increase and the market will return to equilibrium Describe what happens when wages are below equilibrium and explain how the market will correct itself- When wages are below equilibrium, there are less workers that are willing to work, but firms will be willing to hire more workers since wages are lower, leading to an excess demand of labour - For firms to hire workers, they must offer hire wages as a result - This will lead to higher wages, quantity demaded of labour will fall and quantity supplied will increase What is meant by elasticity of demand for labour?How responsive demand for labour is to changes in wages What is meant by elastic labour demand?A small % change in wages will lead to a bigger % change in labour demand e.g. Mcdonalds til workers wanted higher wages they would significantly reduce QD, and replace them with self service machines What is meant by inelastic labour demand?Any % change in wages would lead to a smaller % change in labour demanded e.g. If superstar football players demand higher wages, teams need these players so they wont be very responsive in reducing demand What are the 4 factors that influence ED for labour?"Think 'SECT' 1) Substitutes (labour & capital) 2) PED for the product 3) % Of total Cost 4) Time" How do substitutes affect the ED for labour?For example, if it easy to substitute or replace workers when there wages go up, demand for labour will be elastic But if it is harder then demand for labour will be inelastic How does % of total cost affect ED for labour?When wages make up a small % of a firms total cost, demand for labour will be more inelastic e.g. in a big car company, where machines and parts make up most of the costs, if wages went up by alot firms wouldnt care because they make up a small % of total costs When wages make up a lager % of a firms total cost demand for labour will become more elastic e.g. in a tutoring firm, tutors make up the majority of there costs, so if wages increased by alot, those firms would be significanlty effected since wages make up majority of there costs. How does time (SR vs LR) affect ED for labour?In the short run, there wont be enough time for a firm to find substitutes when wages increase, making there demand for labour inelastic In the long run there is enough time for a firm to find substitutes when wages increase, making demand for labour elastic The supply curve for labour shows [...]The supply curve for labour shows the relationship between the wage rate and number of workers willing to work in an occupation Inelastic demand = [...] wages Elastic demand = [...] wagesInelastic demand = higher wages Elastic demand = lower wages What is meant by inelastic supply of labour?A large % increase in wages will lead to a smaller increase in quantity of labour supplied e.g. If there was a large increase in wages for heart surgeon, supply would only increase by a bit since it is so heart to become a heart sugeon What is meant by elastic labour supply?A % change in wages leads to a larger % increase in the quantity supplied e.g. if Mcdonalds increased wages there would be a significant increase in the quantity of labour supplied since it doesnt require much to work at Mcdonalds What are the factors that influence elasticity supply of labour?- Skills & Qualifications - Unemployment levels - Time How do skills and qualifications influence the elasticity supply of labour?The more skills and qualifications you need the more inelastic the supply of labour is The less skills and qualifications you need the more elastic the supply of labour is How do unemployment levels influence the elasticity of supply of labour?Higher unemployment means that when there is an increase in wages, there will be a greater % increase in the number of people willing and able to work since alot of people wont have jobs i.e elastic supply Lower unemployment means that when there is an increase in wages, there will be a smaller % increase in the number of people willing and able to work since most people will have jobs i.e inelastic supply How does time influence the elasticity supply for labour?In the short run, there wont be enough time for workers to apply/and train for jobs at short notice, so if wages increased quantity supplied of labour wouldnt increase by alot i.e inelastic supply In the long run supply will become elastic because there’s lots of time to apply and train for the job so if there is an increase in wages workers are likely to be more responsive What does the labour demand curve show us?It shows us how many workers will be hired at a given wage rate, in a given period of time The marginal revenue product theory states that [...]The marginal revenue product theory states that the demand for any factor of production depends on its marginal revenue product Why does the MRP curve rise initially and then fall?Law of diminishing returns (Same reasons as MP) When we model MRP we are assuming that [...]"When we model MRP we are assuming that firms are wage takers, in a perfectly competitive labour market <img src=""img140884354139270083.webp""> " Perfectly competitive firms will hire workers up to where [...] This is because [...]Perfectly competitive firms will hire workers up to where MRP = W/MC of L This is because if a firms was to hire an extra worker they would begin to lose revenue And if a firm employed a worker less, this would be an irrational choice since that extra worker would of brought in more revenue Draw a labour market diagram for a firm and the industry [...]"Draw a labour market diagram for a firm and the industry <img src=""img2834133066017653831.webp""> " What are some criticisms of MRP theory?1) In certain professions it may be harder to measure productivity, e.g. teachers because the output that a teacher produces isnt marketed (no numerical value so you cant work out MRP) 2) Self employed goes against the theory 3) MRP takes the assumption that labour markets are perfectly competitive, trade unions may bargain for higher wages, which has nothing to do with a workers MRP or monospsony with lower wages What are the factors that can shift the labour demand curve?"Think ' PDPC' - Change in the final price of the product labour is making - Change in demand for the for the final product - Change in labour productivity - Change in the price in capital" How can a change in the final price of a product shift the demand curve for labour?If the price increases, then a workers MRP is going to increase as a result, (this makes alot of assumptions), this will shift demand to the right How can a change in demand for the final product cause a shift in labour demand?If there is an increase in the demand for a good or service, there will be a derived demand for labour, so demand for labour will shift to the right How can changes in labour productivity cause a shift in labour demand?An increase in labour productivity is going to increase the marginal revenue product of labour (Since MRP = MP x MR) so demand for labour will shift to the right How can a change in the price of capital impact labour demand?Since in the long run a firms factors are variable if the price of capital is lower than for labour, we may see less demand for labour (substitutes) How does the PED of a product impact the elasticity of the labour demand curve?E.g. If demand for a good is inelastic and wages go up, they are not likely to cut there workforce significantly as they can pass the cost on to consumers If demand for a good is elastic and wages go up, they cant pass these costs on to consumers since this will cause TR to fall, so more workers may be fired i.e. reduced demand for labour Describe the following (labour markets) - Income effect: [...] - Substitution effect: [...]Describe the following (labour markets) - Income effect: incomes will rise as wages rise, but with to potential that individuals will reach a target income (can be +/-) - Substitution effect: as wages increase, the opportunity of cost of leisure time increases aswell (always +) Draw an individual workers labour supply curve, explaining its shape"<img src=""img8921607420589793619.jpg""> - When wages rise from a low level, an individuals supply of labour increases since an individual is more willing to work at higher wages to improve there standard of living (+ income effect, + sub effect) - As wages rise, the opportunity cost of lesiure time rises, but individuals begin to reach a level of income that they are happy with, so num of hours worked reduces (- income effect) - When the curve bends back on itself, we assume at this point individuals have reached their target income, so even with higher wages they wont be willing to work more and give up leisure time." Draw labour supply curve for an entire industry"<img src=""img1511259430243412781.jpg"">" For an individual firm, show the 2 different supply curves for labour"<img src=""img8332118588092292750.jpg"">" Why is an individuals supply for labour curve backwards bending but the industry supply curve upwards sloping?- We assume that people trained in a given profession but work elswhere + those retired, will enter into this market What are some factors that will cause the labour supply curve to shift? (5)"Think 'SOIND' - Size of the working population - Overtime - Improvements in occupational mobility of labour - Non pecuniary benefits (fringe benefits, long holidays, employee discounts) - Different wages in substitute occupations" What are some of the characteristics of perfectly competitive labour markets? (5)- There are many potential workers and employers - Labour is homogenous - There is perfect information (workers know the wages, firms know how good workers are) - Firms are wage takes - No barriers to entry/exit Wage differentials would not exist in perfectly competitive labour markets. If they do exist this implies [...]Wage differentials would not exist in perfectly competitive labour markets. If they do exist this implies labour market imperfections What is the benefit of studying perfectly competitive labour markets?- It gives us a bench mark to compare real world labour markets - If we dont get wage differntials in perfectly competitve labour markets, then we can learn that there must be things going wrong with real world labour markets What are the characteristics of imperfect labour markets?1) Labour is not homogenous (Different MRP, Different supplies of labour, Discrimination) 2) Labour is not perfectly mobile (Geographical, occupational, lack of information) 3) Non-monetary considerations (In perfectly competitive labour markets the assumption is that workers base the choice to work one wages alone) 4) Trade unions and supply restriction 5) Monopsonies and wage setting ability What are wage differentials? - The differences in wages between different groups of workers in similar occupations What is a monopsony?- The sole/dominant employer of labour in a given profession - e.g. Teachers, Nurses (UK) Mcdonalds, Walmart What are the characteristics of a monopsony? (3)- Wage makers (ability to set there own wages) - Hire up to where MRP=MC(L) - Reduce employment & Wages Draw a monopsony diagram comparing competitive labour market outcomes to monopsony labour market outcomes"<img src=""img15815685061810648.png"">" Why is the MC (L) twice as steep as the AC(L) for a monopsonist?Although a monopsonist has wage making power, if it wants to change wages, its not just changing the wage for each additional worker, it for all the workers that came before This implies that the MC(L) will be greater than the AC(L) What are the 2 main things we can derive from the monopsony diagram?- Wages and Employment are significanlty reduced - Workers are payed a wage (Wm) much lower than there MRP The lower wages are compared to MRP the [...]The lower wages are compared to MRP the greater the monopsony power that exist in that market Proof mathmatically that the supply of labour is equal to the average cost of labour"1) The supply curve for labour shows us the amount of people willing to work at different wage rates 2) Since this is an upwards sloping linear line we can model this as W = mQ + c 3) AC(L) = TC(L) / Q = (W x Q)/Q 4) The Q's will cancle out leaving AC(L) = W, and since W = A supply curve function the AC(L) must also equal the supply of labour" What is a trade union?- An organisation thats formed to represent the best interest of a group of workers, and bargain for higher wages What is meant by a closed shop trade union?All the workers are part of 1 trade union, i.e, there are no other trade unions With strong trade unions we assume that the TU [...]With strong trade unions we assume that the TU is a monopoly supplier of labour, controling the supply of labour a given wage rates Describe the impact using a diagram that a trade union will have on competitve labour markets"<img src=""img6468061756383223086.jpg""> 1) The trade union will bargain for a higher wage, above the competitive wage 2) At that wage there is a limit to the number of workers happy with the wage rate, shown by the existing supply curve 3) This is because all the workers below that point would of already been happy with a wage below the TU wage since thats what they had been working for 4) Beyond that point the employer would have to raise wages in order to attract in more workers 5) Wages will rise and there will be excess supply of labour (unemployment)" What are the disadvantages of trade unions on competitve labour markets? (2)- They raise costs for firms - They increase unemployment, real wage unemployment How can we evaluate trade unions on competitve labour markets?- Although they make efficient labour market outcomes worse, for a monopsony labour market they could be making things better - Depends on the strength of the trade union (how large the union is) - The real world shows us that trade union strength is actually very limited Give examples of how in the real world the power of trade unions is very limited- 1970 trade union act: Closed shop trade unions are illegal, vote for strikes in secret, can only strike if 75% of the trade union agree - Restructuring of the UK economy: Movement away from large manufacturing jobs where people would work under 1 firm, to service sector jobs, which makes it alot harder to organise trade unions - Competitve pressures: Firms can reject trade union wages in order to keep their costs low and remain competitive Explain using a diagram the impact a trade union will have on a monopsony"<img src=""img2592699476431068407.jpg""> 1) Trade unions will bargain for a wage above Wm 2) The monopsonist becomes a wage taker up until a limit, because there is a limit to the number of workers willing to work at that new wage rate 3) The supply curve will also become the MC(L) and AC(L) until that limit 4) At that limit the monopsony must increase wages to attract more workers. But the key is thats not just for the next worker its for every other worker that follows, so the MC(L) will revert back its shape 5) Employment and wages will increase as a result of this TU " What is the UK national minimum wage?An act first introduced in 1999 to stop firms setting wages so low that there workers couldnt afford a good standard of living For 23 and over it is £8.91 Show the impact of a minimum wage on a perfectly competitve labour market and a monopsony labour market"<img src=""img7129681658284142978.jpg"">" What are some advantages of minimum wages?- Creates incentive for people to work - Fiscal benefit to the government (Reduced benefits payments + Tax revenue from people working) - Boost in morale > workers become more productive - Improve inequality, reducing the gap between the rich and the poor What are some disadvantages of minimum wages? (4)- Can create unemployment (real wage unemployment) - Can cause cost-push inflation because of increased production cost - Unattractive to FDI if NNW is too high, since there is no point of outsourcing in the UK with higher costs - Can cause other pay groups to request higher wages, further increasing costs, and leading to wage push inflation Minimum wage depends on (Evaluation points)- Elasticities of demand/supply for labour: the more elastic the greater the impact of unemployment from a minimum wage, the more inelastic the lesser the effect - Is it high enough to incentivise those on benefits to join the labour force *Add to* What is meant by monopsony power?The ability to change wages Why is that firms in perfect competition are more likely to be profit maximising than a monopoly?- In perfect competition have no choice but to profit maximise in order to survive in the market - A monopoly can choose any price and output between MR=MC and normal profit Explain why the divorce of ownership and management can happen in a firm?- In smaller firms, managers are generally the owners - As a result the day to day running of the firm is done by the owners seeking profit - But as a firm wishes to expand production, they will need to raise shares. - Firms will sell shares to raise funds and expand, but in the process the ownership gets diluted - As a result larger firms will become dependent on specialist managers who are employed to run the business on behlaf of the shareholders

econ

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