Edexcel Econ Paper 1: Market Failure and Firm Objectives

This set of 29 vocabulary flashcards covers Edexcel Economics Paper 1 topics, focusing on market failures related to sugary drinks (negative externalities, demerit goods, and taxes) and business objectives (profit/revenue maximisation and the principal-agent problem).

Indirect Tax

A tax levied on expenditure on a good or service paid by the consumer indirectly.

Demerit Good

Products or services that are consumed to a greater extent than is considered socially desirable from the perspective of society as a whole.

Negative Externality

Occurs when the consumption or production of a good causes a harmful effect to a third party, not involved in the economic transaction.

Healthcare (as a Rivalrous Good)

A good where consumption by more people takes away from third-party usage, resulting in increased waiting list times and usage of capital.

Derived Demand (Demerit Goods)

When demand for healthcare shifts as a result of health problems caused by the consumption of products like sugar.

20% Tax Mechanism

An intervention intended to shift MPB inwards towards MSB by passing costs to consumers, moving quantity from $Q1$ closer to $Q^*$.

$$Q^*$$

The socially optimum level of output where externalities are fully accounted for.

Welfare Loss

The loss of economic efficiency that occurs when the market does not reach the socially optimum level of output.

Price Inelasticity (Sugar)

A characteristic caused by sugar being habitual or addictive with few substitutes, meaning demand reduces less than proportionately when price increases.

Duopoly (Sugary Drinks)

A market structure dominated by two large firms, specifically identified as Pepsi and Coke, which operate at very low LRAC.

Predatory Pricing (Tax context)

A concern where large firms absorb tax costs or lower prices to undercut smaller competitors, potentially increasing monopoly power.

Product Reformulation

When firms reduce sugar content below the tax threshold to maintain profit margins and avoid price increases for consumers.

Allocative Efficiency (Self-correction)

Occurs when the market self-corrects towards $Q^*$ due to firms reformulating products or consumers shifting to sugar-free alternatives.

Revenue Maximisation

An objective where firms aim to achieve the highest possible total revenue (price $\times$ quantity sold), occurring where $MR = 0$.

Profit Maximisation

An objective where firms achieve the highest possible difference between total revenue and total costs, occurring where $MC = MR$.

Business Objectives

A range of goals for a firm including profit maximisation, revenue maximisation, sales maximisation, satisficing, and survival.

Divorce of Ownership and Control

The separation between the shareholders of a company and the managers who make day-to-day decisions.

Principal-Agent Problem

A conflict in priorities where managers (agents) pursue their own interests, such as bonuses, rather than the shareholders' (principals') interests.

Baumol’s Theory

The theory that managers and workers do not see profit-maximising cost cuts or output reductions as beneficial, favoring revenue-based goals instead.

Tesco’s (Firm Objective)

An example of a large PLC that acts at revenue maximisation rather than profit maximisation.

Satisfactory Profit Level

The level of profit managers are forced to perform at to align with shareholder objectives and avoid being replaced.

Management Share Incentives

A modern strategy in large PLCs to ensure managers act in their own self-interest to maximize shareholder value and profit.

Market Discipline

The process by which persistent failure to profit maximise leads to underinvestment, forcing the firm to correct its objectives to remain competitive.

SME’s (Small and Medium Enterprises)

Businesses that constitute 99% of UK firms, where the owner and manager are typically the same person.

Enterprise Reward

The profit that serves as the incentive and reward for the owner who bears the risk of the business.

Marginal Private Benefit (MPB)

The benefit to an individual consumer from consuming a good, which shifts inwards when a tax is applied.

Marginal Social Benefit (MSB)

The total benefit to society from a good, which is less than the private benefit in the case of a demerit good.

Sales-based Bonuses

Rewards provided to managers based on firm size or revenue, which often drive the principal-agent problem.

Retained Profit

The portion of profit kept by a firm to reinvest in the business to maintain long-term competitiveness.