Micro loose ends

What are the types of market failure?

Every Monday dogs play catch in muddy fields

Externalities

Merit goods

Demerit goods

Public goods

Common access resources

Income inequality

Monopoly power

Factor immobility

What is a merit good?

Good deemed more beneficial than consumers realise MSB>MPB

What are examples of merit goods?

Hospitals, education, exercise

What type of failure is with merit goods?

Information failure, asymmetric information

This can cause irrational decisions

What is adverse selection?

When one party has greater knowledge than another party e.g car seller

What is moral hazard?

People take greater risks when they are insured, behaviour change after transaction

What’s a demerit good?

Goods that are more harmful than consumer realise. MPB>MSB

What are examples of demerit goods and why do they fail?

Cigarettes, alcohol, gambling

Fail due to information failure and asymmetric information

What are features of public good?

Non-excludable (no efficient way to price) and non-rivalry (quantity doesn’t diminish upon consumption)

What are examples of public goods?

Flood defences, road signs, street lights, roads and beaches

What is the free rider problem?

People wait for others to contribute to public goods then benefit without paying, leads to complete market failure of missing market

What is a quasi public good?

A public good which can be excludable and/or rivalrous such as roads and beaches

What are common access resources?

Resource with no private ownership that has been established

What do common access resources lead to?

The tragedy of the commons such as for seafood, people will deplete the good especially firms to make money which will lead to the good no longer existing. Negative externality of production from their self interest

What is government failure?

When the costs of intervention outweigh the benefits of intervention , worsens resource allocation and harms social welfare

What are the 4 types of government failure?

Information failure - Valuing externalities

Regulatory capture - when regulating monopoly power, CEOs influence regulators

Admin and enforcement cots are very high - Regulation, subsidies, state provision and price controls

Unintended consequences - Black markets, impact on poor, impact on firms, employment

How does an indirect tax work on NE of production?

Increase costs of production, internalises externalities as polluter pays, solves overconsumption, promotes allocative efficiency

MPC + Tax = MSC

How does indirect tax fix NE in consumption?

same as production but curve shifts MSC=MPC upwards which lowers quantity and increases price, at society optimal level

Where does indirect tax not work?

Price inelastic demand

Setting tax at the wrong level

Regressive

Black markets

What does the government subsidise?

Merit goods or goods with positive externalities

What does subsidising merit goods do to its externality curve?

Shifts MPC outwards, for production it shifts MPC equal to MSC

What are the drawbacks of subsidy?

Costs

Setting it at the right level

Will firms use it correctly

Price inelastic demand

What is regulation?

Non-market approach to solve market failure, law that must be followed by economic agent to encourage change in behaivour

What are drawbacks of regulation which lead to market failure?

Cost

Setting the right regulation

Black markets and unintended consequences

Equity

What are the stages of tradable pollution permits?

Set a cap, permits issued to match cap, firms make decisions based on least cost, enforcement. Lower pollution to social optimum, allocative efficiency

What decisions will firms make to reach pollution cap?

Invest in green technology

Buy spare permits

What are long run incentives of tradable pollution permits?

Investing in green tech:

Increases profit and they are not burdened when permits price rise

What are drawbacks of tradable pollution permits?

Enforcement

Imperfect information for government

Unintended consequences

Need for international cooperation

How does state provision solve market failure?

Government provide these merit goods as firms will not due to profit motive, they solve equity issues

What is the issue with government providing merit (public goods)?

There is excess demand and it is very difficult to solve

Cost

Imperfect information

Inefficiency of state organisations

How do property rights work?

There is incentive to not exploit common access resources, negative externalities are internalised so if enforced Q is reduced to socially optimum level

What are the drawbacks of property rights?

Can they be distributed efficiently

Enforcement is needed which has a cost

Equity - Who gets the rights?

What is productive efficiency?

Minimum of AC at any quantity

What is X efficiency?

When a firm is operating on the average cost curve at any given quantity

What is dynamic efficiency?

When long run SN profit is reinvested

What is the shutdown condition

AR=AVC

What is a market economy?

Markets are allowed to be free

What is a command economy?

Things like socialism

What are the benefits of the free market?

EPIC

Allocative efficiency

Competition

Dynamic efficiency so investment

Job creation and economic growth

Freedom, liberty and choice

No risk of government failure

What are the drawbacks of the free market?

Markets can fail

Inequity

Excessive profiteering

Creative destruction

Price volatility

What are advantages of specialisation?

Higher output

Wider range of goods/services

Greater allocative efficiency

Higher productivity through better use of workers

Quality improvements

What are disadvantages of specialisation?

Finite resources

Changes in fashion/tastes

De-industrialisation

National interdependence

What are advantages of division of labour?

Workers highly productive

Specialist capital for workers

Lower prices, higher quantity/choice and quality

What are disadvantages of division of labour?

Worker demotivation

High worker turnover

Risk of long term unemployment

Highly standardised goods/services

Which part of the demand curve is elastic?

The first half and the second is inelastic

What are returns to scale?

Positive %output>%input

Negative %output<%input

Constant %output=%input

What is the minimum efficient scale?

The lowest level of output required to fully exploit all EoS

What are the types of internal EoS?

Risk bearing

Managerial

Financial

Purchasing

Technical

Marketing

What are types of external EoS?

Better transport infrastructure

Component suppliers move closer

R&D firms move closer

What are types of DEoS?

Communication

Coordination

Control

Motivation

PC conditions?

Many buyers/sellers, Homogeneous goods, Perfect information, Price takers, No barriers to entry/exit

When is total revenue maximised?

MR=0 as it cannot rise anymore

What are explicit and implicit costs?

Explicit are physical costs like TFC and TVC

Implicit is opportunity cost

Why are firms profit maximising?

Reinvestment

Dividends for shareholders

Lower costs and prices for consumers

Reward for entrepreneurship

What are drawbacks of profit maximising?

Knowledge of MC and MR needed

Greater scrutiny from regulators

Key stakeholders harmed

Other objectives are more appropriate

What is profit satisficing?

Sacrificing profit to satisfy as many key stakeholders as possible

Why do firms revenue max?

EoS

Predatory pricing (undercut and drive competitors out)

Principle agent problems (Persuade shareholders with benefits)

When do firms sales max?

AC=AR

Why do firms sales max?

EoS

Limit pricing, takes incentive of profit from new firms

Principle agent problem

Flood the market

What is the principal agent problem?

When there is a divorce between ownership and control

What are some other examples of firm objectives?

Survival

Public sector organisations (P=MC which is allocatively efficient)

Corporate social responsibility

Where on a graph does profit satisficing occur?

Anywhere between profit and sales max along AR curve

What are the 4 main barriers to entry?

Legal - Patents, licenses, red tape, standards, insurance

Technical - Start up costs, sunk costs, EoS, natural monopoly

Strategic - Predatory pricing, limit pricing, heavy advertising

Brand loyalty

What are 4 barriers to exit?

Undervalued assets

Redundancy costs

Penalties for leaving contracts early

Sunk costs

What is society surplus and when is it maximised?

Producer + Consumer surplus

Maximised at allocative efficiency MC=AR

What is productive efficiency?

Lowest point of LRAC curve, fully exploiting EoS

What is X-efficiency?

Minimising waste and producing on AC curve

What is dynamic efficiency?

When LR supernormal profit is re-invested

What is static vs dynamic efficiency?

Static - allocative, productive and x. Occur at one production point

Dynamic - happens over time

What does allocative efficiency do to consumers?

Resources follow demand of consumers

Low prices

Maximisation of consumer surplus

High choice and quality

What does allocative efficiency do to producers?

Retain or increase market share

Stay ahead of rivals

Increase profit

What does productive efficiency do to consumers?

Lower prices

High consumer surplus

Full exploitation of EoS

What does productive efficiency do to producers?

More production at lower AC

Higher profit

Lower prices = Greater market share

What does dynamic efficiency do to consumers?

New innovation

Lower prices over time

High consumer surplus

What does dynamic efficiency do to producers?

LR profit max

Lower costs over time

Retain/increase market share

Stay ahead of rivals

What does x-efficiency do to consumers?

Low prices, high consumer surplus

What does x-efficiency do to producers?

Lower costs, higher profits

Increase market share

What is the shutdown condition?

When PC firms should consider a shut down AR=AVC

What is the breakeven condition?

Normal profit AR=AC

Why do PC firms stay with a subnormal profit like the diagram?

AR is covering AVC so they can hope firms leave the industry due to higher costs and then can convert their subnormal into normal profit

Features of monopoly?

One seller dominating market >25% or pure 100%

Differentiated products

High barrier to entry and exit

Imperfect information

Firm is profit maximising

What is the efficiency of this monopoly?

Dynamic efficiency as they will reinvest LR profit

What is welfare loss?

A loss in society surplus due to inefficient allocation of resources

Why are monopolies bad for society surplus?

They lower society surplus in the economy leaving a DWL

What is price discrimination?

Setting different prices to different consumers for an identical good/service

What conditions are needed for price discrimination?

Price making ability

Information to separate the market (such as elasticity)

Prevent re-sale (Market seepage)

What is 1st degree price discrimination?

Charging consumers what they are willing and able to pay to achieve monopoly profit so no consumer surplus

What is 2nd degree price discrimination?

Lowering last minute pricing to get away all excess supply e.g airlines . There is a gain in CS

What is 3rd degree price discrimination?

Separating consumers into different PEDs e.g train tickets more expensive for daily travellers than leisurely travellers

What are pros and cons of price discrimination?

Dynamic efficiency, EoS, Some consumers benefit, Cross subsidation

Allocative inefficiency, inequalities, anti-competitive pricing

What characteristics does a natural monopoly have?

Huge fixed costs

Enormous potential for EoS

Rational for 1 firm to supply entire market as competition is undesirable

Competition would result in wasteful duplication of resources and non exploitation of full EoS

What is good about natural monopoly?

Regulators make them produce at lower price to allocative efficiency level but government subsidise them so they are not in a loss

What are cons of monopoly?

Allocative, productive and x inefficiency

Inequalities in necessity markets

What are pros of monopoly?

Dynamic efficiency

Greater EoS

Natural monopoly

Cross subsidisation

What are pros of competitive markets?

Allocative, productive and X efficiency

Jobs

What are cons of competitive markets?

Lack of dynamic efficiency

Lack of EoS

Cost cutting in dangerous areas

Creative destruction

Features of MC?

Many buyers/sellers

Differentiated goods - Price makers and PED

Low barriers

Good information

Non-price competition

Firms are profit maximisers

Features of oligopoly?

Few firms

Differentiated goods - price makers

High barriers

Interdependence - Price rigidity

Non-price competition

Profit max not sole objective

How does the kinked demand curve work?

Shows interdependence, PED is initially elastic as firms will not raise price to obtain market share but becomes inelastic after a point as firms will also lower prices to increase their market share.

In vertical gap there is no need to change prices, rigidity

Facture that promote competitive oligopoly?

Large no of firms

New market entry possible

One firm with significant cost advantage

Homogeneous goods

Saturated market