microeconomics

What is the purpose of govt intervention

To prevent the abuse of monopoly power which would cause potential market failure and loss of consumer surplus

Types of price regulation

• RPI - X (retail price inflation - expected efficiency improvements)

• RPI - X + K (K represents investment)

Advantages of price regulation

• encourages firms to be more efficient and cut costs

• Encourages competition in markets

Disadvantages of price regulation

• hard to determine value of X

• can limit profit leading to limited investment

• Risk of regulatory capture

Pros/cons of profit regulation

• fix a max level of profit a firm can earn

- little incentive to cut costs and be efficient

- govt has asymmetrical information of the market

+ encourages investment

Quality standards

• govt ensures minimum standards for quality a many firms only do so to maximise profits

- monopolies will resist (lobbying)

- policies require will and understanding to introduce

Performance targets

• govt sets targets on a variety of outputs for a firm

- monopolists will attempt to find ways to meet targets without improving

- asymmetrical information

+ helps improve services and leads to gains for consumers

Ways to enhance competition through promotion of small businesses

• UK (red tape challenge) - aims to simplify regulations

• Small and medium sized Enterprises (SMEs) - stimulate innovation and investment

Competitive tendering for govt contacts

• contacting out provisions so that private firms operate things such as roads or hospitals

Advantages of government intervention

• govt are able to prevent monopolies changing excessive prices and aim to limit their profit

• Aims to ensure consumers pay fair prices, receive good quality and have lots of choice

• Can increase efficiency by increasing competition and contestability

Disadvantages of govt intervention

• If regulation is too strong, costs and inefficiency may rise

• The public sector is limited and may provide x-inefficiency

• Large firms hold political power and are able to lobby

Regulatory capture

When a regulator becomes more empathetic, removing impartiality, weakening their ability to regulate

Asymmetric information

When regulatory bodies have to use information n provided to them by the industries when setting different targets

allocative efficiency

• when resources are used to produce goods which consumers want and value most highly

• P=MC

productive efficiency

• when firms produce at the lowest point on the AC curve

• MC=AC

Dynamic efficiency

• when resources are allocated efficiently over time.

• Related to the rate on innovation

• concerned with investment

• firms must have SNP

x-efficiency

• when a firm is producing at any given output on the AC curve

characteristics of perfect competition

• many buyers and sellers

• sellers are price takers

• no barriers to entry or exit

• perfect knowledge

• homogeneous goods

perfect competition

• productive and allocative efficiency (MC=AC=MR=P)

• cannot benefit from economies of scale

• LR normal profit

characteristics of monopolistic competition

• many small buyers and sellers sellers

• low barriers to entry and exit perfect

• imperfect information

• heterogeneous goods

• SOME price setting power

monopolistic competition

• assumed to be SR profit maximisers

• can only make normal profit in the long run

• produce at AC=AR and MC=MR

characteristics of oligopoly

• high concentration

• interdependence

• high barriers to entry and exit

• non-price competition

• differentiated goods

n-firm concentration

(total sales of N firms/total size of market) x 100

advantages of collusion

• maximise industry profits

• reduce uncertainty

disadvantages of collusion

• illegal

• fear of others firms breaking agreements

• market share has to be divided

overt collusion

when there is a formal agreement on either price or market divide (cartel)

• an agreement must be reached

• potential competition must be restricted

• ways of preventing cheating must be enforced

tacit collusion

no formal agreement

• price leadership

• barometric firm price leadership

• unwritten rules

price competition

• price wars: repeated undercutting of competitors prices

• predatory pricing: when large firms set price bellow AC so smaller firms cannot make profit (illegal)

• limit pricing: when firms set price bellow profit maximising point to discourage new firms from entering market but must be making normal profit

non price competition

• advertising

• loyalty cards

• beading

• quality

• customer service

• product development

game theory table

game theory

used to examine the best strategy a firm can adapt for each assumption about its rivals

nash equilibrium

where both firms use dominant strategy

dominant strategy

the best option regardless of what the other player chooses

characteristics of a monopoly

• profit maximisation

• one sole seller

• high barriers to entry

• price setters

• price discrimination

third degree price discrimination

• when the monopolist decides to charge different groups of consumers different prices for the same good or service

advantages of price discrimination

consumer:

• may benefit from net welfare gain due to cross subsidisation

producers:

• better use of spare capacity

• higher SNP can stimulate investment

costs of price discrimination

consumers:

• loss of consumer welfare

• loss of allocative efficiency

• higher prices

Producers:

• firms may be regulated by competition and market authorities

• firm may have to divide the market

• may cause inefficiency as there is higher profit

• lack of consumer choice

natural monopoly

when one firm naturally becomes the most efficient firms due to high fixed costs

characteristics of monopsony

• single buyer in the market

• assumed monopsonists are profit maximisers

• price setters

costs of monopsony

• firms providing loose profit

• risk of labour exploitation

• lower productivity if wages are too low

benefits of monopsony

• NHS can negotiate lower prices for healthcare services

• consumers may receive lower prices as cost of production is low

characteristics of contestable markets

• actual and potential competition

• entrants have free access to production techniques and technology

• no barriers to entry or exit (no sunk cost)

• low consumer loyalty

• no of firms in market varies

implications of contestable market for the behaviour of firms

• firms are more likely to be allocatively and productively efficient

• threat of hit and run firms

• firms can earn SNP in short run but only NP in long run

types of barriers to entry and exit

• economies of scale

• legal barriers

• customer loyalty & branding

• predatory pricing/limit pricing

• anti-competitive practices

• vertical integration

• cost of making workers redundant

Marginal Revenue Product of Labour

the extra revenue generated by an individual worker

• marginal output x price

• difference in total revenue

derived demand

demand for labour is derived from the demand for the product the labour produces

factors influencing demand for labour

• wage rate (movement along the curve)

• demand for product/change in price of product wages in other countries

• prices of other factors of production

• technology

• regulation

factors affecting PED of labour

• PED for product

• proportion of wages to the total cost of production

• availability of substitutes

• time

factors influencing supply of labour

• wages

• population & age distribution

• education/training/qualifications

• trade unions and barriers to entry

• wages & conditions of other jobs

• legislation

factors affecting the PES of Labour

• level of qualifications and training

• availability of suitable labour in other industries

• time

reasons for market failure in the labour market

• occupational immobility

~skills gap

~training gap

~experience gap

• geographical immobility

~family ties

~cost of property

~migration controls

~language barriers

~cost of commuting

~access to good schools

• discrimination

curved labour supply curve

work is an inferior good

the more wages rise, the more people are happy to work less hours and substitute work for leisure

Reasons for differing wages

• age

• Education

• Training

• Work experience

• Skill/talent/ability

• Sex and ethnic background (illegal)

Monopsony in the labour market

• only one buyer of labour

• LMC>LAC

• Employ at MCL=MRPL

Monopoly in the labour market

existence of trade unions can operate as only supply of labour

Labour market issues

• skills shortage

• Young workers

• Retirement

• Wage inequality

• Zero hour contracts

• The ‘gig’ economy

• Migration

How to tackle immobility of labour

• Improve supple of houses

• Improve transport links

• National advertising

• Increase vocational training

• Encourage further studies

• Improve education

• Encourage spending on training

• Apprenticeship schemes

• Localised career advice and support

Types of government intervention

• National minimum wage (1999)

• Maximum wages

• Public sector wage setting

Advantages of NMW

• reduces poverty

• Boosts consumer spending

• Reduces reliance on benefits

• More motivated workforce

• Fair wage

Disadvantages of NMW

• potential job loss

• Raises AC for firms, may increase prices

• Small businesses may struggle

• Fall in investment

cost in the short run

at least one factor of production is fixed

cost in the long run

all factors of production are variable

diminishing marginal productivity

• if a variable factor is increased when another factor is fixed, there will come a point where each extra unit of the variable factor will produce less output than the previous unit

economies of scale

when an increase in production causes a lower average cost leading to increase returns to scale

diseconomies of scale

when there is a potential decrease in efficiency and so an increase in output results in a rise in average cost, the firm experiences decreasing returns to scale

what is an internal economy of scale

an advantage that a firm is able to enjoy because of a growth within the firm

• a movement along the LRAS

what are the types of internal economies of scale

• technical EOS- a result of what happens to the production process

• financial EOS- larger firsts can obtain finance easier as there is lower risk

• managerial EOS- larger firsts firsts can appoint specialist managers in every field who are more efficient

• marketing EOS

what is an external economies of scale

advantages which can arise from growth in the industry

• a shift in LRAS

types of external economies of scale

• labour- business established in an area with other successful firms from the same industry will find labour easier (silicone valley)

• support services- business who provide goods for large firms will naturally more to the area those firms are based reducing transport costs

• growth in technology in the market

what can cause diseconomies of scale

• workers may lack incentive- low productivity

• geography- large distances for transport may be hard to control

• management- coordination and control, communication

what are constant returns to scale

where firms increase inputs and receive an increase in output by the same percentage

minimum efficient scale

he minimum level of output needed for a business to fully exploit economies of scale

normal profit

• the return that is sufficient to keep the factors of production committed to business

• AC=AR

supernormal profit

profit greater than normal profit

loss

• when the firm fails to cover its costs

• AR<AC

what are the different business objectives

• profit maximisation

• revenue maximisation

• sales maximisation

• satisficing

point of profit maximisation

• MC=MR

point of revenue maximisation

• MR=0

Sales maximisation point

AC=AR

satisficing point

• where a firm makes enough profit to keep owners happy whilst following other objectives

reasons for firms to grow

• to exploit economies of scale

• to increase market shares

• to reduce risk (have diverse options/economies of scope)

• managers objectives

reasons to stay small

• niche markets

• avoid diseconomies of scale

• lack of finance

• regional monopoly

• fear of divorce of ownership

what is the principle agent problem

where one group (the agent) makes decisions on behalf of the other group (the principal) and may maximise their own benefits rather than profit maximise

private vs public sectors

private- owned and run by individuals or groups of individuals

public- owned or controlled by local or central government

organic growth

where firms grow by increasing their output, for example increased investment

advantages of organic growth

• integration is expensive, time consuming and high risk

• firm is able to keep control of their business

disadvantages of organic growth

• sometimes another firm has a market or an asset which the company would be unable to gain through organic growth

• organic growth is slow

• it will be difficult for firms to get new ideas

what are the three types of integration

• vertical- integration of firms in the same industry but at different stages of production

• horizontal- where firms in the same industry at the same stage of production merge

• conglomerate- where firms in different industries integrate

constraints of business growth

• size of market

• access to finance

• owner objectives

• regulation

• health and safety costs

what is a demerger

when a single business is broken down into two or more components

reasons for demerges

• lack of synergies- different parts of firm have no real impact on each other and fail to make the other more efficient

• value of the company/share price- value of the separate parts of the company is worth more than the company combined

• focused companies- if management is focused of individual markets, they may become more efficient and successful

• avoidance of competition authorities

impact of demerger on workers

• job uncertainty

• changes in compensation and benefits

• opportunities for growth

impact of demerger on businesses

• change in efficiency

• loss/gain in economics of scale

• change in stock prices

• greater independence

impact of demerger on consumers

• change in price/quality of goods

• contractural changes

• more choice/competition

what are the types of government intervention

• indirect taxation

• subsidies

• maximum and minimum prices

• traceable pollution permits

• state provision of public goods

• provision of information

• regulation

advantages of indirect taxation

• market produces at social equilibrium

• raises government revenue

advantage of subsides

• welfare is maximised

• encourages production

advantages of price floor/ceiling

• allow for some consideration of externalities

• makes goods more affordable, reducing poverty

• makes goods too expensive reducing consumption

advantages of trade pollution permits

• pollution will fall

• raise revenue by selling permits

• encourages efficiency and more green production

advantages of state provision of public goods

• corrects market failure

• ensures everyone has access

• the goods provide benefits to the economy