Micro 2

Question 1

How a Free market economy allocates resources

Answer 1

• allocate resources through price mechanism
• demand creates a market and firms are incentivised to use the resources to maximise their profit
• changes in equilibrium price - signals to the market to produce more or less
• consumption by individuals depends on their income and their income depends on the market value of their human capital

Question 2

Efficiency in a market means

Answer 2

• producing goods at lowest possible cost
• minimising the quantity of resources that are needed to produce goods
• only producing goods that are needed by households

Question 3

Market failure (inefficiency )

Answer 3

If a market fails there is a case for government intervention
- negative externalities - costs such as pollution
- lack of competition - increased prices and lower choices
- missing markets - education, healthcare and defence are under provided by the private sector
- abuse of market power (monopoly)
- Public goods
- Information failure

Question 4

Advantages of a market economy

Answer 4

• efficiency - price mechanism allocates according to demand - competition between firms forces efficient use of inputs
• innovation and choice for consumers - better products + lower prices
• individuals are free to benefit (profit) from their own ideas, skills and efforts

Question 5

Disadvantages of a market economy

Answer 5

• unequal access to goos and services - those without the necessary income are excluded from consumption
• individuals may not make good choices - demerit goods - the private sector will provide drugs, alcohol, high fat and sugar foods if consumers will buy them
• profit motive - may lead to firms to pay low wages, reduce quality to cut costs or even sell un-safe products

Question 6

How resources are allocates in a planned economy

Answer 6

• the state allocates resources, deciding what and how much is produced according to its own view of peoples needs
• market prices play little or no part in informing resource allocation decisions and queuing for scarce resources was how they were rationed

Question 7

Advantages of a planned economy

Answer 7

• money not diverted to share holders, so available to improve products and pay better wages
• resources may not be diverted to producing demerit goods
• equality - less wage inequality + more equal access type products
• prices controlled so that those most in need can access
• fewer resources wasted on duplicating goods

Question 8

Disadvantages in a planned economy

Answer 8

• relies on government agents to decide what to produce - lacks the information the price mechanism gives about what consumers actually want
• has no information about market prices. Kit has been said soviet goods were priced using prices from the US
• limits innovation. Becomes old fashioned and uncompetitive on world markets so exports limited

Question 9

Specialisation examples

Answer 9

• business - type of product - H&M clothes
• country - Bangladesh (textiles) - Saudi Arabia (oil)
• region - West Midlands UK (car assembly) - coast or Croatia (tourism)
• worker - doctor (oncology) - economics teacher

Question 10

Gains from specialisation

Answer 10

• higher output - total production increase and quality improved
• variety - consumers have access to a greater range and higher quality products
• economies of scale - global trade increases the size of the market - possible to exploit EOS through lower costs

Question 11

Stages of the price mechanism

Answer 11

• Allocate resources efficiently at equilibrium
• Ration resources by consumption
• signal excess demand and need for resources
  Or
• signal excess supply and need for resources
• incentivise firms to increase output to increase profit
• bidding up or down of prices

Question 12

Advantages of division of labour

Answer 12

• raises output per person as people become proficient through constant repition of their task
• lowers the cost per unit output leading to lower prices

Question 13

Disadvantages of division of labour

Answer 13

• work becomes repetitive and unrewarding - reduced motivation and productivity
• workers take less pride in their work and quality suffers - may lead to absence
• job dissatisfaction causes high worker turnaround
• workers who are not trained in anything will miss out on world - structural unemployment
• rise to standardised goods - lack of variety

Question 14

Price mechanism functions

Answer 14

• signalling function - prices adjust to demonstrate where resources are valued by consumers
• incentive function -higher prices in a market causes new entrants to that market
• rationing function -the goods and services are allocated based on who needs them most (willing to pay for them)

Question 15

Usefulness of PED

Answer 15

• care about their consumers responsiveness to price changes
• different PED values will result in different impacts on total revenue when price goes up or down
• knowing customers PED allows for price discrimination

Question 16

Evaluation of PED

Answer 16

• an estimate - not perfect information
• PED changes in value at different points in time
• tastes and preferences causes PED to change
• tach advancements might remove switching costs (costs that a consumer incurs as a result of changing brands, suppliers, or products) or habitual behaviour (routine)
• internet enables consumers to compare prices

Question 17

Usefulness of YED

Answer 17

• Help with marketing strategies
• incomes tend to rise over time so in the long run firms that produce + YED will so best
• income elastic - greater the potential for expansion in the market
• in a recession firms producing -YED will benefit and highly income elasticity are very vulnerable
• firms protect themselves with having both inferior and normal goods

Question 18

Types of information in a market

Answer 18

• symmetric - when buyers and seller both have perfect knowledge - this is a standard assumption as having perfect knowledge therefore agents have rational decision
• asymmetric - when one party has better information that the other - failure to allocate resources efficiently

Question 19

Types of information failure

Answer 19

Sellers have > than buyers
- buyers become suspicious of all second hand cars and prices have to fall to make sales
- good cars will sell for less than they are worth and bad cars may sell for more than they are worth
Buyers have > than sellers
- sellers can’t trust buyers, they human raise prices to cover the cost of bad transactions
- honest buyers paying more for their goods + services than they need to + failing to maximise utility

Question 20

Moral hazard definition and example

Answer 20

• an economic agent does not suffer the full economic consequences of a risk
• an economic agent. Has an incentive to increase the exposure to risk because they do not bear the full costs of the risk
• driver with car insurance may be less careful

Question 21

Examples of merit and demerit goods

Answer 21

• education
• healthcare
• renewable energy
• drugs
• alcohol
• gambling

Question 22

Private goods provision reasons

Answer 22

Provided in order to generate profits
- able to exclude consumers from producing through use of price mechanism ( can’t afford then can’t consume)
- consumers must also compete for these goods because they are limited in supply

Question 23

Public goods characteristics

Answer 23

Beneficial to society but which will not by provided by private firms
- non-excludability - the inability of private firms to exclude certain stompers from using products - price mechanism,m vacant exclude consumers
- non-rivalry - the inability from products to be used up - no competitive rivalry in consumption to drive up prices to generate profit

Question 24

Examples of public goods

Answer 24

• floode defences
• police and judiciary
• military defense
• lighthouses
• beaches
• street lighting

Question 25

Free rider problem

Answer 25

- situation where customers realise that they can still access the goods even without paying for them - If they are paying them stop and continue to enjoy the benefits e.g. fre riding the backs of other paying customers - over time any customer paying stops - at some point, firms will cease to provides these goods and they will become under-provided in society

Question 26

Government options (public goods)

Answer 26

1. Do nothing therefore no provision is offered 2. Provide the good or service themselves e.g. parks 3. Contract out the provision of the good: accept bids from private companies who wish to provide the good or service the government excepts lowest bid price and pay the company to provide the good for them

Question 27

Indirect tax reasons for provision

Answer 27

- increases producers costs so reduces supply and likely to lead to a rise in price for the consumer - used when product has negative externalities - used to internalise the externality get consumer or firm to pay full cost - tax revenue from the tax can be used to further alleviate the externality

Question 28

Advantages of tax

Answer 28

- corrects the market - cost to firm is closer to the cost to society - internalises external cost whilst maintaining consumer choice - smokers can still choose to smoke but the must pay a price closer to cost to society - works trough the price mechanism therefore simple to operate - the amount of harm reduces because the higher price reduces the quantity consumed - raises tax revenue to address external cost

Question 29

Disadvantages of tax

Answer 29

- difficult to calculate the true cost of pollution/smoking and therefore set the tax accurately - taxes raise the cost of production so when applied in one country will make firms less competitive compared to other firms abroad - may influence firms to reallocate abroad where tax is lower - rise in price may encourage illegal trade, smuggling and black market - fir,s are left with less money to invest in more efficient and environmentally friendly capital

Question 30

Subsidy reasons for provision

Answer 30

- grant provided by the government to firms to encourage the production and consumption of a good or service - reduces production costs so may lead to a price cut - provided on positive externalities

Question 31

Advantages of a subsidy

Answer 31

- principle - tax payer benefits so tax payer contributes - works through price mechanism, so it is simple to understand - amount do benefit increases because lowering price increase consumption - reduce costs of production is when applied in one country will make firms more competitive against firms abroad - may attract producers from abroad giving consumers greater choice

Question 32

Disadvantages of a subsidy

Answer 32

- costs money - opportunity cost : funds Mary be needed more elsewhere - firms may not pass on the subsidy so prices at not fall and is consumption may stay the same - difficult to calculate the true value of the benefit - set subsidy accurately so that the subsidy benefit > subsidy cost - demand may be price inelastic so he effect on demand my be limited - the firms may become dependent on government assistance and become inefficient in the long run - may not be permanent so may be inefficient government spending as prices may eventually rise back up

Question 33

Examples of prohibition (legislation or regulation)

Answer 33

- India alcohol is prohibited in 4 main states and price controlled in the other states - lead to thriving black market - third of the drinkers consume cheap and dodgy locally brewed or country liquor which has caused deaths - consumption has grown by 38% in last 20 years - non-communicable diseases, such as cirrhosis of liver and cardiovascular diseases. "They are increasingly relevant for public health in India and increasing alcohol use will only pronounce this trend".

Question 34

Minimum price example

Answer 34

- Scotland min price on alcohol of 50 pence per unit - reduce hospital admissions + save lives

Question 35

Problems with price floor

Answer 35

- lead to hidden markets - unfair - some consumers will be priced out of market whereas has no effect on the wealthy - demand contracts and supply extends therefore there is excess supply - demand could be price inelastic then there will be no reduction in quantity and a major increase in producer profits

Question 36

Black market issue

Answer 36

- bad quality and consumption is worse for individual than if they bought it legally - policing costs - loose tax revenue of there is black markets

Question 37

Maximum price advantages

Answer 37

- fairness - the product becomes more affordable - unlike subsidy does not cost money therefore no opportunity cost

Question 38

Disadvantages of price maximum

Answer 38

- cause contraction of supply and excess demand leading yo product shortages - reduces profit from business - below fixed costs - shut down - it incentives the producers to reduce the quality of their products - depending on price elasticity of demand, the policy may have no impact at all unless the max price is substantially below equilibrium - incentivises consumers and producers to engage in hidden markets where cost of production is lower

Question 39

Price maximum example

Answer 39

Rent control New York - less houses available leading to less available workers - increased black market - rent in cash so decreased consumer protection and no tax revenue

Question 40

Government provision Reasons

Answer 40

- provides goods + services funded through taxation - typically provided on goods and services which have significant positive externalities or are public goods - prices are high otherwise and exclude consumers from merit goods e.g. healthcare and education

Question 41

Advantages of government provision

Answer 41

- the principle - all taxpayers contribute according to their ability - provides fairer access to to services e.g. education and healthcare for free or low cost - without provision public goods would bot e provided at all so state provision resolves the free rider problem - services not driven by profit motive so may be more adorable or of a higher quantity

Question 42

Disadvantages of government provision

Answer 42

- costs money - opportunity cost - state provision can be less efficient, more bureaucratic + expensive to run because there is no competition between firms to keep costs and prices down therefore no profit incentive - no price mechainsm to determine hoe much should be provided - government might have lack of expertise in the provision of the good required - abuse free provision e.g. overusing healthcare

Question 43

Buffer stock system analysis

Answer 43

- stabilises prices in volatile market - ensure the supply of good - prevent farmers/producers going out of business because of a drop in prices - a commodity is a tangible good that can be sold or exchanged for products of a similar value - prices are volatile because supply can vary greatly, demand is inelastic and supply is fixed in the SR

Question 44

Advantages of buffer stock

Answer 44

- stable prices help maintain farmer income - a rapid drop on prices can make farmers hop out of business - structural unemployment - price stability encourages more investment - farming can have positive externalities e.g. help rural economies - drop in prices our have negative multiplier on areas - targets prices help prevent excess prices for consumers and reduce food inflation - important for households in poverty who might struggle to pay high prices during years of shortage - possible for government to make profit from a buffer stock system - but during glut and sells during a shortage

Question 45

Problems with buffer stock

Answer 45

- cost of buying excess supply and become quite high for the government and may require higher taxes to fund - minimum prices and buffer stocks could encourage excess use for chemicals to maximise yields because farmers know excess will be sold even if market doesn’t want it - some goods can’t be stored e.g. milk and meat - government agencies my macro pure information therefore difficult to know wether there will be a surplus - administration costs of the schemes may be high - globalised markets (agriculture) if some countries form a buffer stock scheme and buy excess supply and they may find that other countries will free rife on their efforts to keep prices high and undercut them

Question 46

Buffer stock examples

Answer 46

- India releasing 50,000 tonnes of onion to stabilise prices to states with shortages - Australian wool - incorrect price settings and constant excess supply huge cost for government - incurring 1 billion a year in storage costs and interest

Question 47

Information provision reasons

Answer 47

Market failure of asymmetric information - provides information to allow consumers to make informed decisions - force companies to provide information when it is negative and positive - e.g drug adverts in America are required to state all major side effects

Question 48

Advantages of information provision

Answer 48

- protect consumers from unknown harm - slow consumers to act rationally which helps market to function properly - e.g. cigarettes packaging - smoking kills and healthy vs smoker lungs

Question 49

Disadvantages of information provision

Answer 49

- consumers can still choose to ignore information 1/8 of uk still smokes - expensive - opportunity cost - government might not have the necessary information or information consumers need to have - forcing producers increases costs + may push business out of business

Question 50

Pollution permits analysis

Answer 50

- cap and trade - governments decide total amount of emissions of CO2 that will be allowed + polluting industries are granted a percentage of total in form of a permit - firms can trade permits with each other e.g. market based solution - energy efficient firms earn money from selling unwanted permits therefore incentivising firms to shift to greener production - heavy pollutants have to pay to buy more permits

Question 51

Examples of pollution permits

Answer 51

- Kyoto protocol -not signed Australia + US and China - Czech airlines makes more revenue from selling permits than from flying

Question 52

Advantages of pollution permits

Answer 52

- Gov can reduce emissions further by reducing no. of permits in the long run - more efficient then taxes + fines - minimises social cost - polluter will spend min and pollution decreases - helps old industries that cannot easily reduce pollution

Question 53

Disadvantages of pollution permits

Answer 53

- move to other countries where there is no permits - countries may not cooperate - costs of permits may increase prices and affect international competitiveness - CO2 may not be main concern in a country - driving vs cycling or deforestation - some CO2 is a necessary part of production process and not all emissions is the same e.g. flying for leisure vs transporting cargo or ambulance vs commuter - large firms absorb costs forcing small firms out of industry - larger financial burden - hard for government to monitor who has polluted how much e.g. firms self report lower quantities than they actually emit

Question 54

Government provision examples

Answer 54

- vaccinations during covid - state schools - the NHS - example of abuse of provision private healthcare in America has shorter waiting lists than in the UK

Question 55

Legislation and regulation definitions

Answer 55

- used to control actions, protect environment against negative externalities and protect private property - targets both consumers and producers - government imposes penalties for breaking laws : fines , prison or confiscation of profit or capital

Question 56

Examples of regulation and legislation

Answer 56

- ban on demerit goods e.g. drugs - protect environment e.g. MOT on vehicles ensuring pollution by vehicles at a minimum - control consumption e.g. drinking age limits, limits on alcohol content and restrictions on the times of sale - control sale + supply e.g. pharmaceuticals only provided by doctors prescriptions - protect consumers from price fixing and collusion e.g. Sainsbury’s and Asda price fixing mil in 2007

Question 57

Advantages of legislation and regulation

Answer 57

- has potential to decrease production and consumption of demerit goods - sends clear message about behaviours government wants agents to adopt - easy for consumers to understand and producers to implement - government controls impact

Question 58

Disadvantages of regulation and legislation

Answer 58

- costs money to monitor and police - opportunity costs + large amounts of police used on drugs due to hidden market - the effectiveness of legislation depends upon how agents respond - producers may ignore penalties if not high enough therefore economic incentive to break law is higher - consumers may ignore rules out of ignorance e.g. average age of first drink is 13-14 in the UK - difficult to quantify negative externality - gov misses out on tax revenue - abuses hidden markets

Question 59

Nationalisation vs privatisation

Answer 59

- nationalisation - transfer of firms or assets from private to public ownership - privatisation - the transfer of organisations from state ownership to private sector ownership

Question 60

Advantages of nationalisation

Answer 60

- strategic control of key industries - no profit incentive so low prices - no shareholders to satisfy through dividends - state-owned natural monopoly can achieve EOS and be more efficient than multiple small firms - better working conditions + increased wages - easier to target social objectives - easier to control negative production externalities

Question 61

Disadvantages of nationalisation

Answer 61

- very costly - opportunity cost - tax revenues may need to rise to fund spending or borrowing increases - distorts price mechanism ad no profit incentive so undercuts prices of private sector - x-inefficiency due to lack of profit incentive

Question 62

Advantages of privatisation

Answer 62

- efficiency - competition encourages firms to cut costs which lead to productive efficiency - removes state monopolies - increase consumer choice and product quality - competition so invest more money in innovation - higher dynamic deficiency and less x-inefficiency - sale of assets raises a lot of one time revenue for the government - democratises capitalism as individual consumers have opportunity to own shares in company

Question 63

Disadvantages of privatisation

Answer 63

- higher prices for consumers because private sector wants profit - single state-owned -> many small private firms makes it difficult to exploit EOS - highly competitive markets firms don’t make enough profit to innovate - social objectives disregarded

Question 64

Examples of privatisation

Answer 64

- rail operators - PFI - concession agreements in place and contracts to private companies to perform services on particular section of rail network - British airways - 1987 - Royal Mail - 2013-2015

Question 65

Private finance initiative analysis

Answer 65

Private sector contracted to build and maintain a piece of infrastructure. Government enters contract to pay the firm usually for 20-30 years

Question 66

Evaluation of PFI

Answer 66

-competition and profit forces firms to keep cots low and be efficient - forces probate firms to be innovative to win contracts - government can spread cost over many years - government is committed to long term investment - infrastructure ends up costing more than upfront cost because of extra costs + interest - in order to win bidding firm may cut costs so significantly therefore quality of service or good may suffer

Question 67

Competition analysis

Answer 67

Is rivalry among sellers where each seller trues to increase sales, profit and racket share using marketing mix ( product, price, placement and promotion) Leads to - lower prices - more innovation - more efficient use of resources

Question 68

Competition law

Answer 68

Law that allows the state to intervene and prevent the distortion + restriction of competition

Question 69

Aims of competition policy

Answer 69

Protecting the public interest - prevent excessive pricing - promote competition - ensure quality, standards and choice - regulate natural monopolies/ ensure effective privatisation of natural monopolies - promote technological innovation

Question 70

Types of competition policy

Answer 70

- antitrust + cartels - eliminating price fixing + abuse - market liberalisation - introducing fresh competition - state aid control - ensuring state aid doesn’t distort markets - merger control - investigating the impact of mergers

Question 71

Antitrust + cartels analysis and examples

Answer 71

- BA + virgin collusion over flight prices form UK to US - cartel in steel and cement industries When is it ok - jointly trying to improve standard of safety, quality or consumer service - shared research projects - information sharing when in best interest of customers or safety

Question 72

Market liberalisation analysis

Answer 72

- Not used in natural monopolies or the separate provision of infrastructure - trains Reducing barriers to entry in order to promote contestability - state aid subsidies to small businesses - profit + price cap - prevents disparity between incumbent firm growth and new firms Creation of competitive market authority - cartel + antitrust

Question 73

Merger control analysis

Answer 73

- mergers should be positive form conermsers - and will act against merger leading to substantial lessening of completion in a market ( market share would now be over 25% = legal monopoly)

Question 74

Evaluation of rejecting a merger

Answer 74

- monopoly power - no clear evidence it will improve efficiency - mergers almost inevitable lead to loss of jobs and of future job opportunities - mergers are usually motivated by expected static and dynamic gains - more capital investment by bugger merged firms will be good for productivity - may have to merge to survive e.g. The EU is a market so firms may need to scale up to meet demands of EU as a whole rather than just member states

Question 75

State aid control analysis

Answer 75

Ensuring state aid does not distort markets - unfair to provide subsidies to some firms - stats aid for R&D, regional development or to small businesses

Question 76

Answer = tax revenue is dedicated for a purpose

Answer 76

Definition = Hypothecated tax

Question 77

Causes of government failure

Answer 77

- examination extent of failure - lack or profit incentive - cost of intervention - moral hazard - regulatory capture - policy myopia - policy interventions seek to address short-term issues rather than longer-term solutions due to short term governments and re-elections

Question 78

Regulatory capture definition

Answer 78

Intervention strengthens failure as firms operating know most about failure not government

Question 79

Consequences of government failure

Answer 79

- costs lead to opportunity cost of not being able to pay for other projects - intervention may lead to firms exiting market - unemployment or loss of industry - disincentivised firms from increasing production to the most efficient points Depends on the cost of monitoring and enforcement and the use of revenues generated

Question 80

Monopolistic competition characteristics

Answer 80

- many buyers and sellers - key characteristic of a competitive market - SLIGHTLY differentiated therefore are price makers but only slighlty as there are good substitutes and therefore are price elastic demand - monopoly characteristic but its limited die to competitive nature in the market - low barriers to entry and exit therefore firms can enter with relatively low cost to compete - good information of market conditions - non-price competition - branding, advertising and quality

Question 81

Examples of monopolistic competition

Answer 81

- taxis - street food sellers - hairdressers

Question 82

Efficiency in a monopolistic competition

Answer 82

- don’t see AE as P>MC therefore consumers are exploited as prices are high and output is restricted - no dynamic efficiency as no long run supernormal profit therefore there is no reinvestment - don’t see PE not at minimum point of AC - they are voluntarily forgoing EOS therefore have higher prices

Question 83

Evaluation of AE in monopolistic competition

Answer 83

Theoretically a very inefficient firm in LR however - there is conception in the market therefore price making abilities are low therefore price exploitation is nowhere near as bad as a monopoly - less loss in CS - in perfect completion there is homogenous products which is not what consumers desire they want differentiated products and therefore are willing to pay more therefore Allocative inefficiency may not be a bad thing it may be desirable

Question 84

Evaluation of PE in monopolistic competition

Answer 84

- no where near as bad as monopoly - good substitutes - firms can’t afford to forego EOS to the same extent as a monopoly and charge higher prices - in perfect completion here might not be EOS at all there’re any EOS being exploited by mon comp is a greater extent than PC and therefore prices may still be lower Productive inefficiency may be due to the product differentiation demands of consumers as it makes it harder to exploit EOS if you have to produce a wide range of goods rather than just one good (bulk-buy very easily, achieve technical economies very easily and achieve managerial economies very easily)

Question 85

Evaluation of DE in monopolistic competition

Answer 85

- SR supernormal profit may be enough to reinvest - in a very competitive market we can still see DE if normal profit is reinvested therefore extent of reinvestment is small but still see DE especially as it could be apart of competition e.g. clothing brands have to bring out new clothing lines

Question 86

Contestable market characteristics

Answer 86

When there is a threatening of competition therefore characteristics must exist for there to be a strong threat : - low barriers to enetry and exit - large pool of potential entrants - good information - know about costs and tech so if they were to enter can compete - incumbent firms are subject to ‘hit and run;’ competition - new firms enter market quickly snatch away supernormal profit then leave quickly before incumbent firms have to time to react and lower profit margins

Question 87

Technology and contestability

Answer 87

Because of a rise in tech over the last couple of decades then contestability has dramatically increased as well because - reduced barriers because business don’t have to be physical (reduced fixed costs of rent) and reduced employment of workers therefore less regulations. EOS ae easier to achieve and there is better advertising to overcome brand loyalty - increased pool of potential entrants - as greater innovation for firms to come in with something brand new and disrupt market e.g. uber - also allowed firms to find cheaper ways of producing therefore coming in with lower prices and disrupting the market - increased information - internet makes it easier to find out and communication has also improved

Question 88

Perfectly contestable market characteristics

Answer 88

Contestable market but - no barriers to entry or exit - perfect information

Question 89

Sunk costs

Answer 89

- costs that a firm cannot get back if they choose to leave the market - no barriers to exit is unrealistic they are just minimal - e.g. advertising, rent paid upfront, startup costs and R&D investment - when these are high the market becomes essentially Contestable and moves towards monopolistic behaviour

Question 90

Example of contestability

Answer 90

- finnair was the only flying airline from London to Helsinki up until 2021 when Ryanair entered the market - it was not a natural monopoly any other airline could have launched their own flights onto the route - if any other airline wanted to enter the market they could of done so with low costs because there were already a airline business and potentially had spare capacity and the fore no opportunity cost

Question 91

Perfect vs imperfect contestability

Answer 91

- firms in perfectly Contestable markets constantly keep in mind great of potential competition by keeping prices low and output high - does not exist - imperfectly Contestable markets only lower their prices and increase their output when the threat of new competition is immediate - because lowering prices and increasing output decreasing supernormal profit

Question 92

Contestability and gov intervention

Answer 92

- as markets become less contestable they move towards oligopoly structure and having monopoly power - contestability matters as cartels and contestability become more common when weak - completion authorities focus more on contestability as an indicator of where regulation may be required

Question 93

Advantages of Contestable market

Answer 93

- allocative efficiency, productive efficiency and x-efficiency even though there is not actual competition we get the benefits as if there is competition. There is a movement towards limit price not actually be at limit price therefore movement towards efficiency. - job creation - higher quantity in the market - labour is a derived demand

Question 94

Disadvantages of a Contestable market

Answer 94

- lack of dynamic efficiency if acting at limit price - as firms react to decrease profit margins to eliminate threat of competition however if new firms come in with innovative ideas that is dynamic efficiency gained by consumers - costs cutting in dangerous areas -question x-efficiency benefits - costs cutting in health and safety, product safety, environmental standards and wages - creative destruction - new firms destroy existing firms therefore job losses however if overall market is greater and new firms are large in size then workers can move to newer firms and get jobs in same industry - anti-competitive strategies - overtime if used like limit pricing, predatory pricing or flooding market therefore contestability may not last overtime leading to static inefficiency

Question 95

Evaluation of contestability

Answer 95

- length if new technology or new firms entering can patient their ideas then market isn’t contestable over time - Role of tech - also reduce contestability - patents and copyrights - improve information for firms in squirting consumer data and therefore 1st price discriminate much more - regulation - minimise issues of cost cutting in dangerous areas and anti-competitive strategies - negates some cons

Question 96

Profit maximisation

Answer 96

as long as MR > marginal cost then next unit will always generates more profit therefore logical point is where no more extra profit can be made I..e. MC=MR Why - reinvestment due to large profits - new/upgraded capital, new technology and R&D - apple - large profit margins to keep developing new models - dividends to shareholders - owners of a company and without finance there wouldn’t be a company therefore profit rewards them with greater dividends - allow for lower costs passed on lower prices for consumers - reward entrepreneurship - risk taking activity of starting a business But reasons why not profit max: - firms may not know their MC and MR - greater scrutiny - if firm is making very large profits competition authorities and regulators may think they are charging very high prices, taking shortcuts with costs or standards are low within business leads to being investigated and outcomes are likely to be anti the interest of businesses - other objectives may be more appropriate

Question 97

Profit satisficing

Answer 97

Sacrificing profit to satisfy as many key stakeholders as possible happens between profit max and sales max - if a business goes to hard for profit stakeholders can be harmed (profit max) - shareholders - increased dividends - managers - receive bonuses and higher incomes - consumers- suffer if excess prices are charged - workers - could suffer if wages are to low due to cost cutting - government - many not like it when consumers and workers are harmed as above - environmental groups - costs are cut e.g. pollution or resources degradation Lead to bad reputation

Question 98

Revenue maximisation

Answer 98

When MR=0 Why - economies of scale benefit - revenue max Q is greater than profit max Q leads to greater growth - greater EOS - lower AC - lower prices for consumers - predatory pricing - revenue max P is lower than revenue max P - firm will undercut its rivals sacrificing profit in order to drive out competitiors - principle agent problem - divorce between ownership and control - managers who control the business might decide to revenue max to go to shareholders for greater perks in their job

Question 99

Sales maximisation

Answer 99

AC=AR business wants to become as large as they can without making a loss Why - economies of scale - limit pricing - takes away incentive for new firms to enter market - limiting competition - principle agent problem - managers use sales to go to shareholders for greater perks - flood the market - benefits of producing lots of output and selling it - therefore more consumers become aware of product and develop loyalty E.g. Netflix, amazon and costa

Question 100

Corporate social responsibility

Answer 100

Recognising social responsibility and ethics - giving to charity - producing sustainably - paying workers and suppliers (farmers) well - paying appropriate wage - acting ethically - body shop don’t test products on animals but test in labs

Question 101

Causes of wage differentials

Answer 101

- differences in demand and supply e.g. acccet lower wages in return for satisfaction or shorter hours - difference in revenue creation - level of skill and training - societal perception of the value of a job - information gaps - don’t know wages on other industries

Question 102

Pay inequality in same jobs

Answer 102

- gender - women earn less on average - ethnicity - ethnic minorities earn less on average - region - London vs wales - length or service/experience - bonuses and commission - public sector vs private sector employee

Question 103

Causes of geographical immobility

Answer 103

- costs involved in moving home - family or social ties e.g. education priorities for children - regional variations in house prices and shortages pf rented properties - difference in living costs between regions - language barriers - differences in tax and pension systems - legal limits of scale of labour migration

Question 104

Causes of occupational immobility

Answer 104

- unwanted skills - redundant workers from declining industries may not have skills in demand - lack of skills required to participate in the labour force e.g. third of adults in UK don’t gave basic school-leaving qualifications - information gaps - unaware of vacancies, choosing wrong training or employers not identifying available workers

Question 105

Improve geographical immobility

Answer 105

- improve supply of housing and restruct rent rises - offer incentive for people to move to areas with labour shortage - ease visa and immigration restrictions - move jobs to ares where their is unemployment

Question 106

Improve occupational mobility

Answer 106

- training schemes for workers in structural unemployment - better vocational education opportunities - provide information about jobs e.g. job centres and helpline with interview skills - encourage businesses to introduce more flexible working patterns e.g. working form home

Question 107

Monopsony characteristics

Answer 107

E.g. teachers and nurses - public sector with dominant employer of the government - wage makers because of significant buying power over workers - will maximise the revenue that they bring on form workers but hiring workers up to where MC=MRP maximising the revenue that each workers brings in - marginal is steeper as bringing in a extra worker they have to increase wages for the worker but can’t do that for just the additional worker they have to increase wages for everyone worker

Question 108

Monopsony impact

Answer 108

- reduces the quantity and employment compared to competitive labour market outcomes - lower wages than competitive labour market outcomes - workers that are being employed have wages a lot lower than their MRP - the lower the wages are compared to MRP the greater the monopsony power that exists its in that market - distorting efficient labour market outcomes

Question 109

Trade union impacts

Answer 109

- distort efficient competitive labour market outcomes - bargain collectively for higher wages for all workers - closed shop TUs becomes a monopoly supplier of labour and has control over how much labour is supplied at given wage rates - set a wage rate above equilibrium - limit to number of workers under control of the trade union - employment has decreased and therefore there is more unemployment

Question 110

Evaluation of trade union impact

Answer 110

- in a monopsony labour market - making it better for wages and employment - strength of TU power e.g. union density - greater percentage of workers in trade union the more power thee greater the bargain power and supply of labour - Union mark up - the difference in wages of workers who are part of a trade union compared to workers in a similar profession who have not got a trade union - the bigger the difference the grater the success of the trade union - real world evidence proves limited power of TU - how strict legislation has been since 1970s against trade unions e.g. close chop trade unions are now illegal and limits density, reduction of the ability to strike (75% workers must agree to strike and workers are only allowed to strike against their own employer) - restructuring of UK economy e.g. part-time work has become more prevalent therefore harder to organise trade union activity - competitive pressures e.g. due to globalisation pressures have increased then firms have more power to reject trade unions as they may go bankrupt and may lose competitiveness gains

Question 111

Bilateral monopoly impact

Answer 111

- causes monopsonist to be a wage taker - wages increase - employment increases ( different to trade unions in a competitive market) - improving efficiency in monopsony employers - trade unions have significant value - the bigger the difference between MRP and wages the higher the benefit a trade union will bring into the market and the bigger the deficiency brought into a market

Question 112

Scarcity problem

Answer 112

Micro economics is how to best solve the economic problem - how to allocate scarce resource given unlimited wants - there isn’t enough resources to fully satisfy wants - resource = factor of production - forces choice to be made e.g. HOW, WHAT and WHO how to allocate and produce

Question 113

Evaluation of EOS

Answer 113

- demand for product - market may not demand the increase in output . if firm increases production to MES then it needs to be able to sell all of its output to take advantage - nature of product - manufacturer will benefit from technical economies of scale but hairdresser is unlikely to - technological advancement - has led to some smaller firms being able to access savings - once only available to larger firms - importance of price - economies of scale allows business to charge a lower price but if product is inelastic may not be a incentive to produce at MES

Question 114

Disadvantages of a monopoly

Answer 114

- allocative inefficiency - P>MC therefore consumers are exploiters paying higher prices - lower CS and restricted output and choices - Productively inefficient - voluntarily forgone EOS - don’t maximise their costs OR are too if they suffered from DOS - X-inefficiency - allow for waste in production process as they are too complacent due to lack of competitive drive - inequalities in necessity markets - because of higher prices the poos is disadvantaged more if monopolies lie in necessity markets e.g. supermarkets

Question 115

Advantages of a monopoly

Answer 115

- dynamic efficiency - supernormal profit is reinvested - benefits consumers through innovation, brand new products, higher quality + better tech in LR - therefore could have lower prices and lower costs in LR - producers can patient new tech and key earning profit over time - greater EOS - despite productive inefffiecies compared to competitive firms - they may still be exploiting greater \eos purely because of their size MCm

Question 116

Evaluation of monopolies

Answer 116

- DE - profit not always reinvested into capital - may go to shareholders, they could save profit, pay off debts or bay higher wages to workers - EOS vs DOS - what is more likely - depends on the size of the firm - Objective - may not be at Pmax - Regulation - helps reduce inefficiencies or increase competition - price discrimination exaggerates negative effects - pure monopoly is unrealistic - more likely for a firm o have monopoly power and therefore there is still competition I.e. Tesco is a legal monopoly - or firm can be Contestable and have threat of entrants - natural monopoly - nature of good/service e.g. necessity

Question 117

Collusion

Answer 117

Firms collude in order to gain monopoly power

Question 118

Natural monopolies

Answer 118

- huge fixed costs and especially start up costs e.g. infrastructure - to minimise average costs it takes a very large quantity and therefore enormous potential for EOS - rational for 1 firm to supply entire market - competition is undesirable - competition would result in a wasteful duplication of resources as incumbent firms would be able to price them put of market and resources are left idle and not exploit full economies of scale - therefore allocative and productive efficiency - downward sloping cost curves and MC is lower than AC due to enormous potential of EOS - must be regulated to make them act nearer to competitive outcomes - where MC = AR however that means they would be forces to act at AE with subnormal profit therefore they would just exit the market so they must be given a subsidy to produce - very little incentive to have a private natural monopolist therefore more likely to have state run monopolist

Question 119

Example of natural monopoly

Answer 119

- utilities - water, gas and energy - rail track providers

Question 120

Conditions necessary for price discrimination

Answer 120

- price making ability - must have monopoly power - information to separate market into different PEDs e.g. price inelastic groups to be charged higher by segmenting consumers

Question 121

1st degree of price discrimination

Answer 121

- consumers are charged exact price they are willing and able to pay therefore eroding all CS in the market and turning into monopoly profit

Question 122

2nd degree price discrimination

Answer 122

- excess capacity pricing - example train company or planes company with a fixed number of seats therefore it makes no sense to leave capacity idle because of their fixed costs therefore they can lower their prices in order to fill capacity in order to contribute towards fixed costs - or used in bulk buying to increase quantity sold

Question 123

3rd degree price discrimination

Answer 123

- charge market segments different prices Example rail company - inelastic = commuters and elastic = leisure - they want to profit max in both cases therefore charge higher prices to inelastic customers to exploit PED - therefore to maximise joint profit as consumers with elastic demand would not be willing to pay the same price as the inelastic customers

Question 124

Evaluation of price discrimination

Answer 124

- anti-competitive nature prices - 3rd degree lower prices drive out competitors giving it pure monopoly power - inequalities - 1st degree and inelastic section on 3rd degree - maybe more reinvestment potential - some consumers might benefit - 2nd degree and price elastic 3rd degree

Question 125

Product (non-price competition)

Answer 125

- quality,design, after-sales services, brand name, reputation, packaging and presentation - Maybe costly in terms of market research and R&D - increased profits may tale a log time to come through (putting up prices brings in revenue immediately)

Question 126

Promotion (non-price competition)

Answer 126

Advertising - activity attracting public attention to a product or business - celebrity endorsements Promotion - short term offers designed to attract attention to product to increase sales - adds to firms costs with no certainty of higher profits - difficulty in judging the effectiveness of a campaign or promotion - there may be a conflict between branding and price cutting - effects may be short term

Question 127

Place (non-price competition)

Answer 127

Distribution options, in-store, online - number sand location of stores/outlets - pick up/home delivery options - high fixed costs of competition y making more outlets than competitors - high costs of setting up new distribution routes - potential complexity of offering same product at different prices through different routes

Question 128

Collusion

Question 129

Oligopoly characteristics

Answer 129

- few firms dominate the market - high concentration ratio - differentiated goods - high barriers to entry and exit - interdependence - sticky prices - non-price competition - profit max - not sole objectives

Question 130

Government failure

Answer 130

Intervention leads to a greener net social welfare loss

Question 131

Tax and government failure example

Answer 131

Landfill tax on the amount of waste Leads to increased fly-tipping which is the illegal dumping of waste elsewhere