# econ 3

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econ 3

## 1. cost and revenue

### 1.1. costs

1.1.1. Fixed costs are costs that don't change with output eg. rent, property taxes, loans.

1.1.2. variable costs change with output, so when output is 0, VC=0

1.1.3. total cost = VC + FC

1.1.4. Average cost = total cost/output

1.1.4.1. decrease until the Minimum Efficient Scale (MES), which is the minimum amount you can make to be productively efficient, after this, average costs rise

### 1.2. production

1.2.1. the short run has at least one fixed factor of production

1.2.1.1. the long run, all factors are variable

1.2.2. where you increase one factor of production, while other factors remain the same, the output per unit goes down - Law of Diminishing Returns

### 1.3. productivity

1.3.1. As productivity leads to falling average costs, high productivity becomes attractive

1.3.1.1. Economies of scale - the cost advantages that a business obtains due to expansion

1.3.1.1.1. also external economies of scale, where because of where a firm is located, they can get lower average costs.

1.3.1.2. Diseconomies of scale are where average costs rise because of expanding.

1.3.2. Marginal product - the increase in production when a factor of production is increased by one.

### 1.4. Revenue

1.4.1. total revenue = P x Q

1.4.2. Marginal revenue is the addition to total revenue from the sale of an extra unit

1.4.2.1. on a graph this is half of Average revenue (demand curve)

## 2. Profit maximisation

### 2.1. MC=MR

2.1.1. My Cat = My Rat

2.1.2. Where this happens, at output q*, going up and down from this point, and then going across from AC to AR immediately gives us the output which yields the maximum area of profit

### 2.2. profit

2.2.1. Normal profit is the level of profit which is just sufficient to keep all the factors of production in their present use 'breaking even'

2.2.1.1. AC=AR

2.2.1.1.1. hard to do in reality, Milton Friedman's 'as if' rule - firms do this already

2.2.2. Supernormal profit is anything above normal profit

2.2.3. roles of profit

2.2.3.1. allocate factors of production

2.2.3.2. signal for market entry

2.2.3.3. Promote innovation

2.2.3.4. investment

2.2.3.5. reward entrepreneurs for bearing risk

2.2.3.6. performance indicator

2.2.4. profit satisficing - managerial status, market share, maximise revenue

### 2.3. Managers

2.3.1. principal agent problem

2.3.1.1. where the agent does not act in the best interest of the principal

2.3.1.2. need: transparency, experts to asses performance, performance related pay, regular meeting

2.3.1.3. conflict of interests: managers want status, market share and revenue maximisation, shareholders want profits

## 3. Perfect competition

### 3.1. goes from perfect competition - to oligopoly - to monopoly

3.1.1. Perfect competition has some criteria:

3.1.1.1.1. no power to set prices

3.1.1.2. no barriers to entry or exit

3.1.1.2.1. the shutdown condition: price is less than AVC, so firms have to leave the market, and profits return to normal as firms leave the market.

3.1.1.3. identical products

3.1.1.4. perfect information

3.1.1.5. no externalities

3.1.1.6. no economies of scale

### 3.4. REALITY

3.4.1. inefficient firms are driven out by competition

3.4.2. pushes prices downwards

3.4.3. consumer sovereignty prevails

## 4. efficiency

### 4.1. surplus

4.1.1. consumer surplus - the difference between the price that the consumer is prepared to pay and the market price

4.1.2. producersurplus - the difference between what a producer is willing to supply and the market price

### 4.2. static efficiency - occurs at a given point in time

4.2.1. Allocative - exists where goods are produced in line with consumer preferences. P = MC

4.2.2. Productive efficiency - Occurs at the lowest point on the average cost curve

4.2.3. X efficiency - occurs when a firm is operating on its average cost curve - X inefficiency is likely to arise when there is organisational slack

### 4.3. Dynamic efficiency - occurs over time

4.3.1. product innovation - examines those improvements that lead to firms and goods to work better with a higher quality

4.3.2. Process innovation - changes in the way production takes place, so that businesses can make goods cheaper so they can experience higher profit margins

## 5. Concentrated Markets

### 5.1. why do firms grow larger?

5.1.1. Market power - increase pricing power

5.1.2. objectives of managers - boost egos'

5.1.3. profit - gain more profit

5.1.4. to gain economies of scale

### 5.2. growth of firms

5.2.1. internal growth - use profits to finance expansion

5.2.2. external growth - acquisitions and mergers

5.2.2.1. Horizontal intergration - same industry at the same stage of production

5.2.2.2. Vertical integration - same industry, but at a different stage of production

5.2.2.3. lateral merger - merge between companies that are related but not identical

5.2.2.4. conglomerate merger - between unrelated businesses

## 6. Price Discrimination - occurs when a producer sells an identical product to different buyers at different prices unrelated to costs

### 6.1. First Degree

6.1.1. where there is no consumer surplus, firms will find out how much people are prepared to pay eg. haggle

### 6.2. second degree

6.2.1. multibag vs single packets

6.2.2. price discrimination due to quantity

### 6.3. third degree

6.3.1. prices depend on: age, time, social standings

## 7. cost and revenue

### 7.1. Definitions

7.1.1. Fixed costs are costs that change with output

7.1.2. variable costs change directly with output

7.1.3. short run has at least one factor of production that is fixed (eg. land), long run nothing is fixed

7.1.4. Diminishing returns: When you increase one factor of production, while others remain the same, and the output per unit goes down

7.1.5. marginal product is the increase in production when a factor of production is increased by one

7.1.6. average cost= average cost/output

### 7.2. because of economies of scale, higher productivity leads to falling average costs. Therefore high productivity is attractive

7.2.1. Economies of scale refer to the cost advantages that a business obtains due to expansion

## 8. Monopoly

### 8.1. Basic definition

8.1.1. Theoretical definition: when one firm is in the industry

8.1.2. Definition used in practice: The Competition Commission say that if a firm have over 25% of market share, then they can be classified as a monopoly

### 8.2. high barriers to entry

8.2.1. Examples

8.2.1.1. High fixed costs: this dissuades firms from entering the market

8.2.1.2. Economies of Scale: they have to produce a large amount of a good to experience economies of scale. This means that the market may only be able to accommodate a few firms - a natural monopoly

8.2.1.3. Brand loyalty

8.2.1.4. Legal Barriers: patenting an idea, or through government licenses

8.2.1.5. control over factors of production: stop firms from getting raw materials

8.2.1.6. control over retail outlets

8.2.1.7. Predatory Pricing: eg. BA when Virgin Atlantic started up

### 8.3. Strategic Barriers - when existing firms make an attempt to reinforce their position against other firms or potential rivals

8.3.1. Hostile takeovers

8.3.2. Product differentiation - developing new products, advertising etc.

8.3.3. Capacity expansion - to achieve lower unit costs from economies of scale

8.3.4. Predatory Pricing

### 8.4. Efficiency

8.4.1. unlike Perfect Competition which is statically efficient, Monopolies produce too low and sell too high, meaning that they are allocatively inefficient as P>MC, productively inefficient because it is not producing on its MES and it is likely to be X inefficient as it is protected by barriers to entry and the absence of competitive forces, meaning that a monopoly does not have to a mechanism to eliminate organizational inefficiency

### 8.5. Costs and benefits

8.5.1. costs

8.5.1.1. they earn abnormal supernormal profits, and there is a loss to consumer and society welfare

8.5.1.2. failure of the markets, as there is allocative inefficiency - goods are being charged too much, and due to the inelastic nature of goods from a monopoly, people buy them. Also because the price is too high, these goods are being under consumed

8.5.1.3. because they are X inefficient, they are not fully utilising scarce resources

8.5.2. Benefits

8.5.2.1. Can exploit economies of scale which leads to higher output and a lower price than under competitive conditions

8.5.2.2. A natural monopoly may lead to internal economies of scale

8.5.2.3. faster rate of technological development - higher profits means that you can invest more thereby increasing dynamic efficiency

8.5.2.4. More scope to be internationally competitive

## 9. Oligopoly

### 9.3. Key features

9.3.1. Interdependence and uncertainty - firms need to take into account the actions of their rivals to any change in price, output or forms of non-price competition

9.3.2. Entry Barriers - It is possible for small firms to operate along side an oligopolistic market, but none of them are large enough to to have any affect on the price in the market

9.3.3. Product branding - so there is some scope of product differentition

9.3.4. Non-price competition - advertising, loyalty cards and an increased range of services etc.

### 9.4. the kinked demand curve (competing oligopolies)

9.4.1. this assumes that a business faces a kinked demand curve for its product based on the likely reactions of other firms.

9.4.2. Common assumptionis that firms in a monopoly are looking to protect their market share, and that a competing firm is likely to match another firms price increase.

9.4.3. Is made up of two demand curves, one price inelastic and one price elastic - if one firm raises its price above where the two demand curves meet, them it would see a more than proportionate fall in sales as none of its rivals would follow

9.4.4. a firm might reach a stable profit-maximising equilibrium where the two demand curves meet, meaning that they will have no incentive to alter prices

9.4.5. predicts that in an oligopoly there will be periods of price stability as frims compete on non-price factors

9.4.6. there is limited real world evidence for this and can be critisised on the following grounds:

9.4.6.1. no explanation how the original price was arrived, so no evidence of price determination

9.4.6.2. the model assumes a given reaction by rivals

9.4.6.3. a firm would benefit from a price war if it believes that it is the strongest firm, and it could force rivals out of the market

9.4.6.4. only deals with price determination and non-price factors

### 9.5. compete

9.5.1. if you lower your prices too much, it could cause a price war, ultimately causing the detriment of firms in the industry

### 9.6. Collude

9.6.1. to stabilise prices, by coming to an agreement between firms

9.6.2.1. when prices and price changes are established by one dominant firm, and all other firms follow suit e.g. Petrol dealers and mortgage lenders

9.6.2.2. another form is barometric price leadership, this occurs where the industry that responds most quickly to changing costs and demand conditions acts as the industry's price leader

9.6.3. Explicit collusion in an oligopoly

9.6.3.1. fixing prices by forming price fixing cartels (illegal in the UK and Europe)

9.6.3.1.1. join together to control supply, you that you can fix the price at a level that we would expect it to be under a monopoly, thereby stabilising price and revenue

9.6.3.2. risks that one firm may break off

9.6.3.2.1. one member of the cartel may break off and sell their goods at a price below the agreed price by the cartel, meaning that it can gain extra profit - if one firm does this, all will follow, causing excess supply and a large fall in price - the cartel agreement breaks down

9.6.4. is easier when

9.6.4.1. small number of firms, and barriers to entry protect those firms

9.6.4.2. market demand is not too variable (or cyclical) i.e. it is reasonably predictable and not subject to violent fluctuations, causing excess supply and demand

9.6.5. Problems

9.6.5.1. enforcement problems - the cartel aims to restrict production to maximise total profits of members - other firms may free ride by producing close, but under the cartel price

9.6.5.2. falling market demand - excess capacity, and puts pressure on individual members

9.6.5.3. successful non cartel firms emerge into the industry

9.6.5.4. exposure of illegal price fixing by market regulators

9.6.5.5. GAME THEORY

9.6.6. benefits from collusion

9.6.6.1. Joint R and D (such as the car industry) can lead to economies of scale and reduced prices to the consumer

9.6.6.2. Share of common facilities, and information can lead to a reduction in costs

9.6.6.3. Adoption of common standards - compatibility of software e.g. bluray discs and players

## 10. Contestable Markets

### 10.1. Was a theory which was developed by William Baumol

10.1.1. It states that it is not the number of firms in a market which makes it contestable, but the number of barriers to entry

10.1.1.1. e.g. a monopoly could be efficient and set competitive prices if there was the threat of new firms entering the market

10.1.1.2. you can have the benefits of perfect competition, without the characteristics

10.1.2. A fully contestable market has

10.1.2.1. No barriers to entry and exit

10.1.2.2. No sunk costs

10.1.2.2.1. When sunk costs are high, this leads to a less contestable market, as it acts as a barrier to entry and exit.

10.2.1. in a monopoly it will push prices down, leading to more consumer surplus

### 10.3. Evaluation

10.3.1. no perfectly contestable market - there are sunk costs etc.

10.3.2. little evidence for the threat of hit and run - why not carry on making supernormal profits?

10.3.3. Firms may protect themselves through patents and strategic entry barriers

### 10.4. increasing contestability of markets

10.4.1. Entrepreneurial Zeal

10.4.2. Deregulation of markets

10.4.3. Competition policy - tougher laws acting against predatory behaviour

10.4.4. Competition policy

10.4.5. Single EU market - opened up the markets of other nations

10.4.6. Technological change

## 11. market structure and technology

### 11.1. Structure

11.1.1. It is best defined as the organisational and characteristics of the market. e.g. number of firms, market share, nature of costs, degree it is vertically intergrated, product differentiation, structure of buyers, turnover of customers (prepared to switch suppliers)

### 11.2. Technology

11.2.1. can enhance production and consumption

11.2.1.1. innovation

11.2.1.1.1. developing something that already exists - e.g. apple with the ipod

11.2.1.2. invention

11.2.1.2.1. something that is completely new

11.2.2. Production - lowers the AC curve

11.2.2.1. with new technology there maybe some initial cost, as you have to train workers to use the equipment

11.2.3. Consumption - moves supply curve, meaning that goods are supplied cheaper

## 12. Privatisation and deregulation

### 12.5. For and against

12.5.1. For

12.5.1.1. it will lead to better dynamic efficiancy and better economic welfare

12.5.1.1.1. the theory is that private firms will now be able to gain additional revenue through the stock market - which means you can invest in more R and D and gain more capital

12.5.1.2. with more competition, firms lower prices

12.5.1.2.1. which means consumers benefit

12.5.1.3. Selling of government assets allows for additional revenue to be made

12.5.1.3.1. Also reduces the size of the public sector - may make it easier to run

12.5.1.4. raises incentives of the firms to innovate in order to retain supernormal profits

12.5.1.5. provides stock market disipline

12.5.2. Against

12.5.2.1. some people say that it may just be transferring a monopoly from the public sector to the private sector

12.5.2.1.1. therefore not actually benefitting anyone

12.5.2.2. nationalised companies price at P=MC

12.5.2.2.1. Therefore prices may rise as privatised firms chase profits

12.5.2.3. may lead to worse conditions

12.5.2.3.1. with privatised firms, they lower costs, which means that things may not be as safe as they should be - in order to retain profits

12.5.2.3.2. May ignore externalities

12.5.2.4. may lead to widening inequality

### 12.6. Utility regulators

12.6.1. they are in place to stop privatised firms from exploiting their monopoly position

12.6.1.1. Their main aims are to create and stimulate disciplines that companies would experience under market conditions (making markets more contestable)

12.6.2. Price capping

12.6.2.1. they intervine in the pricing mechanism - allows businesses to retain a certain amount of profit (or rate of return)

12.6.3. Regulatory Capture

12.6.3.1. when regulators have been 'captured' or influenced by the firms they are meant to oversee. The regulators then end up acting in the interests of the industry not the consumers they are meant to protect

12.6.4. Can be used to correct market failure

12.6.4.1. Recently they have been used to promote efficiency

12.6.4.1.1. E.g. access to BT's distribution infrastructure for other firms in the industry

12.6.5. Need to provide the 4 freedoms

12.6.5.1. Free movement of goods, services, financial capital and labour

### 12.7. Injecting competition into the public sector

12.7.1. 3 ways

12.7.1.1. Introducing internal markets

12.7.1.1.1. sometimes known as a quasi-market, e.g. in the NHS, GP's acted as fundholders and purchased services from competing hospitals - means hospitals have to lower costs and be more productively and allocatively efficient - though could lead to worse conditions

12.7.1.2. Public Private Partnerships (PPP)

12.7.1.2.1. Partnerships between the public and private sector, where the private services contract out the public sector

12.7.1.3. Private Finance Incentives (PFI)

12.7.1.3.1. to provide new capital expenditure, - the private sector competes to finance the building of government projects.

## 13. Competition Policy

### 13.1. Is in place to to promote competition in order to make markets work more efficiently due to increased competition

13.1.1. aims are:to ensure price competition between suppliers; wider consumer choice; technological innovation - gains in dynamic efficiency; investment into claims of anti-competitive behaviour

### 13.2. the methods available

13.2.1. State aid control

13.2.1.1. this could boost R and D, but it could have some negative effects, such as job losses in other areas of the industry, and when stopping a firm from going bankrupt, it may just be delaying the inevitable. In addition to this, it may give a firm an unfair advantage and lead to a loss of competitiveness

13.2.1.1.1. EU has a law that you are only allowed to subsidise a firm once

13.2.2. Liberalisation of markets

13.2.2.1. the idea is to introduce new competition, and to make the market more contestable by providing new firms with subsidies so that they can enter the industry. As a result there is increased competition, and lower prices.

13.2.3. Antitrust and Cartels policy

13.2.3.1. to stop firms from engaging in anti - competitive behaviour that might damage the market, such as predatory pricing, exclusive dealing, territorial exclusivity ( having the sloe rights to sell goods in certain areas), refusing to supply, creating artificial barriers to entry and colluding with other firms

13.2.4. Merger control

13.2.4.1. there are laws in place that stop firms from merging together that could lead to one firm becoming a monopoly and having a dominant position in the market

13.2.4.1.1. though with a larger firm there could be better economies of scale which may be a good thing, as it leads to lower prices

## 14. The labour Market

### 14.1. Usethe perfectly competitive labour market as an example of how it should work - in reality monopsonies push ages down, unions push them up, people aren't identical, and there is discrimination

14.1.1. hasmany buyers and sellers, no barriers to entry or exit, identical labour, perfect information, perfect mobility

### 14.2. Demand for Labour (MRP)

14.2.1. the demand for labour is determined by: productivity and price of the output it makes

14.2.1.1. Demand for labour will rise if: the worker is very productive, and if the price of the output is high (eg. the lawyer example - has a valuable output, therefore the wage is high)

14.2.2. MPP

14.2.2.1. Marginal Physical Product rises at first, as you add more labour, but eventually things return to scale

14.2.2.2. how to affect productivity

14.2.2.2.1. Performance related pay - reward good work

14.2.2.2.2. invest in capital and training to improve the technique

14.2.3. MRP-MPP X P

14.2.4. how valid is it?

14.2.4.1. It is difficult to measure productivity, because sometimes there is no physical output to be sold (eg in services)

14.2.4.2. People are not identical, the theory assumes that each person is identical when they aren't

14.2.4.3. in the public sector 'market forces' have very little to do to affect the wage

14.2.4.4. firms have alternate goals

14.2.4.5. people who are self employed - how do they determine their wage?

14.2.5. MRP - Wage

### 14.3. the supply of labour

14.3.1. supply of labour to an economy is wage inelsatic, but not perfectly wage inelastic

14.3.2. Case study on the EU - we are a part of the European single market, and as a result, there is free movement of labour between boarders

14.3.2.1. Case study on the UK and Poland

14.3.3. supply curve is upward sloping, and is influenced by a number of monetary and non-monetary factors

14.3.3.1. All thisinfluences the wage elasticity of the supply curve

14.3.4. An induviduals' supply of labour - backward bending supply curve

14.3.4.1. it is said to occur because work is a means of earning money to be spent in leisure time. at some point a trade off will occur between work and leisure

14.3.4.1.1. the substitution effect will first start as an individual sacrifices leisure for money, but eventually the income effect will kick in, where a target wage is reached, and people will work less hours even though they can earn more

### 14.4. Monopsony employers

14.4.1. Will employ at MC - MRP - as this is the optimal amount of labour

14.4.1.1. this puts wages below what it would be in a perfectly competitive environment, but allows for greater profits

### 14.5. Unions

14.5.1. they push up wages that may be decreased by monopsonies, but free market economists believe they are bad, as they have a negative effect on the market and cause market failure

14.5.1.1. they prevent the market from operating smoothly, as they act as wage makers than wage takers

14.5.1.2. in addition to this, with a higher wage, it causes more unemployment

14.5.1.2.1. though to evaluate, if it is more inelastic, then there is less unemployment

14.5.2. bilateral monopoly

14.5.2.1. if a firm want to employ more people, it has to raise the wage. this then means that it has to raise the wage of all existing staff as well, causing a bent supply curve

### 14.6. Discrimination

14.6.1. eg. between men and women - causes a lower wage in woman than men - could be down to women being less likely to join a union etc.

14.6.2. to stop discrimination, governments need to educate people, and create legislation to prevent discrimination. eg. the sex discrimination act

## 15. inequality and poverty

### 15.1. measuring inequalities

15.1.1. lorenz curve and GINI coefficient

15.1.1.1. GINI coefficient = A/A+B of the Lorenz curve graph

15.1.2. Poverty

15.1.2.1. Absolute poverty exists when peoples' income is too low to afford the basic necessities in life such as food clothing and shelter

15.1.2.2. relative poverty is when people are poor in comparison to others in society - Joseph Rowntree Foundation says it is where disposable income is less than 60% of median income

15.1.2.3. In the UK it is mainly in the areas where deindustrialisation has occured

15.1.2.4. canlead to multiple deprivation (going without) and social exclusion (not being able to access the things that society takes for granted)

### 15.2. Causes of inequality

15.2.1. people with lack of skills - means a poorly paid job

15.2.2. falling relative incomes - not rising with inflation

15.2.3. marriage - people tend to marry within socio-economic groups, therefore wealth is retained

15.2.4. inheritance

15.2.5. because parents may have had more money, this may have caused people to have a better start in life due to a better education etc.

### 15.3. Reducing poverty

15.3.1. combat discrimination, taxes - redistribute wealth, invest in education, neighbourhood renewal, better childcare so parents can work

15.3.2. A trade of between efficiency and equity