Search for notes by fellow students, in your own course and all over the country.

Browse our notes for titles which look like what you need, you can preview any of the notes via a sample of the contents. After you're happy these are the notes you're after simply pop them into your shopping cart.

My Basket

Buy These Notes

You have nothing in your shopping cart yet.

Title: OCR A level economics revision guide (Micro)
Description: Updated for the new OCR economics syllabus first A level 2017). This is all the notes for A-level students that will start their A-levels in 2017. This is the whole of the micro notes which follows the specification. It includes diagrams such as monopolies, perfect competition, minimum wages and much more. These notes will also match the new specification and contain all the notes needed. Note that these notes does not ramble and give you all the information you need. It has been helpful to many A-level students from 2016. These notes will be beneficial and will for sure help you pass and excel you A-level exams. Good luck.
Buy These NotesPreview

Document Preview

Extracts from the notes are below, to see the PDF you'll receive please use the links above

Table  of  Contents  
The  basic  economic  problem  
...
 3  
Positive  economic  statements  
...
 4  
The  concept  of  the  margin  

...
 6  
Production  possibility  frontiers  (PPF)  
...
 9  
Specialisation  and  trade  
...
 11  
Allocation  of  resources  

...
   
13
Planned  economy  
...
 13  
Mixed  economy  
...
   
15
Supply  and  demand  
...
 16  
Supply  

...
 22  
Elasticity  
...
 26  
Using  knowledge  of  elasticity  
...
 30  
Cross  elasticity  of  demand  (XED)  
...
 31  
Elasticity  calculation  
...
 34  
Types  of  efficiency  
...
   
37
Costs  of  production  
...
 42  
Economies  of  scale  
...
 45  
Revenue  
...
   
48
Profit  maximisation  
...
   
50
Monopolistic  competition  
...
   
56
The  kinked  demand  curve  model  
...
 59  
Monopoly  
...
 63  
Concentration  ratios  
...
   
65
Contestable  markets  
...
 68  
Competition  policy  

...
   
70
Labour  demand  
...
 72  
Wage  determination  in  competitive  markets  
...
   
75
Monopsony  

...
 76  
Occupational  immobilities  –  lack  of  skills  
...
 77  
National  minimum  wage  
...
 83  
Flexible  labour  markets  
...
 84  
Wealth  and  Income  Inequality  
...
   
88
Public  goods  

...
 89  
Negative  externality  
...
 90  
Merit  good  
...
 92  
Moral  hazard  
...
   
93
Kuznets  environment  diagram  
...
   
96
Tax  
...
 98  
Tradeable  pollution  permits  

...
 100  
State  provision  of  public  services  
...
 102  
Government  Failure  
...
   Because  of  this  scarcity  and  
limited  resources,  economics  is  concerned  with:  
 
• What  to  produce  
• How  to  produce  
• For  whom  to  produce  

Economic  goods  /  free  goods  
•
•

Economic  good  –  A  good  which  imposes  some  cost  on  society  to  produce
...
 
Free  good  –  A  good  which  can  be  enjoyed  without  any  cost  to  society
...
 For  example,  air  to  
breathe,  rain  water  (in  most  parts  of  the  world)
...
 In  this  
case,  you  got  the  meal  for  free,  but  it  was  still  a  cost  to  someone  else  in  
society
...
 It  is  an  
economic  good
...
 

Positive  and  normative  economics  
Positive  statements  are  based  on  facts  that  can  be  tested  as  true  or  false
...
5%
...
 

Normative  statement  are  based  on  an  opinion  or  a  value  judgement
...
 For  example:    
•
•

The  government  should  increase  taxes  on  alcohol  to  improve  the  
nation’s  health
...
 

Combining  positive  and  normative  statements  
•

 

Because  oil  prices  have  increased  over  $100  (fact),  I  believe  the  
government  should  cut  petrol  tax  (opinion)
...
 

Note  how  the  same  positive  economic  statement  (oil  price  increased)  can  lead  to  
different  opinions  (normative)  on  how  to  respond
...
 A  good  that  is  required  for  the  basic  functions  of  life,  these  are  
goods  and  services,  such  as  food,  shelter,  clothing,  and  important  services,  
such  as  health  and  education
...
 This  refers  to  things  that  we  would  like  to  consume,  but  are  not  
essential  for  the  basic  functions  of  life
...
 Therefore,  we  could  say  2,000  
calories  of  food  a  day  are  a  need  for  most  people
...
 Because  we  don’t  need  these  extra,  expensive  calories
...
 Referring  to  resources  that  are  limited
...
 
Non-­‐renewable  resources
...
 
Once  used,  they  cannot  be  replaced
...
 
Renewable  resources
...
 Examples  
include  wind,  wood,  fish,  solar  energy,  and  water
...
 There  are  some  resources  that,  in  theory,  
are  renewable,  but  if  they  are  over-­‐consumed  they  can  become  extinct  
and  no  longer  available
...
 But,  
if  we  over-­‐fish,  fish  stocks  can  become  depleted  and  no  longer  available
...
 This  occurs  when  we  consume  resources  at  a  
rate  that  can  be  maintained  in  the  long-­‐term
...
 If  we  plant  at  the  same  rate  as  
cutting,  this  is  sustainable
...
 If  we  continue  to  over-­‐fish,  
it  means  future  generations  may  not  be  able  to  take  any  fish  from  the  sea  
at  all
...
 Governments  collect  taxation  and  spend  money  on  
government  services,  such  as  health  care  and  education
...
 
Firms
...
 Firms  also  
employ  workers  (householders)
...
 Households  are  consumers  of  goods  and  services;  they  are  
also  workers,  providing  labour  for  firms  to  produce  goods
...
 For  example,  coal,  fish,  and  wood
...
 
Labour  –  workers  able  to  participate  in  a  productive  process  –  turning  
raw  materials  into  finished  goods
...
 
Capital  –  machines  and  equipment  used  in  the  productive  process  to  
manufacture  goods
...
 An  entrepreneur  
can  take  a  risk  of  setting  up  a  new  firm  because  of  the  potential  profit  
from  creating  a  successful  business
...
 
Marginal  utility  is  the  benefit  /  satisfaction  from  consuming  an  extra  good  
Utility  is  the  concept  of  how  much  benefit  /  satisfaction  people  get  from  
consuming  a  certain  good
...
 
The  average  utility  for  5  goods  is  7
...
 
Total  utility  
10  
20  
28  
34  
36  

Marginal  utility  
10  
10  
8  
6  
2  

Average  utility  
10  
10  
9
...
5  
7
...
   
This  means  that  they  try  to  maximise  their  economic  welfare  and  make  decisions  
to  enable  this
...
 They  may  give  this  utility  a  monetary  value  like  
£10
...
 For  example,  they  
will  spend  money  on  goods  only  if  they  believe  the  utility  gained  is  
greater  or  equal  to  the  cost
...
 However,  the  second  chocolate  bar  has  a  lower  marginal  utility  –  
you  might  feel  sick  if  you  eat  too  many
...
 
Consumers  may  not  have  the  time  to  work  out  the  marginal  utility
...
 
Consumers  are  not  always  rational,  but  can  be  influenced  by  factors,  such  
as  advertising  and  impulse  buying
...
 For  example,  a  consumer  may  be  unaware  of  the  
marginal  utility  of  buying  a  second  hand  car
...
 For  example:  
 
• If  the  government  spends  tax  income  on  defence  spending,  then  this  
money  cannot  be  spent  on  health  care
...
 
• If  we  spend  our  time  surfing  the  internet,  we  cannot  spend  this  time  
studying  economics
...
 Sometimes  there  are  two  options  that  are  
good,  but  we  need  to  choose  the  relatively  best  option
...
   
6  
 

 
Evaluation  of  opportunity  cost  
•

•
•

It  can  be  difficult  for  consumers  to  know  the  next  best  alternative
...
 But,  how  much  would  we  need  to  currently  spend?    
People  often  don’t  have  time  to  try  and  work  out  opportunity  cost,  even  if  
they  could
...
 

 

Production  possibility  frontiers  (PPF)  
A  PPF  shows  the  maximum  output  that  an  economy  can  produce  if  the  economy  
is  maximising  the  use  of  its  resources  and  operating  efficiently
...
 It  is  
impossible  to  choose  more  consumer  
goods  or  environment  units  without  an  
opportunity  cost
...
   
 
• If  we  produce  more  consumer  goods,  it  leads  to  a  depleted  environment
...
 
 

7  

 
Opportunity  cost  and  production  possibility  frontier  
 
• At  point  A,  we  have  15  goods  /  22  environment
...
 
• If  we  move  from  point  A  to  B,  we  gain  an  extra  3  units  of  the  environment
...
 
Production  possibilities  frontier    
 
Capital  vs
...
 
 
• Consumer  goods
...
 These  are  things  we  buy  
in  shops  like  food,  clothes,  etc
...
 These  are  goods  that  are  used  in  the  productive  process  –  for  
example,  a  machine
...
 
 
• If  we  move  from  A  to  B,  there  is  a  movement  along  the  PPF  curve  enabling  
more  consumer  goods  to  be  produced  (an  extra  3)
...
 
• Increasing  consumer  goods  enables  higher  living  standards  in  the  short  
term,  but  in  the  long  term  we  may  not  be  able  to  produce  as  much  
because  of  less  investment  in  capital  goods
...
 

 

8  

Economic  growth  and  a  shift  in  the  PPF  curve  
•
•

Economic  growth  enables  the  PPF  curve  to  shift  to  the  right,  enabling  
point  C  (more  consumer  goods  and  capital  goods)
...
 

Causes  of  economic  growth  
•
•
•
•

Discovering  more  raw  materials  (e
...
 discovering  oil  fields)  
Increase  in  the  size  of  work  force  (e
...
 immigration)  
Increase  in  capital  stock  (e
...
 investment  in  new  machines,  factories)  
Increase  in  labour  productivity  (e
...
 due  to  better  technology)  

Production  possibility  frontier  and  efficiency  
•
•
•
•

We  say  that  any  point  on  the  PPF  curve  is  productively  efficient
...
 
However,  productive  efficiency  is  not  the  only  criteria
...
 

 

•
•
•
 
 

 
An  economy  could  use  all  its  resources  to  produce  capital  goods  (point  C)
...
   
Allocative  efficiency  would  involve  the  right  combination  of  capital  goods  
and  consumer  goods  –  point  A  or  point  B
...
 
Countries  will  specialise  in  producing  goods  where  they  have  a  
comparative  advantage
...
 Cuba  specialises  in  producing  sugar
...
 
Rather  than  try  to  master  all  aspects  of  production,  some  workers  will  
specialise  at  a  particular  job
...
 
Adam  Smith  in  ‘Wealth  of  Nations’  found  that  the  efficiency  of  a  pin  
factory  was  increased  if  workers  specialised  in  a  particular  part  of  the  pin  
production  process  and  worked  on  an  assembly  line
...
 Overall,  they  need  less  time  to  be  trained
...
   
Without  specialisation  and  the  division  of  labour,  one  person  may  be  
unable  to  produce  a  car  on  his  own
...
 

 

Problems  of  specialisation  
•
•
 

The  division  of  labour  can  make  jobs  highly  specialised  and  repetitive,  
leading  to  boredom  and  possible  diseconomies  of  scale
...
 Therefore,  there  
needs  to  be  some  flexibility
...
 
Countries  can  make  use  of  their  best  resources  (e
...
 low  labour  costs  in  
India  and  China  or  advanced  technology  in  Germany)
...
g
...
   
If  countries  specialise  in  certain  goods,  those  industries  can  benefit  from  
economies  of  scale  as  they  get  bigger
...
 For  example,  if  sugar  prices  fall,  countries  that  rely  
on  sugar  exports  will  see  a  fall  in  income
...
 

Money  
•

•

•

Money  is  an  object  used  as  a  medium  of  exchange  between  two  parties
...
 
Money  enables  people  to  specialise  in  one  job  and  use  their  earnings  to  
purchase  goods  and  services  from  people  who  work  elsewhere
...
   
Without  money,  we  would  need  a  barter  economy,  which  makes  
specialisation  harder  (e
...
 a  pig  farmer  is  unlikely  to  sell  me  some  pork  in  
return  for  a  few  hours  of  economics  tuition)
...
Medium  of  exchange
...
   
2
...
 Money  measures  the  relative  worth  of  goods  (e
...
 a  TV  
priced  at  £250,  a  banana  at  25p)
...
Store  of  value
...
 
4
...
 Money  is  used  to  pay  back  debt
...
 
 
 

 

11  

Allocation  of  resources  
•
•
•

Allocation  of  resources  refers  to  how  goods  are  distributed  in  society
...
 
In  a  command  economy,  resources  are  allocated  by  the  government
...
 
This  higher  price  makes  the  good  more  profitable
...
   

 

 
 

•
•

In  the  long  term,  firms  respond  to  higher  prices  by  increasing  supply
...
 

Evaluation  of  incentive  effects  
•
•
•

There  can  be  considerable  time  delays,  e
...
 people  take  time  to  respond  to  
changing  consumer  preferences
...
 Firms  may  not  
wish  to  produce  goods  if  they  are  of  questionable  ethics
...
 

 
 
 

12  

Types  of  economic  systems  
Planned  economy  
•

•

This  is  an  economy  where  the  government  owns  the  means  of  production,  
and  the  government  decides  what  and  how  to  produce  (e
...
 the  former  
Soviet  Union)
...
 

Advantages  of  planned  economies  
•
•
•
•

The  government  can  reduce  inequality  and  make  important  public  
services  available  to  all
...
 
The  government  can  prevent  the  abuse  of  monopoly  power
...
 

Problems  of  command  economies  
•
•
•

•
•

There  is  no  profit  motive,  so  people  working  for  the  government  may  
have  little  incentive  to  cut  costs  and  innovate
...
 
The  government  may  be  slow  to  respond  to  changing  consumer  
preferences;  with  price  controls,  we  may  end  up  with  shortages  or  
surpluses
...
 
Consumers  may  face  a  lack  of  choice  about  goods  to  buy
...
 

The  market  economy  
•
•

A  totally  free  market  occurs  where  there  is  no  government  intervention  in  
the  economy
...
   

Advantages  of  free  market  economies  
•
•
•
 

Free  markets  tend  to  result  in  an  efficient  allocation  of  resources  because  
firms  have  a  profit  incentive  to  produce  goods  that  are  in  demand
...
 
Consumers  have  the  freedom  to  choose  the  best  products,  which  they  
need
...
 
The  incentives  of  a  free  market  encourages  individuals  to  work  hard  and  
set  up  new  business
...
   
In  a  free  market,  public  goods,  like  street  lighting,  will  not  be  provided
...
 
There  will  be  overconsumption  of  goods  with  negative  externalities,  
leading  to  pollution  and  damage  to  the  environment
...
 
Inequality  will  occur
...
 

Mixed  economy  
In  a  mixed  economy,  part  of  the  economy  will  be  left  to  private  enterprise,  but  
the  government  will  intervene  in  various  areas
...
g
...
 
• Try  to  reduce  relative  poverty  through  redistributing  income
...
 
• Provide  services  that  are  under-­‐consumed  in  a  free  market  (health  care,  
education,  welfare  state,  and  national  defence)
...
g
...
g
...
 
• A  mixed  economy  tries  to  get  the  best  of  free  markets  (efficiency,  
enterprise,  innovation)  but  deals  with  some  of  the  problems  of  market  
failure,  including  pollution,  monopoly,  and  inequality
...
 For  example,  in  the  UK,  the  government  spends  
approximately  40%  of  GDP
...
 
35%  of  GDP
...
   
For  example,  the  government  may  lack  sufficient  information  and  
government  workers  may  have  limited  incentives  to  be  efficient  and  
productive
...
 For  example,  when  choosing  goods,  consumers  will  buy  the  
goods  that  give  them  the  most  satisfaction  relative  to  the  price
...
 
Sales  maximisation  occurs  when  firms  try  to  increase  sales  and  
maximise  market  share
...
 For  example,  this  may  involve  firms  making  less  profit  but  
making  goods  cheaper  for  people  on  low  income
...
 This  may  involve  consumers  avoiding  
the  consumption  of  goods  which  cause  pollution,  e
...
 choosing  to  walk  
rather  than  drive
...
 If  a  firm  aims  at  profit  maximisation,  it  may  conflict  with  the  
environment  or  social  welfare  because  increasing  output  could  lead  to  
more  pollution
...
 Government  intervention  may  be  needed  to  
limit  behaviour  of  firms  and  consumers
...
 It  is  possible  a  firm  may  be  able  to  
harmonise  different  objectives
...
 Firms  
which  look  after  environment  may  get  better  brand  loyalty
...
 For  example,  farmers  will  supply  vegetables  in  the  market,  
and  consumers  will  buy  (demand)
...
 For  example,  within  a  
vegetable  market,  there  may  be  a  sub-­‐market  of  organic  vegetables
...
   
The  market  demand  curve  illustrates  the  price  consumers  in  the  whole  
economy  are  willing  to  pay
...
 

Movement  along  the  demand  curve
...
 
•
•

A  higher  price  reduces  demand
...
 

Demand  Curve  

 
•
•

 

For  example,  if  there  is  an  increase  in  price  from  9  to  12,  then  there  will  
be  a  fall  in  demand  from  30  to  22
...
 If  the  
price  is  higher,  this  discourages  people  from  buying  the  good
...
 

A  shift  to  the  right  in  the  demand  curve  can  occur  for  a  number  of  reasons:  
1
...
 
2
...
 For  example,  mobile  phones  are  
now  more  versatile  and  powerful,  making  them  more  attractive
...
Advertising  can  increase  brand  loyalty  to  goods  and  increase  demand
...
An  increase  in  the  price  of  substitutes
...
 
5
...
 For  example,  a  lower  price  for  Apple  
apps  will  increase  demand  for  Apple  iPhones
...
Fashion  /  trends
...
g
...
 
Evaluation  of  demand  
•

•

 

The  evaluation  of  a  change  in  demand  depends  on  the  type  of  good
...
 
Some  goods  will  vary  due  to  seasonal  factors  like  the  weather  and  time  of  
year  (e
...
 scarves  and  air  conditioners)
...
 The  price  individuals  are  willing  to  pay  for  goods
...
 This  is  the  sum  of  all  individual  demand  curves
...
 This  occurs  when  the  demand  for  a  good  depends  on  demand  
for  another  product  /  service
...
 If  there  was  a  rise  in  unemployment  and  less  people  working,  
demand  for  travel  would  fall
...
 We  demand  café  waiters  only  if  
there  is  demand  for  people  visiting  cafes  and  buying  coffee
...
 This  occurs  when  a  good  has  multiple  different  uses
...
 
•

•

•

For  example,  demand  for  wheat  could  be  due  to  either:  
o Demand  to  use  wheat  in  bread  or  
o Demand  to  use  wheat  as  a  biofuel
...
 With  more  demand  for  biofuels,  the  price  of  wheat  will  rise  
causing  the  price  of  wheat  for  bread  to  also  increase
...
   
• Steel  -­‐  could  be  used  for  building  guns  or  it  could  be  used  for  building  
bicycles
...
 This  occurs  when  two  goods  are  complementary  and  needed  
together
...
 
Therefore,  higher  demand  for  home  printers  will  lead  to  higher  demand  
for  ink  cartridges
...
 A  market  where  there  are  two  goods  offering  very  similar  
levels  of  satisfaction
...
 

18  

Relationship  between  price  and  quantity  demanded  

 
This  shows  the  demand  for  a  good  against  the  price
...
 
The  marginal  utility  of  extra  units  tends  to  be  lower,  so  we  are  willing  to  
pay  lower  prices  for  these  extra  units,  e
...
 fifth  cake  will  give  much  lower  
utility  than  your  first
...
 

Income  effect
...
 
If  the  price  of  petrol  increases,  then  consumers  will  have  lower  disposable  
income;  they  may  not  be  able  to  afford  to  drive  as  much,  leading  to  lower  
demand
...
 This  looks  at  the  effect  of  a  price  increase  compared  to  
alternatives
...
 
•

The  income  and  substitution  effect  shows  an  increase  in  the  price  of  a  
good  effects  both  our  disposable  income  and  changes  the  relative  cost  of  
goods
...
 
The  market  supply  curve  refers  to  the  sum  of  all  individual  supply  curves;  
it  is  the  total  supplied  to  the  market
...
 
If  price  changes,  there  is  a  movement  along  the  supply  curve
...
 

Joint  supply    
Joint  supply  occurs  when  two  goods  are  supplied  together  from  the  same  source
...
   
With  an  increase  in  the  supply  of  beef,  you  also  get  more  leather
...
g
...
   This  could  occur  for  the  following  reasons:  
•

•
•
•
•
•
•
•

A  decrease  in  costs  of  production
...
 Lower  costs  could  be  due  to  lower  wages  or  lower  raw  
material  costs
...
 
Expansion  in  the  capacity  of  existing  firms,  e
...
 investment  to  extend  the  
size  of  a  factory
...
g
...
 
Favourable  climatic  conditions,  which  are  very  important  for  agricultural  
products,  e
...
 good  weather  will  give  a  good  harvest
...
g
...
 
Lower  taxes  on  the  good,  e
...
 lower  petrol  tax
...
 

 

 

 

21  

Interaction  of  markets  
The  price  mechanism  refers  to  how  supply  and  demand  interact  to  set  the  
market  price  and  the  amount  of  goods  sold
...
 

Excess  demand  

 
If  the  price  is  below  equilibrium  (p2),  demand  is  greater  than  supply  (Q2  –  Q1)  –  
causing  a  shortage
...
 
As  price  rises,  there  will  be  movement  along  the  demand  curve  and  less  
will  be  demanded
...
 

Excess  supply  
 

 
•
•

•

If  the  price  is  above  equilibrium  (p2),  supply  is  greater  than  demand  (Q2-­‐
Q1)  –  causing  a  surplus
...
 The  lower  price  also  encourages  more  
demand
...
 

 
Impact  of  increase  in  demand  
•
•

If  consumers  saw  an  increase  in  income,  we  would  see  an  increase  in  
demand  for  goods  like  TV’s;  the  demand  curve  would  shift  to  the  right
...
 

 
 
 
 
 

23  

Impact  of  increase  in  demand  

 
•
•

The  increase  in  demand  causes  an  increase  in  market  price  (P1  to  P2)  and  
an  increase  in  quantity  (Q1  to  Q2)
...
 

Fall  in  supply  
If  the  availability  of  oil  decreased,  we  would  see  a  fall  in  supply
...
   
Since  demand  for  oil  is  inelastic,  we  see  a  relatively  bigger  increase  in  the  
price
...
 Previously  it  was  too  
costly  to  produce  oil  from  here,  but  the  higher  price  may  make  it  
worthwhile
...
 
Therefore,  over  time,  the  impact  of  a  fall  in  supply  may  vary
...
 In  several  markets,  prices  are  not  determined  by  market  
forces,  but  considerations  of  equity  and  ‘being  fair’
...
 
Difficult  to  measure
...
 For  example,  a  fruit  picker  can  be  paid  depending  how  much  fruit  is  
picked,  but  a  teacher  or  a  nurse  has  a  less  measurable  value
...
 Some  goods  are  quite  volatile  in  price
...
 This  is  because  supply  can  vary,  and  demand  
tends  to  be  inelastic
...
 
Government  set  prices
...
 For  example,  TV  
licenses,  train  tickets,  and  price  of  prescriptions  are  all  influenced  or  set  
by  the  government
...
 If  price  is  below  the  equilibrium,  there  is  
excess  demand,  but  a  firm  may  not  want  to  expand
...
 

 
 
 
 

 

25  

Elasticity  
Price  elasticity  of  demand  (PED)  
The  price  elasticity  of  demand  measures  the  responsiveness  of  demand  to  a  
change  in  price
...
 

Example  of  elastic  demand  
•

If  the  price  of  Tesco  bread  increases  5%  and  demand  falls  15%,  the  PED  is    
(-­‐15/5)  =    -­‐3
...
 This  is  price  elastic
...
 
Competitive  markets
...
   For  example,  if  the  price  of  Tesco  
bread  increased,  consumers  could  switch  to  several  other  varieties
...
 With  goods  that  are  bought  frequently,  we  are  more  
likely  to  compare  prices,  and  switch  if  necessary
...
D
...
g
...
5)
...
2    
 
Characteristics  of  inelastic  goods  
•
•
•
•
•

Few  substitutes,  e
...
 petrol  and  cigarettes  have  few  close  alternatives
...
g
...
 
Addictive
...
g
...
 
Small  percentage  of  income  means  you  don’t  worry  if  price  rises
...
 

 
Evaluation    
1
...
 But  demand  for  individual  brands  of  coffee  is  likely  
to  be  more  elastic,  as  there  are  substitutes  to  Starbucks  coffee  (e
...
 Costa)
...
Elasticity  may  change  over  time
...
 

 

27  

Using  knowledge  of  elasticity  
1
...
   
Diagram:  Inelastic  demand  and  price  

 
In  this  example,  the  price  of  oil  rises  from  $110  a  barrel  to  $190,  and  the  quantity  
falls  from  9  million  to  8  million
...
 
What  is  the  PED  of  oil  in  this  example?  
•
•

%  change  in  Q
...
 1/9  =  -­‐0
...
1%)  
%  change  in  price  80/110  =  0
...
7%)  

Therefore  PED  of  oil  =  -­‐11
...
7  =  -­‐0
...
5%  
Revenue  was  110  ×  9  =  £990  
Revenue  has  now  fallen  to  4  ×  £130  =  £520  
A  fall  of  £470  

PED  of  this  example  -­‐55/18  =  -­‐  3
...
 Advertising  and  elasticity  
•
•
•
•

Firms  have  an  advantage  if  demand  for  their  good  is  price  inelastic
...
 
This  is  why  many  firms  spend  money  on  advertising  to  create  brand  
loyalty
...
 
Firms  can  also  make  demand  more  inelastic  by  offering  more  add-­‐on  
features  and  better  quality  products  that  stand  out  from  the  competition
...
 

 
Example  of  YED  
•
•

If  your  income  increases  by  5%  and  the  demand  for  mobile  phones  
increases  by  20%,  then  the  YED  =  20  /  5    =  4
...
25  

Types  of  goods  
•

•

•

•

Inferior  good
...
 Inferior  goods  will  have  a  negative  YED
...
 As  your  income  
increases,  you  buy  better  quality  goods  instead
...
 This  occurs  when  an  increase  in  income  leads  to  an  
increase  in  demand  for  the  good,  therefore  YED  is  positive  >0
...
 
Luxury  good
...
   It  means  demand  is  
income  elastic
...
 
Income  inelastic
...
 Therefore  0  >  YED  <  1
...
 Demand  for  inferior  goods  will  increase
...
 Supermarkets  may  respond  to  a  recession  (falling  income)  
by  supplying  more  ‘inferior’  goods
...
 Developing  countries  who  specialise  in  producing  
primary  products  (with  low  YED)  may  benefit  less  from  global  growth
...
 

 
Substitute  goods
...
 With  two  
substitute  goods,    
•
•
•
•

With  substitutes,  XED  will  be  positive
...
   
Tesco  bread  and  Sainsbury’s  bread  are  close  substitutes  so  XED  is  higher
...
 Therefore  XED  =  15/10  =  1
...
 These  are  goods  that  are  used  together
...
     
For  example,  if  the  price  of  DVD  players  fall,  then  there  will  be  an  increase  
in  demand  for  DVD  discs
...
 If  the  price  of  milk  falls  by  10%,  
demand  for  tea  may  increase  1%
...
1  
 

Unrelated  goods
...
 If  the  price  of  lamb  increases  and  
demand  changes  for  computers,  it  is  just  a  co-­‐incidence  and  not  related
...
 

 
 
 
 
 
 

31  

Diagram:  inelastic  supply  

 
•
•
•
•
•

Inelastic  supply  means  a  change  in  price  causes  a  smaller  percentage  
change  in  supply  (PES  <1)
...
 
In  the  example  on  the  left:  %  change  in  Q  =  3/50  =  6%  
%  change  in  price  =  6/60  =  10%  
Therefore,  PES  =  6/10  =  0
...
Operating  close  to  full  capacity
...
 
2
...
 
3
...
 
4
...
g
...
 
5
...
 

Elastic  supply  
This  occurs  when  an  increase  in  price  leads  to  a  bigger  %  increase  in  supply,  
therefore  PES  >1
...
 
32  

 
•
•
•
•

On  the  left:  Price  increase  from  60  to  63  and  Q  increases  from  50  to  60
...
0  (elastic  supply)  

Supply  could  be  elastic  for  the  following  reasons:  
•
•
•

If  there  is  spare  capacity  in  the  factory
...
 
If  it  is  easy  to  employ  more  factors  of  production
...
   
• But,  in  the  long  run,  supply  can  be  more  elastic  as  the  firm  is  able  to  invest  
in  more  capacity  and  therefore  increase  supply
...
0
...
 If  the  price  increased  from  £30  to  £36,  what  will  be  the  new  Q?  
•

Price  increases  by  £6
...
2)  =  20%  

(PES)  2
...
   
For  example,  if  a  book  costs  £10,  but  the  demand  curve  shows  that  they  
would  have  paid  £16,  the  consumer  surplus  is  £6
...
   
A  monopoly  that  can  set  prices  will  be  able  to  reduce  consumer  surplus
...
 

 
Producer  Surplus  
•
•

 

Producer  surplus  is  the  difference  between  the  price  suppliers  receive  
and  the  price  that  they  would  have  been  willing  to  supply  the  good  at
...
 
34  

Producer  surplus  after  fall  in  supply  
 
•
•
•

If  we  had  an  increase  in  the  cost  of  production,  we  would  see  the  supply  
curve  shift  to  the  left
...
 Producer  surplus  also  falls
...
 

 

 
Consumer  and  producer  surplus  after  a  fall  in  supply
...
Productive  efficiency
...
 It  will  also  occur  at  the  
lowest  point  on  the  firm’s  SRAC  curve
...
Allocative  efficiency
...
 This  occurs  at  an  output  
where  P=MC  because,  at  this  value,  what  the  marginal  benefit  
consumers  get  is  the  same  as  the  marginal  cost
...
X-­‐efficiency
...
 
A  firm  exhibits  x-­‐inefficiency  if  it  lacks  incentives  to  cut  costs  and  so  its  
actual  costs  are  higher  than  they  could  be
...
Efficiencies  of  scale
...
 
 
36  

 

 

 

 

 

5
...
 This  refers  to  efficiency  over  time
...
 Dynamic  efficiency  is  
also  influenced  by  investment  in  human  capital  and  investment  in  capital  
and  technology
...
Static  efficiency
...
 
7
...
 This  includes  all  external  costs  and  benefits
...
 

 
 
 

Business  objectives  
1
...
 Benefits  of  
maximising  profit  can  include:  
•
•
•
•

 

Higher  salaries  for  managers  and  workers
...
 
Encourages  firm  to  be  efficient  and  to  keep  looking  at  cutting  costs
...
 

37  

2
...
 This  
could  involve:  
• Sales  revenue  maximisation  –  maximising  total  revenue  (P*Q)  
• Sales  volume  maximisation  –  selling  as  many  units  as  possible  –  probably  
selling  goods  as  cheap  as  possible  without  making  a  loss
...
   
• Managers  prefer  to  work  for  bigger  companies,  as  it  tends  to  lead  to  
greater  prestige  and  higher  salaries
...
 Social  /  environmental  concerns  
A  firm  may  incur  extra  expenses  to  choose  products  which  don’t  harm  the  
environment,  or  choose  products  not  tested  on  animals
...
g
...
 
• Organisations  like  the  Co-­‐op  have  a  different  structure  to  share  profits  
amongst  consumers  and  workers
...
 Profit  satisficing  /  divorce  of  ownership  
•
•

•
•

•

In  many  firms,  there  is  separation  of  ownership  and  control
...
 
This  is  a  problem  because  owners  may  want  to  maximise  profits,  but  the  
managers  and  workers  have  much  less  incentive  to  maximise  profits
...
 
Profit  satisficing  is  also  known  as  principle/agent  problem
...
 This  gives  
workers  an  incentive  to  think  like  shareholders  and  maximise  profits,  and  
it  could  overcome  the  x-­‐inefficiency  of  workers  without  incentives
...
 

 

 

38  

Social  welfare    
•

Some  businesses  may  be  set  up  with  aim  of  promoting  social  welfare
...
 

Corporate  social  responsibility  (CSR)  
•
•

This  is  a  business  model  where  the  main  stakeholders  in  a  business  are  
considered  –  beyond  the  usual  profit  maximisation  aims
...
 

 
Diagram  showing  different  objectives  

 
 

•
•
•
•

P1,  Q1  –  Profit  maximisation  -­‐  because  it  is  the  output  where  MR=MC  
P2,  Q2  –  Revenue  maximisation  -­‐  because  it  is  the  output  where  MR=0  
P3,  Q3  –  Marginal  cost  pricing  -­‐  P=MC  (allocative  efficiency)  
P4,  Q4  –  Sales  maximisation  -­‐  The  maximum  sales  a  firm  can  make  whilst  
making  normal  production  

 
 

39  

Factors  which  influence  choice  of  objectives  
•

•

•

Aims  of  owners
...
 Entrepreneurs  may  set  up  business  hoping  to  secure  their  financial  
future
...
 
Public  opinion
...
g
...
 This  may  encourage  multi-­‐nationals  to  promote  
schemes  for  the  betterment  of  developing  countries
...
 It  could  be  argued  that  making  
statements  of  social  concern  and  giving  some  profit  back  to  charity  can  
enhance  a  firm’s  long-­‐term  reputation  and  become  a  good  marketing  
strategy
...
 

 
 
 

Costs  of  production  
•
•
•
•
•
 
•
•
•

 

Fixed  costs:  Costs  that  do  not  vary  with  output  e
...
 the  cost  of  a  factory
...
g
...
 
Total  costs:  Fixed  +  variable  costs
...
g
...
 
Long  run
...
g
...
 In  the  long  run,  we  can  get  
economies  and  diseconomies  of  scale
...
67  
475  

 

 
Average  costs  tends  to  be  U-­‐shaped  in  the  short  run
...
 
Total  product  (TP)
...
 
Marginal  product  (MP)
...
 

•
•
 

 

 
Q  of  workers  
1  
2  
3  
4  
5  
6  
7  
 
•
•
•
•

 

MP  
2  
4  
6  
8  
10  
8  
5  

TP  
2  
6  
12  
20  
30  
38  
43  

MC  
10  
5  
3
...
4  
2  
2
...
 If  a  worker  costs  £20,  the  MC  of  those  2  
units  is  20/2  =  10
...
 The  MC  of  those  6  units  is  20/6  =  3
...
 
The  5th  worker  adds  an  extra  10  goods
...
 
After  the  5th  worker,  diminishing  returns  sets  in,  as  the  MP  declines
...
 

42  

Diminishing  returns  explained  
•
•
•
•
•
•
 

Diminishing  returns  occur  in  the  short  run,  when  one  factor  is  fixed,  e
...
 
capital
...
 
This  is  because  if  capital  is  fixed,  extra  workers  will  eventually  get  in  each  
other’s  way,  as  they  attempt  to  increase  production
...
 
When  diminishing  returns  occurs,  there  will  be  a  decreasing  marginal  
product  (MP)  and  increasing  marginal  cost  (MC)
...
 

 
•
•
•

Because  of  diminishing  returns,  we  get  a  SRAC  (short  run  average  cost),  
which  is  U-­‐Shaped
...
 When  the  marginal  cost  is  
higher  than  average,  SRAC  will  rise
...
 

 

 

43  

Economies  of  scale  
•

Economies  of  scale  occur  when  long  run  average  costs  fall  with  increasing  
output
...
g
...
 
Examples  of  industries  with  many  economies  of  scale  include:  
•
•
•

Aerospace  manufacture  
Railways  
Car  production  

Internal  economies  of  scale    
Internal  economies  of  scale  occur  when  an  individual  firm  becomes  more  
efficient
...
Specialisation  and  division  of  labour
...
 With  little  training,  they  can  become  
very  proficient  in  their  task  and  this  enables  greater  efficiency
...
 
2
...
 If  you  buy  a  large  quantity,  then  the  average  costs  will  be  
lower
...
Technical
...
 For  
example,  a  large  machine  (e
...
 blast  furnace  /  combine  harvester)  would  
 

44  

be  inefficient  for  small-­‐scale  production;  for  higher  rates  of  production,  
the  firm  gains  a  better  rate  of  return
...
Financial  economies
...
 
5
...
 If  a  firm  is  undertaking  a  national  advertising  campaign,  it  
will  be  more  efficient  for  large  firms
...
Risk  bearing
...
 This  
gives  them  a  greater  ability  to  avoid  an  economic  downturn
...
   
•

•

For  example,  if  the  car  industry  gets  bigger,  all  car  firms  will  benefit  from  
better  infrastructure,  and  access  to  specialised  labour  and  good  supply  
networks
...
g
...
 

Diseconomies  of  scale  
•
•

This  occurs  when  long  run  average  costs  start  to  rise  with  increased  
output
...
 As  the  firm  gets  
bigger  it  will  become  more  inefficient
...
Poor  communication
...
 
2
...
   Working  in  a  highly-­‐specialised  assembly  line  can  be  very  
boring,  and  therefore  workers  become  de-­‐motivated
...
Lack  of  control
...
 
4
...
 When  whole  industries  get  too  big  and  
suffer  issues  such  as  congestion  and  duplication  of  routes
...
     

 
Significance  of  minimum  efficient  scale  
 
• It  determines  optimal  number  of  firms  in  an  industry
...
 Therefore,  the  industry  
would  be  an  oligopoly
...
 
 
 
 
 
 
 
 
 
 
 

 

46  

Revenue  
•
•
•

Total  revenue  (TR)
...
 TR  =  price  ×  
quantity
...
 
Marginal  revenue  (MR)
...
 

 

 

 
Q  
1  
2  
3  
4  
5  
6  
7  

P  
10  
9  
8  
7  
6  
5  
4  

TR  
10  
18  
24  
28  
30  
30  
28  

AR  
10  
9  
8  
7  
6  
5  
4  

 
This  shows  why  the  demand  curve  is  the  same  as  the  average  revenue
...
   
Normal  profit
...
 This  is  the  breakeven  point  for  
a  firm
...
 
Supernormal  profit
...
 This  is  profit  above  the  
breakeven  point
...
 This  occurs  where  AR  >AVC,  when  average  revenue  is  
greater  than  average  variable  cost
...
 
Accounting  profit
...
 It  is  
also  known  as  the  booking  profit
...
 This  is  the  total  revenue  -­‐  total  monetary  costs  and  
opportunity  costs
...
 
 

The  role  of  profit  in  a  market  economy  
1
...
 Profit  gives  entrepreneurs  an  incentive  to  set  up  businesses  
and  produce  goods  that  are  in  demand
...
Signal
...
 
Declining  profit  can  provide  a  signal  to  reduce  production
...
Investment
...
 
4
...
 Governments  place  corporation  tax  on  company  profit  to  take  a  
percentage
...
 

 
•
•
•
•

If  MR  >  MC,  total  profit  rises
...
 
Profit  is  therefore  maximised  at  Q  =  5,  where  MR=MC
...
   However,  in  the  real  world,  they  may  not  know  exactly  and  make  a  
best  approximation
...
 Features  of  perfect  competition  include:  
1
...

3
...


Many  small  firms
...
 
All  firms  produce  an  identical  or  homogenous  product
...
 
5
...
 
 
Examples  of  perfect  competition  include  foreign  exchange  markets,  many  
agricultural  markets  and  walking  tourist  guides  around  cities
...
 
•
•
•
•

 

The  diagram  on  the  right  shows  the  industry  supply  and  demand;  this  sets  
the  market  price  of  P1
...
   
Firms  will  maximise  profits,  where  MR=MC  (Q1)
...
 

50  

Efficiency  of  perfect  competition  
 
1
...
 This  is  because  the  long  run  equilibrium  (Q1)  
occurs  where  P  =  MC
...
Productive  efficiency
...
 
3
...
 Competition  between  firms  will  act  as  a  spur  to  increase  
efficiency  and  make  sure  firms  use  the  best  combination  of  inputs
...
Resources  will  not  be  wasted  through  advertising,  because  products  are  
homogenous
...
 
Therefore,  the  individual  demand  curve,  and  hence  AR,  will  shift  upwards
...
 
This  will  cause  firms  to  temporarily  make  supernormal  profits  (AR-­‐AC)  ×  
Q2
...
 
There  are  no  barriers  to  entry,  so  this  will  encourage  new  firms  into  the  
market,  until  normal  profits  are  made  and  prices  fall  back  to  P1
...
 
But,  if  firms  make  a  loss,  they  will  close  down,  causing  the  market  price  to  
rise  until  the  industry  is  profitable  again
...
 

Disadvantages  of  perfect  competition  
1
...
 This  is  because  there  are  many  small  
firms  producing  relatively  small  amounts
...
   
2
...
   These  can  be  boring,  giving  little  choice  to  
consumers
...
Limited  investment
...
 
4
...
 With  perfect  knowledge,  there  is  no  incentive  to  
develop  new  technologies,  because  it  would  be  shared  with  other  
companies
...
Externalities
...
 

How  realistic  is  perfection  competition?  
•
•
•

 

In  the  real  world,  it  is  hard  to  meet  all  the  criteria,  such  as  perfect  
information  and  freedom  of  entry  and  exit
...
 Many  markets  can  be  
considered  ‘competitive’,  even  if  not  quite  matching  perfect  competition
...
e
...
 
52  

•

In  the  real  world,  firms  are  often  competing  on  issues,  such  as  quality  of  
service,  quality  of  product  and  extra  features  –  rather  than  price
...
 
The  internet  has  helped  to  reduce  costs  of  entering  an  industry;  you  don’t  
need  a  big  shop,  but  can  spend  a  small  amount  on  a  website
...
 

Internet  and  lack  of  competition  
•

•
•

However,  the  internet  is  not  universally  increasing  competition
...
 
It  would  be  difficult  to  challenge  these  firms,  who  have  the  benefit  of  
being  the  first  to  dominate  (first  mover)
...
g
...
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 

53  

Monopolistic  competition  
Monopolistic  competition  is  a  market  structure  with  the  following  features:  
•
•
•
•

Many  firms
...
 
Freedom  of  entry  and  exit
...
 
Similar  goods,  but  with  brand  differentiation
...
 and  clothing  retailers
...
 This  enables  them  to  set  a  profit,  
maximising  price  similar  to  monopoly
...
 This  leads  to  supernormal  
profit,  because  AR  >  AC
...
 

54  

Monopolistic  competition  -­‐  long  run  

 
•
•

In  the  long  run,  new  firms  are  able  to  enter  the  market  because  there  is  
freedom  of  entry
...
 

Limitations  of  the  model  of  monopolistic  competition  
•

•

Some  firms  will  be  better  at  brand  differentiation  and  therefore,  in  the  
real  world,  will  be  able  to  make  supernormal  profit
...
 
There  is  considerable  overlap  with  oligopoly
...
 In  
the  real  world,  there  are  likely  to  be  at  least  some  barriers,  even  if  just  
through  brand  loyalty
...
 In  monopoly,  there  are  barriers  to  entry
...
 Therefore,  in  the  long  run,  firms  in  
monopolistic  competition  will  make  only  normal  profit
...
 In  monopolistic  competition,  
firms  produce  differentiated  products  and,  therefore,  they  are  not  price  
takers  (perfectly  elastic  demand)
...
   
 
 
 

 

55  

Oligopoly  
An  oligopoly  is  an  industry  which  is  dominated  by  a  few  firms
...
     
 
Features  of  oligopoly  include:  
1
...
   
2
...
 
3
...
 Advertising  and  non-­‐price  competition  are  often  
important  in  oligopoly
...
Price  competitive  /  price  wars
...
 
2
...
 The  kinked  demand  
curve  suggests  prices  will  be  stable  and  firms  focus  on  non-­‐price  
competition
...
Higher  prices  /  collusion
...
 This  may  involve  collusion
...
g
...
 
The  degree  of  contestability,  e
...
 amount  of  barriers  to  entry
...
g
...
 
The  nature  of  the  industry,  e
...
 is  the  industry  in  growth  phase  or  decline?  
A  declining  industry  may  be  more  prone  to  price  competition,  as  firms  try  
to  retain  sales
...
 For  example,  if  a  firm  in  oligopoly  cuts  
price,  the  outcome  will  largely  depend  on  how  other  firms  react,  e
...
 do  
other  firms  also  follow  suit  (starting  price  war),  or  do  they  keep  prices  
high?  There  are  no  guarantees  in  oligopoly
...
 
•
 

This  model  assumes  firms  seek  to  maximise  profits
...
 
If  firms  cut  prices,  then  they  would  gain  a  big  increase  in  market  share
...
 Therefore,  other  firms  
follow  suit  and  cut  prices  as  well
...
 
This  suggests  that  increasing  or  decreasing  prices  will  lead  to  lower  
revenue  and  therefore  prices  will  be  rigid  in  oligopoly
...
 
Limitations  of  this  model:  
1
...

3
...


The  model  does  not  explain  how  prices  were  set  in  the  first  place
...
 
In  the  real  world,  firms  often  do  cut  or  increase  price
...
 

Non-­‐price  competition  
If  prices  are  rigid,  and  firms  have  little  incentive  to  change  prices,  they  will  
concentrate  on  non-­‐price  competition
...
Advertising
...
 
Advertising  can  also  be  used  as  a  barrier  to  entry
...
Product  development
...
 
3
...
 A  reason  for  customers  to  come  back
...
Quality  of  service
...
 
5
...
 Better  location  for  firms
...
 Unless  you  have  a  good  
location,  you  will  not  pick  up  passing  trade
...
g
...
 
Non  price  strategy  is  some  aspect  of  quality,  service  which  encourages  
consumption,  independent  of  price
...
 Non-­‐pricing  strategy  -­‐  advertising  
The  aim  of  advertising  is  to  increase  brand  loyalty
...
 Successful  
advertising  can  make  demand  more  inelastic,  and  therefore  increase  profits
...
g
...
 
Evaluation  
•

•

It  depends  on  the  product
...
 However,  it  would  be  
relatively  ineffective  for  a  product  like  petrol,  where  people  believe  it  is  
homogenous  and  price  will  always  remain  the  most  important  factor
...
 Firms  like  Nike  use  top  sports  
stars  to  wear  their  products
...
g
...
 

2
...
 If  demand  is  
elastic  and  sensitive  to  price,  this  could  lead  to  an  increase  in  sales  and  an  
increase  in  profits
...
 
Evaluation  
•

 

It  depends  how  other  firms  react
...
 

58  

•

It  depends  on  the  product
...
 

Price  wars  
Firms  may  not  seek  to  maximise  profits  but  have  other  aims,  such  as  increasing  
market  share  and  expanding  the  firm
...
 
•
•
•

•

Price  wars  are  more  likely  in  a  recession,  when  demand  is  falling  and  
markets  become  more  competitive
...
 
Price  wars  are  often  selective,  e
...
 supermarkets  have  selective  price  
cuts  on  “loss  leaders”
...
 
Price  wars  can  be  in  the  public  interest,  but  only  if  firms  don’t  get  forced  
out  of  business  by  the  low  prices
...
   
To  set  price  below  cost,  the  firm  will  need  to  cross  subsidise  the  market  
from  other  profitable  markets
...
 There  is  legislation  
which  makes  predatory  pricing  illegal
...
   
A  cartel  is  a  formal  collusive  agreement
...
 
Tacit  collusion  is  an  unwritten  agreement  where  firms  observe  informal  
rules,  such  as  not  undercutting  rivals
...
 
Overt  collusion  is  where  firms  are  open  about  their  deals  to  set  prices  and  
output
...
 
There  will  be  a  similar  price  and  outcome  to  a  monopolistic  industry,  with  
firms  effectively  sharing  the  supernormal  profits
...
 There  is  legislation  against  collusion  and  
cartels  in  the  UK
...
 If  
Tesco  cuts  prices,  whist  Sainsbury  has  high  prices,  Tesco  would  make  
even  more  profit  (£13m)  but  Sainsbury  would  make  less  (£2m)
...
 

To  keep  prices  high,  there  needs  to  be  collusion,  either  overt  or  tacit
...
 

Factors  favouring  collusion  
1
...

3
...

5
...
 
A  dominant  firm  who  is  able  to  have  influence  in  setting  the  price
...
 
Effective  communication  and  monitoring  of  output  and  costs,  and  
effective  punishment  strategies  for  firms  who  cheat
...
g
...
 

Evaluation  of  collusion  
•
•
•

Collusion  enables  higher  profits
...
 
Collusion  is  unlikely  to  occur  if  they  aim  at  sales  maximisation
...
 However,  under  collusions,  firms  may  become  inefficient,  
because  it  is  easy  to  make  profit  and  they  don’t  have  to  try  hard
...
 
In  the  UK,  a  firm  is  said  to  have  monopoly  power  if  it  has  more  than  25%  
of  the  market  share
...
 

•
 
Diagram  of  monopoly  

•
•
•
•

A  monopolist  maximises  profit,  where  MR  =  MC
...
 
Firm  makes  supernormal  profit    =  (AR-­‐  AC)  ×  Q  
If  the  market  was  competitive,  output  would  be  Q2  and  price  P2  (normal  
profit)
...
 
Productive  inefficient,  because  output  is  not  at  lowest  point  on  AC  curve
...
 
Less  choice  for  consumers
...
 

61  

•

Monopsony  power
...
 This  means  the  firm  can  pay  
workers  lower  wages,  and  supermarkets  can  pay  farmers  lower  prices
...
Economies  of  scale
...
 

 
Increasing  output  from  Q1  to  Q2  leads  to  lower  average  costs  (P1  to  P2)
...
   For  example,  airlines  and  car  
companies  tend  to  have  high-­‐fixed  costs  and  therefore  there  tends  to  
be  only  a  small  number  of  large  firms
...
   

2
...
 A  monopolist  can  use  its  supernormal  
profits,  to  invest  in  developing  new  products  which  may  require  high  
investment
...
 
3
...
 A  domestic  monopoly  may  be  necessary  to  
compete  internationally
...
 
4
...
 A  firm  may  gain  monopoly  power,  because  
it  is  efficient  and  innovative  e
...
 Google  and  Apple
...
 
 
62  

Barriers  to  entry    
These  are  factors  that  make  it  difficult  for  new  firms  to  enter  an  industry
...
High  fixed  costs
...
 If  a  new  firm  entered  the  market,  it  would  have  higher  
average  costs  and  struggle  to  compete
...
Vertical  integration
...
   For  example,  a  new  
airline  may  not  be  able  to  get  landing  slots  at  popular  airports  like  
Heathrow
...
Legal  monopoly
...
 
4
...
 If  a  firm  engages  in  advertising,  then  consumers  may  
develop  very  strong  brand  loyalty  to  a  particular  firm,  making  it  difficult  
for  others  to  enter
...
Being  the  first  firm  in  the  industry
...
 
6
...
 If  an  incumbent  firm  cuts  price  when  a  new  firm  
enters  the  market,  it  may  be  able  to  force  the  new  firm  out  of  business  
and  retain  its  monopoly  power
...
Geographical  barriers
...
 
8
...
 If  a  firm  has  high  costs  to  leave  a  market  it  may  deter  
entry
...
 

Natural  monopoly  
A  natural  monopoly  occurs  when  the  most  efficient  number  of  firms  in  an  
industry  is  one
...
 

 
 

63  

In  this  example,  if  the  industry  demand  is  10,000  then,  if  one  firm  produces  
10,000  units,  it  can  have  average  costs  of  £15
...
 Therefore,  it  makes  sense  for  there  
to  be  just  one  firm
...
 A  three-­‐firm  concentration  ratio  measures  the  combined  
market  share  of  the  three  biggest  firms
...
Tesco  29%  
2
...
Sainsbury  16%  
4
...
Co-­‐op  6%  
 
Total  five-­‐firm  concentration  ratio:  79%  
 
• Note  with  29%  of  market  share,  Tesco  is  considered  a  legal  monopoly
...
 
• We  would  classify  this  market  as  an  oligopoly  because  the  market  is  
dominated  by  a  few  firms
...
 
• The  three  firm  concentration  ratio  would  be  62%  
 
 

64  

 

Price  discrimination  
Price  discrimination  occurs  when  a  firm  charges  a  different  price  for  the  same  
good  to  different  groups  of  consumers
...
 This  is  where  the  firm  charges  the  
maximum  price  that  a  consumer  is  willing  to  pay
...
 
2nd  Degree  price  discrimination
...
 For  example,  units  
of  electricity  become  cheaper  after  higher  levels  of  consumption
...
 This  is  when  consumers  are  grouped  
into  two  or  more  independent  markets
...
 

Conditions  necessary  for  price  discrimination  
1
...
e
...
 Price  discrimination  
can  only  occur  in  imperfect  competition  (oligopoly  or  monopoly)
...
The  firm  must  be  able  to  separate  the  market  into  different  sections  and  
prevent  resale,  e
...
 it  must  be  impossible  for  an  adult  to  use  a  child’s  ticket
...
There  must  be  a  different  elasticity  of  demand  for  the  different  market  
sections,  e
...
 train  firms  can  charge  high  prices  at  peak  times  because,  in  
this  period,  demand  for  train  travel  is  inelastic
...
The  cost  of  separating  markets  must  be  less  than  extra  revenue  gained
...
It  usually  requires  low  or  constant  marginal  cost
...
 
•
•

We  assume  marginal  cost  is  the  same  for  both  groups
...
 

Advantages  of  price  discrimination    
1
...
 This  may  enable  some  firms,  who  
may  have  otherwise  have  made  a  loss  to  stay  in  business,  e
...
 train  
companies  need  price  discrimination  to  offer  off-­‐peak  travel
...
Research  &  development
...
 
3
...
 Some  consumers,  often  on  lower  incomes,  will  benefit  
from  lower  fares,  e
...
 pensioners  can  take  advantage  of  cheaper  fares  on  
trains
...
Higher  prices
...
 
2
...
 Often  those  who  benefit  from  lower  prices  may  not  be  the  
poorest
...
 
3
...
 

Common  examples  of  3rd  degree  price  discrimination  
•

•

Student  discounts
...
 This  is  
because  students  have  limited  income  and  are  more  likely  to  be  sensitive  
to  price
...
g
...
 
Buy  in  advance
...
 This  is  because  people  
planning  ahead  have  more  time  to  choose  means  of  travel,  and  will  be  
more  sensitive  to  price
...
 This  requires  low  sunk  costs
...
g
...
 
In  a  contestable  market,  incumbent  firms  will  always  have  the  threat  of  
new  firms  entering  the  industry
...
 

A  perfectly  contestable  market  has  the  following  three  features:  
1
...
Perfect  information  
3
...
 This  means  that  if  an  industry  is  making  supernormal  profits,  then  
a  firm  can  enter  and  take  advantage  of  high  prices
...
 
Therefore,  in  a  contestable  market,  a  firm  should  be  satisfied  with  normal  
profits,  otherwise  it  would  encourage  hit  and  run  tactics  from  other  firms
...
 
Increased  incentives  for  firms  to  cut  costs
...
 
However,  there  could  also  be  significant  economies  of  scale,  because  the  
theory  of  contestable  markets  doesn’t  require  there  to  be  many  firms
...
 
Regulators  in  the  privatised  industries  have  often  focused  on  removing  
barriers  to  entry,  rather  than  breaking  up  big  firms
...
g
...
 

 
 
 

67  

Mergers  
•

•

•

•

Horizontal  merger  /  horizontal  integration
...
g
...
 
Vertical  merger  /  integration
...
   For  example,  a  company  who  produces  beer  could  buy  
a  chain  of  pubs  to  sell  the  beer
...
 This  is  when  a  firm  acquires  another  firm  at  
the  next  stage  of  production,  e
...
 a  firm  like  Ford  which  manufactures  cars  
could  purchase  a  car  sales  room
...
 When  a  firm  acquires  another  firm  at  a  
previous  stage  of  production,  e
...
 a  clothes  retailer  buying  a  manufacturer  
of  clothes,  or  a  beer  producer  buying  a  farm  which  produces  hops  
(ingredient  used  for  brewing  beer)
...
 
The  legal  definition  of  a  monopoly  is  a  firm  with  more  than  25%  of  the  market
...
Higher  prices  leading  to  allocative  inefficiency  and  a  reduction  in  
consumer  surplus
...
Monopolies  are  more  likely  to  be  productively  inefficient
...
If  there  is  less  competition,  complacency  amongst  firms  can  lead  to  lower  
quality  of  products,  less  choice  and  less  investment  in  new  products
...
The  new  firm  can  pay  lower  prices  to  suppliers  (monopsony  power)
...
Mergers  can  lead  to  job  losses
...
Motives  for  mergers  may  primarily  be  based  on  increasing  prestige  and  
wages  of  workers  concerned
...
If  the  firm  becomes  too  big,  it  may  suffer  from  diseconomies  of  scale
...
Economies  of  scale
...
   This  is  important  for  industries  with  high  fixed  
costs
...
Mergers  can  help  firms  compete  on  an  international  level
...
Mergers  may  allow  greater  investment  in  R&D,  because  the  new  firm  will  
have  more  profit
...
 

Evaluation  of  mergers  
The  desirability  of  a  merger  will  depend  upon  several  factors,  such  as:  
•

 

Is  there  scope  for  economies  of  scale?  What  is  the  extent  of  fixed  costs  in  
the  industry?  
68  

•
•
•
 

Will  there  be  a  significant  reduction  in  competition?  
Is  the  market  still  contestable  (is  there  freedom  of  entry  and  exit  for  other  
firms)?  
The  competition  commission  will  look  at  each  individual  case  and  assess  
its  relative  merits  and  demerits
...
 Therefore,  
governments  are  concerned  to  intervene  and  protect  the  interests  of  the  
consumers
...
 
 Anti-­‐competitive  practices  which  the  government  regulates  include:  

Collusive  behaviour  
•
•
•

•
•
•
•

Price  fixing
...
 
Vertical  price  fixing
...
   
Collusive  tendering
...
g
...
 
Agreements  to  limit  output  and  split  up  the  market
...
g
...
 
Charging  excessively  high  prices;  if  firms  are  making  high  profits,  then  
this  is  an  indication  of  abusing  monopoly  power
...
 This  involves  cutting  prices  and  selling  below  average  
cost,  to  force  rivals  out  of  business
...
 If  the  OFT  is  concerned,  they  
can  refer  the  merger  to  the  Competition  Commission,  which  can  examine  
whether  the  merger  is  in  the  public  interest
...
 Within  the  labour  market  for  footballers,  there  will  
be  highly  specialised  sub-­‐labour  markets,  such  as  the  ‘best  strikers  in  
England’  –  ‘goalkeepers’  
Labour  productivity  –  output  per  worker  in  a  certain  period  of  time
...
 
Human  capital  –  the  skills  and  educational  attainments  of  workers
...
g
...
5%  -­‐  real  wages  rise  4
...
 A  higher  wage  may  make  workers  more  motivated  to  work  
hard
...
 
Technology
...
 
Management
...
 Poor  labour  relations  can  lead  to  lower  
productivity
...
 If  labour  becomes  better  educated  and  gains  
valuable  skills,  they  can  increase  their  productivity
...
 Can  workers  take  on  different  tasks  to  avoid  
bottlenecks
...
 Wages  are  biggest  component  of  unit  labour  costs  
Taxes  on  labour,  e
...
 employer  national  insurance  contributions  
Statutory  maternity  /  paternity  paid  leave
...
 

Labour  demand  
•

•

 

Labour  is  a  derived  demand
...
   If  there  is  more  
demand  for  going  to  restaurants,  then  there  will  be  more  demand  for  
catering  staff
...
 This  is  the  value  that  a  worker  can  give  a  firm
...
 MRP  is  effectively  the  
increase  in  revenue  a  firm  gains  from  employing  an  extra  worker
...
 This  is  the  increase  in  output  that  an  
extra  worker  produces
...
   This  is  the  revenue  that  a  firm  gains  from  
selling  the  last  unit  of  output
...
 

Factors  that  determine  demand  for  labour  
•
•

•
•
•

Productivity  (MPP)  of  workers  –  higher  productivity  =  higher  demand
...
 If  there  is  high  demand  for  watching  footballers,  
clubs  will  be  willing  to  pay  higher  wages,  because  there  is  more  money  in  
the  sport
...
 
Substitutes  to  labour
...
g
...
   
Wages
...
 
Non-­‐wage  costs
...
 

Higher  demand  for  labour  (curve  shifting  to  the  right)  could  be  due  to:  
•
•
•

Economic  growth  causing  more  demand  for  the  product,  e
...
 with  greater  
demand  for  tourism,  there  will  be  increased  demand  for  taxi  drivers
...
g
...
 
Changes  in  tastes  and  fashion  causing  more  demand  for  the  good
...
 

Elasticity  of  demand  for  labour  
The  elasticity  of  demand  for  labour  measures  how  responsive  demand  for  labour  
is  after  a  change  in  wages
...
 
Number  of  people  with  qualifications  and  skills
...
 
Time  period
...
 
However,  over  time,  it  becomes  easier  to  substitute  labour  for  capital,  so  
demand  becomes  more  elastic
...
 If  labour  is  a  high  %  of  total  wage  costs,  the  
firm  will  be  more  sensitive  to  a  rise  in  wages
...
  Therefore,   they   tend   to   have  
greater  bargaining  strength  and  can  demand  higher  wages
...
 
Substitution  effect  of  a  rise  in  wages
...
 
This  effect  leads  to  more  hours  being  worked  as  wages  rise
...
 This  effect  involves  workers  working  
fewer  hours  when  wages  increase
...
   
 

Backward  bending  
supply  curve  
 
After  a  certain  point,  
higher  wages  may  lead  
to  lower  labour  supply  
because  workers  can  
reach  their  target  
income  with  fewer  
hours
...
 A  worker  with  little  expenses  
may  find  the  income  effect  soon  dominates  and  higher  wages  encourage  him  to  
work  less  and  choose  more  leisure  time
...
Wage  rate
...
 
2
...
 If  there  were  more  people  qualified  to  be  lawyers,  the  
supply  curve  would  shift  to  the  right
...
The  non-­‐wage  benefits  (non-­‐pecuniary)  benefits  of  a  job
...
   E
...
 if  tube  drivers  have  to  start  
working  nights,  it  may  reduce  supply  of  workers  because  it  becomes  a  
less  attractive  job
...
Population  /  demographics
...
 

72  

Wage  determination  in  competitive  markets  
•
•

The  equilibrium  wage  rate  in  the  industry  is  set  by  the  meeting  point  of  
the  industry  supply  and  industry  demand  curves  (We)
...
 

 

 

 

•
•

Because  firms  are  wages  takers,  the  supply  curve  is  perfectly  elastic,  
therefore  the  wage  =  AC  =  MC
...
 

 
Diagram:  comparison  of  wages  in  different  industries  

 

In  diagram  on  left,  elastic  supply  and  demand  lead  to  lower  wages  
In  diagram  on  right,  inelastic  supply  and  demand  lead  to  higher  wages
...
 This  could  
be  an  unskilled  job  such  as  a  cleaner  or  retail  assistant
...
 
o Also,  demand  is  relatively  elastic,  because  cleaners  have  a  low  MRP
...
   
o This  could  be  a  lawyer,  where  the  number  of  qualified  lawyers  is  
limited
...
 Therefore,  they  have  a  high  MRP
...
 
Economic  rent,  is  anything  above  the  transfer  earnings
...
 
 

74  

Market  failure  in  labour  markets  
Monopsony  
This  occurs  when  there  is  just  one  buyer  of  labour  in  a  market,  or  if  the  firm  has  
substantial  market  power  in  employing  workers
...
 This  is  because,  to  employ  one  extra  worker,  the  firm  has  to  
increase  the  wages  of  all  workers
...
 
To  maximise  the  level  of  profit,  the  firm  employs  Q2  of  workers  where    
MC  =  D  (MRP)
...
 This  is  
less  than  the  competitive  wage  of  W1
...
 
Lack  of  information,  and  difficulties  in  switching  jobs,  gives  many  firms  a  
degree  of  monopsony  power
...
 For  example,  because  of  high  living  costs,  it  may  be  difficult  for  
workers  to  buy  /  rent  a  house  in  London
...
     
 
Government  policies  to  deal  with  geographical  immobilities  
1
...
 However,  this  is  difficult  to  do,  
because  of  limited  space  in  places  like  the  South  East  and  London
...
 
2
...
 However,  
firms  may  be  reluctant  to  relocate  to  the  north,  even  with  subsidies,  
because  of  limited  infrastructure,  which  makes  business  harder
...
Wage  bonuses  for  expensive  areas
...
 
However,  this  would  become  a  very  expensive  way  of  dealing  with  the  
problem
...
 This  leads  to  occupational  
immobilities  and  structural  unemployment
...
 This  is  partly  due  
to  the  UK  not  valuing  practical  vocational  jobs  as  much  as  ‘academic  
qualifications’
...
   

Government  policies  to  deal  with  skills  shortages  
1
...
 This  is  important  
with  the  greater  focus  on  vocational  skills  needed  by  the  economy
...
 
2
...
 This  
helps  to  overcome  government  failure,  as  the  firm  is  likely  to  have  better  
knowledge  of  the  skills  that  industry  really  needs
...
 
 

 

76  

Trades  Unions  
Trade  unions  represent  workers
...
 
Try  to  improve  working  conditions  and  safety  of  the  work  place
...
 

Impact  of  trade  unions  depends  on  
•
•

•

Union  density
...
 
Type  of  job
...
g
...
 If  the  workforce  is  more  diverse,  
working  at  different  times  (e
...
 service  sector),  they  have  less  power
...
 If  the  job  is  critical  to  the  firm  or  economy,  threats  of  
strikes  have  more  power,  e
...
 tube  drivers  can  have  a  big  impact  on  
London;  if  teachers  go  on  strike  it  is  less  influential  in  the  short  term
...
 Thus,  in  competitive  
labour  markets,  trades  unions  can  cause  unemployment
...
 This  would  reduce  demand  to  Q2
...
 
However  the  impact  of  a  trade  union  depends  upon:  
•
•

Elasticity  of  demand  for  labour
...
 
Unions  could  bargain  for  higher  wages  in  return  for  increasing  labour  
productivity
...
 

 
Trade  unions  and  monopsony  
If  a  firm  has  monopsony  power,  it  will  be  paying  a  lower  wage  of  W2,  and  
employing  just  Q2
...
 Demand  will  still  be  Q2
...
 
•
•
•

From  October  2015,  the  national  minimum  wage  will  be  £6
...
 There  are  lower  rates  for  young  workers
...
   
This  is  an  attempt  to  match  the  living  wage  –  a  level  deemed  necessary  to  
deal  with  current  living  costs
...
 This  is  because  the  minimum  wage  of  W2  reduces  demand  for  
workers  to  Q1
...
g
...
 
A  substantial  rise  in  the  minimum  wage  will  be  more  likely  to  cause  
unemployment  in  low  wage  regions,  such  as  the  north
...
 

 
 

79  

Minimum  wage  and  monopsony  
•

A  minimum  wage  could  counter-­‐act  the  effect  of  a  monopsony  employer,  
an  employer  who  pays  lower  wages  and  employs  fewer  workers
...
   
If  the  NMW  increased  wages  to  NMW  1,  the  demand  for  labour  would  stay  
at  Q2  and  not  cause  any  fall  in  employment
...
 

Do  firms  in  the  UK  have  monopsony  power?  
•
•

•

Some  jobs,  like  firemen,  only  have  a  government  employer,  so  that  is  a  
classic  example  of  a  monopsony
...
 There  are  many  costs  and  
uncertainties  in  applying  for  a  job  with  higher  pay
...
 Therefore,  
arguably,  many  firms  in  the  UK  have  a  degree  of  monopsony  power,  
though  it  will  depend  on  the  industry  and  skillset  of  the  workers
...
   
For  example,  if  wages  increase  for  the  whole  service  sector  industry,  they  
can  pass  the  wage  costs  on  to  consumers
...
 

2
...
 A  minimum  wage  may  be  insufficient  to  provide  a  living  
wage  in  London  because  of  higher  living  costs
...
 
3
...
 A  minimum  wage  can  increase  the  incomes  of  
the  low  paid  and  help  reduce  relative  poverty
...
g
...
 Also,  many  who  get  a  minimum  
wage  could  be  second  income  earners  in  a  family
...
 For  example,  until  1961,  there  was  a  maximum  wage  for  
English  footballers  of  £20  a  week!  
A  maximum  wage  can  help  firms  avoid  spiralling  wage  costs,  but  also  
could  be  used  to  increase  firms’  profits
...
 

 
 
 
 

81  

Diagram  of  maximum  wage  
 

 

Discrimination  in  the  labour  market  
•

In  theory,  discrimination  on  the  grounds  of  age,  sex,  and  race  is  illegal
...
 

To  what  extent  are  wages  determined  by  MRP  theory  
MRP  and  supply  of  labour  provide  a  good  starting  point  for  wage  determination
...
 Firms  may  not  be  rational,  but  pay  some  workers  
different  wages  on  the  grounds  of  age,  race,  or  gender
...
   
Difficulty  of  measuring  MRP
...
g
...
 
Regional  labour  markets
...
 In  London,  it  is  expensive  to  live,  and  there  are  more  job  
vacancies
...
 
Different  aims  of  workers
...
 Some  workers  may  prefer  
more  leisure  time  or  take  out  time  from  work  for  family  reasons
...
 
Labour  force  is  everyone  who  is  working  or  actively  seeking  work
...
 
Dependency  ratio  =  %  of  dependents  (children,  old  people)  
                                                                                                                         working  age  population  (16-­‐65)  
Replacement  ratio  =  Gross  income  after  retirement    
                                                                                   Gross  income  before  retirement  
Participation  rate
...
 

 

Flexible  labour  markets  
A  current  issue  in  UK  labour  markets  is  the  increased  flexibility  of  labour  
markets
...
 
Growth  in  zero  hour  contracts
...
 This  means  
weekly  wages  can  fluctuate  significantly
...
 
Decline  in  jobs  for  life,  increase  in  self-­‐employment
...
 Firms  were  more  
willing  to  take  on  new  workers
...
 
Greater  job  insecurity
...
 This  greater  job  insecurity  could  have  negative  effects,  
such  as  people  becoming  de-­‐motivated  because  they  have  little  
attachment  to  the  firm
...
 
A  flexible  labour  market  could  benefit  workers  who  need  to  juggle  looking  
after  children  and  working  from  home
...
 However,  a  flexible  
labour  market  could  be  damaging  to  unskilled  workers,  who  find  it  hard  
to  get  long-­‐term  job  security
...
 Firms  can  pay  lower  wages,  but  would  
increase  inequality  and  relative  poverty
...
 Firms  may  be  more  willing  to  employ  
people  in  first  place,  but  it  can  lead  to  greater  job  insecurity
...
 Good  in  theory,  but  can  be  hard  in  
practise;  it  would  definitely  take  time
...
   Immigrants  could  take  jobs  where  there  are  
labour  shortages,  but  immigration  can  create  new  problems,  such  as  
housing  shortages  and  congestion
...
 Immigration  accounted  for  46%  of  net  
population  growth  in  2008
...
 The  increased  supply  of  labour  has  often  
filled  gaps  in  jobs  which  firms  have  found  difficult  to  fill  e
...
 cleaning  and  
fruit  picking
...
 The  government  has  set  criteria,  making  it  easier  for  
skilled  labour  to  migrate
...
   
Offset  the  impact  of  an  ageing  population
...
 Net  migration  
of  young  workers  helps  the  government’s  budget  situation,  because  they  
are  more  likely  to  pay  income  tax  and  don’t  receive  pensions
...
 Thus,  
migration  can  be  a  counter-­‐cyclical  factor  in  making  UK  labour  markets  
more  flexible
...
 The  UK  experiences  overcrowding,  especially  in  parts  like  
the  south-­‐east
...
   
Underground  economy
...
   
o However,  there  is  a  big  difference  between  illegal  immigration  and  
legal  migration
...
   Some  people  feel  migrants  take  existing  jobs
...
   
o However,  migration  also  creates  jobs,  through  the  additional  
demand  in  the  economy
...
 This  has  several  impacts:  
•
•

•

Relative  decline  in  income  tax  revenue,  relative  rise  in  state  spending  on  
pensions  and  health  care
...
 To  meet  higher  pension  spending  it  may  be  necessary  to  
increase  taxes  on  working  population,  which  could  adversely  affect  
incentives
...
 Firms  encourage  older  people  to  keep  working  
part-­‐time  and  delay  retirement
...
 
Ageing  population  can  be  managed  if  real  GDP  continues  to  rise
...
 

 

 

85  

Wealth  and  income  inequality  
 

Income  and  wealth    
•
•

Wealth  is  a  stock  concept;  it  is  the  value  of  assets,  such  as  savings,  housing,  
and  shares
...
 
Income  is  the  amount  of  money  a  person  receives  per  time  period,  e
...
 
salary
...
g
...
 

Causes  of  income  inequality  
1
...
 Workers  with  high  levels  of  
skills  will  be  able  to  gain  higher  wages
...
   
2
...
 But,  increased  
labour  market  flexibility  has  increased  the  number  of  people  in  uncertain  
job  situations
...
Unemployment
...
 
4
...
 A  powerful  firm  with  monopsony  power  can  
pay  low  wages  to  workers  and  keep  high  profits  for  shareholders
...
 
Those  who  are  wealthy  (e
...
 own  a  house)  can  gain  rentable  income,  
which  they  can  use  to  invest  in  the  accumulation  of  more  assets
...
 
Taxes  on  income  tend  to  be  higher  than  taxes  on  wealth
...
 People  need  incentives  
to  take  risks  and  make  the  effort  of  setting  up  a  business
...
 Therefore  a  
degree  of  inequality  is  needed  in  a  free  market  economy
...
g
...
 Benefits  to  the  
unemployed  /  low  paid  can  discourage  taking  work  (unemployment  trap  
/  poverty  trap)
...
 The  wealthy  can  exploit  their  monopoly  power  to  make  
higher  profits  at  the  expense  of  others,  e
...
 landlords  have  a  degree  of  
monopoly  power  in  setting  rents,  especially  in  places  like  London
...
 High  levels  of  inequality  can  cause  social  friction  and  
resentment  in  society
...
 Taking  more  tax  from  high-­‐
income  earners  has  little  impact  on  living  standards,  taking  tax  from  low  
earners  has  a  greater  impact  because  they  have  to  cut  back  on  essentials
...
 There  is  a  strong  case  for  giving  people  an  equal  access  to  
education  and  the  chance  to  gain  skills
...
 

 

Government  policies  in  the  labour  market  
•

•

•

•

•

Raising  retirement  age  to  67  –  over  time
...
 It  means  longer  working  life  for  new  
generation  of  workers
...
 Government  hope  it  will  reduce  need  for  welfare  
payments
...
 
Raising  income  tax  threshold
...
 
Progressive  taxes  to  reduce  inequality
...
g
...
 
o But,  higher  income  taxes  could  create  disincentives  to  work  if  
substitution  effect  dominates
...
 
Means-­‐tested  benefits
...
g
...
 
o However,  there  is  concern  that  welfare  benefits  may  create  
disincentive  to  work  /  get  a  better  paid  job
...
 
 

 
 

 

87  

Market  Failure  
Market  failure  occurs  when  there  is  an  inefficient  allocation  of  resources  in  a  free  
market
...
g
...
 
Partial  market  failure  occurs  when  there  is  a  market  for  the  good,  but  
there  is  over  or  under  consumption
...
 

Market  failure  can  occur  for  various  reasons
...
 A  cost  or  benefit  imposed  on  a  third  party,  leading  to  under  
or  over-­‐consumption
...
 Lack  of  complete  knowledge  by  one  party
...
g
...
 
Monopoly
...
 
Monopolies  may  also  be  more  inefficient  because  they  face  less  
competitive  pressures
...
 Geographical  immobilities  occur  when  it  is  difficult  for  
people  or  firms  to  move  to  another  area
...
g
...
   
Occupational  immobilities  occur  when  it  is  difficult  for  people  to  retrain  
and  get  skills  in  new  high-­‐tech  industries
...
 Goods  that  are  non-­‐rival  and  non-­‐excludable
...
 Inequality  is  a  type  of  market  failure
...
 

Public  goods  
A  public  good  has  these  characteristics:  
•
•
•
•
•

Non-­‐rivalry/non-­‐diminishability
...
g
...
 
Non-­‐  excludability
...
g
...
 
Non-­‐rejectability
...
 
Zero  marginal  cost
...
 
Examples  include  law  and  order,  national  defence,  and  street  lighting
...
 This  means  that  people  
can  enjoy  the  goods  without  paying  for  it
...
   
Public  goods  usually  require  the  government  to  provide  the  good  directly  
and  pay  for  it  out  of  general  taxation
...
   For  example,  
someone  may  provide  a  beautiful  garden  and  not  mind  if  people  enjoy  it  
for  free
...
g
...
 If  too  many  people  use  roads,  it  causes  congestion
...
 
Pure  public  good  -­‐  A  public  good  with  100%  non-­‐rivalry  and  non-­‐excludability
...
 The  private  good  is  rivalrous  and  excludable
...
 If  you  walk  under  a  street  light,  many  
other  people  can
...
 

Externalities  and  social  efficiency  
Social  benefit    
•
•

•
•

Social  benefit  is  the  total  benefit  to  society
...
 
Social  marginal  benefit  (SMB)  =  the  additional  benefit  to  society  of  
producing  an  extra  unit
...
   
Social  cost  =  private  cost  +  external  costs
...
   
•

•

 

Negative  externality  of  consumption  occurs  when  a  consumer  enjoys  a  
good  but  causes  a  cost  to  a  third  party
...
 If  you  drive  into  a  town  centre,  the  negative  
externality  is  the  congestion  and  pollution  that  affects  other  people  in  the  
town
...
 
For  example,  if  a  firm  produces  chemicals,  the  external  cost  is  the  
pollution  that  causes  damage  to  the  river
...
 

Diagram  of  production  negative  externality  

 In  a  free  market,  the  equilibrium  will  be  at  Q1,  P1,  where  S=D
...
   
Q1  is  socially  inefficient  because  the  SMC  is  greater  than  the  SMB  –  this  
illustrates  an  area  of  deadweight  welfare  loss
...
 
The  socially  efficient  level  of  output  would  be  at  Q2,  where  SMC=SMB
...
   
For  example,  if  you  cycle  to  work  (rather  than  drive),  other  people  benefit  
from  reduced  congestion  and  pollution
...
 For  example,  if  you  keep  bees,  then  a  nearby  apple  farmer  benefits  
because  your  bees  help  to  pollinate  his  apple  trees
...
 
•
•
•
•

However,  this  is  socially  inefficient
...
   
With  a  positive  externality,  there  is  under-­‐consumption
...
 

Externalities  and  absence  of  property  rights  
•

•
•

Externalities  are  more  likely  where  there  is  an  absence  of  property  rights
...
 
It  is  similar  issue  with  global  air  pollution
...
 
If  fisherman  held  property  rights  for  a  river,  they  could  receive  
compensation  from  the  chemical  firm
...
   
•

•
•
 

For  example,  students  may  underestimate  the  benefits  of  studying  and  
therefore  leave  school  early
...
 
Merit  goods  often  have  a  positive  externality  as  well
...
 
91  

Demerit  good  
A  demerit  good  occurs  where  people  under-­‐estimate  or  ignore  the  costs  of  
consuming  a  good
...
 
Demerit  goods  often  have  negative  externalities  as  well  (e
...
 passive  
smoking  effect  to  others)
...
 

Information  gaps  
•

•

•

•

Symmetric  information  means  both  parties  share  the  same  knowledge
...
 
Asymmetric  information  occurs  when  one  party  has  more  information  
than  other  parties
...
 But,  as  a  consumer,  you  may  not  know  this
...
 This  leads  to  lower  prices  for  all  second  hand  cars  and  
reduces  economic  welfare  
Imperfect  information  can  occur  when  all  parties  lack  complete  
knowledge  or  awareness,  e
...
 it  is  difficult  to  measure  the  economic  costs  
of  global  warming
...
 For  example,  there  may  be  unemployment  in  the  north,  
and  jobs  available  in  the  south,  but  workers  may  struggle  to  move  because  of:  
•
•

Difficulty  of  getting  housing  the  south,  
Family  ties  to  the  north,  and  /  or  

Occupational  immobilities  occur  when  labour  lacks  the  relevant  skills  for  a  
particular  job
...
 This  leads  to  structural  
unemployment
...
   
•
•

 

For  example,  if  your  bike  is  fully  insured,  it  reduces  the  incentive  to  lock  it
...
   
92  

Environment  
The  environment  can  be  seen  as  an  economic  resource
...
 
Provider  of  amenities  –  the  environment  is  a  source  of  leisure  activities  
and  tourism
...
 For  example,  countries  who  rely  on  tourism  for  trade
...
 The  environment  can  absorb  waste
...
 Alternatively  we  can  burn,  in  which  case  
the  waste  gases  are  absorbed  by  the  environment
...
 Many  economic  activities  cause  external  costs  
to  the  environment
...
 
For  example,  producing  power  from  burning  coal  causes  damage  to  the  
environment,  such  as  pollution  and  global  warming  

 
•
•

 

Negative  externality  in  production  causes  SMC  to  be  greater  than  PMC
...
 This  output  is  higher  
than  the  socially  efficient  level  of  Q2
...
 
93  

Negative  consumption  externality  
Negative  externalities  can  also  occur  in  consumption
...
 This  is  a  cost  to  the  rest  of  
society
...
 

 
•
•
•

 

With  a  negative  consumption  externality,  the  social  marginal  benefit  is  
less  than  your  private  marginal  benefit
...
 
•
•

•

As  economies  develop  and  industrialise,  we  see  more  pollution  and  
environmental  degradation  (e
...
 steam  power,  use  of  fossil  fuels)
...
 This  leads  to  less  pollution  and  environmental  
degradation
...
 

Evaluation  of  Kuznets  environmental  curve  
•
•

•

•

 

However,  not  everyone  agrees  that  economic  development  will  inevitably  
reduce  environmental  degradation
...
 
With  increased  economic  growth,  there  is  higher  output,  consumption,  
and  consequent  pollution
...
 
It  depends  on  the  type  of  the  economy
...
 Not  all  developed  economies  become  primarily  service  
sector  based
...
 Developed  countries  have  the  potential  to  
limit  environmental  pollution,  but  higher  taxes  and  regulations  to  protect  
the  environment  may  be  unpopular  and  not  implemented
...
 
This  will  reduce  demand
...
 

Diagram  specific  tax  

 
•
•
•
•

 

A  specific  tax  places  a  certain  per  unit  tax  on  the  good
...
 
In  this  case  the  specific  tax  is  £15,  and  it  reduces  the  quantity  from  Q1  to  
Q2
...
 
A  specific  tax  can  be  used  to  make  consumers  pay  the  full  social  cost  of  
demerit  goods,  such  as  alcohol  and  tobacco
...
 For  example,  VAT  in  
the  UK  is  20%
...
 

Tax  to  overcome  market  failure  

 
•
•
•

 

The  ideal  tax  would  be  equal  to  the  external  marginal  cost
...
   
Tax  shifts  the  supply  curve  to  S2  and  reduces  demand  to  Q2,  which  is  the  
socially  efficient  level  (SMC=SMB)
...
 
Internalises  the  externality  (tax  makes  people  pay  the  full  social  cost)
...
 
Tax  can  also  alter  consumer  behaviour  in  the  long-­‐term
...
 

Evaluation  of  taxes  
•
•
•
•
•

If  demand  is  inelastic,  tax  will  only  have  a  minimal  effect  in  reducing  
demand
...
g
...
 
High  taxes  may  encourage  tax  evasion,  e
...
 cigarette  tax  encourages  
cigarettes  to  be  smuggled  on  the  black  market
...
 They  take  a  higher  percentage  of  
income  from  the  poor  than  high-­‐income  earners
...
g
...
 
It  can  be  difficult  to  measure  the  external  cost  and  how  much  tax  should  
be  increased
...
 

 
•
 

In  this  example,  the  free  market  equilibrium  is  at  Q1,  P1  (S=D)
...
   
At  this  price,  the  quantity  demanded  is  Q2
...
 

Evaluation  of  subsidies  
•
•

•

•
•

Cost  to  the  government
...
 
If  demand  is  inelastic,  a  subsidy  will  be  ineffective  in  increasing  demand
...
 
A  firm  that  receives  a  subsidy  is  more  likely  to  be  inefficient,  as  they  
become  reliant  on  the  government  subsidy
...
 
There  may  be  government  failure,  e
...
 the  government  has  poor  
information  about  who  to  subsidise
...
g
...
 

Tradeable  pollution  permits  
These  involve  giving  firms  a  legal  right  to  pollute  a  certain  amount,  e
...
 100  units  
of  carbon  dioxide  per  year
...
 
However,  if  it  produces  more  pollution,  it  has  to  buy  permits  from  other  
firms
...
 If  firms  pollute  a  lot,  there  
will  be  low  supply  and  high  demand;  therefore  the  price  will  be  high  for  
permits
...
 

Problems  of  pollution  permits  
•
•
•

•

 

Difficult  to  know  how  many  permits  to  give  in  the  first  instance
...
 There  is  an  
incentive  for  firms  to  hide  pollution
...
 Also,  pollution  is  very  much  a  global  problem  requiring  global  
solutions
...
 

99  

 
Information  provision  
The  government  may  seek  to  overcome  market  failure  through  providing  
information  about  certain  goods
...
 These  are  demerit  goods,  where  
people  may  not  know  the  costs  of  consumption
...
 

Evaluation  
•
•

•

Government  advertising  campaigns  will  cost  money  and  require  higher  
taxes
...
 Young  people  may  choose  to  ignore  campaigns  about  the  
dangers  of  alcohol  because  they  enjoy  a  sense  of  rebelliousness
...
 

 

Regulation  
To  overcome  market  failure,  the  government  may  use  laws  and  regulations  to  
prohibit  certain  behaviour
...
 

Evaluation  
•

•

Regulation  is  simple  and  can  be  effective  in  preventing  damaging  goods  
and  services  from  being  produced
...
   
It  depends  on  the  enforceability
...
 People  kept  drinking  but  organised  
crime  became  more  powerful  and  more  successful  because  illegal  alcohol  
was  in  high  demand
...
   
For  example,  the  government  could  subsidise  private  doctors  to  treat  people,  but  
there  are  advantages  to  the  government  paying  for  a  national  health  service  
directly:  
•
•
•

•

It  ensures  everyone  has  access  to  this  important  merit  good  and  provides  
greater  equality  in  society
...
 
For  services  like  health  and  education,  workers  do  not  need  the  same  
profit  motive  of  a  private  manufacturing  firm
...
 
Public  goods  like  law  and  order  may  not  be  provided  at  all  in  a  free  
market
...
g
...
Increased  demands  are  being  placed  on  the  public  sector  due  to  
demographic  changes
...
 
2
...
 
3
...
 
4
...
g
...
 
5
...
 

Disadvantages  of  the  private  sector  

 

1
...
 Also,  the  private  sector  may  cut  costs  by  reducing  
the  quality  of  service,  e
...
 cutting  back  on  cleaning
...
May  increase  inequality
...
 
3
...
 
Therefore,  there  is  a  justification  for  government  subsidy
...
 To  undertake  a  CBA  the  procedure  involves:  
1
...
 These  include  both  monetary  
and  non-­‐monetary  costs  and  benefits
...
 
2
...
 

Problems  with  using  a  Cost  -­‐  Benefit  Analysis  
1
...
g
...
 
2
...
 
3
...
 
4
...
   
5
...
 
6
...
 
7
...
 Even  if  there  is  a  net  
gain  to  society,  some  people  may  lose  out  significantly
...
 

Advantages  of  Cost  Benefit  Analysis  
•
•

Offers  wider  benefits  than  private  sector  profit  oriented  approach
...
 
No  alternative
...
 The  best  solution  is  to  improve  methods  of  calculating  
social  costs  and  social  benefits
...
g
...
 
Meeting  forecast  rise  in  demand  for  rail  travel
...
 

Costs  include  
•
•
•

 

Environmental  impact  on  countryside
...
 
Forecasts  not  guaranteed  to  occur
...
   
People  also  refer  to  government  failure  when  government  efforts  to  
overcome  market  failure  do  not  succeed
...
 Lack  of  incentives  working  for  the  government
...
 Therefore  managers  and  
workers  may  feel  no  incentive  to  work  hard  or  cut  costs
...
   
2
...
 For  example:  
•

•
•

•

Minimum  prices  in  agriculture  were  an  attempt  to  stabilise  farmers’  
incomes
...
 Farmers  used  chemicals  to  
maximise  yields  –  knowing  the  government  would  buy  any  surplus
...
 
By  increasing  taxes  on  tobacco,  the  government  made  it  more  
profitable  for  people  to  smuggle  cigarettes  from  Europe
...
 
Higher  income  tax  may  discourage  people  from  working
...
 Lack  of  information
...
   
•
•

For  example,  it  can  be  difficult  for  a  government  body  to  calculate  the  net  
external  costs  of  a  new  airport  or  nuclear  power
...
g
...
 

4
...
 Any  government  intervention  is  likely  to  have  some  
administration  costs  and  bureaucracy
...
 
Many  areas  of  government  spending  are  non-­‐profit  making  industries,  
and  people  are  motivated  by  desire  to  offer  quality  of  care  /  service  (e
...
 
doctors,  teachers)
Title: OCR A level economics revision guide (Micro)
Description: Updated for the new OCR economics syllabus first A level 2017). This is all the notes for A-level students that will start their A-levels in 2017. This is the whole of the micro notes which follows the specification. It includes diagrams such as monopolies, perfect competition, minimum wages and much more. These notes will also match the new specification and contain all the notes needed. Note that these notes does not ramble and give you all the information you need. It has been helpful to many A-level students from 2016. These notes will be beneficial and will for sure help you pass and excel you A-level exams. Good luck.
Buy These NotesPreview