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Microeconomics Notes
Economic agent: any person or group with influence in the economy by producing, buying or selling
...
Government:
 Role: expenditure on public goods and taxation
...

 Objectives: reduce unemployment, carry out manifesto promises, create jobs,
improve NHS, reduce poverty, maximise standard of living
2
...

 Objectives: Maximise utility from consumption
3
...
Decisions
on what resources needed and what quantity
...
Workers:
 Role: what occupation to pursue + what organisation to work for
...
E
...
Income v job satisfaction

Positive and Normative Statements:
Positive: statement about what is, i
...
about facts
...
Can be proved or disproved
...
Subjective,
usually consists of words ‘ought’ or ‘should’
...

Scarcity: insufficient resources to provide all goods + services to meet our infinite wants
...


Economic Goods: Scarce goods
...
g
...
All such goods have a price which reflects their
scarcity
...
E
...
Air, rainwater
...


Four Factors of Production:
1
...
Includes natural resources both
renewable and non-renewable
...
Labour:


Role: all workers in production process where there will be a variety of skills used
...
Capital:




Role: Resources that can be used again and again to produce goods
...
Enterprise:




Role: A person who organises production, identifies projects to be undertaken and
bears the risk of the activity
...
There is a trade-off occurring and the
sacrificed outcome is the opportunity cost
...


Production Possibility Curve (PPC)
PPC shows the maximum combination of goods that can be produces assuming all resources are
used, with current technology
...
E
...
Bread
...
E
...
machinery

Specialisation
Specialisation refers to the concentration of a worker, firm, country or region on producing one or a
narrow range of products
...

E
...
Brazil coffee



Firms ensure specialist
resources and
machinery- increase
quality
Increased innovation
with narrower focus for
R&D
Reliance on narrow
range risky- change in
consumer trends could
cause shut-down
Specialist resources and
labour expensive- may
be hard to resell
resources if go bust



High export rates can
be achieved- helps eco
to grow
Enables local/central
government to help
industry (external
economies of scale)
Reliance on few
products risky
...













Role of Money



Before money, barter
Barter: system of exchange where by goods/services directly exchanges for others without
using a medium of exchange, such as money
...
Unrealistic on a global/national scale
...

Roles:
1
...

3
...


Trusted by both parties
Store of value
Unit of account
Standard of deferred payment (e
...
receive goods on credit)

Resource Allocation

Resource allocation is concerned with the methods used by an economy to deploy its resources
...
Market Economy:
How resources allocated:
 According to consumer
preferences
 Via price mechanism:
consumer sovereignty and
demand changes price, acting
as a signal to deploy more
resources to this product (at
expense of less popular
products)
 All resources privately owed
 Consumers attempt to
maximise utility
 Also known as a capitalist
state

Pros:






Competition = efficiency
Innovation encourages
because provides competitive
edge
Larger variety of goods as
innovation and differentiation
Freedom of individual choice
possible to extent that market
provides options for work,
developing a business,
purchasing goods/services

Cons:
 Disparity in wealth and
mobility as wealth generates
wealth
...
Centrally Planned Economy:
How resources allocated:
 According to government
 Gov appoint central planners
to assess needs of population
 Managers set output targets
 Gov owns all resources and no
private enterprise
 Inefficiency rife

Pros:







Gov can overcome market
failure and inequality and can
create a welfare maximising
society
Prevent abuse of monopoly
power
Gov can prevent mass
unemployment by directing
labour to work
Improve quality of living
standards and ensure
everyone has access to
necessities

Cons:
 Gov agencies usually have
poor info
 Poor innovation as no profit
incentive
 Threat to liberty- creates very
powerful government
 Bureaucratic- decisions held
up by planning and
committees
 Economic growth slow in such
economies

3
...

 Can be hard to identify where
intervention necessary



State generally plays larger
role in setting policy, rules and
objectives controlling labour
than in market economy





Gov has opportunity to pursue
policies that help macro obj
Mixed helps to create equality
and offer welfare safety net
Allows the enjoyment of
financial rewards of enterprise





Free-market economists
criticise as allows excessive
intervention
...

A sub-market forms part of the overall market, but tends to have some unique characteristics
...
Each sub-market could have a different competitive
set and market structure
...


Demand
Demand is the quantity of a good or service that consumers are willing and able to purchase at a
given range of prices over a given period of time
...

Market Demand totals all individual demand to gain the demand from all potential buyers of a
product
...

Joint Demand: demand for goods that are interdependent, such that they are demanded
together
...
g
...
E
...
water
Competitive Demand: demand for goods that are in competition with each other
...
g
...


Income and Substitution Effect



Income Effect: price of product falls, consumers have more income left (real income
increased) that enables them to buy more of a product
...


Other factors affecting demand:






Consumer Preferences
Marketing Strategies
Future prices: IF expected to fall, current demand decrease
Population changes
Cost of Credit

Normal and Inferior Goods:



Normal Good: demand for the good increases when income increases, and falls when
income decreases, ceteris paribus
...
There is a negative relationship between income and demand
...

Complements: if the price of a complementary good falls demand for other product will
increase as more consumers wish to buy the cheaper good (but must buy other good too)
...

Consumer Surplus=

Importance of Consumer Surplus:
Recognises the net welfare to an economic
agent, i
...
consumer
...


Supply
Supply is the amount of a good or services that firms are willing and able to sell at a given range of
prices in a given period of time
...


Types of Supply:






Individual Supply: the amount of product supplied by one firm
...
Typically, one product
is a by-product of another
...
g
...
E
...

water
Competitive Supply: situation in which a firm can use its factors of production to produce
alternative products
...
g
...


The Law of Supply:
The Law of Supply states that more will be supplied at a higher prce than at a lower price, ceteris
paribus
...


Other Factors Affecting Supply:







Production costs
New technology
Taxes and Subsidies
Price of related goods
Expected prices
Entry and exit of firms

Demand and Supply Equilibrium


Comparative Static analysis examines the impact on equilibrium of a change in the external
conditions affecting a market
...


Interrelated Markets
Interrelated market: a change in one market may bring about knock-on effects in other markets
Relationship may be:



Derived demand
Consumers/producers switching their demand and supply

Disequilibrium
Disequilibrium occurs when demand does not equal supply and there is not a market clearing price
...
Minimum Price:

Gov may set minimum price for labour, for example
...
Maximum Price
Government may restrict prices going above a certain
level
...

Supply: volatile due to external factors, e
...
weather or disease
...
(Drought to
glut)
...
Health of economy, e
...
recession
...
Very difficult to
ascertain a demand or supply schedule
...
E
...
Business with business
buying (Tesco and marmite)

Elasticity
Elasticity: a measure of the responsiveness of one variable change to a change in another variable
...
Price Elasticity of Demand:
PED: a measure of the responsiveness of quantity demanded to a change in price
PED=

% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑄𝐷
% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑃

Elasticity

Diagram

Value

Inelastic
Change in price = less than
proportionate change in
demand in opposite direction
...

Firms should decrease price to
increase TR

>1

Unitary
Price and QD change in exactly
the same proportion in the
opposite direction

1

Perfectly Inelastic
QD does not change as price
changes

0

Perfectly Elastic
QD is infinite at one price only
...

PED may change over time

Usefulness:



Useful to firms when making decisions on price
Useful to the government when deciding on tax rates

PED and Prices:



At high prices: low demand, so change in price leads to large % change in QD
...
Inelastic

Factors influencing PED







Necessity v Luxury
Range of Substitutes
Proportion of income spent on good
Habit forming qualities
Customer loyalty
Time period

2
...
Yet, there
is a point whereby consumers
switch to more superior
substitutes, and QD falls
...
Cross Elasticity of Demand

XED: measures the responsiveness of quantity demanded of one good (A) to a change in price of
another good (B)
...
Instead,
consumers switch to the cheaper alternative of Good A, and hence demand for good
A increases
...


Complementary
Unrelated

XED Zero: In most cases, XED zero or very close to zero

Limitations of XED:




Unreliable
Change over time
Difficult to respond if fixed supply

4
...

PES=

% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑄𝑆
% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑃

Elasticity

(PES should always be +ve in theory)

Diagram

Explanation

Elastic >1

Supply P elastic, changes more
proportionately

Inelastic <1

Inelastic, so QS changes less
than proportionate to P

Unitary =1

QS changes in direct
proportion to price

Perfectly Inelastic =0

QS does not change as price
changes

Perfectly Elastic =∞

QS is infinite at one price, and
zero at all others

Factors Affecting PES:






Stocks of finished products and components
Spare production capacity
Ease and cost of factor substitution and mobility (PES higher the more occupationally
mobile)
Time taken to produce
Time period: short-term more inelastic than long-term

Importance of PES data:


Firms can predict changes in price according to their forecasted supply or of any new
entrants in the market
...
Productive Efficiency
Achieved when a firm operates at minimum average total costs
...
All economies of scale have been utilised and diseconomies of scale have not
yet come into effect
...
Allocative Efficiency
Achieved when consumer satisfaction is maximised
...
g
...
g
...

e
...
Local government support, local
college support

External Diseconomies of Scale

Average costs increase as an industry
expands in the long-run
e
...
Shortage of raw materials,
shortage of skilled workers

The Marginal Concept
Marginal refers to the costs or benefits attained from one more unit of output or consumption
...
The firm will not know the P=MC point until they
expand and reach this point
...
There is a divergence between
marginal social benefit and marginal social cost
Marginal Social Benefit v Marginal Social Cost
MSB: the additional benefit that society gains from consuming or producing an extra unit of the
good
...

Market failure may lead to the over/under consumption and therefore production of certain goods
...

There is not an optimum allocation of resources
...

MPC: The cost to the first party who is either the buyer or seller of the good from the extra unit of
production or consumption
...
(Aka negative externalities)
MSC: totals the private and external costs of one additional unit of production/consumption
...

MEB: the benefit to the third party who is neither the buyer nor the seller of the product from an
extra unit of production/consumption
...

MSB= MPB + MEB

Externalities in Production and Consumption
Production externality: an externality that affects the production side of the market, which may be
positive or negative
...


Negative Externalities Generated in Production e
...
Toxic fumes

 In free market, firm only take into account
their private costs, and ignore external costs
...

 For amount overproduced, MSBcreating a net social cost
 Area of lost welfare not accounted for by
first party indicated by shaded triangle

Positive Externalities Generated in Production E
...
Factors chemicals boost local fish numbers




In free market, firm only take into account
their private costs, and not impact on society
(third-party benefit), creating net gain of lower
costs for society
...


For amount underproduced, MSB>MSC
creating net social gain
The potential welfare not exploited is indicated by the shaded triangle

Positive Externalities Generated in Consumption e
...

Christmas lights







In a free market, the consumer only considers
their private benefits and do not consider the
external benefits
In unregulated market: E1, P1, Q1
However, preferable for consumers to consider
their external benefits and operate at: E2, P2,
Q2
In free market, product is under consumed
(P2>P1) and under-priced (P2>P1)




As product underproduced, market failure as too few resourced allocated
For area of under consumption (Q1-Q2), potential welfare gain as MSB>MPB that not
realised
...
g
...







Merit
Characteristics: More private benefits than realised, may have P externalities, society values
Examples: education, healthcare
Free Market Provision: Underprovided: consumers not demand high enough as not realise
how beneficial, consumers not realise external benefits
Market Failure: underprovided, too few resources allocated
Government Intervention: Increase provision: provide free, subsidise, regulate to ensure
consumption, provide info

2
...







2
...
Gov may outsource provision so more cost-effective

3
...
g
...
E
...
Housing: seller know more than buyer
...


Adverse Selection and Moral Hazard
Adverse Selection: situation in which a person at risk is more likely to take out insurance
...

E
...
Financial crisis

Taxation and Subsidies
Taxation


Gov places tax on goods that exhibit higher private costs than consumers realise, and/or
have negative externalities
...


Types of Tax:



Ad Valorem: a percentage tax such as VAT
Specific: a flat rate tax, e
...
60p per item

Specific Tax





Ad Valorem Tax

Total Paid: shaded rectangle (E2-B-C-P2)
Paid by Producer: Blue rectangle: P1-A-B-C
Paid by consumer: Red rectangle: P1-P2-E2-A





Total Paid: shaded rectangle (E2-B-C-P2)
Paid by Producer: Blue Rectangle: P1-A-B-C
Paid by Consumer: Red Rectangle: P1-P2-E2-A

Tax provides tax revenue which can be ringfenced to further reduce market failure: e
...
revenue
invested in adverse marketing for cigarettes from cigarette tax
When PED Elastic: Most of tax absorbed by producer
When PED Inelastic: Most of tax absorbed by consumer
Perfectly elastic: Producer pays all
Perfectly Inelastic: Consumer pays all

Tax and Economic Welfare

Before Tax:
Total Welfare= CS + PS (green + red shading)
= Y-E1-X


After tax:
Total Welfare= CS + PS + Gov Revenue (green
shading)
= Y-E2-B-X



Excess Tax Burden: E2-E1-B (red triangle)

Taxation: Pros v Cons
Pros

Cons






Increases costs, decrease supply, reduces
consumption of demerit goods to socially
desirable levels
Raises rev for gov- can be ringfenced
Makes first party responsible
Raises awareness of higher private costs
than realised- acts as a sort of information
provision in itself








Indirect tax is regressive
Requires an unreliable method to value the
negative externalities that are complex and
subjective (Shadow Pricing)
Taxes on external costs (such as landfill) can
increase costs for firms and decrease their
international competitiveness
Excess burden of tax- an area of lost
welfare

Evaluation of tax: effectiveness depends on…




PED
Size of tax
Shadow pricing reliability

Subsidies
Subsidy is a payment by the government to the producer that lowers producer’s costs and
encourages production increase

 Price of product falls from P1 to P2
 Quantity traded increases from Q1 to Q2
 Reduced market failure as higher allocation of
resources
 Consumer Gains: P1-C-E2-P2 (Red rectangle)
 Producer Gains: A-B-C-P1 (blue rectangle)
 Total Gains: A-B-E2-P2 (shaded area red and blue)

Subsidies: Pros v Cons
Pros






Reduce costs to supplier so they supply
more-they work at reaching socially
desirable output
...


Cons






Very difficult to decide on correct size
of subsiding order to bring about the
socially desirable level of output once
positive externalities are consideredcomplex shadow pricing
Could lead to greater inefficiencies on
behalf of the producers because a rise
in costs can be offset by the subsidy
leaving less of an incentive to lower
costs
...
Left to the free-market, there
would be some who cannot afford
healthcare
...
g
...
Protects low
income groups and ensures equality

Private
 Greater choice as market no longer
dominated by one supplier
 Greater competition may lead to lower
prices and better patient care
 Not limited by public budget that may
not stretch to expensive treatments








Merit good- may be market failure in
free-market as externalities and private
benefits may be overlooked- some
people may go untreated or be
discouraged from going for a check-up
as may be expensive
Economies of scale: e
...
buying
economies of medicines
In free-market the profit private firms
may exploit consumers-e
...
little
attention or checking on patients to
save money
In a free-market, the scale of regulation
needed to keep consumers safe may
offset the advantages a private firm
would be seeking in the market and
may lead to a lack of supply







Arguably fairer as those that use
healthcare more, such as the obese,
pay for what they use
...

Private health care firms may have
efficiency incentives to provide better
service than government bodies as the
profit motive exists and targets will be
set to achieve profit targets
...

If paid for by private insurers, doctors are happy to prescribe expensive treatments for little
benefit
...

Free-market logic cannot be easily applied to healthcare
...

In reality, there is very rarely a case for full government provision or full private sector
provision
...


The Private Finance Initiative (PFI)







Launched in 1992
Increases involvement of private sector in public provision- partnership between the private
and public sector
Public sector specifies the services it requires and invited tenders from the private sector to
design, build, fiancé and operate the scheme
...
g
...

Or, private sector may undertake the project and sell it to the public sector

PFI: pros v cons
Pros


Improved financing of public sector
with competitive element involved
driving efficiency

Cons


May raise cost of borrowing- public
sector would have been able to borrow
on more favourable terms than the
private sector









Risk of project shared- less likely for an
unsuccessful project to crash a firm
Large efficiency gains
Improved resource allocation- private
sector more in tune with demand and
supply
Enable building of important facilities
that government may not be able to
afford
Lower taxes in short-run because gov
doesn’t pay immediately







Private firms have less of an incentive
to maximise safety and quality of
facilities: e
...
collapse of Edinburgh
schools
Could result in a private monopoly so
extra measures may need to be put in
place
Cost more in long-run than the private
sector spent building it

Conclusion of PFI:




Depends on balance between efficiency and quality of service
Regulation imposed on the building of the facilities: make sure safe
Opportunity cost of the initiative in the long-run: could the government have built it
cheaper?

Price Controls
Maximum Prices
Max price: producers cannot exceed the price set by the government
...

 Fall in price: producers
disincentived to supply due to the
lower profits derived from the product:
supply contracts to Qs from Qe
...





Outcome:
 Excess demand of Qs to Qd
...
g
...
For
example, governments may impose a minimum wage on workers
...


Higher price: consumers less willing
and able to acquire the product, and so
demand contracts from Qe to Qd
...
g
...
g
...
E
...

agriculture
...

Aim: achieve price stability and income stability for producers- ensure industry survival
...

Drawback: Encourages vast overproduction and wastage of resources as farmers can sell
stock at guaranteed price
...

Drawback: Increased prices to consumers as unable to benefit from cheaper imports and can
lead to retaliation of foreign governments
...

CAP has two objectives: Increase agricultural production, support agricultural incomes
Open ended price support
Food security
Protects rural employment
Protects environment- farmers get
more if sign up for agricultural
environment commitments

Cons





Hugely wasteful
Farmers: 3% of EU population, 6% GDP,
30% of budget on CAP
Most of budget goes to mega-farms
Consumers pay twice- tax for the
subsidies and inflated prices

Legislation and Regulation
Regulation: rules that are set by the government or an industry that firms have to abide by
Legislation: laws that are passed by the government that all consumers and firms have to abide by
Purpose:


Reducing demand of a demerit good
Method: banning, restricting age of consumption,
Reduce supply of a demerit good
Method: increase costs to businesses by enforcing minimum standards
Increase demand of a merit good
Method: enforce consumption, e
...
education until 18
Increase supply of a merit good
Method: deregulation to reduce costs of production





Industry Regulators


E
...
ABTA- Association of British Travel Insurers: holiday market, expect high standards,
complaints and protect members financially
E
...
ASA- Advertising Standards Authority: independent advertising regulator, paid for by
businesses, prevent harmful, misleading offensive adverts, also offer advert advice



Regulation: Pros v Cons
Pros





Forces compliance with rules to bring
about desired change in behaviour
Gov can enforce rules through
legislation- most economic agents feel
morally bound
Fines imposed on those that do not
comply generates revenue, can be
ringfenced

Cons





Very difficult to decide correct level of
regulation- not want to damage infustry
long-term
Gov face significant administrative costs
in monitoring and enforcing
May reduce international
competitiveness of UK goods

Conclusions for Regulation: Success depends on…
...
Consequently, allocative inefficiency as over/under consumed
...
This means:


Reduce demand for demerit



Increase demand for merit

This can be through:



Government Intervention: gov can issue rules/guidance for private sector
...
g
...
g
...
g
...
g
...
(mostly undertaken in public
sector)
Process of CBA:
1
...
Give costs and benefits monetary value
Where no market price- shadow pricing
3
...
Decisions making: interpret the CBA
CBA: Pros v Cons
Pros





Aids decision making- net social benefit
projects carried out
Considers all effect of decision
Ensures firms acting in a socially
desirable way
Allows for value of money changing
over time by ensuring future flows
discounted to account for inflation

Cons





Conclusions for CBA:



Size and complexity
Accuracy of shadow pricing and skill of the analysts

Difficult to decide on C/B to includesome may be overlooked
Shadow pricing used which may be
unreliable and subjective
Can be v time consuming so not
attractive to the private sector
Poor decisions may be taken due to
shareholder influence

Government Failure
Government failure occurs when gov intervention imposes a cost greater than the benefit brought
about through the gov action
...
g
...
g
...
g
...
g
...

Unsustainable Development: Occurs when present progress is at the expense of future generations’
progress
...
g
...

Households experience higher incomes and own more cars/use more energy
Government more likely to focus on promoting growth to help reduce poverty than
protecting environment
After turning Point: Businesses more likely to adopt cleaner and more efficient
technology
Government imposes tighter regulation and devote more resources to protecting
the environment- change of obj from growth max to save environment
Household damage likely to slow- less buying of cars etc
Kuznets Curve: Whether eco growth reduce enviro degradation/sustainable
Motives of businesses- profit at all costs? Or socially/ethically operate
Role of gov- is gov proactive in protecting environment
Gov around the world- e
...
Kyoto agreement- intl pressure

Externalities and the environment
Causes






Concerns
Power generation and manufacturing- CO2
Deforestation
Mass agriculture: methane and fertilisers
Rise in national and intl transport
Fossil fuels in homes







Global warming
Acid rain- bad for plants and aquatic species
Reduction in water resources: World Bank 80
countries water shortages , WHO 1bn lack
water to meet needs
Loss of biodiversity- more vulnerable food
supplies

Key Problems with Dealing with such issues:





Worldwide issue- all nations need to cooperate, not all willing e
...
US withdraw from Paris
agreement
One country’s use of a resource can affect another’s- e
...
Nile
No value on most externalities- easy for market to ignore
Loss of diversity may mean scientific research limited- e
...
disease cures lost

Extended Reading:
i)
ii)
iii)

Tragedy of the Commons: shared resource used with each use acting in self-interest and
overconsuming
Property Rights: need for extension to prevent market failure
Coase Theorem: externalities can be internalised in conditions where: property rights can
be enforced, transaction costs of enforcing such rights not too large
...


Costs and Revenue: Short-Run
Short-Run: The period when at least one factor of production is in fixed supply- e
...
capital
Fixed Costs: Costs that do not change with output
...
g
...
E
...
Marketing
Variable Costs: Costs that vary in direct proportion with output
...
g
...
Diminishing returns occurs when the
marginal product begins to fall
...
Beyond a point, factors of
production scarce and workers have to queueproductivity falls

Criticisms of LDMR:





Assumes business operates in SR- only
really true for small/medium
Globalisation- allows for global sourcing
and rapid transfers in technology
Firms not aware of theory- instead focus on
costs and revenue
Difficult in reality: may be difficult to
calculate- e
...
Agriculture and services

Short-Run Cost Curves:
LDMR beyond Q1- MC rises
Productive efficient at Qp

Costs and Revenue: Long-Run
Long-Run: The time period when all factors of production are in variable supply
...
However, as a firm expands, its capital
stock will be on another short-run scenario, but at a higher output
...







Managerial: specialists employed- e
...
accountants
Purchasing: Buy in bulk- lower cost per unit
Financial: Larger firms find it easier and cheaper to raise finance- banks offer more favourable
rates
...
Reduces chance of
experiencing a loss should a product flop
...






Communication Problems: Large firm has more tiers of management and more staff- less
clear information
Inflexibility: Larger firms in possession of specialist equipment that hard to transfer to another
product line should product flop
Demotivation: ‘them and us’ and dissatisfaction with management
...
Lower productivity
Management and Control Issues: Can be difficult to run a large firm- harder to coordinate
production
...


Evaluation of Internal: Impact on Shareholders and Stakeholders





Performance related pay can provide financial incentives solving Principal-Agent
...
g
...





Suppliers: more specialised to provide for growing industry, firms may become own suppliersreduce time lags and cut out middle-man costs
Government: government to improve infrastructure/subsidies
Colleges: run courses specialised in industry- reduce training costs for firms and increase
supply of specialist labour (lower wage)

External Diseconomies: Average costs increase as an industry expands in the long-run




Congestion: Higher levels of traffic congestion around local area- increase delivery times
Shortage of raw materials: drives up their price
Shortage of skilled labour: increase price and may involve employ less skilled and productive
workers or training costs

Evaluation: Impact on Business and Stakeholders



Human Resource Management focuses on improvements in recruitment, communication etcfirms may employ
Business may have to charge higher price

Revenue
Total Revenue: amount of money firm receives from selling product
Average Revenue: revenue per unit (in most cases, price)
Marginal Revenue: change in total revenue as a result of selling another unit of output
...
g
...
g
...
Need for a shared obj- incentivise workers
to work in interests of principals, e
...
profit sharing schemes

Not all firms pursue MR=MC:
Charities, public sector, smaller firms, infant firms, football clubs

Alternative Objectives:









Sales Revenue Max: e
...
if salaries linked to net profit (max at MR=0)
Evaluation: unusual as managers responsible for maximising profit, responsible to
shareholders, likely to be some compromise between this and profit max
Sales Volume Max: managers seek to achieve this to increase firm’s presence in market- may
allow market leader/create barriers to entry
Evaluation: Unlikely as profit max with shareholder pressure, may only be obj in SR
Growth Max: Possible if managers believe promotion opportunities improve in larger firm
Evaluation: Profit max more likely with shareholders, may only be obj in SR when firm infant
Utility Max: managers seek to maximise own utility from work, e
...
enjoying ststus, fringe
benefits
Evaluation: More credit to this with fat cats, however after financial crash less likely and more
pressure on profit max
Profit Satisficing: aim for sufficient profit to fulfil firm’s future plans, managers opt for ‘quiet
life’ and favour low-stress over profit
Evaluation: reasonable theory for family-run/sole trader firms, less likely in firms with
shareholders like FTSE 100





Social Welfare: managers run firms to maximise benefits for society e
...
provide excellent
service
Evaluation: applies to public sector firms and some private sector firms
Corporate Social Responsibility: firms seek to gain favourable reputation- e
...
promote
environmental projects
Evaluation: costly so only realistic when CSR costs make up small proportion of TC
...
In operation may also
support aims, e
...
employing disadvantaged groups
Seek to maximise revenue
Seek to maximise benefit for workers- higher pay and better
conditions before profit

Profit
Accounting Profit: revenue a firm receives subtract the monetary costs a firm pays out (AP=TR-TC)
Economic Profit: revenue a firm receives subtract the monetary costs and the opportunity cost
(alternative returns foregone by using chosen inputs)
Supernormal Profit: profit above normal levels
Normal Profit: level of profit needed for a firm to stay in the market in the long-run
...

Allocative: firm produces goods wish to buy (D=S)
...
There is Pareto Optimality where no one individual can be made
better off without making another worse off
...
Prod and allo static concepts because they involve ways of
reallocating resources to avoid waste and meet consumer demands best
...
Firms dynamically
efficient if resources used to produce greater output over time
...
Present in
highly-profitable markets where investment
...

Increases cs as prices fall and boosts GDP
Consumers gain goods wish to buy- increases cs
Allows firm to stay ahead of competition, can
increase exports, better products for consumer
...

Commonest to consider 3/4/5-firm ratio
...
g
...
g
...
g
...
g
...
g
...
g
...
No barriers to entry, perfect knowledge, firms price takers, only normal profit
in LR
...
Price takers and compete only on price
...

No non-price competition
No barriers to Entry/exit: firms able to join if tempted by supernormal profit and free to
leave
Perfect knowledge: all participants have pk about the trading conditions in market
...
(no
b of e/e)

Shutting Down in the SR:
 TRcost
 TR>VC: continue operation in SR to reduce
losses
PC in the Long-Run

New firms enter, more firms= increased supply and lower price, supernormal profits eroded, process
continues until all supernormal profits absorbed

Efficiency in PC:
Allocative
Productive
X-Inefficiency
Dynamic

SR: yes (P=MC)
LR: Yes (P=MC)
SR: no (AC>min AC)
LR: yes (at min AC)
Unlikely due to competitiveness of market- little room for higher than potential
costs
Highly unlikely in LR as only normal
...
g
...
g
...
V high barriers to entry and
exit
...
Very high
barriers to entry and exit
...
g
...
V high
barriers to entry and exit
...
Typically, such firms have very high fixed costs as
a proportion of total costs, e
...
energy providers, rail services, severn trent



Assumptions for Monopoly Theory:





Single seller- one firm that has total control
Price maker- only supplier so able to set prices freely
No substitutes for good- no alternatives in market nor is there potential for new alternatives
High barriers to entry and exit- entry is near impossible

Natural Monopoly
Exploit continuous economies
of scale to reward shareholders
or invest in R & D
...


Supernormal profit= C-P-A-B (red
shaded square)

Efficiency in a Monopoly:
Allocative
Productive
Dynamic
X-Inefficiency

NO, P>MC
NO, AC>min AC
Likely- high supernormal
...
g
...
Price
consumer pay in excess of cost of
producing that last unit
Not productively efficient- waste
resources
Monopolist can use price maker to set
prices higher than in PC- reduce cs (not
all of which transferred to monopolist)
Little choice
Limited output (less than PC)

Evaluation: Goodness/Badness depends on…



Objective of monopolist (e
...
pub v priv owned)
Strength of monopoly power (legal monopoly or pure)

Monopolies should be allowed provided:




Heavily regulated- not anticompetitive or exploitative (competition and markets authority)
Publicly owned- utility of consumers prioritised
Gov encourage competition- reduce monopoly power e
...
grants to new entrants/tax credits
to infants

Price Discrimination under a Monopolist:
Price Discrim: charging a different price to different groups of customers for the same good or
service for reasons not associated with costs
...
g
...
Firm must have market power (p maker)
2
...
g
...
Prevention of Arbitrage- not allowed to buy at a lower price in one market and sell at higher
price- monopolist prevent or cannot charge higher price
4
...


Types of Price Discrimination:



First Degree: extreme, consumers charged p willing and able to pay, cs falls to zero, only
really realistic in bidding markets
Second Degree: charging different price based on q sold, e
...
bulk sale strategy- high
quantity discounts
...
Firms do this to encourage
greater demand
...
g
...
Also: interdependence, product differentiation, high barriers to entry/exit, non-price
competition and price maker power
...
g
...
g
...

Assuming oligopolistic profit max, Q* (MC=MR) for a range of MC curves
...
E
...
branding, quality,
packaging

Criticisms of KDC Theory:



Not explain how market price determined in first place
Does not explain price wars that occur in real life oligopoly markets (e
...
budget airlines)

Theory of Oligopoly 2: Game Theory
Another explanation of oligopolistic behaviour developed by Albert Tucker- prisoner’s dilemma
...

Prisoner’s Dilemma: an example of game theory with a range of applications in oligopoly theory
...

Dominant Strategy: a situation in game theory where a player’s best strategy is independent of the
strategy chosen by the other party- decision that always ‘wins out’ regardless of other party’s
actions
...
Firms may agree to price fixing or controlling supply to increase the market price
...
(maximise collective profit- links to game theory)
...

Cartel in UK Law: agreement between businesses not to compete with each other

Cartel members agree on:





Price fixing
Bid rigging: deciding who wins a contract in a competitive tender process
Output quotas/restrictions: limiting supply
Market sharing: choosing which customers/geographic areas each firm will supply to so not
competing

Example: OPEC- Organisation of the Petroleum Exporting Countries




International cartel
Goal is to secure a steady income for member states and to collude in influencing world oil
prices through economic means
Members include: UAE, Qatar, Libya, Iran…

Common reasons for Cartel Failure:






Falling demand creates tensions
Entry of non-cartel firms increases market supply
Exposure by government or regulatory agency
Overproduction/cheating
Prisoner’s dilemma suggests collusion breaks down- dominant strategy is for high output

Cartels in the UK:



Chapters 1&2 of the Competition Act 1998- prohibits anti-competitive agreements between
businesses and abuse of a dominant position of firm
...

May result from:



Price leadership- dominant producer sets price, other firms follow
Copying price movements of market leader or barometric price leadership- copy
movements of firm that reacts the quickest to market conditions

E
...
2007 supermarket milk fix, 2010 Imperial Tobacco fined £112m for influencing price of tobacco
unlawfully

Oligopoly: Pros v Cons
Pros







Cons
Firms can achieve supernormal profits- dynamic
efficiency may benefit consumer e
...
mobile
phones
Price stability can benefit consumers in budgeting
Non-price competition can benefit consumers
Firms larger and less likely to fail- stable supply
and jobs
Large firms exploit economies of scale- lower
prices?
Many features realistic- e
...
airlines, cinemas,
banks









Collusion lead to higher prices and lost CS
High barriers to e/e can reduce competition- may
exploit consumers and suppliers
Sticky pricing higher than in PC market- prices
consumers out market
Some aspects on non-price (e
...
heavy marketing)
waste of resources?
Inefficient in terms of productive and allocative
Not realistic as see price wars
Barriers to entry not always deter- e
...
budget
airlines, Aldi

Contestable Markets
A contestable market is one where incumbent firms can only make normal profits as setting the
price above AC (making supernormal) would attract entry, owing to the absence of barriers to
entry/exit and sunk costs
...
of firms not important)
Potential for hit and run competition: enter market expecting supernormal and rapidly leave
when only normal

Degrees of Contestability:
1
...
High Contestability (low barriers to entry/exit, similar to monopolistic competition)

3
...
g
...


Pure monopoly price at P*
(supernormal)

But, market perfectly
contestable

No supernormal can be
made- as all would be eroded
away by new entry

Normal profit at AR=ACoutput of Qc and price Pc

Threat of new entry may be
just as powerful an influencer as
behaviour of existing firms

Limit Pricing:
Limit pricing is where existing firms set prices as high as possible but not so high as to
encourage/enable new firms to enter the market
...


Incumbent has LRAC1- operates at
P1 and Q1 of profit max

Incumbent wary of potential
entrant (with LRAC2) so incumbent prices
at PL- same level as new entrants LRAC so
entrant cannot make supernormal

New entrant will increase supply,
lowering price to P2 making entry lossmaking

Factors that have increased contestability in recent years:








Entrepreneurial zeal- not accept market structure is a given, willing to take risks
Recession- opened up markets
Deregulation- reduce barriers to entry
Competition policy- encourage
EU single market- markets liberalised
Technological change- brought down some entry costs, e
...
web browser development
Technological spill over- emergence of products that can imitate incumbent’s products- e
...

Levitra v Viagra

Contestable Markets: Pros v Cons
Pros



Lower prices for consumer
Increased incentive for incumbents to
lower costs – X-Inefficiency unlikely,
and build customer loyalty

Cons



Limited supernormal (if any) reducing
dynamic efficiency
Hit and run not ideal as consumers may
have product warranties

Criticisms of theory:




Imprecise- only talks in degrees of contestability, no market perfectly matches
Difficult to assess contestability- e
...
asymmetric info for new entrant hard to measure
Assumptions may not hold true: are incumbents actually worried about new entrants?

Integration of Firms
Firms can grow organically or by integrating via:


Takeover: one firm buys out shareholdings of anther to have complete ownership (e
...
BT
takeover EE 2015)
Merger: two firms join together and hare ownership of new (e
...
Facebook-WhatsApp 2014)



Method of Integration 1: Horizontal
Integration of two firms at same stage of production e
...
two manufacturers merging
Pros to Firms




Increases economies of scale (higher profit)
Increased market power and price maker
ability
Potential synergy- ie combines business
stronger through pooling of skills and
talents

Cons to Firms



Potential diseconomies of scale such as
coordination problems
Different cultures of firms may create
barrier to successful integration

Impact on other economic agents:





Likely to see higher prices
Firm may bargain down on suppliers
Shareholder benefit from increased profits
Workers may lose jobs- i
...
no need for two admin departments

Method of Integration 2: Vertical
Integrating with a firm at a different stage of production



Forward integration: integrate with firm later stage (upstreaming)
Backward integration: integrate with firm at earlier stage (down streaming)

Pros to Firms





Some economies of scale such as risk
bearing and financial
Cutting out costs of middle-man increasing
profit
Forward: guaranteed market to sell
to/better information on demand
Backward: firms are able to ensure reliable
just-in-time delivery, reduce costs

Cons to Firms




Vertical will have less economies of scale as
production at different stage
Less chance of synergy because no
‘common’ knowledge of markets
Can reduce flexibility of business- will stick
to supplier merged with, may get lower
elsewhere

Impact on other economic agents:




Lower prices as cut out middle-man
Competition may find it more difficult to secure supply
Shareholders likely to benefit

Method of Integration 3: Conglomerate
Merger between two companies that are completely unrelated in products sold
Pros to Firms




Helps company in diversification- risk
bearing economies of scale
Helps when excess cash but not enough
opportunities for growth in same industry
Increases customer base of company- can
now cross-sell to new customer base

Cons to Firms




Impact on other Economic Agents:




May protect workers jobs as can be redeployed
If successfully managed- increase profits and dividends
Potential risk of damage to customers of core business

Increased risk of poor management and
decision making
More likely to have different culturesmanagement clashes
Firms may lose focus on previously strong
product area

Evaluating the impact of Integration: successfulness depends on



How successful management
How similar cultures/management styles were to begin with

Factors influencing the Growth of Firms:
Internal Factors
 Financial resources- retained profits
 Skills of management and workforce
 Objectives of owners- risk takers?

External Factors
 Growth of market
 Economic stability- are returns from
investment likely
 Competition- has a competitor failed
giving a gap in the market

Regulation and Competition Policy
Regulation refers to the wide range of legal and other rules that apply to firms
...
g
...
g
...
Also covers situations of tacit collusion
Competition Policy in UK:



Office of Fair Trading: investigates suspected cases of monopoly power abuse and
engagement in prohibited practices- collusion, abuse of market power
Competition and Markets Authority: investigated industrial cases e
...
mergers and online
gambling

The Labour Market
Productivity and ULC
Productivity: output per unit of labour input (output per worker per time period)
Unit Labour Costs: labour costs per unit output produced
ULC=

𝑻𝒐𝒕𝒂𝒍 𝑳𝒂𝒃𝒐𝒖𝒓 𝑪𝒐𝒔𝒕𝒔
𝑻𝒐𝒕𝒂𝒍 𝑶𝒖𝒕𝒑𝒖𝒕

Labour costs: salaries (usually 80%), NICs, pension contributions, recruitment and selection, training
costs, redundancy payments

Total Output
Main determinant is labour productivity
Affected by:





Skills/experience of workforce
Technology
Motivation
Management of workers

ULC may increase if:



Total labour costs increase
Total output falls

Implications of differing ULC:




E
...
2015: Manufacturing +5
...
2%
Consequences: efficient sectors that have declining ULC increase profits and offer more
competitive pricing compared to intl competitors- may have large growth
Vice-versa

Implications depend on:




Starting base- %change not enough
Proportion of ULC to total costs
Performance of foreign industry ULC

ULC UK: +30%, Germany +4%, Italy +30%, Spain +28%

Implications of High ULC:



Reduced intl competitiveness (prices higher)
Reduced exports – B of P and eco growth

Depends on:


proportion of total costs are ULC,





compromise profits to stay competitive?
strength of non-price competition (PED inelastic?)
Exchange rates

Reasons for Poor Labour Productivity:







Education system poor
Financial system not supporting firms with growth prospects
Market dominated by incumbents who not willing to give way to more efficient firms
Lack of labour mobility- mis-allocation of labour resources (not best suited to jobs= 1/3)
Lack of investment into tech with uncertainty over Brexit
Demotivation of workers due to poor contracts

Consequences of poor intl ULC:
Low ULC in UK, firms have engaged in:



Outsourcing: sub-contracting work to another firm (often more productive overseas)
Offshoring: moving production/other aspects overseas to exploit better productivity

Human Capital
Human capital is knowledge and skills acquired by individuals acquired through:




Education system
Employer training schemes- e
...
apprenticeships
Individual investment: e
...
studying for MBA/new language

Demand for Labour
Labour is a factor of prod so demanded for output it produces
Demand for labour is derived from the demand for the final good or service
...

The Theory of Demand for Labour: firms demand workers for the contribution they make to output,
therefore, need to measure this value of output to determine most profitable level of employment
for a firm
...


Specialisation becomes exhausted and
capital/land resources become scarce- congested
workplace- decreases MPP

Plotting MRP

MRP curve shape derived from MPP curve
shape- as MRP=MPP x P

Movements along MRP can be caused by
changes in wage rate
Shifts in MRP can be caused by:

Changes in D for final product

Changes in P of final product

Changes to labour productivity

Changes in price of capital in LR: if falls,
replace labour with machinery

Wage Elasticity of Demand:
WED measured the responsiveness of the quantity demanded of labour to a change in the wage rate

% 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝑸𝑫

WED=% 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒘𝒂𝒈𝒆 𝒓𝒂𝒕𝒆
WED Influenced by:





Ease of substituting capital for labour
Labour cost as proportion of total cost
PED for final product
Time period under consideration- SR firms find harder to make changes to workforce

Criticisms of the MRP Theory:



Can be difficult to measure MPP in service sector
Putting price on output difficult for public services

The Supply of Labour
Labour supply to an industry: the quantity of workers who are willing and able to work in an industry
at given wage rates
...
Same as the labour force
...

In SR, Labour Supply influenced by:
1
...
The Income Effect:
 Low wages, workers seek to improve standard of living and work more hours- +ve relationship
 As wages continue to rise, workers find can reach target income and work fewer hours (-ve
relationship)
 Leisure time acts as a normal good: more leisure time purchased as wages increase

Backward bending labour supply curve (SR)
Up to A: income and substitution effect +ve
A to B: Income effect negative but
outweighed by substitution effect
After B: substitution effect +ve (always is) but
income effect negative and outweighing the
sub effect (Overall -ve)

Evaluation of Theory: Realistic?





Not all workers able to cut hours as wages rise (fixed contracts)
Generous benefit system may not encourage sacrificing leisure time as wages rise
(replacement ratio >1)
High marginal tax rates discourage working more hours- little extra income earned
Some workers materialistic and income effect always +ve

Labour Supply in the LR
In LR, sufficient time for workers to change occupation- supply influenced by net adv of job
Net adv include:



Pecuniary factors: monetary reward (e
...
wags, commission, piece rate, bonuses)
Non-Pecuniary factors: non-monetary adv and disadv factors of the job (e
...
company cars,
stress, long holidays, long hours, unpleasant work, unsafe work, fringe benefits)

Net advantages and the Labour Supply
Net adv must be +ve to attract workers
If occupation exhibits high non-pec disadvantages, higher wage must be offered to entice workers- a
compensating differential (to ensure +ve net adv)

LR Labour Supply Curve
 Change in wage = movement along curve
 Any factor other than wage = shift

Wage Elasticity of Supply
WES measures the responsiveness of quantity supplied of lab to a change in the wage rate
...
g
...
This means:






Many suppliers of labour (potential labour) and many employers
Labour is homogenous (skills, talent, experience same)
Perfect knowledge of market conditions: workers know if another firm offers higher wage
Each participant wage taker
No government intervention

profit max at MC=MRP Q*, W*
Criticisms of the PC model:






Trade unions exist which distort market wage (TU mark-up)
Firms may have buying/monopsony power- main employer suppress wage
Workers not homogenous- differing skills, experience, talents- MRP and WED distorted
...
5m workers

Wage Differentials
Wage differentials are the differences in wage that occur in an economy due to differences in:







Workers (heterogenous)
Gender: women low degree of attachment to labour force and may take career breaks, child
bearing = economically inactive (less time to progress up career ladder), historic legacy, parttime work more attractive
Age: NMW and NLW change with age, more experienced suggests more promotions,
incremental pay scale
Ethnicity: migrants less qualified, concentrated in low pay sectors, reluctance to migrate in
search of work, discrimination
Regions of work: lack of demand in N/E (heavy manufacturing in decline), regional multiplier
(less employment=less spending= …), migrants tend to locate to areas like N/E where low
living costs, higher living costs=higher pay

Explaining Wage differentials:
e
...
tube driver $46,000, shop assistant NMW, FTSE 100 CEO 4
...
g
...
Long-term supply increase through increased wage, wage and ER fall again
...
of workers willing
and able to work at given wage rates

If wage falls, workers transfer out of
industry to next best alternative

Area under supply curve= transfer
earnings


Above supply curve to equilibrium
wage = economic rent

Supply conditions:
All of wage TE
All of wage ER

WES is perfectly elastic
WES is perfectly inelastic

Impact of Trade Union Activity:
Trade union: organisation that collectively bargains on behalf of members with employer to further
their interests
...
5% in Private sector 2014 to 2015

Unionisation in Real Life:



Train drivers: earn £30k immediately after qualifying, good holidays, little stress taken home
Tube Drivers: £49k, 36hr week, 43 days annual leave, unionised by ASLEF

Factors affecting the effectiveness of a union:








Membership numbers
Type of job (can be replaced by capital easily?)
Publicity
Leadership
Gov regulation (Thatcher 1980s)
Militancy of union
How financed

Impact of a Monopsonist on Lab Market
Assumption: monopsonist is ‘pure’- only one employer for occupation
...

Therefore: MC sits above AC curve and rises at a faster rate

Monopsonist Diagram

Profit max employer: MRP=MC at
Qm, Wm to attract these workers

Monopsonist suppresses wage rate,
Wm, down from Wpc (wage in a PC lab
market)

This is LMF as under employment
compared to a PC labour market: allocative
inefficiency

Examples: Junior doctor pay reduced, postoffice workers forced to work longer hours,
teacher real salary cuts due to pay freezes

Evaluation: Whether a monopsonist suppresses wage depends on…






Obj of monopsonist- profit max?
Is monopsonist pub/priv sector- gov don’t tend to suppress
Ability of workers to move to other occupations- if easy, monopsonist power reduced
Strength/existence of TU power to offset monopsonist
NMW legislation

Impact of a Bilateral Monopoly
Bilateral monopoly is where power is held on both sides- buying and selling
...
g
...








New AC=
Mew MC=
Wage is maximised at D=S, or AC=MRP
...
g
...
8m public sector (+0
...
7m private sector (-0
...
g
...
g
...
4m), NUT, British Medical Association, GMB (0
...

Unite covers a number of sectors such as education, finance, automobiles
Unison biggest public-sector union (>1
...
E
...
investment banking, CEOs, footballers, barristers
...
Employees often represented by TU
Productivity bargaining: process of reaching an agreement through collective bargaining
whereby employees of organisation agree to changes that intended to increase productivity

Impact of Bargaining and TU activity: Pros v Cons
Pros






Unions represent unhappy and negotiate
solutions that should motivate
Bargaining should result in loyalty of workerscontent and less likely to leave
Productivity bargaining can bring about changes
that employers need to remain competitive
TU can counterbalance exploitation of
monopsonist- higher wages and employment
Collective reduce number of negotiations org
involved with, reduce costs and time
Evaluation: impact of TU depends on…







Cons







Increased ULC as wages above equilibrium- less
intl competitive and classical unemployment
Improved working conditions etc increase ULC
Reduced labour flexibility- unions may prevent
redundancies/cut in hours
Unions can restrict labour supply and choice to
employer
Increased union activity can deter FDI
Increased ULC erodes supernormal and possibility
of dynamic efficiency

Type of market- monopsonist? Monopsonist suppressing? If PC, increased wage=
unemployment
Power of TU v Monopsonist
Actions TU prepared to take
Gov intervention on TU power- reduce need for TU
Attitudes of employer- collaborative relationship or “us and them”
Ease at which firms can relocate overseas

Labour Market Definition:
Labour Force: all those who are economically active
Working population: all those who are economically active and inactive ie population between the
ages set by the government that are able to work (16-65)
Economically active: people in work or unemployed- seeking work and willing and able to work in he
next two weeks
Economically inactive: people who are not in work or seeking work
...
𝑜𝑓 𝑑𝑒𝑝𝑒𝑛𝑑𝑒𝑛𝑡𝑠

reliant on the output of those working
...

=

𝑁𝑜
...


If >1, then little incentive to work and often adds to the number of

unemployed/discouraged workers
...


Wage Controls: Minimum Wage
Minimum wage: is the legal minimum hours rate that workers must be paid
...
g
...
60
 NB to be effective must be imposed
above equilibrium

Results in:
 Qd workers being paid more
 Qe-Qd redundancies
 Giving a total unemployment of QsQd

Justifying NMW: Reasons for low pay



Lack of access to lab market- barriers to entry
Lack of bargaining power by individuals in uncompetitive markets- employer ‘take it or leave
it’ attitude
Lack of skills leading to elastic demand- higher wage reduce demand= unemployment
...
No max wage in UK, but
case of it being used by the football industry in 1960
...
May
be shortage of skilled workers
If firms willing to pay high wages,
workers must have the MRP- deserve it
Apart from specific industries, little
benefit of max wage- mainly for a mild
feeling of social justice
Lower costs may be redistributed to
shareholders or just turn into bonuses

Any wage control interrupts role of wages to allocate scarce resources- prevents efficient
markets
Increased D for product=Increased Price of output= Increased D for lab- but max wage stops
mechanism from working and wages do not increase so supply does not increase to match
increase in demand

Discrimination
Discrimination is the unjust or prejudicial treatment of different categories of people on grounds of
race, gender, age, religion, belief, sexual preference, gender realignments
Theories of Discrimination:
1
...
Statistical discrimination: arises because of imperfect information
...

Impact of discrimination:






Labour market failure: market forces of D and S fail to result in an efficient allocation of
resources
...
g
...
g
...
9%
higher than white)
Women earn £300,000 less than men over lifetime or 24% less- some groups have lower
wages

Macro Impact:



Higher ULC could be inflationary- damage intl competitiveness (however discrimination rare)
Shortage of staff could lead to lower GDP, slow growth

Evaluation:




Gov regulation tightened- discrimination illegal and more rare
Increased pressure of globalisation forced efficiency- cannot afford to have higher costs than
potential
Tight labour markets in some sectors led to firms widening scope for employment

Demographic Changes:
Ageing Population: Pros v Cons
Pros





Older workers more experienced and
more productive e
...
B and Q- help and
advice
Statistically less time off in sickness
Less occupationally mobile- less
recruitment and selection costs
More able to train and support younger
workers

Cons


Less likely to move jobs- geographical
and occupational mobility reduced
(LMF)
Slower to adopt to change may need
more training
Usually more expensive (incremental
pay)
Some older workers tend to be less
productive- productivity peaks in 30s
and 40s





Impact Depends on:




Pay policy of firm: incremental less common- more paying according to results
Attitude of firm to older workers- some tailor workplace to older workers
Health of older workers- future obesity and diabetes will impact future generations

Wider Implications: long-term ageing population will




Pressure on gov and public services
Increased demand for state pension- younger have to subsidise
‘Demographic time bomb’

Migration
Supply of workers affected by workers entering/leaving workforce
+ve net migration figure= immigration> emigration
Trends in migration: 2015- net migration to UK 333000, more British citizens leave than arrive
Net Migration: Pros v Cons
Pros







Plugs shortage of workers (incl skilled
positions)- seen shortages of farm labourers,
nurses, plumbers, engineers etc
Downward pressure on wages- helped control
costs and prices
May migrants occupationally and
geographically flexible
Many keen to work way up career ladderproductive
Many return home after a few years in UK- help
poorer economies
Many send home pay- help families in need

Cons







Migration can prevent lab market correcting
itself- if jobs not filled, wages increase, but
migration prevents this
Led to low paid workers seeing no pay increases
Increased population- pressure on public
services
Displacement of UK population from jobs
Many come from countries where skills needed
Return of migrants= costs of recruitment and
selection for UK firms

Evaluation: UK benefits depends on…




How skilled migrants are
Capacity of UK infrastructure to cope
Willingness of migrants to be flexible

Incentives to Work
Unemployed seek work if replacement ratio (RR) >1 – net earning in work>out work
Incentives:





Living wage- monetary incentives, longer hours, acceptable standard of living
Piece rates- more output, more pay
Profit sharing schemes- work harder
Performance related pay- discourages laziness and motivates workers

Criticisms:





Not all workers motivated by money: ER may already be high
Net adv needs to be considered
Higher wages may lead to income effect > substitution effect
Research indicates pay not a major factor incentivising workers past certain level

Informal Labour Markets
Informal labour market is economic activity not registered or recorded, so not part of formal
...
g
...
g
...
Two key aspects:



Labour Mobility: both occupational and geographically mobile
Flexible working patterns: use of practices that enable employers to vary hours of
workforce in response to changes in D for output

Reasons for Increased Flexibility:






Gov policy reduced power of TU, supported changes to working contracts, reduced
discrimination
Firms intro more flexible working practices- e
...
zero hour- to respond to globalisation and
competition
Changing structure of wage bargaining away from national bargaining to decentralised
bargaining in private sector- greater flexibility of wages
Increased technological abilities: improves ICT skills more occupationally mobile
Changing composition of workforce: more women working, and people prepared to work
part-time

Future Factors:
Increasing Flexibility
 Improving infrastructure e
...
HS2
 Low unemployment continues- lower
risk of hysteresis
 Improvements in education- reformed
exams

Decreasing Flexibility
 Exiting EU could reduce immigration
and skilled labour
 New NLW/NMW reduce flexibility
because hinders wage mechanism
 Growing dissatisfaction with big
business power

Impact of Changes to UK Flexibility:
Over time, more flexible and more flexible than many European counterparts
Micro Impact
 Reduced costs of productioncompetitive wage rates and hours
needed
 Prevents shortages of labour hindering
output
 Lower product prices and more
responsive supply to orders- UK intl
competitive

Macro Impact
 Reduces unemployment- workers have
transferable skills
 Reduces labour shortages- helps GDP
 Reduces inflationary pressure of wagessupple=demand to prevent wages
rising and improved worker efficiency
 Improved use of scarce resources as
less likely to be unemployed

Mobility of Labour
Geographical mobility: workers able to move from one area to another to find work
Occupational mobility: workers able to move from one occupation to another to find work
Reasons for Immobility:
Geographical
 Family and social ties
 Roots in area
 Differences in housing prices
 Working spouse
 Children’s education
 Information failure- not aware of jobs
in other area

Occupational
 Not transferable skills
 Older workers less willing to retrain
 Info failure- not know of job vacancies
or aptitude
...
g
...
g
...
E
...
wages (earned), benefits,
inheritance (unearned)
Wealth is a STOCK concept and is measured by valuing the stock of assets owned by a
person/household
...
Wealth can be inherited or accumulated
over a lifetime
...
g
...

Income inequality often measured in terms of percentage of income to percentage of population
(cumulative)
...

Evaluation: does not always hold- young, high-earning entrepreneurs (e
...
IT) and sole older
in low-paid with few assets
Evaluation: future- younger people increasingly qualified and reduced use incremental pay
Evaluation: increasing younger of young graduates (higher MPP) narrow gap
Different educational opportunities: educated more skilled and higher MRP, higher skilled
workers can apply for professional and higher paid jobs e
...
solicitor/doctor where limited
supply and high wages
Evaluation: increased number becoming graduates- aiming for 50%- already evidence gap
reducing
Evaluation: shortage of skilled in UK could widen gap but depends on new immigration
policy post-Brexit- could have ‘visa system’ with skilled only
Differences in wealth (financial and physical assets): all income derived from assets, more
assets=more income which can be invested (more assets=more income)
Evaluation: only accounts for small % of society but increasing numbers investing in
property
Evaluation: some taxation on wealth e
...
inheritance/capital gains reduces gap
Differences due to gender/ethnicity: men earn more than women and ethnic minorities
tend to be lower paid
...
Women
tend to supply to jobs (like nursing/caring) which reduces wages (dual labour market for
women)
...
g
...
g
...
g
...

DATA: richest 1% hold as much wealth as bottom 60%, bottom 20%= 0
...


Consequences of Income and Wealth Inequality:








Large groups excluded from opportunities others enjoy- e
...
merit goods
Reduced life chances for low income- cannot afford to continue education
Can lead to cycle of deprivation- low income groups unable to break out of trap (little class
mobility)
Increased supervision costs for demotivated workers-increase ULC
Social disharmony- increased tensions between low and high-income groups
Political instability and social problems- drive away investment
Increased crime rates ad divisions grow

Definition:
Unemployment trap: people who are unemployed have little incentive to work as employment
reduced benefits and they may start to pay tax, reducing income to only marginally above, if not
below, that on benefits (RR>1)
Poverty trap: workers on low wages have little incentive to work longer hours as their net income
may only increase marginally, if at all, due to increased tax and cuts in benefits
...

Gov Intervention to Tackle Income and Wealth Inequality:
1
...
g
...
Universal Benefits:
 Benefits all groups regardless of income e
...
state pension for all over retirement age
Pros

Cons




Evaluation


Ensures basic standard of
living
Increases income of
lowest paid
Avoids unemployment
and poverty trap (RR kept
less than one)- not
removed as income
increases




Cannot be set at high
amount and all groups
eligible for benefit- huge
opportunity cost
Not well targeted- impact
in inequality limited
Can create a dependency
on the government to
provide income




Parameters set for
benefit- e
...
state pension
age increased
Size of benefit and
opportunity cost

3
...
Inheritance tax:
 Progressive tax
 Inheritance below £325k is tax free, above is 40%
Pros

Cons




Reduces amount of
inherited wealth passed
down through
generations- tackles longterm inequality
Revenue can be used for
means-tested- large
revenue

Evaluation




Can have unintended
consequences- e
...
sell
family homes
Can be unfair as wealth
accumulated from
already taxed income
Encourages tax avoidance



Generally viewed as
highly punitive and
unfair- many families take
action to reduce this bill

5
...

Places a cap on the value of benefits
Created a JSA claimant commitment- outlines actions those in receipt of JSA must do
New Child Poverty Strategy 2014: provided childcare support, free school meals, fruit and
vegetable vouchers, discounts on energy bills, increased the income tax threshold

Government Intervention in the Labour Market: Policy Evaluation
1
...
Pension Reform:






Expensive with high
opportunity cost
No guarantee will work
if unemployment
cyclical as supply-side
policy
No short-term fix

Evaluation
 Quality of education
and training- does
meet needs of industry
 May be preferable to
subsidise private sector
who better know
training and needs of
sector



successive govs raised retirement age as life expectancy increased (now 68)- increase
number of years have to pay in to reap rewards

Pros

Cons



increase supply of
labour- plug
shortages
reduces pressure
on gov budgets as
tax revenue
increases and
demand for
pensions fall





older workers may
not be very
productive but
more expensive
morally
questionablegovernment
exploitation of
labour?- more
stress, may reduce
life expectancy

Evaluation
 raising retirement age not
guarantee workers will
continue in paid work
 depends on sector- older
workers less use to
manufacturing/construction/IT

3
...
g
...
Migration Policy:
 Current government committed to reducing immigration to abide by wishes of LEAVE votersmay be achieved through a points immigration system like Australia
Pros

Cons


Points system should
ensure migrants meet
demands of
employers- plugging
shortages while not
contributing to
unemployment



Reduced supply of
labour likely as
employers forced to
offer higher wages to
attract domestic
workers- increase ULC

Evaluation
 Deal negotiated with
EU regarding free
movement of labour
 How accurately points
system reflects needs
of employers
 Strictness of points
system

5
...
g
...
g
...
g
...
Regional Policy:
 Encouraging firms to relocate to depressed areas by offering financial incentives e
...
grants
...
g
...
Minimum Wage Legislation
 Setting hourly min wage for workers in UK
...
g
...
Affordable Home Ownership:
 Gov may help low to medium income groups onto housing ladder by helping with deposit,
e
...
“help to buy” ISA, low interest loans, mortgage guarantee, home through shared
ownership
Pros

Cons


Improves geographical
mobility



Limited gov budgethelp small

Evaluation
 Home ownership only
one factor affecting







Reduced regional and
structural
unemployment
Plugs lab shortages in
expensive areas
Allows escape from
rented accommodation



geographical
immobility

Even with help, some
areas with lab
shortages unaffordable
Expensive- large opp
cost



9
...
At 16, must: stay in full-time education,
apprenticeship, work as volunteer while in part-time education, start traineeship
Pros

Cons







Should improve long-term
skills of workers
Use of
traineeships/apprenticeships
helps to plug shortages in
skilled labour
Reduce pressure on JSA
budget



Increases gov
spending on
education for 16-18
yo
Reduces supply of
cheap labour to firms
that not offer
apprenticeships

Evaluation
 Quality of training
and education on
offer- may not
engage if very
academic
 Significant admin
costs to gov to
check 16-18 y/os
...
Privatisation/Deregulation of Markets:
 Successive gov reduced size in public sector and opened up more markets to competition,
e
...
energy, transportation
Pros

Cons






Increased competition
reduced monopsonist
power- higher wage
reduce RR
Firms may engage in
more training
programmes to
compete- increase
skilled labour and
productivity



Policy does not
guarantee higher
wages to workers as
new competitors may
simply adopt wages of
incumbents
New firms may find
difficult to offer high
wages in short-term

Evaluation
 Mixed success of
introducing
competition- many
previously gov owned
may retain high market
share and monopsonist
 Depends on TUs’ ability
to fight against
monopsony

11
...
e
...
Universal Credit:
 Replaces: child tax credits, housing benefits, income based JSA, income related Employment
and Support Allowance (ESA), working tax credit etc
 Means tested benefit that is intro in stages
Pros

Cons






Should keep RR<1
...
g

---

Title: FULL A-LEVEL MICROECONOMICS NOTES (AS AND A2) - 84 PAGES!
Description: These are the full 2 year A-Level Economics course notes for microeconomics. These notes are suitable for all examination boards but have a particular focus towards OCR. NOTE: These notes do NOT include diagrams due to copyright issues.

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