Notesale: Turn your study into money

Document Preview

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

---

3 Business behaviour and the labour market
3
...
1
...
1
...
1 Reasons why some firms tend to grow
→ Increase market share – to hopefully become the dominant firm in a particular industry,
allowing them to move beyond perfect competition and obtain supernormal profit in the
long-run
→ Increase sales – through larger brand recognition and more sales outlets, either in the same
country, or even allowing a firm to gain a holding in a foreign market
→ Increase economies of scale – the firm’s increased size allows it to lower long-run average
cost (LRAC), moving closer to productive efficiency
→ Gain power – to prevent takeover by larger predatory businesses and withstand shocks such
as the 2009 Financial Crisis
→ Satisfy managerial ambitions – some managers will seek to expand in order to improve
confidence in the business, which may cause share prices to rise, especially where managers
are paid – in part – with shares, and it also allows them to leave a legacy behind
→ Make the most of an opportunity – some firms will have revenues that they do not wish to
class as ‘profit’, upon which they will pay corporation tax, so they will instead use them to
acquire another business or expand their own
→ Gain expertise – some firms may wish to expand into a new industry, and rather than trying
to establish themselves in this sector slowly, they can instead buy a ready-made business
that has a history of making profit
3
...
1
...
1
...
3 Significance of the divorce of ownership from control: the principal-agent problem
→ In cases where there are a large number of shareholders, it becomes impractical for all
shareholders to have a say in the day-to-day running of the business
→ As a result, they delegate this task to a board of directors, who in turn delegate work to their
managers – this chain is known as the ‘divorce of ownership’
→ The ‘divorce of ownership’ has one main issue, referred to as the ‘principal-agent problem’,
the ‘principal’ being the owner of the business, and the ‘agent’ being the manager of the
business
→ The ‘divorce of ownership’ means that the business may not be managed by the agent in the
way that the principal wishes, and in such examples asymmetric information exists where

the agents know their behaviour yet principals do not necessarily, and principals know their
objectives, but agents do not necessarily
→ The ‘principal-agent problem’ may lead to dismissals, such as Antony Jenkins’ dismissal from
Barclays Bank in 2015, when he was not able or willing to cut costs, and therefore did not
increase profits as much as the directors wished
3
...
1
...
1
...
4
...
1
...
4
...
1
...
4
...
1
...
1
...
1 How businesses grow
3
...
2
...
1 Organic growth
→ Firms can grow by expanding the scale of their operations, thus increasing market share
→ This is known as internal or organic growth, and is achieved by investment from the firm
within the firm
→ It is paid for either by ploughing back profits within the firm or by borrowing (through taking
out loans, selling shares, or issuing bonds)
3
...
2
...
1
...
1
...
1
...
1
...
1
...
1 Horizontal mergers
→ This is a merger between two firms at the same stage of production
→ Examples include the merger of the banks TSB and Banco Sabadell in 2015, or the proposed
merger between phone providers O2 and Three, which was blocked by the Competition and
Markets Authority (CMA) in 2015
→ The advantages of horizontal mergers to firms is that they may increase their market share,
benefit from economies of scale, and face reduced competition
→ The disadvantages of horizontal mergers to firms is that they may face unknown costs, and
more importantly their brand may be diluted or weakened
→ The advantages of horizontal mergers to employees or other stakeholders is that there may
be some opportunities for promotion, and the firm’s prestige may improve
→ The disadvantages of horizontal mergers to employees or other stakeholders is that those
who are duplicating work or are unable to move to new headquarters may lose their jobs
3
...
2
...
2
...
1
...
1
...
3 Backward vertical mergers
→ This is when a firm merges with a firm closer to the suppliers in a production process
→ For example, in 2008 Petronas, a state-owned Malaysian petroleum company, bought Star
Energy plc, a British oil exploration firm
→ The advantage to firms is that backward vertical mergers assures supplies in timing and
quality, leading to reduced costs of supply for firms
→ However, the firm may lack expertise in the new industry, and may lead to over-exposure to
the end-product in one market; if demand for that one good falls then that firm is at very
high risk

→ The advantage to employees and other stakeholders are that expertise and opportunities for
promotion are widened, they experience increased market presence, and profitability may
lead to increased share prices in the long-run
→ However, the initial costs of integration may damage profitability and therefore negatively
impact the share price in the short-run
3
...
2
...
2
...
1
...
1
...
5 Vertical demergers
→ This is where firms at different stages of the production process are broken up
→ In 2015, eBay, an online auction site, demerged PayPal, a payment system, and listed its
shares separately
→ This approach avoids negative attention from competition authorities, and decreases
exposure to risk in the market as a whole
→ However, any economies of scale cost savings are lost, and there are sunk costs in goodwill
(the reputation of a business), branding and human capital
→ Vertical demergers allow employees and stakeholders to focus on the core product,
providing scope for specialisation and increased returns to investors
→ Nevertheless, it narrows expertise and reduces opportunities for promotion
3
...
2
...
2
...
1
...
2 Constraints on business growth
→ Barriers to entry into or exit from an industry are obstacles that ensure the continued
monopoly power of firms in a market

3
...
2
...
1 Regulation
→ The government itself may prevent the entry or growth of a firm
→ Acts of Parliament can allow monopolies to be formed and protected, such as the provision
of the National Lottery, and the former nationalised utilities – water, rail and electricity – all
enjoyed government protection of their monopolies
→ Patents also give firms legal protections to ensure that ideas or processes are protected
from competition throughout the life of the patent
→ This is important in innovation-heavy industries such as pharmaceuticals, where
considerable money is invested in research and development and this innovation can only
be rewarded financially over time
→ Firms require licences or specific qualifications in order to enter a certain industry, so for
example law and accountancy firms have to be approved by their respective trade bodies,
and radio stations have to obtain a licence before they can broadcast
3
...
2
...
2 Marketing barriers
→ Marketing barriers are imposed by businesses currently operating in an industry
→ This could be through branding or through a new advertising campaign to establish brand
recognition
→ This investment in marketing cannot be recouped if the campaign fails – this is known as
sunk costs
→ For example, Coca-Cola spent millions in trying to bring its purified tap water Dasani to the
UK market, but after negative publicity the product failed to take off and Coca-Cola
abandoned its plans
→ Most companies do not have the capacity to take such a risk, and so these market barriers,
caused by the size of sunk costs, can prevent a business growing into a new industry or
moving its operations overseas
3
...
2
...
3 Pricing barriers
→ Firms already in the market may try to prevent new firms entering in two very distinct ways,
predatory pricing and limit pricing
→ This is explored in more detail in section 3
...
6
...
1
...
2
...
If this occurs then
supply will increase vastly, causing prices and revenues to fall, meaning that any potential
profits will be eroded
3
...
2
...
5 Size of the market
→ If a firm serves a niche market that will not support expansion then there is little scope for
growth
→ Manufacturers of cricket bats or a local grocery store may have expanded as far as their
market will allow

→ In some cases the firm may hold a local monopoly, and any further expansion will put this at
risk
→ Some small firms may survive on the basis that they are able to produce a personal service;
if they grow then they may lose some of their loyal customers and revenues may fall
3
...
2
...
6 Lack of resources and access to finances
→ The owner of the firm may lack the knowledge, expertise or funds needed for expansion
→ As the firm expands as employs more people it may encounter increased bureaucracy, such
as needing to complete National Insurance returns or having to comply with greater financial
regulations
→ Either of these will add to the firms costs or may be beyond the managers’ level of expertise,
and so this acts as a barrier to expansion
3
...
2
...
7 Minimum efficient scale
→ In some cases a firm may have already exploited economies of scale and be operating at the
most productively efficient point
→ Optimum efficiency may have already been achieved and so any further growth would lead
to diseconomies of scale and inefficiencies
3
...
2
...
8 Owner objectives
→ Expansion may lead to increased rewards but it may carry an opportunity cost in terms of
lost leisure
→ In the case of a sole trader, such as an artisan spoon whittler, they may derive pleasure from
their work, and by scaling up production and becoming removed from the production
process, they may lose this utility
→ They therefore lack the motivation to expand; this is an example of satisficing
→ This is where firms make enough profit to stay in business and then allows other motives,
such as personal pleasure, to take precedence
→ Some managers are risk-averse, and will not be willing to face the potential negative
consequences of expanding a business – this may be a result of behavioural economic
phenomena, or it may simply be a wish to insulate family finances, a mortgage or personal
savings against risk
3
...
2
...
9 Avoiding attention from potential buyers
→ The growth of the firm and its increased profits may result in unwanted overtures from
larger firms wishing to buy out the sole trader
→ It may therefore be advantageous to sole traders and small firms who want to retain control
of their own production to remain small; this allows them to avoid attention
3
...
2
...
10 Tax thresholds and other benefits of remaining small
→ Small firms are able to access additional training grants and government finance schemes,
and they may also receive tax benefits
▪ After 2002, firms with profits of less that £10,000 were not liable to pay any
corporation tax, although this was reversed in 2006
▪ Firms with turnover of less than £85,000 are not liable for VAT in the UK, starting
from April 2018
→ Since 2009, the government has supported small firms with a turnover of up to £41 million
through the Enterprise Finance Guarantee, which allows smaller firms to access bank loans

of between £1000 and £1
...
1
...
1
...
1 Reasons for demergers
→ Some firms may grow too large and experience diseconomies of scale
→ As a result of the growth of output, the business and managers may lose focus and control
over day-to-day management of the firm, leading to an increase in long-run average costs
→ In order to avoid this, a firm may chose to break up or demerge
→ This may create a number of smaller firms, all able to concentrate on their specialist areas
and maximise their own economies of scale, and, with that, the profits available for
shareholders
→ However, as a result, some parts of the business may be shut leading to a loss of jobs
3
...
3
...
2 REVENUES, COSTS AND PROFITS
3
...
1 Revenue
3
...
1
...
2
...
2 Average revenue
→ Average revenue (AR), or revenue per unit, is how much people pay per unit (price) and also
the demand curve
→ 𝐴𝑅 =

𝑡𝑜𝑡𝑎𝑙 𝑟𝑒𝑣𝑒𝑛𝑢𝑒
𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦

3
...
1
...
2
...
4 Price elasticity of demand and its relationship to revenue concepts
→ If we consider the elasticity of two
points on the average revenue
curve, we can see that the elasticity
changes at different points along
the curve
→ In the diagram to the right, we can
demonstrate this point
→ Moving from point A to point B
involves a fall in price of 25%, and
an increase in quantity of 50%
...
3%, and
an increase in quantity by the same
amount, with a PEd of -1
→ The top half of the demand curve, where the elasticity is -2, is relatively price elastic, and the
bottom half of the demand curve, with an elasticity of -1, is relatively price inelastic
→ We can apply this theory to understand what happens to total revenue as quantity
increases; an fall in price with price elastic demand leads to greater revenue, and a fall in
price with price inelastic demand leads to reduced revenue
→ The maximum total revenue is located at the quantity at which the price elasticity of
demand for a good is unitary

3
...
2 Costs
3
...
2
...
2
...
2 Total cost
→ There are two types of cost: fixed costs and variable costs
→ Fixed costs – these costs do not change with output
...
In the future, the supermarket will be able to buy more land adjacent to the site,
showing that in the long-run, all factors of production are available
→ Fixed costs may be referred to as overheads
→ Variable costs – these costs do change with output and can occur in both the short-run and
the long-run
→ An example may be a firm’s raw material costs, which increase as the firm produces more
products
...
2
...
3 Average costs
3
...
2
...
1 Average fixed cost
→ Average fixed cost (AFC) is calculated as follows:

𝑓𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡𝑠
𝑜𝑢𝑡𝑝𝑢𝑡

→ For example, if a firm’s fixed costs are £1,000 and output is 100, AFC is calculated at £10 per
unit of output
→ As output increases, AFC will always continue to fall because the fixed cost is being spread
across a greater output
3
...
2
...
2

Average variable cost

→ Average variable cost (AVC) is calculated as follows:

𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑐𝑜𝑠𝑡𝑠
𝑜𝑢𝑡𝑝𝑢𝑡

→ If a firm’s total variable cost is £5,000 and it produces 100 units, then AVC is £50 per unit
→ The average total cost (abbreviated to AC) is equal to 𝐴𝑉𝐶 + 𝐴𝑉𝐶 which in this case is
£10 + £50 = £60 at an output of 100 units
→ Average cost can also be found by dividing total cost by quantity produced
3
...
2
...
2
...
5 Deriving the short-run average cost curve
→ The AC and AVC curves initially slope downwards because of increasing returns to a fixed
factor, approaching minimum efficient scale (MES)
→ Beyond the MES (the lowest point of the AC and AVC), the firm begins to experience
diminishing returns to a fixed factor, adding less to total output than the last unit of
production, meaning that marginal cost begins to rise above the average cost curve
→ As a result, AC and AVC begin to increase past the MES point

3
...
3 Economies and diseconomies of
scale
→ In the long-run, all costs are variable
→ Average costs in the long-run are
therefore explained by economies and
diseconomies of scale
→ Economies and diseconomies of scale
are indicated on the diagram
→ MES, or minimum efficient scale,
represents the quantity of output at
which costs are lowest
3
...
3
...
2
...
1
...
2
...
1
...
2
...
2 Diseconomies of scale
→ A firm may experience diseconomies of scale if it grows too large and moves beyond its
minimum efficient scale
→ Diseconomies of scale may result from a breakdown in communication or other managerial
difficulties, leading to a rise in long-run average costs as output increases
→ This may occur via organic or inorganic growth
→ Such expansion may also lead to a lack of co-ordination between departments of the firm,
leading to productive inefficiency, waste and an increase in long-run average costs
3
...
3
...
3 BUSINESS OBJECTIVES
3
...
1 The main business objectives
→ Firms may be assumed to profit maximisers
→ However, in some cases they may opt to profit-satisfice, i
...
make enough profit to satisfy
shareholders, and explore other objectives
→ These objectives include revenue maximisation and sales maximisation
3
...
1
...
3
...
2 Revenue maximisation
→ Revenue maximisation occurs when a firm seeks to make as much revenue as possible

→ Firms are wiling to sell products until the last unit sold adds nothing to total revenue,
knowing that the next unit sold will reduce revenue – they sell until the marginal revenue is
zero
→ As the firm expands output, the marginal revenue declines, meaning that total revenue
declines
→ While MR is positive, it continues to add to total revenue; once MR falls below zero, any
increases in output will lead to a fall in revenue
3
...
1
...
3
...
4 Other motives for firms
→ Governments may seek to
ensure that firms operate at
the allocatively efficient point
→ This is where price is equal to
marginal cost
→ The price paid for a good by
the consumer is equal to the
cost of the factors of
production used to
manufacture the last unit
→ Allocative efficiency is at the
point where 𝑃 = 𝑀𝐶
→ Other motives include
satisficing, which involves
making just enough profit to
keep stakeholders happy,
allowing other motives to be pursued
→ Another motive is long-run profit maximisation, achieved through short-term increased
market dominance; in this situation firms may intend to maximise sales in the short run with
the motive that this may drive rivals out of business and will allow firms to charge higher

price (with greater market power from a monopoly structure) in the future – long-run profit
is maximised
3
...
1
...
3
...
5
...
e
...
4
...
4, titled
‘price discrimination’
▪ Discount pricing, such as ‘buy one get one free’ offers, are also used
→ These strategies often have a good practical rationale and can generate greater consumer
loyalty, thereby increasing profit in the long-run
3
...
1
...
2 Non-price competition
→ As an alternative to limit pricing and predatory pricing, firms may seek non-price
competition in order to increase sales or profit
→ This is particularly evident where price competition could lead to a price war
→ Any action by a firm that does not involve raising prices can be classed as non-price
competition, including the following:
▪ Advertising – placing the product in the hands of celebrities or sponsoring sporting
or cultural events
▪ Branding – promoting the brand as being of certain quality (which may be
communicated through advertising), or imposing measures to improve brand
loyalty, such as loyalty cards
▪ Packaging – which may include free gifts, or competitions to win prizes
▪ After-care/customer service/warranties
▪ Product development
▪ Quality and innovation
▪ Mergers and acquisitions – these reduce the number of firms in the market and
therefore act as a way of removing competition from the market

→ The aim of non-pricing strategies is to shift the average revenue (demand) curve to the right
or to prevent it from falling as other firms try to increase their market share
→ The cost of advertising must fall below the increase in supernormal profits that comes from
shifting the average revenue curve
→ The effectiveness of non-pricing strategies may be questioned:
▪ It may be the case that other firms will also advertise or may copy the innovations
introduced (although this can be countered through effective – but expensive –
intellectual property protection)
▪ Spending large sums of money on an advertising campaign carries no guarantee of
success
▪ Non-pricing strategies may take a long time to work, and the firm may lack the
available fund or expertise to deploy these sorts of strategies
▪ Non-price strategies may not actually work, especially if rival firms counter with nonprice competition of their own

3
...
4
...
4
...
4
...
4
...
1 Characteristics of perfect competition
→ There are a number of characteristics of perfect competition:
▪ Perfectly competitive markets have many small firms
▪ They tend to produce homogenous products (i
...
the product is exactly the same
and cannot be differentiated)
▪ Firms have perfect knowledge; they do not know everything about rival firms’
behaviour and actions, but they can access the latest technology and techniques,
and they have access to details of which firms are making supernormal profits
▪ There are no barriers to entry or exit
▪ Firms in a perfectly competitive market have no price-setting powers; they take the
price set by the market and are therefore known as price takers
→ These characteristics mean that there are few industries that approximate to the model of
perfect competition
→ Examples include the market for foreign currency, where there are low barriers to entry,
price takers, many small firms, and homogenous goods
3
...
3
...
4
...
3 Short-run and long-run shutdown points
→ The shutdown point for a firm occurs when the firm can no longer cover its average variable
costs; it may be feasible for a firm to make a loss in the short-run, so long as it makes
enough to cover the variable cost of making the good

→ The example of a lemonade stall helps to explain this
▪ A lemonade stall costs £100 to set up, and can sell 100 cups of lemonade each day,
which each cost 50p to produce
▪ In the first day, the average total cost of each cup of lemonade is £1
...
4
...
4
...
1 Characteristics of monopolistic competition
→ Monopolistically competitive firm s have many of the characteristics of firms operating
under conditions of perfect competition
→ However, firms in monopolistic competition are able to set price to a very limited extent and
their products are slightly differentiated – the demand curve is no longer perfectly elastic
→ The following are characteristics of monopolistic competition:
▪ There are many small firms in the market
▪ These firms produce similar goods, although there is the potential for these goods to
be slightly differentiated, through quality, branding or advertising
▪ Firms cannot differentiate their products too heavily through branding or
advertising, as these represent sunk costs and create a barrier to exit
▪ Firms have imperfect knowledge about the rival firms’ prices and output decisions,
but firms can still identify where supernormal profits are being made
▪ There are low barriers to entry
▪ Firms in the market have low sunk costs, and therefore have low barriers to exit –
they cannot therefore invest too heavily in marketing or branding
▪ Firms can set price to an extent because they are producing slightly differentiated
goods from those of rival firms

3
...
4
...
4
...
4
...
1 Characteristics of oligopoly
→ Oligopoly exists where a few interdependent firms dominate the market
→ Interdependence means that the actions of one firm will affect the action of another firm in
the market
→ For example, if one firm were to lower their prices then this may cause another firm in the
industry to also lower their prices in order to avoid losing market share
→ This sort of market structure therefore tends towards collusive behaviour among the main
firms in the industry
→ Examples of oligopolies include the brewing industry, pharmaceuticals, food and
confectionary manufacturers and petrol retailers
→ Oligopolies have the following characteristics:
▪ A few large firms dominate the industry
▪ Firms produce goods with some similar characteristics but brand loyalty tends to be
strong
▪ Imperfect knowledge exists between rival firms; they do not fully know each other’s
pricing and output decisions
▪ There are high barriers to entry and exit, with a high level of sunk costs

▪

Oligopolies can set price, but may decide to agree price-fixing deals with rival firms
in order to keep prices high, avoid price competition and enjoy supernormal profits
in the long-run

3
...
5
...
3
...
5
...
3
...
5
...
4
...
3 Reasons for collusive and non-collusive behaviour
→ Collusion is an arrangement between two or more firms to limit competition
→ This can be done for a number of reasons:
▪ Divide the market
▪ Set prices or output
▪ Increase the welfare gains of firms – at the detriment of other firms and/or
consumers
→ Most collusion is illegal due to its restrictive nature and its impact on firms and consumers
3
...
5
...
1 Overt and tacit collusion
→ There are two types of collusion that take place:
▪ Overt
▪ Tacit
→ Overt collusion involves firmly openly fixing pricing, output, marketing or the sharing out of
customers
→ An extreme for of overt collusion involves creating a cartel, which is a formal agreement
between producing firms to act together
→ This was the case with the sugar cartel that operated in the USA between 1934 and 1974,
and OPEC is considered by many to be a cartel of oil-producing countries
→ Nevertheless, cartels and other forms of overt collusion are banned in the EU and many
other countries
→ The second form of collusion is tacit collusion, which is quiet or ‘behind-the-scenes’, and
may take the form of implicit co-operation and can involve no spoken agreement
→ The result of tacit collusion is often the same as with overt collusion (although its effects
may not be quite so profound)
→ However, tacit collusion involves no formal or informal agreements, and is instead based on
the main firms in the industry following the market leader – known as a price leader
→ This form of collusion is also illegal in many countries, but it is much harder to identify due to
the unspoken and hidden nature of tacit collusion
→ It is always tempting for firms to break collusive agreements: if they lower prices then they
may catch a rival unawares and can rapidly increase market share, or they may be granted
immunity from the competition authorities if they blow the whistle on the arrangement

3
...
5
...
4
...
4
...
1 Characteristics of monopoly
→ A monopoly exists where there is a sole provider of a good or service
→ The firm is able to set prices – it is known as a price maker – and output, and can maximise
profits
→ Monopolies have the following characteristics:
▪ There is one firm in the market
▪ They produce a unique product
▪ There is imperfect knowledge; potential rival firms will not know the incumbent
firm’s pricing and output strategy
▪ There are high barriers to entry and exit
▪ The single seller is a price maker
3
...
6
...
4
...
3

Comparing monopoly with perfect competition
MONOPOLY
PERFECT COMPETITION
PROFIT MAXIMISERS
Yes
Yes
ALLOCATIVELY EFFICIENT
No
Yes
(𝑨𝑹 = 𝑴𝑪)
PRODUCTIVELY EFFICIENT
No
Yes
(MIN POINT OF AC CURVE)
PRICE
Prices are higher under
Prices are lower under perfect
monopoly compared with
competition compared with
perfect competition
monopoly
QUANTITY
Quantity is lower under
Quantity is higher under
monopoly compared with
perfect competition compared
perfect competition
with monopoly
3
...
6
...
4
...
4
...
e
...
4
...
4
...
4
...
5 Price discrimination
→ Price discrimination occurs when a firm sells the same product in different markets with
differing elasticities of demand at different prices
→ This is used by a firm with monopoly power to increase profits and reduce consumer surplus
→ It is only possible because of high barriers to entry and exit
→ Price discrimination is likely to be successful under three conditions:
▪ There are high barriers to entry and a degree of monopoly power
▪ There are at least two separate markets with different price elasticities of demand
▪ The markets can be kept separate at a cost that is lower than the gain in profits; this
is to prevent resale (arbitrage) between the markets
→ In practice, it is unlikely for perfect price discrimination to occur, and so we normally talk
about third-degree price discrimination
→ This is where firms use different prices based on regional, consumer-age or time-of-use
differences
→ A good example of this is with rail travel, where all three forms of discrimination are shown:
▪ Journeys into London cost more, even if they are the same distance as a journey
elsewhere in the country, hence regional differences
▪ Child, student, adult and concession tickets are available, hence consumer-age
differences
▪ Peak and off-peak travel are available, hence time-of-use differences
→ This can be shown on a diagram by splitting the market in half; with fixed costs, the firm
separates the market into more inelastic demand (adult, peak, London travel) and more
elastic demand (student, off-peak, rural travel)
→ More inelastic demand is shown by a steeper average revenue curve, and more elastic
demand by a shallow AR curve
3
...
6
...
4
...
4
...
g
...
g
...
g
...
g
...
g
...
5 LABOUR MARKET
→ Demand for labour comes from firms and is derived demand from total demand for goods
and services throughout the whole economy – this is referred to as aggregate demand (AD)
→ The supply of labour is from households
→ The equilibrium point determines the wage rate and the level of employment

3
...
1 Demand for labour
→ As demand for a firm’s output increases, then so too does the firm’s demand for labour,
because they require increased factors of production (including labour) in order to increase
output
→ Demand for labour is derived from aggregate demand (AD)
→ As workers become more productive, the demand for labour increases and so does their
ability to demand higher wages
→ Firms can substitute labour for capital, so if capital becomes more expensive then demand
for labour will rise
→ In the developed world, labour costs are high and so firms may specialise in capital-intensive
production instead
→ In the developing world, however, labour is cheap, so there is no incentive to automate a
process

3
...
2 Supply of labour
→ The supply of labour depends on a number of factors
→ These are essentially the rewards of supplying labour, and takes three main forms:
▪ Pecuniary benefits – the wage rate and any financial bonuses
▪ Non-pecuniary benefits – the quality of the office, colleagues and general working
environment
▪ Taxation and welfare – if taxes are high then work is disincentivised because
earnings are taken away, and equally high welfare disincentivises work because
there is a comfortable safety net for those out of a job
→ Beyond a certain point, work has a negative income elasticity of demand; as income rises,
the supply of labour will increase, but after incomes reach a certain level, supply of labour
will contract as workers substitute work for leisure
3
...
2
...
5
...
1
...
5
...
1
...
e
...
5
...
5
...
50 per hour
→ Some firms, such as ITV, Barclays Bank, and Transport for London, have joined the Living
Wage Association, which binds them to providing a higher so-called ‘living wage’
→ This decision may be good for branding and may increase long-run profits despite a shortterm cost increase, but it may simply be that businesses feel a sense of social responsibility
→ In the 2015 budget, the Chancellor of the Exchequer pledged a £9 per hour National Living
Wage that would be available to those over the age of 25 and would be introduced by 2020
3
...
4
...
6 GOVERNMENT INTERVENTION
→ Governments intervene with the workings of business in order to maintain competition
using two main methods:
▪ Competition policy – enforcing competition law, which prevents abuse of market
dominance and actions that prevent competitiveness
▪ Regulation – introducing direct controls on firms, such as price caps, where
increasing competition does not solve market failure problems
→ Competition policy is the means by which governments of countries and groups of countries
seek to restore and maintain competition in markets, ensuring efficiency and improved
consumer welfare
→ The aim of such policy is to block any action that “prevents, restricts or distorts competition”
→ Fair trading is also enforced, so restrictive practices such as predatory pricing and collusion
are prevented
→ The Competition and Markets Authority (CMA) was formed in 2014, replacing the
Competition Commission and the Office of Fair Trading

3
...
1 Government intervention to control mergers
→ The minimum condition for investigation is if a merger of firms will result in a market share
of more than 25%, or if it meets the ‘turnover test’ with a combined turnover of £70 million
or more
→ The Competition Markets Authority determines if a merger leads to a “substantial lessening
of competition”, in which case it is likely to be blocked
→ Following the 2002 Enterprise Act, the competition authorities have had increased powers,
and they were merged in 2014 to form an even larger, more powerful body
→ However, the authorities may choose not to intervene; this was the case in 2008, where
Lloyds TSB and HBOS were allowed to merge, despite the 35% market share of the new
Lloyds Banking Group, because it was deemed to be in the national interest

3
...
2 Government intervention to control monopolies
3
...
2
...
6
...
2 Regulation
→ Regulation is direct government control of firms, and is often used where market forces are
deemed to be inadequate to protect consumer interests
→ Unlike in competition policy, the government tries to act as a surrogate for competition,
making firms cut prices or taking legal action
→ For example, in 2008 BAA were forced by the Competition Commission to sell off a number
of airports in order to encourage competition
→ If regulation is not followed then firms can be fined or lose their right to operate
3
...
2
...
6
...
4 Price regulation
→ Price capping is often used to regulate several privatised industries in the UK
→ The price cap is an upper limit set on the amount by which firms can increase their retail
prices
→ It takes into account the level of inflation measured by the Retail Price Index (RPI), and then
takes account for any possible efficiency gains or investment
→ The advantage of price capping is that it allows a firm to keep any profit it makes through
bringing about greater efficiency gains that the regulator has calculated as reasonable
→ In addition, because the X and K factors are usually in place across a lengthy period – around
five years – firms are able to plan ahead and know that they will not be penalised for further
efficiency savings
→ However, if the regulator underestimates the efficiency gains a firm can be expected to
make then the firm can make large supernormal profits
→ The tendency for this to occur has led to claims of regulatory capture, with the regulator
being less strict on firms under its control
3
...
2
...
1 RPI + K
→ This takes the RPI and allows for the K factor, which account for the additional capital
spending that the regulator and the firm have agreed is necessary
→ For example, a water board needs to spend on capital in order to maintain water
infrastructure, and they will agree this amount of spending with the regulator and can pass
this cost onto the consumer
→ A similar process is used by train companies

3
...
2
...
2 RPI – X
→ This take the RPI and subtracts a factor X determined by the regulator
→ X represents the efficiency gains that the regulator has determined can reasonably be
achieved by the firm in question
3
...
2
...
6
...
6 Performance standards and quality targets
→ The regulator can also set performance targets that it will then monitor
→ These may be based upon improvements in the quality of a service or reductions in the
number of customer complaints
→ This may be supplemented by a system of fines, should the firm fail to meet the
performance targets, or rewards, should the firm meet them
→ This has been used by the regulator to monitor the punctuality of trains in the UK and so
helps determine price increases
→ Penalties can be attached to the targets so that consumers derive the benefit if customer
service falls below a minimum standard
3
...
2
...
6
...
7
...
6
...
7
...
6
...
6
...
e
...
6
...
6
...
6
...
1 Limits to government intervention
→ Government actions can also result in government failure
→ This is where the government’s actions actually move the industry further away from the
social optimum level of output that the government intended to reach
→ In many cases, regulators have years of experience in the industry that they are now trying
to regulate, and so they will have connections with many senior individuals in the industry
→ For this reason, they may be subject to regulatory capture and may treat the firms overly
fairly due to personal connections with the members of that firm
→ Firms will closely guard much of their data surrounding costs, innovations, pricing strategies
and unemployment, especially where such data is commercially sensitive
→ It may therefore be difficult for the regulator to get a proper picture of the business
→ In some cases, the firm will possess vastly more information than the regulator, and so
asymmetric information exists – in such a situation the firm would be in a good position to
prevent competition
→ This asymmetric information, where one party has access to more information than another,
means that the regulator cannot properly fulfil their duties



---