Notesale: Turn your study into money

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Theme 3
3
...
1 Size and types of firms
Why firms want to grow:
● Market dominance, which prevents competition putting them in a better place to exploit the
market in factors such as price setting power and less needs for efficiency
...

● Increased divorce of ownership from controlallows increased salaries for managers as size is
normally to do with salaries and bonuses
...

● Reduces risk from demand changes as it means that they have more diversified products and
less uncertainty about taste changes and reliance on the business cycle
...

● Asset stripping is possible due to so many parts to the company in times of loss and also to
make profits
...
However, vertical mergers are less
likely to result in technical economies of scale
...

Why firms remain small:
● Economies of scalemay be small making it more advantageous due to average costs to stay
small, with factors like technology decreasing economy of scale sizes
...
Furthermore, large firms may operate in markets such as more
formal ones resulting in higher pay
...
g
...

● Barriers to entry may be low so producers sell homogeneous products resulting in little
incentive due to competition to grow due to perfect competition
...
Themarket may also be declining in size
...
This may also result in it being harder to access finance
...
Internet selling may also widen its scope
...

● Lack of finance availabledue to low levels of equity(small in a market) and a weak
macroeconomic climate and demand
...
Thus they will not be able to expand
and finance new capital
...

● Macro economic climate with small levels of demand,low growth, high interest rates and high
inflation rates
...

● The owner may be satisfied with current profits and have no desire to expand, they may want
to keep it a family business or focus on the objectives of the business and communityit
serves
...

● Avoid takeovers due to having little threat to incumbents and those with large market share
...
The only main influence of a shareholder may be through board
meetings (which only a few take part in) who oversee the running of the business, or selling shares
resulting in the price dropping pressuring stakeholders to change their actions
...
This
creates a divorce of ownership of control and the principal agent problem (due to the conflict of
interest)
...

● Owners or shareholders want to maximise profits and thus are interested in the profit margins
of companies
...

● Suppliers want a larger more successful company so they have secure wide scale purchases
and profits
...

● Workers want a more successful company to ensure job security and also increased profits
may result in higher pay
...

● Pressure groups want companies to operate in a sustainable way that maximises social
welfare
...
There is no difference between them and the company
...

● A private limited business, is a privately held business with owners only liable to their shares
and no assets can be claimed by debts
...
They
raise finance through selling to friends or family
...
The owners and company are separate
entities
...

Private sector organisations like Apple are owned by individuals or companies with the aim to profit
maximise (subject to the owners wants and balancing of lifestyle)
...
This is seen in companies like shelters, diversity UK (encouraging
acceptance and diversity) and the NSPCC (protecting children), who spend all their profits achieving
their aims
...

● Changes within a market and competition
...
1
...
g
...
This is as they are
● Small
● Less expensive
● Less risky as the owners know the business environment well
...

➔ For some types of growth that is hardthrough organic growth such as expanding into
a new market with no knowledge making it easier to buy a company already operating
in that market
...

➔ You can lose control if shares are sold of franchisesestablished
...

External growth (outside a firm) is through mergers/amalgamation which is the joining together of two
or more firms under common ownership with the agreement of shareholders to merge
...

Merger types:
Horizontal integration occurs when two firms in the same industry at the same stage of production
merge e
...
two bakeries
...

● Reduce market competition through taking out a competitor increasing market power
...

● It results in a larger recognition and knowledge of the brand as more people recognise the
two companies
...

● There are large synergies with them working well together
...

➔ The two firms may be poorly managed resulting in key workers and expertise leaving
...

➔ It may result in a brand being associated in a negative light with the new brand being
seen in a worse light
...
This can be forward when a supplier mergers with a buyer
such as a car manufacturer merging with a car dealership
...
Reasons for this is:
● Cost saving through integrating a supplier or buyer into the firm making operations more
efficient as it also cuts out the middleman due to control of the supply chain
...

● Access to raw materials may allow you to access these resources at a lower price
...

● Increase market control as it results in a firm owning another that has brought its products,
thus increasing control of the price and market it is sold in
...

➔ This is risky as it may have little expertise in this industry and a lack of knowledge
resulting in a worse performance in this new integrated business
...

➔ Firms can often pay too much for a firm as they take over it resulting in the share
price falling after the rise
...

➔ Many key workers may leave with their expertise due to the merger decreasing its
success
...

➔ There may be supply chain issues resulting in them having to buy from another
company like their competitors whilst still owning the vertically integrated one due to
overdependence resulting in a loss of money and dilutingthe benefits of a takeover
...
Reasons for this is:
● This reduces risk as you are no longer dependent on the ups and downs of one market and
are diversified due to product differentiation and cross subsidisation
...

● Allows economies of scalethrough operating in multiple markets
...

● Asset stripping can be extremely valuable to the new company creating profits
...

➔ There is a lack of expertisein the new market as there is a lack of specialist
understanding reducing performance
...
g
...

➔ This may result in diseconomies of scaleoccuring
...

➔ The company may overpay for the new company and may result in a negative brand
associated with the new company such as a scandal
...
1
...

Reasons for demergers:
● Lack of synergies, due to managers feeling the firms don't work well together
...
This is as there also may be frictions and
x-inefficiencies
...
Such as
due to one part growing faster than the other, resulting in investors devaluing it due to its
association
...

Regulatory requirements, may result in them having to split up a company due to too much of
a dominant market share, or due to large monopsony power reducing efficiencies due to
reducing contestability
...

● Maintaining focus on companies, due to managers wanting to not diversify risk and instead
focus on the growth and profitability of one firmin a limited market to focus core activities
which they can make successful due to specialisation and higher expertise
...

● Cultural clashes may reduce demand from the product, such as a healthy and unhealthy brand
reducing overall profit and demand
...
This is as two firms may be hard to manage thus reducing
communication increasing costs
...
This is as they can cut costs (diseconomies of scale) or develop more
➔

innovative products (due to increased focus)
...
It allows an increased source of finance to reinvest in
other areas
...

➔ They have a smaller market power and have reduced market power due to increased
competition
...
It also may result in fewer culture clashes
...

● Consumers will benefit or lose out
...
Furthermore, it may increase
contestability in markets resulting in less x-inefficiency and more dynamic efficiency,
operating closer to allocative and productive efficiency points increasing consumer welfare
and surplus with lower prices
...
However, they will lose out if thedemerged firm moves to maximise profit, increasing
profit through limiting output and raising prices
...
2
...
Profit maximisation, when the difference between total revenue and total cost is greatest
...
They argue in the short run firms will adjust prices and output
accordingly according to market conditions to maximise profit thus always
operating when marginal revenue = marginal cost
...
This is done as they expect sales to
increase in the future
...
The firm does this through a cost + pricing strategy
which keeps profit low in the short run as market conditions change
...
It will also involve costs to the
company through having to change the price
...

A firm thus in the short run will operate even if it is below the variable cost, stopping a disruption to
suppliers as it will profit in the long run
...

This strategy keeps prices stable, attracting more demand, building confidence and attracting loyalty
...

Cost + pricing strategy looks at the average total cost of a good or service and then adds a profit
markup
...
Revenue maximisation, when total sales revenue is greatest and marginal revenue is zero
...
It is a way for them to justify
their rewards
...
This encourages strategies such as price discrimination to be
implemented by managers and also deters new entrys due to lower
incentives
...
However, they
are only paying the marginal cost times the marginal revenue
...

3
...

Sales maximisation is when average cost = average revenue or total cost = total revenue
...

Managers and owners may want to maximise their own utility and this is at the sales maximisation
point
...
Therefore it is in their best interest to
maximise sales whilst still making a normal profit
...
This is usually a short term strategy
as firms in the long run will want to maximise profits
...
Satisficing (managers do the bare minimum to keep shareholders happy) especially done with
profits by managers to satisfy owners
...

Stakeholders and their control:
● Consumers, such as trade organisations can bear pressure on companies to make them
change their policy
...

● Owners or shareholders who usually control a large portion of the business
...
They can be pressured by sacking at meetings and the selling of shareholder stocks
causing a takeover
...

● Workers can influence the company operations through trade unions
...

● Pressure groups like oxfam will target larger companies and can make them change their
policies
...
Owners may hold a large
proportion of shares, however shareholders are normally fragmented
...
However, of course managers want toprofit
satisfice or they are at risk of job loss
...
This
is a principal agent problem
...
3
...
This is the same as the price
...

Total revenue = price * quantity sold
Marginal revenue is the addition of total revenuefor each extra unit sold
...
This results in an
upward sloping graph
...

Average revenue and marginal revenue is constant resulting in a
horizontal graph, as all units are sold for a constant price
...

● This horizontal graph illustrates perfectly elastic demand
...

Graph for revenue at falling prices (A market of imperfect competition)
The average revenue curve at falling prices is equal to the
demand curve
...

As output increases on the average revenue and marginal
price curve the curve is downward sloping as prices are
falling
...

Total revenue increases until the price reaches the unitary
elasticity price and then slopes downwards as it becomes
inelastic in price
...

● As the total revenue curve reaches the stationary point it is perfectly elastic and this is when
revenue is maximised
...

● The average revenue curve has the same elasticity as the demand curve,
Max revenue is when marginal revenue = zero
3
...
2 Costs
The economic cost is the opportunity cost of an inputinto the production process
...
g
...

The total cost is the whole cost of producing anygiven level of output
...
g
...

Average variable cost = Total variable cost / quantity produced
The total fixed/indirect/overhead cost is the total cost of production which does not vary however
many units are produced e
...
the rent
...

Average cost = Average variable cost + average fixed cost
Average cost = Total cost / quantity produced
The marginal cost is the cost of producing each extraoutput
...
In the
long run all factors are variable costs
...
g
...
After some time they would be able to reinvest profits and thus factors are variable
...

The total fixed cost curve is a straight line as fixed costs are constant at all
levels of output
...
The inflections in the curves represent the change
from increasing returns to diminishing returns
...
Theaverage cost
and average variable cost curve fall and then rise as diminishing returns set
in
...

The marginal cost curve falls and then rises as diminishing returns set in
...

In the short run the average cost decreases as the output increases as the
cost of production is spread across all the output
...
This is the point when MC cuts AC at the lowest point
...

Points to note:
● MC and AC are always u shaped in the short run because of the law of
diminishing returns
...

● Product and cost curves are mirror images of the marginaland average
product curves
...
This is only if there are constant factor costs per unit
...
g
...

● Marginal cost curve cuts the average cost curve at its lowest point
...

● Average cost and marginal cost curve are equal for all levels of output that average and
marginal cost is constant
...
However, as more resources are added to the fixed factor the output will begin to fall
...
4
...

Allocative efficiency is when scarce resources are used to produce goods and services which satisfies
consumer preferences and maximises their welfare
...
However the private marginal cost may differ from
the social marginal cost
...
Thus monopolies are not allocatively
efficient
...


Long run monopolistic competition
Due to increased competition the average revenue and marginal
revenue curves shift in
...
This is still not allocatively efficient and the
firm is making a normal profit
...
However, this is also allocatively efficient as average revenue =
marginal cost
...

Productive efficiency = Marginal cost = Average cost
Dynamic efficiency is when resources are allocated efficiently in the long run
...
You must have supernormal profits to be able to reinvest in
the firm on factors such as technology in order to improve productive capacity
...
Allocative and
productive are both static efficiency points
...

X-efficiency/organised slack is when a firm fails to minimise its
average cost of production at a given level of output
...
It could also
happen due to poor management of firms or managers overpaying
themselves and not reinvesting profits
...

Welfare economics is the study of how an economy canbest allocate resources to maximise utility of
society
...
Productive
efficiency is only achieved in the long run perfect competition market
...
3
...
This is a long run concept as factors of production are
variable it has an impact on output and costs
...

Minimum efficient scale occurs at the lowest level of output at which long run
average cost is minimised
...

This is the optimum level of production
...

Internal economies of scaleoccur when economies of scale arise because of the growth of scale of
production within a firm
...

Reasons for economies of scale:
● Technical, as firms get bigger, they can purchase specialist machinery
...
As a result output increases,
lowering the cost of production
...

● Financial, bigger firms are able to secure loans faster as they are more creditworthy,
compared to smaller firms
...
Smaller firms are also normally given higher interest
rates on small loans, which is more expensive
...
If one firm is failing they will be able tocross-subsidise
profits from the more successful company, thereby increasing overall profits and keeping
costs low through not having to take loans or advertise etc
● Marketing, bigger firms who have a range of productswill be able to market their products
together as opposed to advertising products individually
...

● Managerial, bigger firms have access to more money and can hire specialist managers who
make efficient decisions and fewer mistakes
...

Reasons for diseconomies of scale:
● Poor communication, occurs as it is too big to ensure efficient communication especially if it
is operating world wide
...

● Lack of control, larger firms may be harder to control, especially if they are operating in
several locations
...
The larger breath of location may
increase costs as goods may have to travel further
...
g
...

● Communication, improved communication allows firms to make use of this which saves both
time and money (to set up) and allows the business to operate efficiently lowering long run
average costs
...

● Education, if businesses are able to obtain an educatedworkforce, this means they do not
have to spend money on education and training
...
Also this is why companies choose to locate close to universities such as MIT and tech
companies, as they are able to recruit an educated workforce faster, lowering the long run
average costs
...
The government may also
impose more beneficial measures to industries if they are larger
...

3
...
4 Profit
Profit is the total revenue - total costs, the break even point is when total revenue is equal to total
costs
...
Normal profit is when
a firm makes profit by using its resources at best use
...
Abnormal profit is any
profit above normal profit and is when total revenue is greater than total cost
...

When there is the largest
gap between total revenue
and costs it is the profit

max point
...

Increases in a firms revenues due to higher demand or lower costs, will increase the output/price that
MC=MR is at and the profit max output
...
However, in the long
run it has to cover all costs to
continue to operate
...
4
...
They are price takers from the
market as they have no control over the market price, due to many buyers or sellers one's increase in
supply or demand would have little effect on the market price
...
There are many
small firms who are price takers of the small buyers
...

● Perfect knowledge of prices, with one firm charging higher than the market price leading to
zero demand as consumers can go elsewhere
...

● They are firms with the objective of profit maximising
...

A near example of perfect competition is the farming market, however there may be few large
supermarket buyers or governments may set a fixed price
...

In the short run there are supernormal profits as AR is
above AC, in the long run this incentivises other firms
to join the market due to profits
...
Thus the AR=MR curve
shifts downwards eroding away supernormal profits
creating normal profits in the long run
...

The demand curve is perfectly elastic when there is perfect competition (horizontal)
...
Producers don’t reduce the price as it would create a price war
...
Thus if a firm is operating at a loss with AC
below MR, some firms will drop out causing MR to shift up resulting in long run normal profits
...

Furthermore, due to perfect knowledge, perfectly competitive firms will have identical cost curves e
...

a technological advancement from one firm, will spread across all firms eroding short term
supernormal profits away, if this is not picked up a firm will be removed from the market
...

3
...
3 Monopolistic competition
Monopolistic characteristics:
● There are many firms in the industry
...

● They have differentiated products
...

● Their objective is to profit maximise in the short run
...

● In the short run they are neither allocatively or productively efficient
...
Firms can operate in this market (different to perfect
competition market) due to differentiated products and brand loyalty
...

The firm will profit maximise where MC=MR where the difference between the cost of producing the
good to the revenue received is greatest
...

Short run
Long run
As the entry barriers are
low firms can enter the
market incentivised by
supernormal profits
...

Limitations of this model:
● Brand loyalty, resulting in some firms maintaining consumers and making supernormal profits
in the long run
...

● Not close substitutes, some firms entering the market may not be seen as close substitutes
resulting in inertia and consumers not altering their behaviour and switching to a suitable
alternative resulting in AR not switching inwards
...
4
...
The concentration ratio is the ratio
of the market share of the top few firms in relation to the whole market (worked out by adding up the
market share of the number of firms asked for)
...


The knowledge is asymmetric
...

● Firms are interdependent with their behaviour affecting other firms resulting in competitive
strategy adoption
...

● They are price setters
...

An example is the phone, airlines or supermarket industry
...
However a collusive oligopoly is
when firms work together to achieve an objective such as higher prices and reduced output
...

The CMA bans collusion and makes it illegal with overt and tacit collusion being traceable as they
believe it stops innovation and reduces consumer welfare and economic growth in the long term
...
A wide spread formal collusion produces a cartel, to limit output and raise
prices
...

They regularly meet to discuss issues, a clear example is OPEC
...
However, the more successful the cartel the higher the temptation to break it
...

● Cheating has to be prevented as it would end up in a price slashing war resulting in
supernormal profit erosion
...

There may be informed collusion when no agreement was made but customs appear through firms
monitoring each other's actions
...
This allows there to be price stickiness in oligopolies (they do not compete on price)
...

Benefits of collusion:
● Attracts investors due to creating supernormal profits that attracts investors due to a
guaranteed profit allowing them to reinvest in dynamic efficiency
...

● Future investments will increase as there are guaranteed future profits from higher prices set
and thus the firm will aim to reduce average costs and thus reinvest profits and improve
dynamic efficiency
...

● It saves time and money as resources are thus not wasted in practices such as advertising or
undercutting other firms
...

●
●

It improves quality as they can increase profits that can be used for dynamic efficiencies
...

Cons of collusion:
● Barriers to entry, are put in place by the oligopoly reducing new innovative firms that may
improve economic growth entering the market and reducing competition and a need for
dynamic efficiency
...

● Loss of consumer surplus and welfare, due to the oligopoly price gauging and restricting
supply resulting in lower allocative efficiency and welfare levels in order to profit maximise
...

● Reduced competition, resulting in lower innovation and long run dynamic efficiency due to a
smaller fear of creative destruction and companies to lose customers to
...

● Loss of allocative efficiency, due to a lack of competitionallowing the oligopoly to be price
setters restricting supply and profit maximise
...

Game theory is a theory that analyzes non-collusive oligopolies and looks at the outcomes of two
independent players' decisions, when certain choices are laid in front of them
...
Thus game theory can
be used to analyse the behavior of these firms when they are making strategic decisions
...

Nash equilibrium is when one player bases their decisions on the actions of the other player, due to
leading to the best overall outcome
...

Prisoners dilemma:
How it works:
1
...

2
...

3
...

4
...

5
...

6
...

Payoff matrix:
A payoff matrixshows the outcomes for interdependent players when there are
different strategies
...
If they both increase their prices they both increase supernormal profits
...
If one lowers the price the other loses out with smaller revenues and
supernormal profits whilst the other benefits in the short term
...
This may result in an unstable market and smaller overall net gains for
both parties, resulting in a price war to advantage their firm
...
If airline B were to go low the best outcome for
airline A to go low
...

Dominant strategy:
This is a strategy a player takes regardless of the action of the other player
...

●

Types of price competition:
● Price wars, this occurs when non-price competition is weak and firms find it difficult to
collude
...
This may lead to
prices being driven down to levels where firms are frequently making losses
...
This is done to
gain or defend market share and outcompete others
...

● Predatory pricing occurs when an established firm is threatened by a
new entry
...
After this the firm will raise pricing again
...

This is illegal and requires a large firm
...
The price
has to be big enough to make a normal profit or above and to deter new
entrants
...

● Discounts offered reducing the price such as special offers gives firms
an edge over their high price rivals temporarily, moving away from profit
max
...

Types of non-price competition (the marketing mix the strategy designed to
create demand):
● Product, this must appeal to customers and may be differentiated from rival products
...
They may also develop the product to do this and gain a competitive
advantage
...

● Promotion, this may come in forms such as advertising and sales promotion and is essential to
inform buyers of the product and change views to a positive light on the product
...
A good
customer service will also maintain a good reputation along with loyalty cards
...

● Delivery services
...
Goods like Rolls Royce are
unique and the imagined characteristics of the product are sometimes more important than
the real one
...
4
...
A pure monopoly is when there are no other
firms and thus competition
...

Monopoly characteristics:
● High barriers to entry and exit, preventing new firms entering the market
...
The higher these are the stronger
the monopoly power
...

● There is only one monopolist firm in the industry/controlling over 25% of the market
...

● The products are unique and heterogenous with no substitutes removing competitors
...


The monopoly is allocatively and productively inefficient in the short and long run
...

The demand curve is downward sloping as to sell a higher quantity
the monopoly has to decrease the price for all consumers
...
The profit
maximising point occurs where MC=MR, thus they will make an
abnormal profit
...
This means
producing anywhere before or after this point will yield smaller
profits
...

A monopoly is able to third degree price discriminate (when a firm charges different prices for the
same good in different markets to different groups of customers)
...
Second degree price
discrimination occurs when there are discounts for additional units sold
...

● The location may result in varying prices such as the same car being different prices in
different countries
...

The four conditions needed for price discrimination:
● They must be a monopoly power allowing them to be a price setter and charge different
prices
...

● The monopolist must be able to split the market up into different groups of buyersin order to
charge different prices
...

● The monopolist must be able to keep the markets split at low costs without arbitrage e
...
a car
buyer buying from a different country
...

➔ This may result in government intervention
...
However it also
allows a monopoly to cover losses in other markets allowing more consumers to purchase a product
through the profits in larger price discriminated markets
...


Monopoly advantages:
● Supernormal profits are earned which can be reinvested, provide higher wages for workers
and managers, create RandD and innovation
...

● Globally competitive, due to being able to produce lower prices in the short run due to
economies of scale encouraging tax revenue and decreasing imports reducing the trade
deficit
...

● Price discrimination, will allow the capture of consumersurplus maximising profits, but also
creating goods for more consumers
...

● Resource duplication does not occur due to only one producer resulting in a more efficient
allocation of scarce resources and avoids any misallocation
...
Furthermore, supernormal profits allow
RandD with any innovation being rewarded hugely due to few competitors stealing the idea
due to high barriers of entry
...
Monopolists are motivated by the fear of creative destruction
...

Monopoly disadvantages:
● Complacency, resulting in a lack of reinvestment insteadof giving money to shareholders and
a lack of innovation creating x-inefficiency increasing AC and a lack of dynamic efficiency in
the long run
...
This will reduce employment and consumer surplus
increasing inequality
...

● Loss of consumer surplus, as there is price descrimination eradicating consumer surplus and
welfare, with higher prices than is allocatively efficient being charged
...

● A personal service is not available due to such a large scale firm
...

The network rail and national grid (necessities) are examples of apure
monopoly when there is a single firm in the market, which normally form
as a natural monopoly due to large economies of scaleand high start up
costs making it impractical for new entrants to compete with the
incumbent firm
...

PZB= Supernormal profits
CxAP1= Loss of the firm/subsidy

The economies of scale are so large in a monopoly, no single firm can exploit it
...
No firm can produce at an allocatively
efficient level where AR=MC as they would be operating at a loss (the government could subsidise this
loss)
...

3
...
6 Monopsony
A monopsony is when there is only one buyer in the market
...

They are profit maximisers, through paying the suppliers the lowest possible price, they are price
setters as there is only one buyer in the market
...
Another example is the NHS, amazon or tescos who are big buyers of their products
...
However, if the price is inelasticthis cost reduction may not be passed
on, furthermore the quality may suffer as the suppliers are not incentivised to produce a
better quality product due to lower pay reducing consumer welfare
...

● The firms are able to profit maximise due to lower costs, increasing output and reducing the
average cost thus resulting in profit maximisation
...

● The supplier will have definite purchases with a longer contract that will allow planning ahead
...
They will lose out due
to prices paid for their good falling and being exploited
...

● Employees will receive different outcomes, with the monopsonist purchasing less of the goods
at a lower price, they may be able to pay the employee more however due to profit maximising
they may not do this and alienate workers
...
However, due to the seller providing less they will definitely decrease
employment
...

3
...
7 Contestability
Contestability is how open a market is to competition and not how much competition exists, it
measures how easy it is for firms to enter or exit the industry
...

High contestability has low levels of concentrationin the long run with low barriers to entry to join the
market and compete, making it a normal competition style diagram in the long run and characteristics
...

Contestable market characteristics;
● No barriers to entry and exit
● New firms face no competitive disadvantage to incumbents
● No sunk costs
● Firms are profit maximisers
● Firms do not collude
...


Barriers to entry and exit restrict a new firm from entering or leaving an industry:
● Dominance and market share of dominant firms
...

● Large volumes of collusion
...

When incumbent firms and monopoly power set their price above their average costs in a highly
contestable market, new firms are incentivised by supernormal profit to enter the market
...

Thus firms will operate at AR=AC in highly contestable markets and no supernormal profits
...
This results in a price war with the incumbents which they then leave at low cost
when these profits are eroded
...
This results in allocative and productive efficiency
similar to that of perfect competition in the long run
...

● Consumer welfare due to better quality products due to efficiency needed due to large levels
of competition and also a larger variety of products and choice for consumers
...
5
...
The demand curve shows,more
labour will be hired when the price is cheaper
...

● In the long run the higher the wage rate the more likely it will be
substituted for machinery
...

● In the short run fixed capital means that there is a law of
diminishing marginal return for labour (more inputs to a given
factor results in higher total physical product but lower marginal
physical product and revenue, achieved after a certain point),
resulting in them less willing to pay the same amount for each
extra unit of labour hired
...
Thus wages falling increases the
amount of labour hired
...
It is the
value of the physical addition to output of a extra unit of
variable factor of production
...

Influences in demand for labour (productivity and price):
● Wages being lower will increase demand, as their contribution is likely to be positive for
longer to the firm as the wages are lower than the marginal revenue product up to a further
point of labour hired
...

● Demand for the final product increasing results in a increase in price of the product, this
means the marginal revenue product from extra labour hired will be higher meaning the
contribution of extra labour to the firm will stay positive for longer
...

● Government regulation will increase the cost and time of hiring labour resulting in the cost of
keeping the labour rising meaning contribution of workers to the firm will be lower and thus
the MC being larger than the marginal product sooner
...
However, it may also
make it more easy to displace them
...

● Worker wage rates abroad, result in less workers being hired domestically as they are less
competitive in comparison to offshoring production resulting in profit maximising firms being
likely to offshore production to minimise costs decreasing domestic demand
...
The
demand curve for labour however is always the marginal revenue product curve
...
More elastic demand means that the quantity of labour
supplied is much more responsive and aggressive to wage changes
...

Factors influencing PED of labour:
● Substitutability of labourmakes it easier to replace labour with capital resulting in firms more
likely to cut labour when there is a rapid price change as it is easy to replace them such as by
machinery resulting in little output loss
...
If workers abroad are cheaper
businesses will respond to outsourcing
...

● Time period, with the longer the time period being the easier it is to substitute labour for
capital whilst changing production techniques to be more labour efficient
...

Furthermore, factors like contracts, redundancy payments, costs of machinery (in comparison
to wages) or penalties of redundancy make it harder to remove labour
...


Elasticity of final productwith rising wages easily being passed on to consumers for inelastic
products resulting in rising wages having little impact on contribution
...

➔ However, if the business can cut costs elsewhere there may be a smaller extent of
demand for labour being elastic
...
This thus has a larger impact on the supply curve of a firm
resulting in a larger drop in quantity sold and thus derived demand for labour
...

3
...
2 Labour supply
The supply curve for labour shows the quantity of labour supplied in the
market at a given wage rate and the hours willing to work
...

The wage rate will be in real terms as the worker will look at the wage and
hours extra to work in relation to what it can purchase in real terms
...

Supply of labour influences (industry):
● Wages increasing results in there being an increase in supply as more people leave the
inactive population as there is a larger incentive to join and enter the workforce
...

● Education expectations of labour results in therebeing a lower supply of labour as less of the
population is available to be able to work due to not matching the industry skill requirements
...

● Migration increases results in more workers in the pool meaning that the supply curve
increases, this heavily depends on their skills, willingness to work and age
...

● Benefits being to generous then more of the activepopulation (lower skilled) will be
incentivised to not work and claim benefits creating a poverty trap resulting in a fall in supply
as there is a smaller opportunity cost resulted with leaving work
...

● Income tax rising reduces the supply of workers asit means extra wages are smaller as more
is taxed away
...

● Trade unions will increase the supply of workers asit results in them having better conditions
in the workforce increasing their incentive to work
...
However, after a certain amount of income extra
wages brings less utility than the leisure time lost resulting in the
supply bending in and thus less labour on offer
...

The income effect and substitution effect describes this process
...

The inferior nature of workresults in the income effect to be negative with higher wages resulting in
an increase in this negative income effect:
● At low levels of income the substitution effect islarger than the income effect resulting in
hours worked increasing as wages increase
...

● When the income effect is equal to the substitution effect wages increasing will not affect
supply
...
This is as they can work fewer hours and afford the same amount
of living standards
...
Furthermore, those on higher wages often retire earlier with higher savings
and pensions
...

Non monetary influences to supply of labour in a marker:
● Job satisfaction with it increases attraction to a marker with sometimes increasing the number
of hours willing to work at higher wages due to increasing wages increasing as the control of
their environment increases
...

● Location is key such as being close to home or being in a good environment like London close
to services
...

The marginal cost of labour to the firm is higherthan the extra price paid to the worker being
recruited at a higher price as they have to increase wages of all the workers
...

The elasticity of labour supply is the measure of the responsiveness of quantity supplied in
comparison to wage changes, this is based on:
● The availability of substitute labour in other industries, such as due to being poached
...

● Time, is key with elasticity being higher in the long run such as due to having time to retrain
...

Market failure occurs when there are barriers to the mobility of labour resulting in unemployment:
● The geographical immobility of labour is when workersmove from one area to another with
difficulty such as the searching costs or not wanting to leave friends and family
...
Thelower income someone is the more immobile they are likely to be
...
Over time this
increase in ability although the costs may be high
...
5
...

The firm here takes the wage from the labour market and

will hire up to the cost of hiring extra workers is equal to their marginal revenue product of labour
...

A more inelastic demand and supply means that there is more significant effect on wages than
employment in the economy
...
A increase in
participation rate means there is closer to full capacity so thus wages have to be raised to cater to the
demand for labour)
...
Underemployed are employed but working below their capacity such as part time work, a
increase in wages may not thus increase as workers are willing to work for lower wages such as due
to cyclical unemployment
...

● Youth unemployment as firms are looking for more experienced individuals the tendency thus
to hire young workers is limited
...
This makes them unattractive in the labour
market
...

● Changes to retirement age as people are living longer there is a increase in the number of
people retired
...
g
...
Therefore the working age has been extended so
people are now working for longer resulting in higher government revenue to cover the costs
of the ageing population
...

● Zero hour contract is when employees do not have to provide a minimum amount of hours, and
the employee can take as much work as desired, this results thus in no fixed income and
workers losing out due to lacking of protection such as redundancy rights
...

A minimum wage rate is a price at which below the wage cannot fall
legally resulting in an extension in labour supply but contraction in
demand, resulting in unemployment in the labour market
...

● Increase productivity of those that experience a risein
reflected value of wages
...

● Decrease the wage gap and worker exploitation
...

● Increasing firms average costs resulting in capital substitution
or outsourcing in the long run
...


Whilst a maximum wage means that the wages cannot rise above a
certain level legally
...

● Reduces cost for firms and therefore reduces cost push
inflation
...

● Prevents higher skilled workers from doing the highest paid
jobs, this may discentivise becoming more productive due to no
reflected wage increase, which may lead to a brain drain
...

Public sector which involves working in the state sector is affected by
wages set by the government
...

How the government tackles labour market issues (supply mainly):
● Trade union power, when stronger, allows there to be a more flexible labour market from
increased satisfaction as there are higher wages and job security resulting in there being
more people willing to work thus increasing the population pool
...

➔ This may result in increased capital substitution, cost of production rising resulting in
there being a increase in price passed onto consumers
...

● Housing results in affordable housing thus there is a increase in ability for labour to move,
resulting in a reduction in geographical immobility thus helping there to be labour available in
the right places where demand for skills are
...

● Infrastructure that is affordable and faster allows committing time to reduce, reducing
geographical immobility of labour allowing their to be higher pool of work with a larger job
opportunity
...

● The relaxation of immigrationresults in their being a increase in labour force supply, which
may be skilled thus resulting in a decrease in deterrent for migrants to come and fill skill gaps
...
6
...

● Restricting output from firms with larger market power may result in higher prices and
operating further from the allocatively efficient point at the cost to consumers
...

The CMA (Competition and marketing authority) regulates the UK competition policy and is a surrogate
for competition (acting like it is there)
...
They have power to impose regulations such as fines, prevent mergers
and get businesses to correct decisions
...
The CMA would consider the
business environment and if the merger should go ahead, it will be allowed to proceed if the potential
consumer and market benefits are greater than the costs
...

The EC (European commission) looks after competition in the EU and the main areas
of legislation involved; antitrust, mergers, antitrust, cartels and state aid
...

Monopolies operate at a profit maximising cost which often leads to a welfare loss as
shown by the triangle, as they should be operating at the allocatively efficient of
MC=AR
...
OFWAT regulates water and OFSTED regulates education
...
Price controls/regulation is when the government would set a maximum
charging price equal to the marginal social cost of production, to
prevent monopolies from exploiting consumers through charging high
prices, also known as price capping
...

This means consumers cannot get exploited, through increased
consumer surplus due to lower prices
...
If the
regulator believes further efficiency gains can be made, they increase X
...

This is to account for industries where significant capital investment is required to maintain
the quality of service provided
...

● Surrogate for competition as these industries are natural monopolies and there is a lack of
competition, the regulator is acting as a surrogate for competition
...

Problems:
● Asymmetric information, it is hard to know where costs and revenue curves lie making it hard
to know what the allocatively efficient price is
...

● Regulatory capture, due to being susceptible to corruption meaning the price cap it set to
high
...
This does not allow reinvestment,
dynamic efficiency which will in the long run reduce consumer surplus
...

2
...
This is done by
calculating operating costs of the monopolist andadding a rate of return on capital employed
...
If the regulator
deems the profit level as higher than determined, there may be price cuts or further profit tax
for the firms (windfall tax, one of tax- although this promotes a hide of profits)
...

Why this is introduced:
● Encourages investment, to ensure firms reinvest in the company keeping the profit at a fair
level, creating also further dynamic efficiency in the long run
...

● Better quality services as firms reinvest more profits in the company essentially improving the
service quality thus benefiting consumers at the end of the day
...
This results in the monopoly earning more due
to these slightly subjective guesses of profits
...
This is as there is punishment for being successful
this reduces consumer welfare as the quality will thus not be improved and passed onto the
consumers
...
This may not necessarily
increase the quality of goods
...
Quality standards are required as monopolists may not focus on quality only profits reducing
welfare due to higher quality may not be adding to profits (however, this may be a profit max
strategy)
...
This may result in codes of standardsand enforcement laws being drawn
up in order to increase quality and dynamic efficiency
...
g
...

4
...
This requires a high
understanding of the industry in order to increase thequality of services to benefit
consumers
...

E
...
Departure and arrival times of trains or reducing the business complaint number
...
Merger policy is a way of controlling monopolies by stopping their creation
...

Others:
● Self regulationis when monopolists conduct their own code of practices, and keep to them
with regulating bodies
...

➔ This is very weak with the regulator normally chosen by the firm
...

Lowering the barriers to entry such as through reducing legal, marketing barriers and
financial barriers
...

● Breaking up the monopolist results in lower prices and profits and greater consumer choice
...
This
will result in welfare losses along with high levels of lobbying from firms
...

➔ It is hard to know long run costs and creates inefficiencies
...
The
government may give small grants to businesses in order to encourage entrepreneur activity
...
Thesestrategies
make it more contestable (new firms enter and compete) in the market encouraging
investment due to the contestability in the market
...

➔ Small businesses may become inefficient resulting in a misallocation of recources as
they are reliant on government support
...

● Deregulation is when governments remove monopoly power through removing legislation to
lower barriers to entry increasing contestability, through decreasing anti competitive
practices
...
This
should lower prices and increase choice/output due to lowering production costs with firms
may also keep to quality to please consumers
...

➔ It also creams markets as only services in most profitable areas are provided
resulting in missing markets
...
This promotes
competition when competitive tendering creates a specification for the goods and services,
and private actor firms bid for the contract providing proposals on costs and how they will
complete the project
...

➔ This however depends as it is highly costly and time consuming to engage in this
...

➔ The principal agent problem occurs due to different aims of profit maximising firms to
social welfare maximising government
...
This
increases efficiency and competition due to the private sector having more experience with
the aim of minimising costs increasing productive efficiency which often does not happen in
the public sector and improving quality
...
The wealth is in the hands of the publicand
can be spread through shares
...

➔ Profit maximising firms will not provide these merit goods for everyone, and may
increase prices, resulting in lower welfare as they profit maximise not focusing on
societies welfare
...

How governments intervene to protect suppliers and employees:
● Restricting the monopoly power of firmsworkers are no longer vulnerable to exploitation,
being paid the lowest wage in an unpleasant environment
...
To be successful regulators should not be run by monopsonies and
fines should be large enough to prevent misbehaving
...

● Nationalisation happens when assets move from the private to public sector helping to allow a
more fair treatment (as people are often exploited by monopolies e
...
welfare and
environment of work) along withcosts falling and output increasing as governments maximise
social welfare instead of exploiting consumers
...

➔ This however, may result in workers not being paid more due to lower prices and
profit
...

➔ This may be inefficient in the public sector, due to no objective of profit maximising
resulting in lower quality and higher prices
...

Government intervention effectiveness:
This is done to increase all efficiencies, lower prices, profits and increase quality/choice
...

The firms influence the government through:
● Lobbying such as requesting meetings with the governments, funding pressure groups, bribes
and lawsuits
...
This may be
done through creating a relationship with the regulator or pressuring them
...

● A minimal compliance, may be done through minimising code of conducts thus minimising
cost of compliance

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