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

---

Business Growth Year 2 Micro:
Private Sector:
Firms in the private sector = privately owned
Sole Traders, Partnerships,PLCs,LTDs
Limited companies have shareholders who own shares in a firm and receive profits in the
form of dividends as rewards for taking the risk of ownership
...

The Reason why firms seek to max profits is that the purpose of economic activity is
to increase economic welfare, which incentivises production
...
In the
public sector managers do not share in profits
...

● Firms become more profitable
● Lack of political interference, governments make poor economic managers because
their motivations are political rather than economical
...
Too many
works may lead to diseconomies of scale
● Government will raise revenue from the sale
Disadvantages of Privatisation:
● Natural monopoly = most efficient firms in the industry is one,tap water has high fixed
costs therefore no scope for competition
...

Nationalisation = is the transfer of assets, control and ownership from the private sector to
the public sector of an economy
Advantages of Nationalisation:
● Natural monopolies are better public and controlled than private and exploit
consumers
● Profits contribute to government revenue and facilities lower taxes
● Positive externalities which a private firm would ignore
● Welfare issues and help provide public goods/basic necessities
● Labour/trade unions are in favour of it because it benefits them more
● Government investment in industries where investment is lacking
● Free Market failure
● Saved the banking system in 2008
● Public interest - healthcare and transport
● Privatisation leads to the exploitation of workers
Disadvantages of Nationalisation:
● Inefficient due to no competition and required efficiency in order to survive
...

● Government objectives aren't the same as business objectives
● Opp cost of tax revenue if the government invests in a nationalised firm = using our
money
EV: ownership and how gov manage it, may reduce efficiency, they have to provide
incentives to increase efficiency
Workers pride
Depends on the industry
Not for Profit = Are firms such as charities and community organisations that don't have a
profit maximising objective
...
In Sole Traders and partnerships the owner will have a
lot of power and control
...

Managers operate more efficiently than shareholders
...

This leads to the principal agent problem
...

The agent makes decisions on behalf of the principle
...

Managers = Agent (Objective Pay/Bonus/Pension)
Shareholder = Principle (Objective Dividends + profit)
Managers want to maximise their salaries,their profits, their pension and company car
...

Whereas shareholders are interested in profits and profit maximisation, so they get a higher
share price and greater dividends
...
Thus there is a difference in objectives
...
The principal hires managers and directors to run
the firm as they can't but the shareholders also cannot monitor the behaviour of the agents
Perfectly
...

The agent has a degree of autonomy because of Asymmetric information
...

The Divergence of interests causes agency costs (when they buy other companies for
status or fund unnecessary projects)
Shareholders have an Annual General Meeting (AGM) to vote directors on and off the board
and pass resolutions; EV: however only the major stakeholders can attend these meetings
...

Agent Based Inertia = Most shareholders are old = they do nothing about it to their
own detriment
EvEv = MOST INVESTORS ARE PASSIVE
Stakeholder = Anyone who has a vested interest in the firm (stakeholder objectives can
clash and there can be a conflict of interests)
...

- Contracts between the principle and the agent to address issues of asymmetric
information and lack of incentives
- Monitoring of the agent
- Stock/share options, Bonus on performance, profit sharing
- Make the Agent's utility align with the principles profits (company car when this
level of profit is achieved)
- Principal punishes the agent = threatens to fire them
- Taylorist piece rate
- Non Financial Compensation
EV:
-

Agency Costs = Costs of monitoring the agent (audits and financial statement
checks)
costs of share ownership schemes = they get equity without giving finance to the firm
Profit sharing = belongs to shareholders not managers
Bonding costs where the agent tries to build trust
Performance related pay = Moral Hazard

Issues with share ownership (EV):

-

Share ownership might lead to illegal action to hike share prices up
If a manager is getting paid a large salary the likelihood share ownership schemes
will work is minimal
It's obsolete if the shares aren't accessible to the agent immediately

Reasons Firms Grow:
- Higher profits = private sector aim to max profits, = done by boosting sales revenue
via launching new products, entering new markets, takeovers
- Greater Market share and Power = Firm grower leads to larger market share = less
competition as they become more monopolistic = greater market share means they
can influence price and raise and consumers have less Substitutes to switch too =
Boosts profits and profit margin (monopsony power)
- Ecos Of Scale = operate on a larger scale firms reduce their long run average costs,
this allows firms to lower the price becoming more competitive and creating barriers
to entry and Improving profit margins
- Reduce Risk = Diversification lower risk and the firm is less likely to rely on one
product or industry for its profits therefore the firm is less likely to make losses and if
it does make losses in one area it will make profits in another
- Higher Barriers to Entry = Brand loyalty, start up costs, ecos of scale
- Divorce of Ownership from control = managers may bring about growth and
create a more efficient and profitable environment
- Survival = no choice to grow in order to survive in the market
Reasons Firms Stay Small:
- Owners wish to maintain control
- Niche marketing and meeting consumers needs = Luxury products = charge a
premium = tailored small scale production = Bespoke goods
- Personal service = expected personal input and thus personal experience allows
the firm to raise prices because of brand loyalty and if you grow you become less
personalised and bespoke
...

- Lack of expertise and motivation to expand = lack the necessary finance to
expand, some owners may not want to expand because it means more work, and
less leisure (poorer work life balance), managers may satisfice rather than maximise
- Low barriers to entry and too much competition = lots of firms = less incentive to
grow as excess profits maybe competed away by competition, also if its a highly
competitive and you expand you incur costs contrasted to firms who don't and thus
lead to a loss in profits
- Avoid Unwanted Attention = stay small to avoid unwanted attention via regulatory
bodies and competition bodies
...

Employing too much ppl
...
Overvalued firms
- Bad time if occurs when there's a trend decline

Horizontal Integration = When a firm merges or acquires firm in the same industry at the
same stage of production
Advantages:

-

Market share
Market power = influence on price
Higher profits from ecos of scale
Cost advantage
Taking out the competition
Gain unique ideas and new assets to work with
Ecos of scale lower LRAC = reduce price, more comp = more profits
Rationalisation of reorganising the entire firm to improve efficiency
Spread risk, profit in one firm offeata loss in the other = Cross Subsidisation

Disadvantages:
- Expensive to buy out your competitors
- Clash in cultures and objectives, conflict and inefficiencies
- Diseconomies as their Is greater chance in larger firms
- Subject to regulation
- Redundancies due to duplication of roles may causes negative productivity and
moral
- Overspecialsiing in one market
Vertical Forwards Integration = When a firm merges/acquires another firm in the same
industry further along in the production process
Vertical Backwards Integration = When a firm merged or acquired a firm in the previous
stage in their chain of production in the same industry
Advantages:
● Ecos of scale = Greater profits
● Limiting competition by creating barriers to entry
● Control over the supply chain
● Price control
● Quality control and assurance because they own the suppliers
● Control how goods are portrayed and sold
Disadvantages:
● Diseconomies as merger creates increased firm size growth, and LRAC due to
communication coordination duplication of roles and bureaucracy
● Mergers restrict competition = and increases barriers to entry = investigation of the
competition and regulatory authorities CMA
● Lack of expertise causing inefficiency and damaging profits
● Costly, culture clash
● Overdependence and saturation in one market
...
Therefore its difficult to expand as their aren't enough customers with out
going mass market
...
If you go mass you lose consumers
because lack of personal service
...
A firm my lack the retained profits to reinvest and they may need to pay
dividends to shareholders
...

- Owners objective to stay small and niche to maintain the exclusivity of the brand
and they may not want to take on extra work load == The opertunity cost is high and
some managers are risk averse
- Regulation governments don't want monopolies and place limits on certain firms and
industries for the public social welfare
...
Firms don't want to be investigated for anti competitive practices
Demergers:
Demergers = When a larger firm splits into two or more independent businesses
Reducing the risk of diseconomies of scale, they may demerge as they fail to gain Synergy
and LRAC rise which may cap growths and profits
Clash of Cultures, different cultures may cause issues with productivity,morale and the
efficiency of the business
...


A form of asset disposal to raise finance and reinvest in the more profitable portion of the
business
Adds value via the two separate valuations of the firm may be higher than the previously
merged firm
...

Meeting regulatory requirements because of monopoly power against the social welfare
interest
...

Ebay PayPal demerger
Impacts of a demerger on the business:
- More focused business objectives
- Become more efficient because the lack of diseconomies
- Stronger separate brand image
- Raise finance from selling off unprofitable business which hasn't be used to reinvest
- Time consuming because it takes time to organise and sort out the business
...

- Still remain inefficient (a structural problem)
- Loss expertise and human capital of the merged firm
- lose marketing benefits and branding research (marketing ecos of scale)
- Less monopoly power
Consumers:
- Greater competition which brings Lower prices as firms compete
...

- Less diseconomies lowers price as costs are reduced
EV
- Dominant firms may rise because of the demerger causing monopolies to form which
may keep prices high also they'll lack competitive pressure
- May be that they remain inefficient resulting IN higher prices for consumers
- Branches may close down
Employees:
- Job Security as selling the lost making part of a business can boost profits and thus
employees will have greater job security because the firm is more profitable which
will increase the amount of remuneration and lead to higher morale and
employee motivation
...
This may motivate
employees and may work harder to gain the promotion
...


EV:
-

-

Job losses as a firm resolves diseconomies of scale to run more efficiently =
stopping role duplication
Lower worker morale and productivity, as colleagues leave the firm and the
destruction of social bonds
...

Forced to move location

Revenues, Costs and Profits:
Total = All added up
Average = Divided by total
Marginal = The additional of one extra unit
The Short Run = a time period At least one factor of production is in fixed supply
Usually capital (Machinery) and land (office overheads) are fixed = you only have so much
capital and land on hand
And Labour, raw mats, energy are variable factor inputs
Variable = Quantities vary in proportion to output
In the Short Run a firm's cost curve is closely associated with short run productivity of labour
In the short run a business sticks with its scale of production (how much they want to
produce):
Total Product = Total Output = The maximum produced with current FOPs
Average Product = Total Product / Workers = A measure of the output per worker
employed/per capital
The Main One = Marginal Product = The additional (extra) output as a result of
employing one more worker or machine
Capacity = The maximum output in a given period with current factors of production
The Law of Diminishing Marginal Returns = As more variable factors are added to a fixed
Factor, Marginal Product will fall
More labour/machines in a fixed land = less Productive
More workers to operate on fixed machinery = less productive

Marginal Product is positive to a point, because adding more workers increases total product
via the specialisation of labour which breeds efficiency and boosts overall productivity and
results in more output
...
DMR = TP increases at a decreasing rate per worker
...

As the firm gets closer or at full capacity each worker adds less due to overcrowding and
thus the gains from specialisation is less
...
Their
productivity falls and eventually so does AP
...

This is why production increases for average products and then begins to diminish as a
curve
...
He has overcrowded the factory so much that him being there has lowered the
maximum that is able to be produced with current FOPs
...

More workers = More output = DMR = less output
Long Run = More workers = bigger factory = more output and more production before DMR
sets in again (because once you hit the long run you immediately move into the Short Run
again)

SR = to increase output you increase workers till profit max level has been reached and after
that you hit dmr
Long run = you have to change scale to increase production and profits
Return to Scale = Describes how output changes when all factors of production change in
the long run
...

Variable Costs = Costs that vary with output (Raw Mats, Wages)
VC = As output increases so does variable costs, an increase in Short run output will cause
TVC to rise, Variable Costs is determined by the marginal cost of extra units as more labour
is hired
Total Fixed Costs (TFC)
Total Variable Costs (TVC)
Total Costs (TC) = TFC + TVC (addition of all costs)
Averages:

Average Cost = Total Cost / quantity
Or ATC = AFC + AVC = ATC helps figure a price so they can sell above and profit
Average Fixed Cost = Total Fixed Cost / quantity
Average variable cost = Average Variable Cost / quantity = Labour costs and stock unit costs
= At the beginning of the curve there is IMR but as more is produced DMR kicks in
Increasing output brings down AFC because the same fixed costs are spread over more
units

Marginal Cost (MC) = The cost of producing one extra unit of output
MC = Change in TC / Change in Quantity
The MC Curve:
Marginal Cost on a graph is variable costs
Begins to fall because of Increasing marginal returns as each worker adds more than the
previous and costs the same due to specialisation in the short run, but then rises because
we experience DMR and each worker adds less due to overcrowding, and gets steeper the
closer we are to full capacity at current scale due to overcrowding
...
Cost advantages that a business can exploit by expanding their scale of
production
...

The lower costs represent the increases in productive efficiency and helps give a firm
competitive advantage
...

- Financial via access to loans from banks at a lower cost/interest rate due to it being
a large firm and being less risk
- Spreading of fixed costs by increasing output or owning the market/ being a large
firm
- Marketing whereby a firm spreads the advertising costs over more units/products
lowering LRAC which a small firm with a low output can't
...
Machinery means more productively efficient than smaller firms who don't
have the equipment
- Managerial via spreading a manager's salary over more units and employ specialist
managers who have a background in accounting / Finance which improves efficiency
and lowers LRAC == Specialist managers boosts productivity which boosts output
- Increasing dimensions which reduces risk and lower LRAC
- Research economies = Easier for large firms to carry the overheads of
sophisticated research and development
All of these boosts output greater than the rise of total costs
= quantity rises faster than costs hence bringing down average costs
= spread total costs over greater level of output
Really Fun Mums Try Making Pies
Diseconomies of Scale = Factors which cause long run average costs to rise as a firm's
output increases which comes from decreasing returns to scale
Diseconomies is often the result of expanding above the optimum size and losing productive
efficiency
LRAC = Increasing curve = Diseconomies
Often failures in managing growth cause diseconomies
-

-

-

-

Communication and Coordination, in larger firms communication becomes harder
as there are more employees to talk to and to organise, with more divisions in the
firm
...

Workers feel isolated in larger firms which leads to a reduction in morale and thus
being inefficient and less productive causing LRAC to rise
...
It becomes difficult to monitor
the quality of work
...

External Economies explains rapid city growth, and it's the expansion of the industry which
the firm is apart in
External Diseconomies of Scale = Diseconomies of Scale that negatively impact the entire
industry
Too many firms have clustered together = Increasing LRAC for all firms in the industry,
competition of labour amongst clustered firms may force the wage rate increase, local labour
becomes scarce and firms compete on wages
...
= Cost of Factories and
Machinery increases in that area
- Local transport infrastructure becomes congested and delayed increasing transport
costs
- Commodity prices increase as there is a high market demand for raw materials
- Regulatory costs
Total costs rise
The LRAC Curve (Envelope Curve):
The LRAC curve can only be below or equal to the short run average costs curve
...
And
The working assumption is that a business will choose the least-cost method of production in
the long run
...
For example double
factor inputs will result in more than doubling of output
...
If you change your scale you can choose which LRAC curve you operate on
...
They cannot set any price as consumers may be unwilling
or able to buy
...

Average Revenue = Demand curve as they both show how much quantity of a product
they can sell at a given price
Marginal Revenue falls twice as fast compared to average revenue and is steeper because
when you lower the price to sell an additional unit all consumers including the current
consumers gets the good for a lower price
So the price optimum that maxes revenue is when marginal revenue = 0
...


Beyond and Before marginal revenue is zero either total revenue hasn't been maxed and
there still an open unity to increase or it becomes negative which means revenue falls,
neither of these maximise revenue
...
(Lowered the price so much the it becomes
negative)
Revenue Max actually lower price
IN PERFECTLY COMPETITIVE MARKETS, ALL FIRMS SET THE SAME PRICES OVER
ALL LEVELS OF QUANTITY
...
In
perfect comp the Revenue curve is perfectly elastic demand and the market price is
fixed/constant
...

Total revenue always increases as an additional unit is sold
In perfect competition = Demand is perfectly elastic = no reason to increase or decrease
price
PED and Revenue:
Assume imperfect comp
...
Dropping the price from the start of the AR curve all the way till MR = 0
means Total revenue will increase as demand is price Elastic
...
Which means each unit sold will
subtracts from Total revenue
...

Rev Max = is when the ped is neither elastic or Inelastic, but when MR = 0 == Unitary Elastic
where PED = -1

Profit:
Profit = The difference between total revenue and total costs
Total Profit (TP) = The difference between total revenue and total costs (TR-TC)
Average Profits (AP) = Profit Per Unit (TP/Q)
Marginal Profit (MP) = Additional profit earned by selling one extra unit (Change in TP
/ Change in Q)

Neoclassical economics tells us firms seek to maximise profits
Economists define profit differnt from accounts, Economics takes into account opportunity
costs
Economic Profit = The amount of profit needed to make an investment worthwhile, (Profit of
1 approach- the opp costs)
Econ Profit is measured by the benefit that could have been gained by the resources (FoPs)
in their next most profitable use
Normal Profit = Minimum amount of profit to keep a firm in the industry (min profit needed to
keep factor inputs in their current use i
...
in the industry in the long run
...

If Price (AR) Covers AC then the firm is making Normal Profit
...

-

They encourage new firms to enter the market – as long as it is possible for them to
do so = supernormal profit sends signals

-

Creation of worker incentives: profit-related pay/share ownership schemes can
lead workers to work harder

-

Creation of shareholder incentives: high profit leads to high dividends leading
to more demand for a company’s shares
...
= Non Interventionist Classical Economists

-

High profits encourage more firms to enter the market and existing firms to use more
of their resources to produce the good or service
...


-

Large profits may mean firms have managed to lower their costs, suggesting there is
more economic efficiency
...


-

Finance for capital investment and research: Retained profits are a key source of
finance for businesses undertaking capital investment + funds for acquisitions

-

Demand for and flow of factor resources: Resources flow to where the risk-adjusted
rate of profit is highest

-

Signals about health of the economy: Rising profits might reflect improvements in
supply-side performance
...


Profit Maximisation:
- Traditional economic theory is that firms seek to profit max
...
= costs more than revenue damages profits
Maximising profits leads to lower costs for the firm therefore they can pass on lower prices to
consumers
Profit max = rewards entrepreneurship
and if it was before we can increase the total level of profit
EV = If a firm is profit maxing regulators are likely going to scrutinise them more, because of
the size and degree
...

= firms will not profit maximise to avoid making profits to reduce their scrutiny
Profit Maximisation = Key stakeholders are harmed

●
●

Private Sector = Profit Max Objective
Public Sector = Social Welfare

-

Profit is an important objective of most but not all firms
...

They sales max
...
This is called the structure-conduct-performance model
...
e
...
g
...
g
...

EV: Different grades e
...
steel, cement, coal, fresh fruit
Non-homogeneous goods = Products differentiated from their competitors Branding,
packaging and marketing are key here
Strong product differentiation and brand loyalty allows firms to charge higher premium prices
Demand become less price elastic
Reduction in the cross-price elasticity of demand
Higher profit margins for a given unit cost

Efficiencies:

●
●
●
●

Allocatively Efficient = When a firm's Price is equal to marginal costs = AR = MC
Dynamic Efficiency = Achieving economic efficiency overtime
Productively Efficient = Firms produce at the lowest point of LRAC when AC = MC
X Efficiency = lack of competitive pressure leading to Monopolistic firms to forgo
minimising costs of production

High Competition = Many firms competing for consumers = strong incentives to be efficient =
if firms do well they gain higher profits and if they do bad they may not be able to survive

Perfect Competition:
Perfect Competition = A market structure where there are a large number of buyers and
sellers who are price takers, and sell homogenous goods with low barriers to enter of exit
Perfect competition is a non-existent market but a model used to compare monopolies
against
...

Perfect Competition has Six Characteristics:
Perfect information = Consumers have readily available Information about market prices
and Substitutes,zero access to information costs, few transaction costs involved for
searching what the market price is
Large number of buyers and sellers = All firms are price takers, there are lots of firms
without market power
Able to buy and sell as much as you want at the market price
Can't influence market price = There are lots of small firms without market power and each
firm is so small that a change in output can't influence market price
Homogenous goods / services = good are identical, perfect Substitutes, consumers buy
from the cheapest provider, each firm is a passive price takers, firms face a perfectly elastic
demand curve
No barriers to enter or exit the market = No sunk costs, entry and exit from the market is
feasible in the long run, firms can enter the market if there is abnormal profit, all firms make
normal profit in the long run but in the short run it can make supernormal profit
Perfect Comp Assumptions
● Many firms each with an insignificant share of the market
● Too small to affect price via change in Supply = Price takers
● Homogenous goods that are perfect Substitutes for each other
● Complete information
● Transactions are costless, buyers and sellers incur no costs making an exchange
● Equal access to resources
● No barriers in long run = comp from new suppliers
● No externalities in production and in consumption

-

AC = the same whatever the structure
MC = the same shape
AR = horizontal MR = D = Its perfectly elastic, so it can't charge a higher price
otherwise it would lose all its customers, it can be lower but there's no incentive to do
so because it can sell as much as it wants at market clearing price and that would
result in all firms lowering prices
...
If it goes above the Equilibrium Price the firm is
making a loss
...
We can bring down the
average costs by lowering wages, New machinery, lower energy prices and make
supernormal profit (anything that reduces costs)
...

Perfect Comp Long Run:
1) In a competitive market business make normal profit in the long run
2) New technology or lower energy prices can cause AC to fall
3) In the short run The firm makes supernormal profit
4) But because of perfect knowledge, low barriers, homogenous goods, can't influence
market price, large numbers of buyers and sellers and you can produce and sell as
much as you want at market price, every other firm is able to make supernormal
profit and more firms enter the market creating a new long run Equilibrium where the
market price falls below average costs and thus all firms make normal profit
...

5) In ceteris paribus there is no incentive for firms to leave the market or enter
Short run = supernormal profit = firms enter the market because low barriers = increases
industry supply and reduces industry price = continue till new equilibrium and firms make
normal profit against = more firms in the industry therefore production increases overall but
each firm produces less as there is less incentive to produce (lack of supernormal)
Firms enter the market as well
EV:
-

Most firms have some degree of price making power and not all firms are price
takers
Differentiation in the real world and brand loyalty
There always information gaps due to the complexity of goods and services
sold especially from the consumer perspective
Search costs and information costs = again no perfect info
Patents, control of intellectual property is ignored in perfect comp and other barriers
to entry

-

Almost impossible for entry and exit to a market to be costless
Takes time to reach the new long run equilibrium
May be below marginal costs
Firms that can't make normal profit leave the market

Perfect Competitive Market:
- Lower prices due to many competing firms
- High Cross Price Elasticity of Demand due to consumers wanting the most
competitively priced good which means consumers have a tendency to switch
- Low barriers to entry which means firms enter and keep prices low
- Firms are productively efficient and not X inefficient
- Dynamically efficient with tech advancements and innovation to be competitive
Perfect Comp Loss Short Run:
Assume firms can leave the market and there no cost
Outward AC (rising energy prices) above AR
Firms are making subnormal profit
Everyone's costs rise
Long Run Loss:
Firms in the long run will leave a market if they can't make, normal profit and continue to
make a loss
...
The industry supply
contracts raising the price until firms make normal profit again
...
AR = MR = D readjusts
Shutdown Point = The point at which a firm's closes down because it can't pay its fixed costs
or make normal profit
Short Run Shutdown Point = When price is less than or equal to average variable costs not
making a positive contribution to fixed costs and would make a smaller loss by discontinuing
production
...
If the firm
prices above Average Variable Costs then they can use the revenue to pay towards fixed
costs
...
If a firm shuts down immediately it may
invoke greater losses (they'd have to pay the fixed cost in full)
Even firms who are making abnormal losses may
not close down immediately
...
If they gain a
price greater than variable costs then they can use the extra to put towards fixed costs,
therefore reducing their losses for that year
...

If variable costs are higher than selling price then the firm will make a negative contribution
to fixed cost and thus close down
Price Meets AVC = Shutdown Point
Shutdown Long Run:
It makes no sense to produce in the long run if you don't cover average costs
...

Price < AC = Shutdown Point
Nobody wants to make a loss forever
...

Static vs dynamic
COMPETITIVE MARKETS = NO SUPERNORMAL PROFITS = NO DYNAMIC EFFICIENCY
= but it has static efficiency = Consumers are willing to pay higher prices to get innovation
from dynamic efficiency and improved quality good Yr on Yr on ur
Efficiency:
Efficiency = the use of factor inputs in a profitable way, making the optimal use of scarce
resources
Static Efficiency = Measured at a point in time
Static Efficiency = Concerned with the most efficient combination for resources at point in
time to maximise profits
On the ppf curve
-

Productive
Allocative
X inefficient

Doesn't get better overtime
Productively Efficient = producing at the lowest point of the average cost curve
...

Allocative efficiency is reached when no one can be made better off without making
someone else worse off
...
With Pareto's efficiency
comes opportunity costs
...

-

The firm may be technically inefficient = employing too many workers (over-manning)
or investing in machines or software that it rarely uses
It can be caused by paying managers or workers
unnecessarily high wages or by buying machinery or capital at unnecessarily high
prices
...
O
...

It could be complacent in an uncompetitive environment knowing it can pass on
higher costs to customers
They may choose to be inefficient because it's very difficult and requires a lot of
changes to reduce costs to the absolute minimum and reduce wastage and If there is
no incentive to do so due to a lack of competitive pressure then they will choose not
to do so

Managerial Complacency As a result of a lack of competition
Dynamic Efficiency = Measures the extent to which various static efficiencies improve over
time
Innovation is putting new ideas or approaches into action
...

●
●

Product Innovation = Changes to the product
Process Innovation = Changes to production = improves manufacturing methods
reducing long run costs

Innovation = Joseph Schumpter = Creative Destruction = upheaval of the established
order in the pursuit of innovation
...

Innovation = Destroys inefficient uncompetitive complacent firms by bringing a product that
consumers demand and enjoy more
...

New products
Increased choice
Process Innovation = lower prices
Higher consumer surplus
LR profit max = stay ahead of rivals by bringing in brand new products
LR Lower costs via process innovation
Retain marekt share
Principle agent problem + giving dividends to shareholders holders stops innovation
Perfect Comp Efficiency:
Productive (MC = AC):
Short Run = perfect comp firms aren't not productively efficient as they do not minimise
average costs
Long run = yes productive efficient as firms enter
Allocative (P=MC) [AR = MC]:
Perfect comp will always be allocatively efficient (P = MC) because firms are price takers
and do not have market power to raise prices
...
Goods are homogenous = no
innovation
X Inefficient = Perfect competitive pressure as incentive to minimise average costs

Monopoly Efficiency:
Allocative = Monopolies are allocatively inefficient because they can price above marginal
costs being price makers and market dominance
...

Productive Efficiency = No because they don't minimise Average costs(Typically X
Inefficient) = they can if they get ecos of scale which reduces LRAC and operates on MES
Dynamic Efficiency = Monopolies have the potential to be Dynamically efficient due to their
high levels of supernormal profit
...
But if they're a dominant Firm they may not have the incentive
to do so
...

X Inefficiencies = Dominant Monopolies are likely to be X inefficient because they don't have
competitive pressures and may hide behind high barriers to entry
...

Monopoly is allocatively & productively inefficient
...
When substantial economies of scale are to be gained in a market it could be argued
that monopolies are more productively efficient than perfectly competitive firms
...

- There are always some barriers to the contestability of a market and far from being
homogeneous; most markets are full of heterogeneous products due to product
differentiation and strong branding
- Most consumers have imperfect information and preferences are influenced by
persuasive marketing
- There may be imperfect competition in related markets such as the market for key
raw materials, labour and capital goods
...

Monopoly power gives the firm the chance to act as
a price maker
...
Patents, marketing, ecos of scale,
●

Inelastic demand due to lack of substitutes == High barriers to entry helps
restrict schumpeter's creative destruction

●

Differentiation allows them to have loyalty from other producers and gain market
share and increase price because people want the differentiated product

Firms may be investigated for examples of monopoly power when market share exceeds
25% = CMA
-

high barriers to entry and therefore = Prices above equilibrium and a quantity
below equilibrium (less quantity, induces Scarcity which increases price)

-

limited substitutes
...

Dominant Firm = is a firm that has at least a 40% market share
The monopolist can influence prices, so faces a downward facing Demand curve
...
This leads to resource misallocation: too little of the good is produced
and consumed, at too high a price
...


●

The monopoly will therefore enjoy supernormal profits
...
Also little incentive to be innovative and develop new ideas
...


-

British Gas
EDF Energy
EON

There's 1 monopoly diagram with no long run/short run distinction = Because of barriers to
entry, they are able to have supernormal profit in the long run and the short run
...
Also there are none of the six characteristics found in perfect comp
markets
...
They
restrict competition, They seek to protect the power of existing firms in the market
...

Limit Pricing = A pricing strategy that deters entry by pricing below AC
...
The monopoly can actually lead to a lower price and a higher quantity
...
Competitive Markets have many smaller firms which can't
benefit from the same degree of ecos of scale

EV: Unlikely and assumes that firms sanf to lower prices or have such a degree of ecos of
scale isn't feasible
...

High supernormal profits = Dynamic efficiency = randd = but not guaranteed
Firms:
- Monopolies should be able to set higher prices and make supernormal profit and
protect these profits through high entry barriers
- Supernormal profits benefits shareholders and they gain increased dividends and a
higher roi via share price
- Supernormal profit can be invested into R&D and they can be Dynamically
efficient, innovate
- Supernormal profits can offset short term losses and they can draw on retained
profits from the previous year
- Monopolies should be able to gain economies of scale as they dominate a
market
...
Boosting consumer surplus while the firm maintains its
profit margin
...
Widens the consumer range and choice
...

Employees:
- High levels of employment and Job Security,as the firm has supernormal profits it
will remain in business in the long run and even if they sustain short term
losses it doesn't matter
...

- Employees may gain higher salaries and bonuses as thr more successful a firm
is the more likely you can reward your employees
...

Long term relationship and trade credit and friendship which is profitable for years

Disadvantages of Monopolies:
-

High prices for consumers loss of surplus
Product is underconsumed
X-inefficient lack of both productive and allocative
Deadweight loss to society = MONOPOLIES ARE REDUCING THE TOTAL LEVEL
OF SOCIETIES SURPLUS compared to competitive markets
Lack of innovations for consumers
Regressive effects on power income houses
Diseconomies of scale if they get too bit
Higher prices therefore consumers wants and needs aren't being satisfied =
underconsumption
Increases wastage due to X inefficient

ALLOCATIVELY INEFFICIENT = CONSUMERS ARE BEING EXPLOITED PAYING MORE
THAN IT COSTS TO PRODUCE = Lower consumer surplus
X inefficient = Monoplies allow waste and slack due to barriers of entry
The government pays the losses for natural monopolies = reliant on subsidies
Firms:
- Can be X inefficient and Productively inefficient suffering from organisational slack as
they face little competitive pressure which may incur higher costs such as
manager and lower factor productivity
...
If they don't maintain their competitive edge, other firms will
...
They may
revenue max instead of profit max for growth and prestige
Consumers:
- Consumers suffer from high prices compared to perfectly competitive market as they
can raise prices due to price making power
...
They choose to give profits to shareholders instead of
investing because their the dominant Firm

Employees:
- Fewer employment opportunities because lower level of Output means there's
less derived demand for labour and therefore lower employment
- May be exploited by the firm via lower wages, and if they have monopsony power
and higher the majority of employees geographically they can force wages down
through negotiations as they have more bargaining power
...
If the Monopolists are
the only ones who buy, they can use their bargaining power to force the prices of raw
mats and thus suffer lower profits
...

LRAC falls over a wide range of output so room for 1 supplier to fully exploit internal
economies and reach mes (productivity efficiency)
Exist when there is great scope for economies of scale to be
exploited over a very large range of output
...
Eg the fixed
costs of establishing a national
distribution network for a product might be enormous, but the
marginal (variable) cost of supplying extra units of output may
be very small
...


Large capital investment is required because of the high fixed costs
...

If a firm owns the whole market their Long Run average costs are cheaper because they
own all the consumers and their fixed costs are spread on all of them
...

The Natural monopoly is more productively efficient than if the market has segmentation and
competition of SRATC1
...

Infrastructure = Large Sunk Costs for natural monopolies = mKes barriers to entry high
Left to their own devices, a natural monopoly will pursue profit max and abuse their powers
...
The gov regulation forces shareholders to leave and sell their shares due to no profit
max, no dividends and higher share price
...

Lowers Water prices
Lower Energy prices
EV:
●
●
●
●
●
●

Opp cost of taxpayers paying for public goods
Underfunding other sectors
Non Interventionists oppose this
Might nationalised and make tax revenues for gov Spending
Outcomes / means
Still potential for diseconomies of scale = organisational slack from managers

Price Discrimination:
Price Discrimination = Is a firm changing its prices to different segments of the market for the
same product based on willingness to pay
Some Price Discrimination is illegal based on Sex etc
Third Degree Price Discrimination = Firms Charging different market segments different
prices based on PED on the same overall market
To Price Discriminate:

-

A must have monopoly power to make prices
Must be able to identify segments
Separate consumers into segments
Two distinct markets differing in PED
And Enforce the no arbitrage law so that secondary markets do not form, people in
the elastic market shouldn't be able to resell to the Inelastic market which would
reduce profits

Price discrimination attempts to eat into the consumer surplus by charging a higher price and
capitalising of the people who are willing and able to pay more which in turn increases
revenue
2nd Degree:
Airlines,Cinema, Trains , Hotels
Diagram:
- Regular MR/AR
- Horizontal MC = because the additional costs are relatively the same, every extra
person costs the same because the additional variable cost is an average so MC
doesn't increase = think a plane an extra person doesn't cost more so its essentially
the same
...
Firm doesn't want idle FOPs so they fill seats for extra revenue
...

Advantages of Price Discrimination:
Firms:
- Increased total revenue and profits for consumers because their gaining more sales
with elastic consumers and more profit from charging a higher price to inelastic

-

-

consumers assuming costs do not rise (EV: cost can rise due to admin of Price
Discrimination)
Higher profits should benefit shareholders gaining a higher ROI and dividends
Supernormal profits for R and D
Supernormal profits can offset short term losses in the form of retained profits
Producers can use price discrimination to prevent entry into the market
...

Uses up spare capacity

Consumers:
- Some consumers gain lower prices than before which increases their surplus and
welfare
- Consumers will benefit if extra price discrimination revenue is used to invest
and innovate which will improve choice and surplus
- Cross subsidisation benefits by moving profits from the inelastic market to better the
elastic
- Avoids overcrowding in trains and allows for investment into improved perks for
consumers Food, WiFi etc
- Positive externalities = as you get some goods for cheaper
- Thr Inelastic demand still get the good/service rather than being denied it given the
fact that they have less time etc
Disadvantages:
- Producers may incur higher costs when enforcing no arbitrage
...
Economic activity seeks to boost
welfare WHICH INCENTIVISES PRODUCTION
...

Conditions for Profit Maximisation:
● High Market Share
● Low contestability
● Low competition
● Barriers to entry
● Differentiated products
● Lots of Price making power
● Inelastic Demand
● No X inefficiencies
= The Average Firm cannot do this who has this power
...

● Rail Industry = network rail = heavily regulated
● Apple can because it has that brand value = price Skimming
● Designer clothes
● Niche markets charging a premium = Satifiys needs and wants more effectively
● Favourable geographic location = where consumer have Inertia
= These firms can profit max because they have these favourable conditions
Revenue Maximisation:
MR = 0 to max total revenue
LESS ATTRACTIVE = LOWER OPERATING PROFIT = LESS INCENTIVE FOR NEW
FIRMS TO ENTER THE MAREKT
= lower average costs due to ecos of scale and lower prices to consumers
On the diagram more quantity is sold In comparison to profit max which means they grow
...
As managers (especially sales
managers) benefit the most of maximising sales rather than operating profit
...
They also gain prestige and reputation and increased market share which
causes growth
...

Also sales related pay may move the firm to rev Max instead of profit
...
It looks less attractive and new firms may not be able
to match the lower prices associated
...
Less profit = less dividends = less attractive to investors = shareholders
sell shares = share price falls

Sales Maximisation:
AC = AR / Breakeven / Normal Profit
Sales Max = When a firm attempts to sell as much as possible without making a loss
The most likely reason behind this is to increase size and
gain economies of scale = leading to growth and increased market share
LIMIT PRICING = TAKES AWAY INCENTIVE TO ENTER
THE MAIN BENEFIT OF SALES MAX IS TO FLOOD THE MARKET WITH YOUR
PRODUCT AS YOUR SELLING A LOT OF OUTPUT
...
And
down the line you can change your objective
Netflix,Amazon,Costa all used sales max
This will make it more difficult for new firms to enter the market
...
They don't have
the conditions
...

Satisficing means achieving satisfactory objectives acceptable to all the powerful
stakeholders that make up a firm
...

As long as they make a satisfactory level of profit, they can pursue other objectives at the
same time
...
Eg
reducing carbon footprint may increase costs but make more stakeholders happy
...


-

However the divorce of ownership and control definitely means that the needs of
other stakeholders will be considered
...

In reality, shareholders will not have enough information to know if the level of profit
is actually the maximum level
...
Satisficing
is the probably the most common approach that businesses take across markets
Businesses get a feel for changing market conditions and they learn from experience
...

Differentiation gives a firm price making power = Which means average revenue
slopes downwards
However entry and exit barriers are still low

We Assume:
- Firms Profit Max = MC = MR due to imperfect comp

-

There are many producers and consumers so there's lots of competition of similar
firms that face slight differentiation which will limit the ability for some firms to raise
price and makes demand elastic

-

Product Differentiation and Non Price Factor competition which means consumers
will switch to Substitutes

-

Producers have some control of price (Price Makers) but their PED is Elastic and
XED is high and positive = switch likely = Price matters = Consumers will
switch even if there's a small price increase

-

Low barriers to entry so firms face competition in the long run and firms can enter in
the short run to gain supernormal profit
...


-

Firms will lose revenue if they raise their prices because of elastic demand and
consumers switch to competitors

Short Run - Long Run:
In the Short run profits are at any level and there are no barriers to entry
...
As new firms enter the market the Demand (AR)
shifts inwards to the left as consumers opt for substitutes with differentiation
...
Which means in the long
run the firm will make normal profit
...
Some newer products do better than others and ultimately enter the
Product life cycle with extension methods such as innovation and marketing are used

Monopolistic Efficiency:
They Price Above Marginal Cost by exploiting their monopoly
power (gained from differentiation) and aren't not allowing for the optimal distribution of
resources = Not allocatively efficient
As firms enter they get closer to allocative in the long run
Not producing at MES or the minimum of the average cost curve = not productively efficient
= Market saturation means that they cannot fully exploit economies of scale
Dynamic Efficiency = They have the ability due to supernormal profits but with low barriers to
entry it can be competed away therefore they have less of an incentive to invest
...

Marketing + Advertising = inefficient use of scarce resources
Social costs of packaging = Negative externalities

Oligopolies:
Oligopoly = A market structure where a few firms dominate the market, there are high
barriers to entry and exit, products are differentiated and firms are Interdependent
Interdependence = The actions of one firm will directly impact another therefore firms must
take into account the reactions of their rivals when setting their strategies
Because of interdependence = Uncertainty
Cartel = Association of businesses or countries that collude to
influence production levels and thus the market price
...

A rule of thumb is that an oligopoly exists when the top five firms in the market account for
more than 50% of total market sales
...

-

High Barriers to Entry = Oligopolies even supernormal profit in the long run making
new entrants into the market difficult

-

Product Differentiation = Able to significantly Differentiate their product from
competitors therefore they are price makers
...
Each
firm supplies branded products

Interdependence = Firms can't act independently of each other
...
This means firms will face UNCERTAINTY as they do not know how other firms
will react to a change in price or a new product
...
The kink shows that rival firms
react differently to price cuts and increases
...
This means demand is price
Elastic, and total revenue decreases
...
But in the long run this is
likely to initiate a price war as other firms cut their prices due to falling market share
...
That
part of the curve demand is price inelastic
...
Rivals match price falls
and don't match price rise
...
This makes non price comp vital because they cant compete
on price
...

EV: some firms compete on non price factors rather than price
...

Concentration Ratios:
Concentration = The extent to which a particular market is dominated by a few firms
N-firm Concentration Ratio = The total market share that the top n firms have
A concentration ratio measures the market share (percentage of the total market) of the
biggest firms in the market; e
...
5 firm concentration ratio measures the market share of the
5 largest firms

Five-firm concentration ratio of more than 50% usually
considered to indicate an oligopoly
...
With perfect comp having a low ratio and monopoly the highest
...
The wider the market definition the lower the
concentration ratio will be
●

Concentration Ratios may be misleading = same concentration ratio different market
structure = doesn't facilitate comparison

Collusive Oligopolies:

Collusion = collective agreements with firms not to compete to boost industry profits, restrict
competition and reduce uncertainty
Collusion occurs when firms recognise their interdependence and choose to act together
...
The business is more
able to survive and thrive when colluding and facing little to no competition
...

●
●
●

Firms in a Cartel attempt to maximise their joint profits through exploiting
Interdependence
Collusion lowers the cost of competition and stops expensive marketing wars
Collusion Reduces uncertainty and increases a firm's supernormal profit, and
increases the producer surplus

However collusion is illegal and punishable under anti competitive laws because it reduces
consumer choice, eats into consumer surplus and hurts their welfare in the form of higher
prices
...

EV: However its very hard to prove if a firm is actively colluding or that collusion has taken
place
...


In order to collude firms must have price setting power and high barriers to prevent new
entrants from undercutting
...
It's not illegal and agreed
upon by the competition authorities
...
According to the EU competition authorities "contribute to improving the
production or distribution of goods or to promoting technical progress in a market
...

Information sharing designed to give better information to consumers
...
The EU has introduced a "R&D Block Exemption Regulation" Electric Car Providers
this Is OK
...
A formal collusive agreement is called a Cartel
...
The formal agreement is
still there but it can be done in secret against consumer interests
...

There is an understanding of collusion but it's not explicitly mentioned between firms
...

-

Monitoring each others behaviour closely
Refraining from competing with one another on price

Price leadership = When one firm the price leader sets its own prices and other firms price
in relation to the leader
...

It's difficult to prosecute Tacit Collusion to conceal a firm's behaviour, however Tacit
Collusion is hard to manage for firms if there's no formal agreement
...
X-inefficiencies leads to higher unit
costs which passes onto consumer in the form of higher prices
- Less incentive to innovate / loss of dynamic efficiency
- Output quotas penalise firms who want to expand
- Reinforces the cartel’s monopoly power
- Harder for new businesses to enter the market – this reduces market
contestability
- Illegal = fines = jail time
- No innovation
- Whistleblowing breaking the agreement for immunity
- Cheating on the agreement
- Rep dmg
- EV: It may be that not every firm in a collauive agreement earns the same level of
supernormal profit
Many Cartels Fail or Breakdown:
● Other firms in the Cartel cannot directly impact their production or pricing of other
firms, the Cartel may decide to curb production but they expand production
individually
...


●

Communication between firms is poor

Non Collusive Monopolies:
Non Collusive Monopoly = Where a few firms dominate the market and decide compete
rather than collude
Essentially firms aren't colluding so they won't reach the collusive equilibrium therefore
overall they all make less profit
...

They actively attempt to also reduce contestability
Non Collusive Behaviour = Price and Non Price
-

-

Difficult to maintain a collusive behaviour due to illegal,fines and rep damage
...
A firm has a higher chance to gain higher
supernormal profits, market power and market share
...
g advertising, branding, differentiation
...

Aggressive undercutting one another on price which damages short term profits and may
lead to making a loss
...

To protect market share as consumers are price conscious
...


Limit Pricing = Setting a price below a firm's average costs to deter entry therefore meaning
new firms can't enter the market and profits
...

Limit pricing sets price so low firms can't jump in and profit
Limit pricing increases market share due lower price and this can have longer term benefits
...

EV:
-

Limiting price will reduce profits in the short run but it could be a part of a long run
profit max strategy
...

Start up costs might reduce the strategy to be redundant
Firms may enter with a higher price due to having a higher quality good
Having retained profits from a diversified business
Firms may sustain a loss to establish themselves in the industry
Non Price competition is easier than limit pricing
They may use creative destruction that will make the strategy redundant by offering a
superior product

Predatory Pricing = An anti competitive strategy in which firms set a price below average
variable costs in an attempt to force rivals out of the market and achieve market dominance
...
The dominant Firm should be able to sustain
the loss for much longer than these smaller firms due to having more retained profits and
Ecos of Scale from the previous year
...

EV:
-

PREDATORY is illegal, CMA, fine, arrested rep damage
...
Some firms will
enter the market once the dominant Firm raises prices to gain supernormal profit
...
Make a loss on the loss leader itself and attract consumers to other products

Non Price Competition:
Non Price Competition = Strategies that involve competing on others areas of the marketing
mix than price
Kinked demand = Price Stability
Advertising = Boosts demand, market share and profits by informing and persuading
consumers of the good
...

EV:
●
●
●
●
●
●

Impacts a firm's costs, therefore if the fixed costs outweighs the success of the
campaign and revenue generated it want worthwhile
Advertising has to be narrowed down to a particular target market
The message has to clear and concise and persuasive
Enough people have to view it
Will it really boost TR, Advertising doesn't make for poor brand loyalty and a
faulty product
A Lot of marketing campaigns tend to float in the back of the minds of consumers

Sales Promotion = Short term activities designed to attract attention and increase sales =
loyalty card, point of sale displays, competitions, gifts and prizes = this should boost
sales and thus boost market share
...
Ecommerce,shelf space on major retailers, multi channel
distribution click and collect
EV:
●
●
●

Costly to step up new distribution channels
Setting up a new store incurs significant fixed costs
The success of the distribution channel is dependant on whether it meets the needs
of the consumers, reliable time,low price delivery

Customer Service EV = incur costs, expensive to train staff, customer service is an essential
comp advantage
...

No sign of interdependence
The size of the market is shrinking overall so there's more aggressive behaviour
Firms can't set low prices in the long run as it may negatively impact other stakeholders

Game Theory:
Oligopolies play games with each other, there are tactics,strategies and planning that takes
place
...

How firms behave in strategic decisions, where they must take into account the responses to
their own actions from rival firms
Prisoners’ Dilemma = Problem in game theory that demonstrates why two people might not
cooperate even if in their best interests
2 Assumptions:
1) Firms do not know for absolute certainty how rivals react

2) Firms make their decisions based on the fact that they do not want the worst case
scenario to occur
(limitation as some firms ignore,this for the chance of greater supernormal profit)
A limitation of the kinked demand curve is that it does not map the interdependence of
oligopolistic firms to the same detail as game theory, game theory gives us more detail,
nuance and conclusions than kinked demand
...
Each firm is facing the same pricing decisions, whether to charge a high
price of £1 or a low price of 90p
...
Left number
= A, right number = firm B
...
What firm A should do depends on the actions and price of
firm B
...
The rational decision
is to undercut firm B and price at 90p
...
5m
If were looking at the decision of firm B we look vertically, if looking at firm A we look
horizontally
What firm B does depends on what firm A does
...
And if A prices at 90 B will price at 90
to get 1m as well
...

conclusion:
If 90p is the Nash equilibrium firms will have no reason to change thus prices become stable
and the firms compete on non price factors
...
The Nash equilibrium highlights that
both firms will end up worse off if they do not cooperate which provides a strong
incentive to collude
...
However if 1 firm
charges £1 the other will attempt to charge 90p to get 4m as opposed to you who upped the
price will get 0
...
So rationally it makes no sense to do this, but if firms could break this
interdependent uncertainty via collusion they could both make 3m and gain excessive
supernormal profit
...
The other firm always has the incentive to
cheat and gain higher supernormal profit
...
In the long term though firms will revert to the nash equilibrium
...


-

The collusive equilibrium is illegal and they will be forced back to the Nash
equilibrium by the CMA

-

CMA provides immunity if you snitch on the Cartel and punish the other firms
...


-

Incentive to undercut the collusive agreement for higher supernormal profit

Game Theory is a normative theory not a descriptive one
...
Not every firm
is rational, in reality oligopolistic firms may set prices that aren't optimal and above the game
prices
...
Asymmetric knowledge is found in all markets
that aren't perfect competition
...

Assumes consumer rationality and that they don't suffer from habitual,computational and
herding
Game Theory simplifies reality and doesn't accurately convey incentives of firms and
reasoning behind collusion and Interdependence
...

Helps explain Interdependence

Oligopoly Efficiency:
Oligopoly = Collusive and Non Collusive, Collusive = Profit Maxing but sharing Supernormal
profits
Allocatively Efficient = An oligopoly will not be Allocatively Efficient where Price = MC = AR
because they're price makers able to force prices above marginal coats to max profits
...
More likely in
collusive oligopolies due to them having an agreement on price rather than non collusive
where they compete heavily on price and can't afford inefficiencies
...
If
they attempt to sell to others they will have no sales
...
= This reduces the cost of
inputs and thus boosting profit margins
Exists in product and labour markets
Electricity generators can reduce the price for coal because who else are they going to sell
to?
Monopsony Power is Reduced:
If there are more buyers = suppliers can sell to substitutes firms = more chance of
negotiating a better deal with other firms if they're being given an unfair price = EV: collusion
can stop this and they all raise prices
Suppliers become more powerful = If suppliers gain more market share = they have have
more negotiating power = this reduces a firm's monopsony power because they fail to
negative a deal they have less of an ability to switch suppliers
Porter's 5 forces = Bargaining power of suppliers
Benefit of Monopsony Power for the firm:

●
●
●
●
●
●

Lower costs of supplies = lower variable costs = because they have significant
negotiating power
Lower marginal costs and increased output, lower variable costs due to better deals
with suppliers shifts MC downwards
...
The firm may achieve lower prices
from suppliers but may inadvertently ruin their own supply chain
...
If you increase
costs on the supplier then they're going to have to cut corners
...

Therefore coerced to accept the lower monopsony price therefore giving less
incentive to supply
...

- Lower supernormal profits as price is driven down lower and fewer orders will
be gained and thus price could drop below average cost
...

- Pushed closer to the Shutdown point as costs increase
- Less producer surplus
- Less finance for investment
- Less profits for R&D
However: suppliers with negotiating monopsony power can enjoy higher prices and profits
...

Impact on Employees:
- Increase in output from the decrease in marginal costs means more workers
get employed
...

- EV: No certainty this will occur prices may remain stable for higher profit margins

-

Benefits from Reinvested profits = Dynamic efficiency increased choice and new
products
Improved value for money NHS driving down the prices for drugs

EV:
-

Lower Supply = lower price = suppliers are less willing and able to supply due to no
profit motive which restricts the supply of products
...
Thus we have the issue of regulating monopolies to make things more fair and
markets more competitive and stop exploitation etc
...
He said that market power did not matter if it was easy
for firms to enter the market
...

Perfect Comp = Perfectly Contestable
Lower barriers = increases the chance for potential creative destruction

Essentially the threat of competition(low barriers) is the same as actual competition so firms
can't afford to be X inefficient and raise higher prices because there's the constant threat of a
firm entering the market
...

Threat of competition = alters the behaviour of existing firms = begins to resemble more like
perfect competition =
Characteristics of a contestable Market:
- No barriers - for the threat of comp
- No sunk costs (irrecoverable costs) = advertising because marekt has lots of
brand loyalty
- Perfect knowledge - no comp Disadvantage due to imperfect information = No
competitive disadvantages (have the same access to technology)
More vertically integrated market = less contestable
Technology has removed barriers to entry because firms don't have to be physical anymore
getting rid of start up costs, technology allows for greater innovation (both) which increases
the pool of entrants
...

More contestable = More likely firms move to AC = AR = to Breakeven limit point (Or
Satisficing) = this reduces supernormal profit which stops hit and run competition and you're
prepared in case that competition becomes real because your operating at a lower price and
a higher quantity
More contestable = incumbent firms become more responsive to consumers preferences
Lower profits than a monopoly
Banking sector being more contestable = its become easier to set up via Internet and no
physical shop
It's not the number of firms of the homogenous/differentiation = it's the barriers of entry
and exit
The threat of competition (low barriers of entry and exit) alters the Monopolists behaviour
...
Forces firms to behave more economically
in regards to pricing and static efficiency
...


To prevent this firms need to limit prices where AR = AC and make normal profit
...

= Sales Maximisation acts as a barrier to entry
= Increase Barriers to Entry Reduces Contestability
The threat of competition forces monopolies to increase output and lower price than the
traditional ScP monopoly market structure model
Judging the Degree of Contestability:
Barriers to entry = anything thing that prevents firms from entering and competing in a
market
How many firms are entering / exiting the market is it low or high if high than very
contestable
Are there:
● Start Up Costs
● Brand Loyalty (brand Proliferation (umbrella brands))
● Advertising
● Patents
● Regulation
● Legislation
● Ecos of scale and operating at MES
● Restricting Access to raw mats and distribution channels
● Limit pricing
● Price wars with ecos of scale
● Predatory pricing
● Nationalised industries
Sunk Costs = Costs that cannot be recovered if the business decides to leave = less
freedom to exit market = by shutting down they may incur extra costs (redundancy costs, not
getting revenue from R&D, asset write offs) = exit is not costless or advantageous = Specific
capital or equipment would have little to no alternative use = therefore a large portion of the
firm's investment has sunk
= And therefore provides a disincentive to enter as firms would experience these costs and
makes markets LESS contestable
If there are sunk costs you can't do hit and run because because there are significant losses
if you leave
Little / 0 = Sunk costs = more contestable markets
●
●
●
●

Advertising / Marketing
R&D
Industry specific capital and equipment
Asset write offs

●
●
●
●
●

Closure or project cancellations
Redundancy costs
Penalty costs from suppliers or leases for properly
Bad debts
Loss of reputation and goodwill = old cars where you can't get the parts to fix pisses
ppl off

Profit levels = if profit levels are high and split between a couple dominant firms then it isn't
contestable
...

EV = however low profits could be a sign of recession or impact in the macro Economy
-

Control of important tech
Expertise and reputation

The More contestable a market = more smaller firms = Shuptmers creative destruction
Policies to boost Contestability:
- Deregulation of an industry = less rules = more competition
- Privatisation = no nationalised barrier to entry via gov support
- Banning predatory pricing = stop monopolies forcing firms out the market
- Subsiding new firms
- Provide the relevant information
- Promote small businesses and competition = more comp
- Encouraging international trade = compete with international firms
- Lower tax
- Competition policies such as liberalisation of a market that help to open up an
industry to new suppliers or persuade consumers to switch in greater numbers
help to increase contestability
- Allow other firms to use the monopolies technologies
●
●
●

Contestable market = Low consumer loyalty
Markets become more allocatively efficient
Leads to normal profits in the long run

EV = Barriers of entry may be difficult to remove or overcome, you can't remove natural
barriers such ecos of scale, ownership of resources, industry experience
Contestable Efficiency:
Same to perfect comp
...

●

Allocative Efficiency = The threat of competition alters the day to day behaviours of
the firms which helps achieve allocative efficiency
...
And minimising their average costs (MC = AC) or firms can
jump in and undercut
...
Or they raise price which signals
supernormal profits and allow a firm to enter the market

The threat of new competition is often a powerful an influence on the behaviour of existing
established firms = more productive and allocative
A highly contestable market will resemble perfect competition, regardless of the number of
firms, since incumbents behave as if there were intense competition
EV:
-

It's hard to judge the degree of contestability, since in reality there will be some costs
to entry and exit
All markets have high sunk costs which is a barrier to entry
High sunk costs = pushes price and output similar to monopoly
Lack of Dynamic efficiency As supernormal profits aren't being made which reduces
innovation and negatively effects the consumer
Long run contestability may lead to anti competitive practices to eliminate real threats
Enter market and then use patents making it less contestable in the long run

Labour Markets:
Price of Labour = Wage (Y Axis)
Quantity of Labour = Employment (X Axis)
Labour Market = Factor of Production Market as labour is bought and sold
Labour = derived demand = goods demanded for the production of other goods = Always
Mention this
Labour = demanded as firms need to produce G+S
Builder = employed for houses to be sold
Firms demand labour
Households supply labour
Labour Demand:
Demand curve of Labour = Shows how many workers Will be hired at any given any wage
rate in a period of time
Demand for Labour = Firms Perspective to minimise costs

Downward Sloping In SR and LR = There is an inverse relationship between demand for
labour and wage rate
...

= Short Term they're stuck with labour
Fall in the wage rate leads to the substitution effect and an expansion in labour demand =
less capital more labour
When the economy is growing strongly, many businesses will be looking to hire extra
workers to supply increased output
During a recession or a prolonged economic slowdown, the
demand for labour tends to fall causing a rise in cyclical
unemployment
...


But new technology could also lead to a switch from labour to capital as the capital is more
efficient via increasing automation
...


-

PED of the final product = If the ped is inelastic then there is a high chance of
labour demand being Inelastic
...
There will
be little change for the demand of labour and employment levels
...


-

Time = Short Run = Inelastic as there is less time to employers to substitute
labour with capital, contracts, redundancy costs, reluctant to lose trained
workers, = Long Run elastic more time to do so

People stay employed = Short run, Inelastic PED of product, hard to switch to capital, labour
is a small % of costs
Unemployed = Long Run, elastic Product, big total cost %, easy to switch to capital

Labour Supply:
Labour Supply = The number of hours people are willing to work and supply at a given wage
rate
Supply = households
Upward sloping because as the wage rate rises more workers will want to work to earn this
higher wage (higher incentive to work)
Lower wages = Contraction in labour supply

Increase in the wage rate = Expansion in the supply of labour = extent dependant on the
elasticity of labour supply
-

As wages rise others workers will enter the market/industry as they're attracted
by the incentive of higher pay
...

Equilibrium Wage rate = Workers are employed to the exact point where the extra costs are
equal to extra revenue generated by selling their output
At equilibrium Workers are paid equal to their MRP (productivity) = no exploitation of workers
= efficient wages
Maximum employment at y1
Wages above equilibrium can lead to unemployment as there will be excess supply of
labour
...
However, assuming no legislation wages should rise, clearing the market and
expanding the supply of labour
...

Wage Differentials = Is the difference between wages in different occupations
The presence of wage differentials highlights that labour markets aren't perfectly competitive:
- Job Satisfaction
- Differences in Education, skills, natural ability and training
...

- Different skill levels – market demand for skilled labour (with inelastic supply)
grows more quickly than for semi-skilled workers
...
= Taylorism
- Trade unions who might use their collective bargaining power = to achieve a
mark-up on wages compared to non-union members
- Other artificial barriers to labour supply like professional exams = CFA
- Employer discrimination = a factor that cannot be ignored despite over twenty
years of equal pay legislation in place
- Region
- Private sector gets paid more than the public sector because there not at the
mercy of fiscal policy from the government = austerity
- Monopsony power forces down wages
- Lack of trade union membership
- Gig economy = temporary part time potions that need filling in = zero hour contracts

Demand side = skilled workers tend to be more demanded than low skilled workers
...
Skilled workers bring in more revenue for
firms therefore they are paid more
...
Labour is a derived demand so if more people are demanding coffee there is more
of a demand for baristas
...
Moral total
revenue = more profits = Higher wages
Supply side = Fewer skilled workers than low skilled workers due to the training and
education needed
...
Inelastic supply
and if wages rise people can't simply switch to high skilled jobs
...

EV = Wage differentials shows its imperfect and perfect
Doesn't include bonuses, financial rewards and non financial rewards
- Increasing or decreasing?
- Depends on the industry?
- NMW,Union, Social Media and public pressure
- Difficult to measure a workers productivity
- More symmetric info in the labour market = Workers pay attention to relative pay
gaps
- Non monetary benefits of Job
- Salaries are fixed in contracts
- Reciprocity and good will
...
For example, an employer may rely on a worker’s goodwill to do unpaid
overtime, if a cafe is exceptionally busy
...
These ideas are more
common in behavioural economics than this neo-classical model
...


Wage Determination in Non Competitive Markets:
Not all markets achieve equilibrium
Monopsony firms can use their power to push down wages
In a monopsony, workers can not choose between alternative employers as there is only one
buyer of their labour services
...
They will collectively bargain on the behalf of their
members and therefore have a stronger negotiating position than a single worker
...
The more workers that join a TU, the more power it
has
...

●

The TU can use its monopoly power to increase wages
...

EV:
-

Depends on the level of Monopsony power within the market
...

Workers look for same job but different area = can't because they can't move to that area to
gain a job
Worker may want to find a new occupation but if they have Occupational immobility they
won't be able to find another job in another industry
Factors affecting Geographic immobility:

-

●
●
●
●
●
●
●
●

Moving from an area with low house prices to high house prices = areas with
unemployment have lower house prices also most of the UK have mortgages rather
than renting which is a barrier to moving
Lack of affordable renting as housing costs are high
Costly and time consuming to move house = takes time to sell a house and get
another and its hard to find a buyer due to high unemployment
Cost of living
Social attachments such as family ties and kids schools
Language and accent / colloquialism barriers
Family and social ties - older people more reluctant to move
Financial costs involved in moving home including the costs of selling a house and
removal expenses
...
8
...
Leading to the
unused factors to be unemployed or used inefficiently
...

Imperfect market knowledge on available work
-

Improving the supply of affordable housing = provide subsidies to homebuilders
to increase the supply of houses or directly provide via government provision
...
Subsidies to the private sector to hire more apprentices

EV:
Again these schemes cost money which cost the government which may increase taxes and
hurt the unemployed which could be used elsewhere in the economy
...

Training does not guarantee employment as they're may be no available jobs in the
profession they have trained in
...

Time lag = it takes time to complete a qualification and they remain in the short term
occupationally imoblie EV: in the long run its improved

Both can be fixed by = Higher min wage, tax cuts (Income and national insurance),
preventing the poverty trap
Labour Shortages = Labour Market Failure
Public Sector Wage Setting:
Drive down wages
Public sector = controlled by the state = therefore the government has a significant impact
on labour markets by setting the wage as it employs millions of people
...
Some of this can be offset by unions and
threaten IA
...
UNEMPLOYMENT MEANS MORE WELFARE
SPENDING AND DISTORTIONOF INCENTIVES(more ppl jump into the market cuz
the wage rate is good) Ev that depends on if the market is competitive
- Forces small firms out by increasing costs of labour, this causes
unemployment, inequality and spending on welfare payments
...

- If below equilibrium it has 0 impact on poverty and income levels
- Requires a high level of monitoring and doesn't account for cash in hand
- Tax evasion = cash in hand to avoid NMW = less tax rev for the government =
- Training = their are better incentives for training than min wage (tax relief for
apprentices)
- May make the UK firms less comp in global markets due to their increased
costs
...
They're Unaffected by an increase because
they're on benefits
Limited impact on relative poverty
CAUSES COST PUSH INFLATION

Hairdressers and cleaning companies see a larger wage bill if the NMW rises
...
Some say minimum wage is an example of government failure
causing shadow markets to develop (cash in hand)
...
Some may try to cause job losses due to rising costs
...
e
...
e
...
Excess demand = skills shortage
Extent of skills shortage depends on:
Elasticity = more elastic greater the responsiveness on labour demand and supply
Magnitude of Max wage = the greater below the Equilibrium, the greater skills shortage
Don't cause skills shortages:
Max price above equilibrium = no impact as firms charge equilibrium = Useless
Offsets union power or powerful employees = wage might be above equilibrium due to
union the max price can force it down which reduces unemployment rather than cause a
skills shortage
Advantages of Max Wages:
- Reduced income inequality by capping the pay of high earners reducing the gap
between the rich and the poor
- Lower costs for firms as they have lower labour costs = Boosts profits =
dividends/, randD
- Fairer labour market as bankers don't deserve so much
- Offsetting power of strong unions or employees by putting a cap on wages so
they can't barter to a ridiculous degree
- Curbs inflation
Disadvantages:
- Skills shortage due to less supply and more demand
- Distortion of incentives, there's less incentive to work because of lower wages
and this may cause human capital flight by migration abroad causing a brain drain
and a loss of taxation
- Lower incentives for high earners as it will reduce their standard of living and they're
not being paid the market rate for their skills and investment in human capital
- Less trickle down
- Employees will be rewarded with excess non financial and financial awards
- Increased illegal activity as the firm attempts to not declare wages paid to staff to
evade tax
- may continue to pay higher wages against the max price
- Ineffective if set above the market equilibrium
- Move abroad
- Limits how much income someone can earn ev: can be used to increase equity in
wealth
The trade off here is about reducing inequality and the negative effects in the economy for
example shortages and workers emigrating to earn a higher wage
...
Some employers don't enforce the max wage as they'll lose their best employees
abroad or to other professions
...
g
...
g
...
Regulators impose pricing formulas for example rail fares,
stamps and water bills
...
= reduces
the level of supernormal profit = reduces consumer exploitation
RPI Price Capping = The firm can raise prices only by Inflation of the RPI subtract X =
X set by the regulators = Price Capping = Phasing out of utility markets because they're
becoming more competitive giving consumers choice = for water it's RPI - X + K where k is
capital investment on pipes to improve water quality and meet standards
Below RPI - X = more strict = less profits = but it incentivises efficiency and to cut costs
more and still make profit, you don't need an RPI Price increase but if you cut costs below
RPI - X then its calm because then you can profit off the difference
●
●
●
●

For:
-

Must be set below pmax price
May force dynamic efficiency
May lead to allocative efficiency and improved welfare
Requires a normative judgement on behalf of the government about what the price
should be

Appropriate way to stop natural monopolies or dominant firms making excess
profits at the expense of consumer
Helps cut real prices on households and consumers increasing consumer
surplus and higher long run living standards due to a rise in real incomes
Increases in price forces the firm to be productively efficient and lower average costs
in order to profit
Can be a tool to control inflation = lower the cap = contract AD because more
expensive

Against:
- Asymmetric Information as how do the regulators know what X should be, What
determines it? Do they have accurate information when setting the cap?
- Slow - the regulators will go through lots of red tape and bureaucracy for years and
then eventually do something but it would most often be too late
...
The
Government calculates the rate of return they'd make in a comp market
...
Often a rate of return on
capital employed which increases productivity production and profits
...

Advantages:
- encouraging enterprise in the private sector
- lower costs and prices due to increased efficiency,
- less red tape and bureaucracy which slows things down and are unnecessary costs
for the firm,
- removing barriers to entry promoting productive efficiency and allocative efficiency
- Less chance to abuse consumers if markets are in a perpetual state of competition
- Emphasis on competition which stops x-inefficient firms and incentives firms to satisfy
consumers more accurately
- Brings Lower prices as firms constantly have the threat of other firms entering the
market = forces pricing ro competitive equilibrium
- Deregulation lowers barriers and improves firms incentives to enter the marekt
- Still chance for significant ecos of scale because contestability is about the threat of
comp

Disadvantages:

-

Increased risk to consumers and employees as regulation is placed to protect agents
Less control over quality due to removal of standards
Less choice and firms move to the most profitable product in the market
Deregulation via Privatisation leads to the formation of regulatory bodies so nothing
really changes
Lower profits than monopoly = prevents reinvestment
Depends on the market structure

UK Banking industry is becoming more contestable
Competitive Tendering = Public Private Partnership (contracting out to private firms) = Public
goods/goods with positive externalities need to be provided for = gov might not be a
producer of these goods but they may ask private sector to produce the goods and buy it
from them = bid for contracts and the gov can make sure they're getting a higher quality
good or service for the lowest prices, leading to good value for
= Asymmetric Info, Poor Value for Money, regulatory capture and lobbyism which leads to
self interest

Privatisation = Is the transfer of assets from the public sector to the private sector of an
economy
Advantages of Privatisation:
- Saves taxpayers money
- Increases the need for efficiency due to competition and profit motive
...
The private sector is more likely to cut costs
...

- Asymmetric knowledge, governments won't allow for redundancies because of media
backlash
...
So if they are privatised it can lead to a
private monopoly which can raise prices and exploit consumers, better to be a
controlled public monopoly than an uncontrolled private one
Government misses out on dividends
Negative externalities and market failure propensity
Privatisation can cause a risk to the public interest where a profit motive is
placed where there shouldn't be like healthcare
We need government regulation of private Monopolies
Firms may seek to please shareholders in the short term rather than investing in
projects that benefit the economy
Redundancy costs short term to lower costs
Regulatory bodies need forming

EV:
depends on the industry, healthcare no, telecoms yess
Depends on the quality/level of regulation, do regulators get captured or actually enforce
rules in the private sector Extremely comp market may need a monopoly
Can you create incentivises as a nationalised firm - performance related pay
Legal Collusion (cooperation) = helping each other out instead of cartelling sharing info,
tech, office spaces, joint research, improving standards of production and safety to benefit
consumers
Whistleblowing Cartel Policy = if you inform the CMA on price fixing its all good and
they're lenient and have their financial penalty reduced or avoided altogether, Game theory
suggests that with sufficient profit motive they will betray the collsuvoe agreement= EV:
Requires full cooperation and stopping their involvement, unlikely to break the collusive
agreement as shown by game theory matrix, collusion reduces uncertainty which is the most
valuable and it restricts comp
Stopping Monopsony Power = Anti Monopsony laws making it illegal = regulators that fine
monopsonist (won't have the necessary info to charge fines) = self regulation
Protecting employees = Pmax firm = lower wages to staff and spend little on the working
environment = NMW, Herzberg/Mayo(it's in the firm's interest to protect employees),
redundancies possibility, health and safety at work, trade unions, codes of practice,
Nationalisation = Private to public ownership
Labour Party Manifesto of 1945 = "Amalgamation under public ownership will bring great
economies of scale in perdition and make it possible to modernise production methods…
...
"
"Only if public ownership replaces private monopoly can industry become efficient
...

Regulatory Lag = the time it takes for request of new regisltion and when it actually
happens
Asymmetric information = firms try to avoid giving information to regulators = makes it
difficult for regulators to make effective decision
Examples:
Fundamental Economic Problem = Water Scarcity in India = only 4% of the world's fresh
water despite having over a billion people = climate change, river pollution, poor rainwater
harvesting
Demand Increasing = UK consumers for Spanish holidays, Oil demand
Demand reducing = newspapers online , student accommodation due to rising prices of
education
Supply increasing = subsidies for coal oil and gas in India, Air travel in the UK as more
cheap firms enter the market increasing the industry supply reducing prices
Supply Inward = Fizzy drinks because indirect sugar tax which increases cost of production
PED Inelastic = Cigarettes,fast food alcohol, transport
PES Inelastic = Heathrow Airport, Gas/Electricity, Housing
XED Compliment = Printers and Ink, Games and Games Consoles

XED Sub = Chicken and Chips Shops
YED Normal Good = Dining, Foreign Holidays = As incomes rise there's an increase
YED Inferior = Tesco Own Brand Food
Negative Externalities of Production = Manufacturing of chemicals,metals, and clothing
create air pollution, pollute rivers and lose biodiversity
...

Max Prices = Energy Cap 1 october 2022 - april 2024 = necessity = makes energy cheaper
and Fairer for consumer, stops excess profits being made and stops consumer exploitation,
help reduce the cost of living consumer pay less
Monopolistic Competition = Taxis, Streaming services, Coffee Shops
Competitive Oligopolies = Lidl and Aldi VS Tesco (price and non price competition), Cars,
Mobile Phones, Short Haul Airlines
Collusive Oligopolies = EDF Energy, EON and N - Power raising price of electricity and gas
in the UK (weak consumer switching,vertical integration, increased supplier profits without
being more efficient, tacit, barriers to entry)
petrol stations, oil companies OPEC,

Hitachi and Mitsubishi = fined £105m by EU regulators for price fixing alternators and
starters = Denso whistle-blower on them avoided a fine = Price increases from 2004 to
2010 = parts increase = manufacturers pay more = eu consumers pay more
Frances Competition Authority fines 20 package delivery firms 488m for colluding to
artificially raise prices annually
...
They
paid a reduced fine of €55
...
2004 - 2010 price
rises were agreed during secret meetings (tacit) FedEx express, DHL Express, TLF were
also fined
...
An extra fine of €1
...
They were
gonna raise 5% but after the secret meetings they raised it by 7% = meetings were
organised regularly before and after pricing rounds, which enables them to homogenised
price demands and secure their commercial negotiations
Monopoly Power = Google and search engines, Durex (necessity good but monopoly of 80%
market share), Tesco
Price Discrimination = 2nd Degree = Hotels, Airlines, Cinema
3rd Degree = Rail, Uber Surge Pricing
Natural Monopoly = Network Rail, Royal Mail on Boxes
Contestable Markets = Taxis, Fast food, streaming (Disney + Entering the Market)
Loss Making = Kodak, Nokia, Blackberry
Ecos of Scale = Supermarkets, Energy,
Profit Maxing Firms = Pharmaceutical and Electronics so they can re invest into R&D
Sales Maxing = Costa rivaling Starbucks to have more stores, Amazon not paying
shareholders to grow and get economies of scale
Demerger = Ebay PayPal
CSR = Disney, Starbucks paying tax and sourcing coffee
Monopoly Regulation
RPI on trains and Gatwick Landing Charges
RPI X on Heathrow Landing Charges
RPI X±K Affinity Water
Quality Control = Rail services have to pay if there's too many delays, Virgin Media if they
don't provide a certain speed they have to pay
Merger = N Power and SSE being investigated by the CMA

Privatisation = Royal Mail in 2013
Deregulation = Airlines in the 90s, busses in the 70s
Nationalisation = Royal Bank of Scotland, Loyds in 2008, rail network was renationalised in
2001 after Privatisation of 1993 promised competition need for integrated national railway
Demand for Labour = Pilots
Supply of Labour inward = Low skill workers
Supply labour Outward = Amazon
Wage Inelastic Demand = Footballers, Plumbers and Electricians
Wage Elastic Demand = Call Centre Workers
Wage Inelastic Supply = Doctors, Engineers
Wage Elastic Supply = Driving instructors and waiters
Monopsony Employment = Government and NHS
Redistribution = Labour Party and Tax the Rich, New benefits and removing caps on
benefits, Education and Healthcare, increasing the minimum wage
Climate change is the biggest market failure we've ever seen UKs net zero strategy by 2050



---