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Micro Revision Document
Costs to a firm
Firms face two types of costs: Fixed costs and Variable costs
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They have to be paid whether or not anything is produced
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Variable costs DO vary with output – they increase as output increases
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e
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Total Cost is all the costs involved in producing a particular level of output
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-

The AC curve is a ‘u’ shape, due to the law of diminishing returns
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Law of Diminishing Returns
Marginal product is the additional output produced by adding one more unit of a factor input
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This might occur due to specialisation
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Eg if a company has 6 sewing machines and 6 workers, adding a 7 th worker
would not be recommended because the 7th worker will add less output than the 6th worker, and employing an 8th worker will
add even less output
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Diminishing returns eventually causes productivity to fall
So if a firm employs more and more people, it will eventually find that the productivity of the those employees fall
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Productivity can be improved in various ways
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Better training and management
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Increasing productivity will allow a firm to reduce its costs of production
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What are the main labour costs employers incur?
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Wages 80%
Pension contributions
Training
National insurance
Holiday pay
Redundancy payments

2 major things influence ULC
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Productivity
Wages

How would productivity affect ULC?
High productivity would lead to a decrease in ULC,
because output per worker would increase and the
costs are the same
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How would productivity affect ULC?
High productivity would lead to a decrease in ULC,
because output per worker would increase and the
costs are the same
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Limitations
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Data ignores variations in quality and other non-price factors
Could rank poorly on ULC but make up for it with cheap resources e
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low cost land and capital
Exchange rate also determines the price competitiveness of products

Marginal Revenue Product MRP
Firms demand labour in order to make revenue from selling the goods that the labour produces
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Firms will hire a worker if they add more to revenue than
they add to costs
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An example: A worker produces 10 units per hour that are sold for £12 each
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So long as the worker
costs less than this to employ then it is profitable
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Labour productivity is important because wages make up a large amount of total expenditure, TNC often look at ULC
figures as it gives indication of how competitive an economy is, ULC can deter and persuade firms to invest in a
country hence FDI can be affected
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Economies of scale can be internal or external: - (High fixed costs and low variable costs create large E of S)
External economies of scale – These are savings made by firms from the growth of the industry as a whole
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External diseconomies of scale – Diseconomies of scale resulting from the overgrowth of the industry
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Purchasing E of S – buying raw materials in bulk gives stronger grounds for negotiations and allows firms to purchase products
from suppliers for lower prices, decreasing their average cost and increasing profit
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Cheaper lending means lower total costs
Managerial E of S – as firms grow it becomes possible to hire specialist managerial workers, this usually leads to better decision
making
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g
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This increases the productivity of the firm and hence lowers average costs
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Production lines allow
workers to specialise and become more efficient
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g
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Risk Bearing E of S – Larger firms can diversify into different markets to spread risk, this diversification makes the firm less
vulnerable to industry declines and also makes the overall demand more predictable
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Larger firms also benefit from brand awareness
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Communication problems – Poor communication with employees results in workers without a clear direction
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Transport costs
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Economies of Scale can allow firms to cut production costs and in turn lower the prices of their products, hence undercutting the
competition
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Total Revenue- The total amount of money received in a time period
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Marginal Revenue- The extra revenue received as a result of producing one more unit of output
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Normal Profit occurs when Total Revenue = Total Costs
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I
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If a firm makes less than normal profit, it would be better to put
the factors of production to another use
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This means that the revenue generated
from using the factors of production in this way is greater than could have been generated by using them in any
other way
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If a firm cannot make normal profit it will close in the long run, because its revenue is not covering all its costs
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Profit is maximised when Marginal Cost (MC) = Marginal Revenue (MR)
This is the optimum output level of which a firm should operate at in order to create the largest profit possible,
firms that operate at this level are called profit maximisers
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If MR is less than MC at a point then the firm should reduce output, because the extra revenue gained is more than
the costs so profit would be reduced
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But in reality
firms often have other objectives
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Revenue maximisation – This is when firms produce at MR=0 in an attempt to generate the largest revenue possible
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For
example a firm might be a revenue maximiser in the short run in an attempt to increase market share and gain
monopoly power
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Directors, employees and shareholders may have different objectives to the firm’s owner
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Likewise employees are likely to aim to increase their
wages ahead of aiming to make a profit for the firm
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Satisficing means doing just enough instead of
aiming to maximise
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In a perfectly
competitive market the following conditions are satisfied:
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There are an infinite number of producers and consumers
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All firms have to sell at market price
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i
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every consumers decision is well informed
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I
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No firm has a ‘secret’
production technique, and every firm knows the price charged by other firms
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Firms are profit maximisers, so all decisions are based around maximising profit
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No firms will make
supernormal profits in the long run, this is because if a firm makes supernormal profit in the short run, new firms
have an incentive to join the market seen as there are no barriers to entry/exit
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This is because firms in a perfect market only make
normal profit so there is no reward for taking risks
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Perfect competition at one end,
and a pure monopoly at the other end
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Competitive markets also result
in a fair price for the consumer
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Encourage enterprise with advice and business grants
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Discourage mergers and takeovers
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A
market with high barriers to entry allows firms to make supernormal profit
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Brand strength – large firms with a strong brand have an immediate advantage and small firms entering the
market cannot compete
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Aggressive pricing tactics – Large firms can drive new competition out of the market before it becomes
established
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‘Capital intensive industries’ – If an industry requires large amounts of capital investments before revenues
produced, e
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Airplane construction
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Government Regulations – Some markets require licenses to trade, new factories need planning
permission, and health and safety regulations have to be adhered to
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Barriers make a market less contestable
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The ‘height’ of the barrier determines how long it will and how expensive it will be for a new
firm to establish itself within the market
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Barriers to entry – an obstacle that makes it difficult for a firm to enter the market
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However in reality a working
monopoly is any firm with 25% or more of the market
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Monopolies may
come about as a result of: Barriers to entry, Product differentiation, and few competitors in market
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Monopolist suppliers are profit maximisers and make

Oligopoly – when a handful of competitive firms dominate the market (most common) e
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banking, airlines etc
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Collusion is common within oligopolies and involves the co-operation of firms to determine market prices; this exploits the
consumer and is illegal
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Features of oligopoly:
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High concentration ratio
Non price competition
High barriers to entry
Price stability
Dynamic efficiency due to non-price competition
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There are two assumptions
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If one firm raises prices, then the other firms will not raise theirs
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I
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demand will fall by a higher proportion than
price increase hence total revenue will be less
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The second assumption means
that a firm which lowers prices will not gain any more market share
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e
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The outcome is that no firms want to change prices because they will lose out as a result; the result is price stability for
prolonged periods of time
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(I
...
potential competition) even if currently there
is no actual competition
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High
barriers to entry mean low contestability
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This
involves entering a market whilst supernormal profits are made and then leaving the market once prices have been
driven down to normal profit levels
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So for example it may be beneficial to lower prices to prevent new
firms from entering the market as this may lead to higher profits in the long run
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Governments may also introduce legislation or deregulate markets in an attempt to raise or lower barriers
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The socially optimum level of output is Marginal Social Cost (MSC)
= Marginal Social Benefit (MSB)

Merit goods benefit society and Demerit goods do the opposite – Merit goods have a greater social benefit than private
benefit, merit goods are under consumed if left to free market
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Government intervention takes place in an attempt to correct the market failure
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For demerit
goods with negative externalities, indirect taxation or regulation may be applied to try to decrease consumption/production to
the socially optimal output
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Non excludability - states that it is impossible to exclude individuals from consumption
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Some goods exhibit some but not all of
the characteristics of a public good
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Monopolies – Monopolies are a cause of market failure because they are allocatively inefficient and produce at where profit is
maximised
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Imperfect information means that consumers cannot make informed decisions
and so merit goods are under consumed and demerit goods are over consumed
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Eg labour immobility
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They use methods of
intervention e
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regulation, privatisation or deregulation
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However privatisation also has drawbacks with less concern for health and safety and a primary focus on
profit could lead to exploitation of consumers
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However regulations can be difficult to set and
expensive to police, they also act as barriers to entry and so make markets less contestable
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It increases contestability within the market, particularly in
monopolistic markets
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However deregulation could result in exploitation of consumers and a lack of health and safety
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For example, in the UK
relative poverty is defined as income 50% less than average incomes
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Economic growth should reduce absolute poverty, so long as the poorest can gain some increase in living standards from the
nation’s growth
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Economic Growth creates job opportunities which reduce the level of unemployment
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Minimum Wages increased in line with average earnings

Why Economic Growth May not Reduce Income Inequality and Poverty
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Economic Growth often creates the best opportunities for those who are highly skilled and educated
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Modern economies are creating an increased number of part time jobs
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In the UK, government benefits have been indexed linked
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This
means that benefit incomes have fallen behind average earnings
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For example, growth cannot solve structural and
frictional unemployment; this is unemployment caused by lack of skills and geographical immobility’s
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Restricts economic growth and wastes talent
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Inequality provides incentives for people to work
harder and earn more – rewarding hard work
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Encourages people to work instead of claiming benefits
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Lorenz curve and Gini coefficient
The Lorenz curve is a graphical representation of the distribution of income or of wealth
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e
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The Lorenz curve shows
how wealth within a country is distributed between
rich a poor and also shows the level of inequality
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The
Gini coefficient is a measure of equality; the
coefficient always lies between 0 and 1
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If a country is highly unequal the Gini coefficient
will be closer to 1
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State provision – such as health care, eg people of varying incomes receive the same state services
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This aims to
redistribute wealth
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Economic growth – jobs created, unemployment reduced, it will also tend to lead to higher wages
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National Minimum Wage
The NMW aims to make wages fairer; it sets a legal minimum hourly rate of pay
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It encourages people to work instead of claiming benefits; this increases the labour supply within the economy and
stimulates growth
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Introducing a minimum wage above the
industry’s equilibrium wage would cause firms to cut back on labour and make workers redundant
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Advantages
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Disadvantages
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Introducing NMW may help those on very
low incomes and reduce the level of
poverty
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This will lead
to higher productivity within the economy
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It gives
people more incentive to get a job
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Reduced exploitation
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NMW could increase ULC hence resulting in a decrease in
international competitiveness compared to firms in other
countries where labour is cheap
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There are doubts about whether introducing a NMW
really decreases poverty
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I
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disabled and
elderly
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If labour
demand is inelastic then the wage increase will have
little effect on demand and as a result employment
will not suffer
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However in a labour market where labour
demand is elastic, the increase wage caused by NMW
decreases demand significantly resulting in higher
unemployment and lower GDP
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The structure of employment in the UK
Since 1970’s the structure of employment in the UK has changed considerably
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In general developing countries have large proportion of workforce employed in primary sectors where as
richer more developed economies have most of their workforce employed in the tertiary sector
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Leisure is time spent not
working
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This is seen between 0 and A and is called the
substitution effect
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This
time with work
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This is seen at B
and is called the income effect
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Skilled jobs eg Brain Surgeons have a highly inelastic supply
curve, whereas unskilled jobs are highly elastic
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Factors affecting elasticity of labour
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Qualifications and skills
Length of training period
Mobility of labour

Supply of labour is not always determined by wages
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Example of non-pecuniary include: working hours, holiday, location, job
security, perks, location, promotion opportunities
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Net migration can increase the supply of labour within the economy

Labour supply
Long run supply for labour- Total number of workers willing and able to work in a given occupation for a given wage
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Factors affecting labour supply
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Size of working population
Net Migration
Willingness of population to work
Elasticity of labour supply

Ways to increase supply for labour
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Tighter eligibility for welfare payments
National minimum wage
Fall in value of benefits
Investment in education and training
Better access to child care
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When firms
demand workers it is because they need them to make the goods that are being demanded by their
customers
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Wages are directly linked
to the Marginal Revenue Product (Extra revenue the employee brings to the firm) MRP can be difficult to
measure for example a public service like a Teacher
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Causes of a shift in labour demand:
 Labour productivity, higher productivity would increase final demand for labour
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Factors affecting elasticity of demand for labour:
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The price elasticity of demand of final product
The proportion of wages to total costs
The elasticity of supply of complimentary factors
The ease of which labour can be substituted for other factors (e
...
machinery replacing labour)

Wages
Wages are made up of economics rent and transfer earnings
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Transfer earnings – The amount a worker could earn in its best alternative occupation; the minimum
amount that has to be paid to ensure that a worker stays in their current job; if wage falls below this level,
they will transfer to another job
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Highly elastic supply for
labour represents low barriers to entry because no
qualifications required etc
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The same
occurs here
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Wage differentials
Market forces determine differences in wages between different groups of workers
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Also demand for lawyers is high because they have a large MRP
and so add large amounts of revenue to the firm
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Supply for cleaners is elastic as an increase in cleaners wages would result in a large increase in the number
of cleaners, this is because there are relatively little skills needed to become a cleaner and so in a sense the
barriers to entry are low
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In a perfectly competitive labour market firms are price takers
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A firm will take on labour until the point where MRP
equals the wage because this is where the firm generates the most profit
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It is when an employer is the sole
employer of a particular type of labour
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This means that workers in these sectors do not have a choice of who they can work for
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A Monopsonist results due to lack of competition; they use their power to drive down wages in the market
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Wage discrimination
Wage discrimination is similar to price discrimination; it takes place when employers with monopsony power pay
different wages based on different workers willingness to supply labour
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Wage discrimination should not be confused with labour market discrimination where workers aren’t paid equally
due to race etc
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Workers
can be discriminated against because of age, gender, sex etc
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Workers suffering discrimination tend to earn less; it may also be difficult to find a job
Employers who discriminate can incur increased costs, employers think that MRP of discriminate group is lower than
it really is; this means they demand fewer of these workers
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Discrimination leads
to increased costs for government and economy, increased welfare payments have to be put in place to support
discriminated workers, those paid unfairly low wages result in loss of tax revenue
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The opposite happens for
favoured workers
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They
employ too many of them
and this can be shown in
the same diagram however
with MRP shifting outwards
and not inwards
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Immobility is made worse
by immense house price variation between regions
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When this happens they end up either unemployed or in a job which isn’t suited to them –
this is a misallocation of resources and is hence market failure
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The stresses
of moving home can also be a deterrent to mobility for some
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Occupational immobility
Occupational immobility occurs when workers find it difficult to change jobs within an industry due to lack of skills and
qualifications
...
Occupation immobility is most likely to happen
when skills are not transferable between industry and job
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A resulting problem with labour market immobility is that it can create structural unemployment and can cause people to be out
of work temporarily or permanently
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Policies to tackle labour immobility
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Increase vocational skills e
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give subsides to employers to offer apprenticeships and work schemes
Build more affordable homes – Subsidise affordable housing projects (very expensive to subsidise)
Lower stamp duty to make moving house more affordable (loss of tax revenue)
Introduce adult literacy classes (hard to police)
Compulsory state education until 21 (high opportunity cost, large finance required)

Consequences of immobility
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Prevents firms from generating maximum profit – Skilled workers produce more output, so without these skilled workers
productivity is lower and output is lower meaning revenue and profit are limited
...

Limiting economic growth - The quantity and quality of labour force is diminished causing AS to shift inwards increasing price level
and reducing GDP
...
This causes higher unit labour costs
within the economy
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AD = C + I + G + (X-M)
...

Structural unemployment – This causes an increase in the benefits bill, which has a high opportunity cost
...
Fiscally, income tax will be reduced significantly as a result
of the unemployment
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If
wage is increased demand supplied cannot
necessarily increase because of lack of skills and
geographical immobility
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AD shifts inwards because AD = C + I + G
+ (X-M)
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The productive potential of the
economy suffers as a result of labour immobility
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GDP is decreased
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•
•
•
•
•
•
•

Immigration
Benefits
Fresh skills and higher productivity - fall in ULC
An increase in the size of the active labour supply
Driver of innovation and entrepreneurship
Positive multiplier effect
Reducing skilled labour shortages
Tax revenues increase
Shifts AS and AD outwards

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Benefits
Less strain on public services NHS, School
Remittances

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Costs
Welfare costs: increase cost of public
services
Possible displacement of domestic workers
Rising demand for housing
Poverty risk
Strain on NHS, schools etc
Lowers price of labour

Emigration
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Costs
Lower GDP, AD and AS
Cost push inflation
Loss of skilled labour
Loss of tax revenue
Leakages from economy

Immigration increases the labour supply of an economy; migrant workers can fill skills gaps in the
economy
...
g
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Filling these gaps helps achieve economic growth and decrease
unemployment
...
Increase supply
means wage rates of domestic workers will decrease causing domestic workers to have less

Leisure
Leisure is time left to do what you want after work and chores
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Working for money means giving up time for leisure, but most people need to earn money to support a family
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Income pays for leisure activities
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This creates leisure jobs, so more people have money to spend, and so on
...


The Air travel market
Deregulation has made the air travel market more contestable, the air travel market used to be dominated
by large state owned airline (British airways) regulations regarding which routes could be flown were very
strict
...
They have
done this by deregulating (open skies agreement) and also by privatising the state owned firms
...
Over time this industry is becoming
more concentrated due to mergers of large firms, however this is frowne upon as large firms retain their
price making power
...
Long haul and short haul
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Short haul – Barriers to entry are relatively low, smaller cheaper planes are used and rights to routes costs
significantly less for short haul flights
...
However in the short run supernormal profits can be
made with exclusivity deals, airlines operating popular routes exclusively can make supernormal profit by
price making – so in the short run the industry has the characteristics of a monopoly, with one supplier
offering an exclusive route
...
The short haul industry hence has the
characteristics of monopolistic competition
Long haul – Barriers to entry are much higher, larger more expensive aircraft in combination with
expensive route licensing and fuel costs
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Firms use non price competition like quality of food to sell their products
...
I would say the long haul industry has features of an oligopoly however
as like the short haul industry, in the short run firms can make supernormal profit so this more likely
represents a monopoly in the short run
...

Unions do not always want better pay
...
Trade unions can protect workers from being exploited or discriminated
...
Also the elasticity of demand for labour is a significant factor
...
The opposite
applies if demand for labour is elastic
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