Economics

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  • Created by: Farida
  • Created on: 12-12-12 16:45

Revenue

Revenue is the receipts from sales

Total revenue - quantity of a product sold multiplied by its price = Quantity x Price.

Price taker: A firm in a competitive market that has to accept the market price

Price maker: a firm that has control over the market price

The average revenue: Total revenue divided by quantity

Marginal revenue: Addition to total revenue from one addition sale

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Costs

  • Fixed costs: costs that are independent of output produced e.g rent
  • Variable costs: costs that are directly related to the level of output produced e.g fuel
  • Total cost: The total cost of production or provision of a service. Fixed cost + Variable cost
  • Average cost: The cost per unit. Total cost/Quantity.
  • Marginal cost - the change in the total cost that occurs when output is changed by one unit e.g cost of one extra passenser. Change in total cost/change in quantity
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Short run to long run

  • Short run: time period when a firm is unable to change factors of production except for one, usually labour
  • Long run: time period when all factor inputs can be changed. Can operate at different levels of capacity e.g increase amount of quality of technology in relation to labour making average costs fall.
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Economies of scale

The benefits gained through producing on a larger scale where output rises proportionately more than its inputs.

Technical economies: Occurs when physical capacity increases with a resultant fall in unit costs. These benefits can apply in most forms of passenger and freight transport through larger vehicles that carry more passengers or freight at a reduced average cost.

Purchasing economies: A firms increase in scale, increase their purchasing power with suppliers e.g bulk buying able to purchase inputs more cheaply reducing average costs. A transport example of this is fuel, buying huge quantites of fuel at favourable prices.

Mangagerial economies: In large firms these are the result of specialisation. Specialists employed to work in human rescources or financial. Smaller firms have to reply on multi-tasking.

Financial economies: Borrowing funds, perceived risk of lending to large scale is reduced.

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Diseconomies of scale

Causes of an increase in long-run average costs beyond the point of minimum efficient scale

  • Problems in communication: In large firms, extra costs may be incurred in making managers aware of what is going on.
  • Problems of co-ordination: Large firms invariably have layers of management and several tiers of decision making, which can sometimes hinder change.
  • Problems of industrial relations: As firms increase in scale, workers may feel alienated and relationships with the employer may become more strained.

These will increase long run average costs as a firm grows in its scale.

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Firms and their objectives

Profit maximisation: MC=MR. The cost of producing the last unit of output is exactly equal to revenue the firm receives from the customer. Reasons why firms may not produce at profit maximisation:

1) difficult to identify profit maximisation position as they are more likely to know their long run average cost and use this to determine profit margin

2) Large profits might attract government watchdogs and damage employee relations.

Profit satisficing: Reasonable amount of profit that satisfies stakeholders. This is to keep stakeholders satisfied.

Sales revenue maximisation: marginal revenue is zero, predatory pricing to drive rivals out and prevent new firms from entering - tactic to establish a monopoly.

Sales maximisation: involves the maximisation of sales.

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Barriers to entry

  • High set up costs
  • Economies of scale
  • Legal barriers
  • Brand loyalty
  • Intimidation
  • Predatory pricing
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Monopoly

  • No close subsitutes the firm is the industry
  • power obtained by high barriers of entry legal form - patent
  • supernormal profit long run and short run
  • Not productively efficient as not producing at lowest point on average cost curve
  • Not allocatively efficient as price charged is greater than marginal cost of product
  • May benefit from ecnomies of scale
  • Natrual monopoly :Overwhelmingly cost advantage, sole ownership of rescource expensive to duplicate, high fixed costs.
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Price discrimination

Where a monopolist charges different prices for the same product in different markets

For price discrimination to be effective the firm must have:

  • Sufficient power to set prices
  • Must be kept seperate from other markets
  • The product must have different price elasticities of demand.

E.g off peak and peak train travel prices.

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Monopolistic competition

Many firms producing a differentiated product and where there are few barriers to entry and exit. e.g taxi services e.g greek inter island ferrys

Product differentiation - minor variations in the types of products on offer

Firms are price makers - they exist because of the slight product differentiation

Large number of firms in the market but none large in overall market size

Low barriers to entry - easy for firms to enter market, cost of exit low

Inefficient because: in short run and long run price is greater than marginal cost so allocative efficiency is not being acheived. There is deadweight loss - loss to society of the firm producing where price exceeds marginal cost.

Compete through non price competition e.g quality of service, adverstising and brand loyalty.

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Oligopoly

A market dominated by a few large firms

High concentration ratio as it is concentrated in the hands of a few large firms.

High barriers to entry

Price rigidity due to risks and uncertainties associated with price competition

Non price competition in order to gain market share

Profit maximisation may not be the firms objective

Collusive: Where firms collide to secure greater profits, not allocatively or productively efficient and lack of competition discourages dynamic efficiency.

Competitive: extensive non-price competition, price leadership, they are interdependent

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Contestability

The extent to which barriers to entry and exit in a market are free and costless

Contestable if competitors can influence the conduct of firms currently in the market

Entry and exit are free and costless - no sunk costs when leave the market

Charecteristics of hit and run: Firm enters the market where supernormal profits are being earned and leaves when profits return to normal.

All firms are subject to the same regulations and state of technology

Mechanisms are in place to prohibit responsive or entry limit pricing, as existing firms have lower costs than potential entrants

A perfectly contestable market: only normal profits earned in the long run,firms are not able to apply cross subsidisation, prices cannot be set below average cost to deter new entrants, allocative and productive efficiency are being acheived, number of firms in market doesnt matter.

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Deregulation

When the government delibrately removes official regulations that act as a barrier to competition in a market.

  • Can be used to protect a public sector monopoly from outside competition

Express buses and coaches (1980) local bus services (1986)

Domestic EU air passenger transport (1997)

  • Objective of deregulation has been to improve efficiency through increased competition
  • One reason - local bus service market declining annualy - had to give high subsidies
  • After deregulation only barrier to entry was operators license n health and safety
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Franchising

The outcome of a competitive system to bid for the provision of services

  • Minimum service levels laid down and type of vehicle to be used
  • Franchise subject to supervision to ensure quality is being maintained
  • provides the opportunity to operate with no or little competition and obtain benefits from economies of scale.
  • Transport for london keep length of franchise show in order to sustain a competitive situation
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Privatisation - cons

The process by which a former publicly owned is sold off to the private sector

Reasons not all economists favour privatisation:

  • The natrual monopoly arguement, economies of scale meant it made sense to have a single provider - avoided the problem of duplication and waste of rescources
  • Transport produces large external benefits that may not be taken in by private sector
  • Private monopolies will replace public sector monopolies and some profits earned will go back to shareholders
  • Benefits are only short term, only get one sum of money
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Privatisation - pros

Benefits that privatisation could produce:

  • Allow businesses to focus on more long term planning rather than meeting short term political requirements and without government interference
  • Private sector management would be more motivated and have a greater emphases on customer service provision
  • Provide new source of investment funding as public sector borrowing was limited
  • Revenue gained by the government through privatisation
  • Reduced cost to the government (no longer nationalised)
  • The benefits of increased competition e.g increased efficiency and theortical benefits such as lower fares/increased quality
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Negative externalities arising from transport use

  • Atmospheric pollution
  • Noise
  • Accidents
  • Congestion
  • Visual intrusion
  • Blight
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Problems of estimating values of negative external

Present cost of congestion estimates based on:

  • Value of time that is lost when road users are stuck in traffic
  • Addition fuel costs and maintenance costs of running vehicles in congested conditions
  • The cost to the economy of lost inward investment from firms that would otherwise have invested in the UK.
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The london congestion charge and low emission zone

A flat-rate indirect tax levied on all vehicles entering a designated charging zone road pricing

  • It is hypothecated - to improve transport for london
  • A way of internalising the external costs of congestion 'polluter pays principle'
  • LEZ zone seeks to improve air quality in london
  • LEZ an example of the use of regulations to correct negative externalities
  • Purpose of LEZ is to meet EU air quality targets and reduce the incidence of repiratory problems
  • These measures have been put in place to tackle congestion and encourage drivers to switch to public transport
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Public transport subsidies

Positive externalities: External benefit to the community as it is a way of reducing road traffic congestion e.g yorkshire where passenger transport executive investem in new railway stock in opening new stations and keeping fares down through payments to train operating companies

Social equity: Able to ensure that unremunerative services are retained e.g bus only means on transport in some rural areas and non car owners. Through subsidisation, redistribution of income comes about and cheaper fares enhance the work opportunities for lower paid workers.

The problem with subsidies is that the total cost to government is increasing. It is not possible to target those in greatest need - irrespective of the salary earned - dependent upon when the ticket was purchased.

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Sustainability and its application to transport

Sustainable development meets the needs of the present without compromising the ability of future generations to meet their own needs

A swith from enviromentally damaging to more enviromentally acceptable modes of transport for moving people and goods and reduction in distances travelled.

  • LAND
  • NEGATIVE EXTERNALITIES
  • NON RENEWABLE FOSSIL FULES
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The international experience of road pricing -Sing

1998 ERP introduced, the amound of charge varies by time of day

Impact of the ERP:

  • 16% fall in peak traffic in the first year of operation
  • reduction in the number of multiple trips in the charging zone
  • improved vehicle speeds
  • greater traffic volumes in the morning prior to the start of charging
  • road levels have reminaed reduced since the launch year
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PPP (public private partnership)

Contractual arrangement between the public and private sectoes in order to fund large scale projects

Advantages to public sector:

  • Injection of additional resources above what public sector can provide
  • efficiency due to private sectors patricipation
  • access to innovative techniques and technology
  • risk transfer to an organisation with proven management expertise

Advantages to the private sector:

  • Higer rate of return than if funding the whole project
  • opportunity to apply best practices
  • Opportunity for indirect benefits from the management of similar projects
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Traditional cost-benefit analysis

Identification of costs and benefits - (private costs and benefits, external costs and benefits, indirect costs and benefits) Proving cause and effect e.g house prices down due to crime rates not new road. Might forget someting.

Enumeration or measurement of the costs and benefits- finding a monetary value (normal market price or shadow price) - hard to put a price on pollution e.g extra cost to NHS

Forecasting the costs and benefits over the length of the life of the project - predicitability more difficult not sure of future economy

Establishing the net present value - the net benefit to cost ratio of the project, Benefits of cost ratio to be greater than one.

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COBA - objections

  • Model is very difficult to comprehend, therefore hard for the general public to contribute to any debate.
  • Does not recognise all the benefit and costs involved. Only a user based method of appraisal - What about external costs and benefits involved - indirect costs and benefits.
  • Enviromental affects not adequately addressed
  • Value judgements have to be made to estimate total benefits of the road project especially related to the value of time.
  • Coba only applies to roads - a model applied to all forms of transport
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Commercial approaches

Commercial approaches

  • Average rate of return - Calculation of annual profit as a % of initial outlay
  • Net present value - calculates the present value of money coming in from the project in the future, then sets these figures against the money being spent on the project today.
  • Payback - The time taken for an investment to repay the initial outlay. We go for the project that has the shortest payback period.

Issues for analysis:

  • Uncertainty? Predicting cash flows and future levels of interest rates
  • Balancing risk against potential reward
  • Reliability of data - who provided it? How was it gathered?
  • Balancing quantative and qualatitve data - numbers of enviromental concerns
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Objectives of transport policy in the UK

In striving to acheive best allocation of resources, the operation of national transport policy:

  • Structure of transport operations- determination of responsibilities for the public and private sector. Who should own what has been an important political and social challenge. Today this lies firmly with the private sector
  • Regulation of transport operations- the issue here is the relative roles of the government and the market e.g rules of enviroment and vehicle standard but still deregulate many markets
  • Control of transport infastructure- Who owns it? Private sector or Public sector? So therefore who controls it
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