microeconomics

  • Created by: amyylanc
  • Created on: 09-05-19 17:37

POSITIVE AND NORMATIVE STATEMENTS

- positive statements are objective statements that are capable of being tested against the facts (eg. a rise in consumer incomes will lead to a rise in the demand for new cars)

- normative statements are subjective statements that carry value judgements (eg. the government should introduce higher taxes for those earning over £100,000)

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FACTORS OF PRODUCTION

- factors of production are the inputs available to supply goods and services in an economy (land, labour, capital, entrepreneurship)

- land includes all natural physical resources which are extracted or used for the production process

  • some countries are richly endowed with natural resources, and therefore specialise in their extraction and production (eg. oil sands in Canada)
  • some countries lack such resources, and therefore rely on importing (eg. Japan)

- labour is the human input into production through the workforce involved

  • in order to grow, a country or business must increase the size and quality of the labour force
  • migration of workers in recent years has changed the labour force
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FACTORS OF PRODUCTION

- capital is any item used in the production of a good or service

  • fixed capital is machinery, equipment, new technology, factories and buildings
  • working capital is stocks of goods that will be consumed in the near future
  • new developments in capital items are used to boost the productivity of labour

- entrepreneurship is the ideas and decision making behind the production process

  • an entrepreneur is an individual who supplies products to a market in order to make a profit
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ECONOMIC OBJECTIVES

- the central objective of economic activity is the production of goods and services to satisfy consumer needs and wants

- different groups involved in economic transactions will also have their own objectives:

  • consumers want good quality and low prices
  • workers want fair play and job security
  • firms want profit maximisation
  • the government wants to maximise economic welfare
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ECONOMIC WELFARE

- the ultimate objective of economic activity is to increase peoples' economic welfare

- increased production enables economic welfare to improve, but only if it leads to higher levels of consumption

- however, production can lead to resource depletion and resource degration

- generally, consumption improves economic welfare and peoples' standard of living

- economists use the word 'utility' for the welfare that people enjoy when they consume goods and services

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CONSUMER NEEDS VS WANTS

- a need refers to something that people have to have and can't do without (eg. food)

- a want refers to something that people would like to have but don't need in order to survive (eg. designer clothing)

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THE ECONOMIC PROBLEM

- the basic economic problem is that resources are finite yet wants are unlimited

- therefore, the big problem is choice:

  • which goods and services should be produced?
  • how should the goods and services be produced?
  • who should get the goods and services produced?
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THE PPB

- the production possibility boundary indicates the maximum possible output that can be achieved, given a fixed set of resources

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PRODUCTION POSSIBILITY DIAGRAMS

- the key feature of a production possibility diagram is a production possibility frontier

- a PPF curve illustrates the different possible combinations of goods that can be produced with a certain quantity of resources, provided that all the resources are being used

- therefore, a PPF curve shows what the economy can produce when all of the economy's resources are employed and there is no spare capacity

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OPPORTUNITY COST

- rational behavior means that people try to make decisions in their own self-benefit

- when people make a choice, they always choose what they think is the best alternative, meaning that the next best alternative is rejected

- providing people act rationally, the opportunity cost is the next best alternative foregone when an economic decision is made

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PRODUCTIVE EFFICIENCY AND INEFFICIENCY

- PPF diagrams are often used to illustrate productive efficiency or inefficiency

- productive efficiency is achieved when output is maximised from the available inputs

- allocative efficiency is achieved when output is optimal, according to consumer preferences

- all the profits on a PPF curve show productive efficiency, yet not necessarily allocative efficiency

- all the points within the PPF curve show producive inefficiency, as they sugggest the unemployment of certain resources

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COSTS OF PRODUCTION

- fixed costs are costs that remain the same as output changes (eg. rent)

- variable costs are costs that change with output (eg. materials)

- total costs are the sum of the fixed and variable costs

- average costs are calculated by dividing the total costs by the output

- the short-run is a period of time in which at least one input is fixed

- the long-run is a period of time in which all factors of production and costs are variable

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PRODUCTIVITY

- production converts inputs, or the services of factors of production such as capital and labour, into final output

- productivity measures how efficiently production inputs are being used to produce output

- labour productivity is the volume of output that is obtained from each employee

labour productivity = output / employees

- capital productivity is the volume of output that is obtained from each capital unit

capital productivity = output / capital expenditure

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ECONOMIES OF SCALE

- economies of scale occur when an increase in the scale of production leads to reductions in average total costs for the firm, representing increased efficiencies

- internal economies of scale arise from the growth of the business itself, whereas external economies of scale occur due to growth in the market within which the business operates

- there are many types of economy of scale:

  • purchasing economies of scale (when large businesses get cheaper costs per unit when buying in bulk)
  • financial economies of scale (when large businesses get cheaper costs per unit on sources of finance)
  • marketing economies of scale (when large businesses get cheaper costs per unit of marketing)
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ECONOMIES OF SCALE

- managerial economies of scale (when large businesses can afford to employ specialist consultants which can drive down average costs)

- technical economies of scale (when large businesses benefit from purchasing the most efficient technology)

- risk bearing economies of scale (when large businesses can diversify into different products and markets)

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DISECONOMIES OF SCALE

- diseconomies of scale arise when a decrease in efficiency leads to an increase in average costs, due to coordination and cooperation issues

- coordination issues occur when there are added costs to a business' operations when it becomes larger

- cooperation issues occur when a workforce struggles to motivate all workers when a company becomes too large

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DEMAND

- demand is the quantity of goods and services desired by customers who have the ability to pay

- the demand curve slopes downwards as a price increase will generally lead to a fall in demand

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DETERMINANTS OF DEMAND

- incomes

- fashion and tastes

- the availability of substitute goods

- the availability of complementary goods

- seasonality

- legislation

- uncertainty over future prices

- population changes

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SUPPLY

- supply is the quantity of goods and services that producers are willing to provide based upon their profit incentive

- the supply curve shows that, as price increases, so does quantity produced, as higher prices increase the profit incentive of producing for businesses

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DETERMINANTS OF SUPPLY

- the cost of raw materials

- labour productivity

- improvements in technology

- wage rates

- the availability of subsidies

- taxation

- legislation

- expectations about future prices

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MARKET EQUILIBRIUM

- markets are in equilibrium when demand equals supply

- market equilibrium is also known as the market-clearing price

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MARKET DISEQUILIBRIUM

- a market not in equilibrium is called market disequilibrium, and is caused by excess demand or supply

- if the market price is set below the equilibrium price, then excess demand occurs

- if the market price is set above the equilibrium price, then excess supply occurs

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PRICE ELASTICITY OF DEMAND

- price elasticity of demand is the responsiveness of demand for a product to a change in the price of the product

price elasticity of demand = % change quantity demanded / % change price

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OUTCOMES OF PRICE ELASTICITY OF DEMAND

- outcome will always be negative

>1 = elastic

<1 = inelastic

1 = unitary

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DETERMINANTS OF PRICE ELASTICITY OF DEMAND

- substitutability (when a close substitute exists for a good, demand is highly elastic, as consumers can replace the more expensive good with a cheaper alternative)

- time (the longer the time period, the more elastic demand for a good becomes, as it gives people time to respond to the price change, such as by finding alternatives)

- the necessity of the good (the more essential a good is, the less elastic demand is, and the more of a luxury that it is, the more elastic demand is)

- the percentage of income that the good costs (demand for goods which people spend larger amounts of their income on tends to be more elastic, as it's more noticable and significant when there's a price increase)

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INCOME ELASTICITY OF DEMAND

- income elasticity of demand is the responsiveness of demand for a product to a change in consumer incomes

income elasticity of demand = % change quantity demanded / % change income

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OUTCOMES OF INCOME ELASTICITY OF DEMAND

- outcome can be positive or negative

negative = inferior good

0-1 = normal good

>1 = superior good

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CROSS ELASTICITY OF DEMAND

- cross elasticity of demand is the responsiveness of demand for one good to a change in the price of another good

cross elasticity of demand =

% change quantity demanded of good B / % change price of good A

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OUTCOMES OF CROSS ELASTICITY OF DEMAND

- outcome can be positive or negative

positive = substitute good

0 = no relationship between goods

negative = complementary good

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PRICE ELASTICITY OF SUPPLY

- price elasticity of supply is the responsiveness of the supply of a good to a change in the price of that good

price elasticity of demand = % change quantity supplied / % change price

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OUTCOMES OF PRICE ELASTICITY OF SUPPLY

- outcome will always be positive

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DETERMINANTS OF PRICE ELASTICITY OF SUPPLY

- the length of the production period (if firms can convert raw materials into finished goods very quickly, supply will tend to be more elastic than if several months are involved in production)

- the availability of spare capacity (if a firm has spare capacity, production can generally be adapted easily, so supply is more elastic)

- time (the longer the time period, the more elastic supply is likely to be, because it gives firms more time to leave the market if a price change causes them to want to)

- the ease of using alternative methods of production (the easier it is for businesses to alter the way they produce output, such as changing labour or capital inputs, the more elastic supply is likely to be, as the producers have more choice)

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DEFINITIONS

- value judgements are statements made that aren't testable against the facts, and depend on the views of the individual

- superior goods are goods which see a proportionately higher increase in demand compared to a rise in income (eg. 10% income rise leads to 25% demand rise)

- composite demand is when a good is demanded for more than one purpose (eg. land can be demanded for farming or for housing)

- derived demand is when the demand of one good comes from the demand for another (eg. demand for pilots comes from a demand for air travel)

- joint supply is when one good is produced, another good is also produced from the same raw materials

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DEFINITIONS

- competing supply is when the same raw materials are used to produce one good, so they therefore can't be used to produced another good

- ceteris paribus is where all other things apart from the variable being measured remain the same

- factor markets are the market for capital goods (eg. a market for workers)

- free market economies are where free market forces operate, and there is little government intervention

- planned economies are where the government makes all the decisions within the economy with equality as the prime objective

- mixed economies are where there is a mix between the use of free market forces and interventionist policies 

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DEFINITIONS

- monopsony is a market which is dominated by one buyer

- collusion is when firms cooperate to fix problems (eg. joint labour training schemes)

- complementary goods are those which are in joint demand with another good

- barriers to entry are things that make it difficult for new firms to enter a market (eg. patents in the pharmaceutical industry)

- innovation is converting the results of invention into marketeable goods and services

- market share maximisation is where a firm maximises its percentage share of the market in which it sells

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DEFINITIONS

- market structures are the organisation of markets in terms of the number of firms and how they operate

- market supply is the quantity of a good or service that all firms plan to sell at given prices in a given period of time

- missing markets are where there is no market because the functions of price have broken down

- natural monopolies are where either a firm has complete control over a natural resource, or there is only room in a market for one firm to benefit from economies of scale fully

- price maker is the firm possessing the power to set the price within the market

- price taker is the firm which passively accepts the ruling market price

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SPECIALISATION

- specialisation is when a worker only performs one task or a narrow range of tasks

- firms can also specialise by focusing on the production of a limited scope of goods to gain a greater degree of efficiency

- division of labour is when different workers perform different tasks in the course of producing a good or service

- there are various benefits to specialisation and division of labour:

  • a worker won't need to switch between tasks, saving time
  • the argument that 'practice makes perfect' can be used to support the fact that workers before more efficient at the task the more they do it
  • allows for capital deepening as more 'state of the art' technology can be invested in
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AVERAGE VS TOTAL REVENUE

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AVERAGE REVENUE AND DEMAND

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MARKET STRUCTURES

- market structures are defined by the number of firms in the market, and their competitiveness

- market structures fall into two types of market structures:

  • competitive, wherein firms try to outdo eachother (perfect competition, imperfect competition)
  • concentrated, wherein there is only one or a small number of firms operating (monopoly, oligopoly)
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FEATURES OF PERFECT COMPETITION

- very concentrated market with many sellers

- zero barriers to entry

- zero barriers to exit

- homogenous products

- price taker

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FEATURES OF IMPERFECT COMPETITION

- concentrated market with many firms selling

- low barriers to entry

- low barriers to exit

- heterogenous products

- price taker

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FEATURES OF AN OLIGOPOLY

- few firms dominating the market

- limited barriers to entry

- zero barriers to exit

- some product differentiation

- price maker

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FEATURES OF A MONOPOLY

- unconcentrated market with one firm dominating

- many barriers to entry

- some barriers to exit

- heterogenous products

- price maker

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CONCENTRATION RATIOS

- concentration ratios provide a good indicator of the degree of monopoly power in a market structure

- they indicate the total market share of a number of leading firms in a market, or the output of these firms as a percentage of total market output

- concentration ratios are calculated by first ranking the market shares of leading firms in descending order

- the market shares are then added up, according to the concentration ratio that you are working out (eg. the five-firm concentration ratio is the cumulative percentage market share of the five leading firms)

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ADVANTAGES OF MONOPOLIES

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DISADVANTAGES OF MONOPOLIES

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MARKET DOMINANCE

- market dominance occurs when it's difficult for new firms to enter the market

- barriers to entry exist to ensure that monopoly power exists and certain firms have market dominance

- barriers to entry include:

  • patents/ copyright
  • knowledge and skills of workforce
  • economies of scale of large firms already in the market
  • the use of saturation advertising by monopolies already in the market
  • infrastructure (eg. Severn Trent)
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MONOPOLIES AND MARKET FAILURE

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MONOPOLIES VS MONOPOLY POWER

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BUSINESS OBJECTIVES

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THE MARKET MECHANISM

- the market mechanism is the system in a free market whereby changes in price are determined by the interaction of decisions by consumers and firms, which determines the allocation of scarce resources

- the three functions of price are:

  • rationing
  • signalling
  • incentive

- the signalling function of price is that prices provide information that allows buyers and sellers in the market to coordinate their economic activities

- a shift in demand or supply will signal to the market which will then re-allocate resources efficiently using the market mechanism

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THE MARKET MECHANISM

- the rationing function of price is that, if consumes can't afford a good or service then rationing will take place as certain consumers won't purchase the item, and therefore excess demand is removed

- the incentive function of price is that, if the price of a good or service increases then there will be greater incentives for more firms to enter the market

- similarly, if the price of a good or service falls, then there will be less of an incentive for firms to produce the good, so supply may fall

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MARKET FAILURE

- market failure is a term used to describe market outcomes which aren't socially or economically desireable

- this occurs when supply and demand fail to allocate resources in the most efficient way

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CAUSES OF MARKET FAILURE

- public goods

- merit goods (if underprovided)

- demerit goods (if overprovided)

- monopolies

- immobility of factors

- unequal distribution of wealth

- imperfect information

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PRIVATE GOODS

- private goods are goods which are excludable, and rivalled in consumption

- private goods have two features:

  • excludability means that the owners of the goods can exercise private property rights, and prevent people from consuming their goods (eg. shopkeepers can prevent people from benefitting from their goods unless they pay for them)
  • rivarly means that when one person consumes a good, the quantity of that good available to others diminishes
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PUBLIC GOODS

- public goods are goods that are non-excludable and non-rivalled in consumption

- public goods have two features:

  • non excludability means that consumers can't be excluded from consuming the good
  • non-rivalry means that consumption by one person doesn't affect the amount of the good available to others

- public goods create market failure as they aren't provided by the free market, as a price can't be charged, due to the free rider problem

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QUASI-PUBLIC GOODS

- quasi-public goods are goods which have characteristics of both private and public goods, including partial excludability, partial rivalry (eg. roads)

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THE SIGNIFICANCE OF TECHNOLOGICAL DEVELOPMENTS

- technological developments have meant that many previously public goods are now considered as quasi-public goods

- eg. technological advances have meant that the government can use electronic pricing to charge motorists for the use of certain roads, especially congested routes

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THE FREE RIDER PROBLEM

- public goods can create market failure as it's impossible to exclude 'free-riders' from using the goods, so it may be difficult to collect enough revenue from their use to cover the cost of producing them

- this removes the incentive to provide the good, and so there is a lack of provision of goods which are clearly needed

- this means that the government, through its public spending scheme, or a charity, must provide the goods

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EXTERNALITIES

- externalities are the effects on a third party of economic activity

- externalities cause market failure if the market mechanism doesn't take into account the social costs and benefits

- negative externalities are the costs to a third party of an economic transaction

- positive externalities are the benefits to a third party of an economic transaction

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NEGATIVE EXTERNALITIES IN PRODUCTION

- a negative externality in production can be things such as pollution, or a factory providing an eyesore in the scenery

- in the case of a power station producing electricity, the price that the consumer pays for the good only reflects the money cost of production, and doesn't include all the real costs such as the negative externalities of production

- therefore, the power station's provision of electricity is underpriced

- this shows that the allocative function of price has broken down, and can lead to over-consumption of goods, which results in over-production of the good, and along with it, the negative externalities 

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POSITIVE EXTERNALITIES IN PRODUCTION

- sometimes, production can have positive externalities

- for example, a company may make technological advances in producing their product, which other businesses can then benefit from in the future, perhaps to achieve better efficiency and produce goods at a lower cost for consumers

- therefore, in a free market where there is positive externalities in production, there is a misallocation of resources, and under-production of the good

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NEGATIVE EXTERNALITIES IN CONSUMPTION

- if consumption of demerit goods reduces benefits enjoyed by third parties, the benefits to society are less than the benefits obtained by the individuals consuming the product

- this results in excess demand

- eg. smoking in a public place reduces the pleasure that non-smokers are getting from being outside

- if the demand for the product reflected its overall benefit to society, demand would be less

- therefore, in a free market, there is a misallocation of resources because negative externalities lead to overconsumption and overproduction

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POSITIVE EXTERNALITIES IN CONSUMPTION

- if consumption of a merit good provides benefits for third parties, the benefits to society are more than the benefits obtained by the individuals by consuming the product

- this results in a lack of demand

- eg. injections not only prevent the person being immunised from catching a disease, but they also reduce the risk of greater society contracting the illness

- in a free market, there would be a misallocation of resources through under-production and under-consumption of the product

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MERIT GOODS

- merit goods are goods for which the social benefits of consumption exceed the private benefits

- merit goods can lead to partial market failure, as they are often under-provided by the market, as the optimum level of production and consumption would always be higher

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DEMERIT GOODS

- demerit goods are goods for which the social costs of consumption exceed the private costs

- demerit goods can cause market failure as they are often over-provided and over-consumed in a free market setting

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SOCIAL COST AND BENEFIT

- the social cost is the total cost to society of an economic transaction

- it's made up of the private cost and the external cost

- the social benefit is the total benefit to society of an economic transaction

- its' made up of the private benefit and the external benefit

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MARKET FAILURE FROM THE EXISTENCE OF MONOPOLY

- monopolies are more likely to restrict market output and raise prices than competitive markets

- this can result in consumer exploitation, wherein prices are too high

- this can be an issue wherein monopoly markets produce merit goods, as this leads to an under-production and under-consumption of goods which benefit society

- however, if demerit goods are provided by monopoly markets, then this will not cause market failure, as it reduces the amount of demerit goods produced and consumed

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MARKET FAILURE FROM THE IMMOBILITY OF FACTORS

- geographical immobility of labour is when barriers prevent workers from accessing jobs, as the jobs available may be in other parts of the country, or the world, from where the job-seeking workers are

- occupational immobility of labour is when workers don't have the required skills to move between different types of employment, especially when they lose jobs in the industry in which they were previously employed

- both of these causes of immobility of labour result in unemployment, and contribute to market failure

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MARKET FAILURE FROM IMPERFECT INFORMATION

- imperfect information in markets, wherein the consumers or producers don't have full knowledge of the costs and benefits of the goods being provided can cause market failure

- this is because it can cause people to make misinformed decisions (eg. in the past, when there wasn't sufficient information available about the consequences of smoking, cigarettes would have been over-consumed as people didn't know the health risks and social costs attached)

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MARKET FAILURE FROM INEQUITY OF INCOME AND WEALTH

- unregulated market forces often produce highly unequal distributions of income and wealth

- this causes market failure, as it means there is an unequitable distribution of wealth, which thereby leads to an unfair allocation of resources 

- this would be socially undesireable, as it means that the poor in society cannot afford the goods that some of the wealthier members of society can, which is especially problematic when these goods are merit goods (eg. healthy food)

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FREE MARKET ECONOMY

- a free market economy is based on supply and demand through the market mechanism, where prices are set freely between seller and consumer, without intervention from the government

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INTERVENTIONIST ECONOMY

- an interventionist economy is one in which government intervention occurs to control the market with the objective of changing the free market equilibrium/ outcome

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GOVERNMENT INTERVENTION

- government intervention is regulatory action taken by government that seek to change the decisions made by individuals, groups and organisations about social and economic matters

- it includes any action carried out by the government that affects the market with the objective of changing the free market equilibrium/ outcome

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INDIRECT TAXATION

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SUBSIDIES

- subsidies are sums of money granted by thegovernment to help an industry or business keep the price of a good or service low

- this is often done by the government to try and remove market failure by encouraging the supply of merit goods

- it helps to solve the issue of the under-provision and consumption of merit goods by shifting the supply curve to the right and increasing consumption

- however, there are certain issues with subsidies:

  • they cost the government lots of money
  • the government has limited funds, and so every policy which costs them money has an opportunity cost attached to it
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PRICE CONTROLS

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PROVISION OF GOODS

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REGULATION

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EMPLOYMENT POLICIES

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GOVERNMENT FAILURE

- government failure is when government intervention leads to a worstening of the problem, or a new problem arising

- the outcome of such intervention would reduce economic welfare, leading to an allocation of resources that is worse than the free market outcome

- government failure can occur as:

  • market failure occurs
  • government decides on intervention
  • this intervention either solves the problem, partially solves it, or creates government failure
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TYPES OF GOVERNMENT FAILURE

- the law of unintended consequences:

  • eg. when government policies have unintended outcomes such as when the use of maximum price laws creates excess demand in a market, so black markets form to satisfy the extra demand, which are sometimes characterised by corruption and illegal activity

- disincentive effects:

  • eg. by increasing unemployment benefits to aid those without work, this could increase the poverty trap so people are less inclined to work and eventually lead to long-term unemployment

- administrative costs of policy:

  • eg. providing Universal Credit costs the government lots
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TYPES OF GOVERNMENT FAILURE

- bureaucracy and red tape:

  • eg. the cost of enforcing government policies may damage businesses, such as that of meeting health and safety or environmental requirements, so companies may try to avoid abiding by such regulation

- political self-interest:

  • eg. the government may make decisions based upon political lobbying
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DEFINITIONS

- product differentiation is making a product different from others through product design, the method of producing the product, or its functionality

- productivity gaps show the difference between labour productivity in the UK compared to other developed economies

- profit maximisation occurs when a firm's total sales revenue is the furthest above total cost of information

- quantity setter is the firm who chooses the quantity of goods to sell (in a monopoly the maximum price is that at which the total quantity can be sold)

- resource misallocation is when resources are allocated in a way which doesn't maximise economic welfare

- scarcity results from the fact that people have unlimited wants and limited resources

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