Flashcards · H060 · Topic 2

How competitive markets work flashcards

35 cards on Topic 2, subtopics 2.1 to 2.7. Pick a subtopic or study them all.

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Resource allocation: How scarce resources are shared between competing uses: what is produced, how, and for whom.
Functions of the price mechanism: Signalling: prices tell buyers and sellers about scarcity. Rationing: a higher price limits demand to the supply available. Incentive: a higher price rewards producers for supplying more.
Incentive: A reward or penalty that changes the pay-off of a choice, and so changes behaviour.
Allocation under a planned price vs a market price: A planned price held below equilibrium causes a shortage, so goods are allocated by queuing or rationing. A market price adjusts until quantity demanded equals quantity supplied.

The usual objectives assumed for consumers, firms and government: Consumers: maximise utility (satisfaction). Firms: maximise profit. Government: maximise the welfare of society.
Maximisation vs satisficing: Maximisation: choosing the option that gives the greatest value of an objective, subject to a constraint. Satisficing: aiming for a satisfactory outcome rather than the maximum.
Profit maximisation vs revenue maximisation: Profit maximisation: output where MR = MC. Revenue maximisation: output where MR = 0. Maximising revenue is not the same as maximising profit.
Principal-agent problem: The agent's (managers') aims differ from the principal's (shareholders'), and information is unequal, so managers may pursue pay, status or growth instead of profit.
Corporate social responsibility: Voluntary action by a firm for its stakeholders (workers, community, environment) beyond what the law requires.

Contraction of demand vs decrease in demand: Contraction: a movement along the demand curve after a rise in the good's own price. Decrease: a leftward shift caused by anything else.
Consumer surplus and producer surplus: Consumer surplus: the most buyers would pay minus the price paid; area beneath demand, above price. Producer surplus: price received minus the least sellers would accept; area above supply, below price.
Shortage vs surplus: Shortage (excess demand): quantity demanded above quantity supplied, so price tends to rise. Surplus (excess supply): quantity supplied above quantity demanded, so price tends to fall.
Joint supply vs competitive supply: Joint: one process yields two or more products (beef and leather). Competitive: producers can switch inputs between products, so the goods compete for resources.
Derived vs composite demand: Derived: demand for a good or factor because of demand for what it helps to make. Composite: one good is wanted for several uses.
Diagram: a fall in the cost of raw materials: Supply shifts right. At the old price there is excess supply, so price falls; quantity demanded extends to a new equilibrium at a lower price and higher quantity.

PED, YED, XED and PES formulae: PED = %ΔQd ÷ %ΔP. YED = %ΔQd ÷ %Δ income. XED = %ΔQd of A ÷ %ΔP of B. PES = %ΔQs ÷ %ΔP. Percentage change = change ÷ starting value × 100.
A shop cuts price from £20 to £19 and sales rise from 250 to 270. PED, and what happens to revenue?: Price −5%, quantity +8%. PED = 8 ÷ −5 = −1.6, elastic. Revenue rises from £5,000 to £5,130.
Inferior good, necessity and luxury (YED): Inferior: YED below 0. Necessity: YED between 0 and 1. Luxury: YED above 1.
Substitutes vs complements (XED): Substitutes: XED positive (a rise in B's price raises demand for A). Complements: XED negative.
Determinants of PES: Time period, spare capacity, level of stocks, and ease of switching factors of production. Supply is more elastic in the long run.
Why do firms and government care about PED?: Firms: a price rise raises revenue only if demand is inelastic. Government: indirect taxes on inelastic goods raise more revenue but change behaviour less.

Productive efficiency: Output produced at the lowest possible average cost: MC = AC, the lowest point of AC; on the PPF.
Allocative efficiency: Resources go to the goods society values most: P = MC (with externalities, MSB = MSC).
Economic efficiency, static vs dynamic: Economic efficiency: productive and allocative together. Static: at one point in time, given resources and technology. Dynamic: over time, through investment and innovation, so cost curves shift down.
X-inefficiency: Cost above the lowest possible for the output (actual AC above efficient AC), often from weak competitive pressure.

Fixed costs £150 a day; at 30 jars TVC is £210. Find TC, AC, AFC and AVC.: TC = £360. AC = 360 ÷ 30 = £12.00. AFC = 150 ÷ 30 = £5.00. AVC = 210 ÷ 30 = £7.00. Check: 5.00 + 7.00 = 12.00.
MC formula, and how MC relates to AC: MC = rise in TC ÷ rise in Q (equal to the rise in TVC). When MC is below AC, AC falls; MC cuts AC at its minimum.
Law of diminishing returns: With at least one factor fixed (short run), adding more of a variable factor eventually makes marginal product fall, so marginal cost rises. Diminishing returns are not negative returns (TP falling).
TR, AR and MR: TR = P × Q. AR = TR ÷ Q, which equals price. MR = change in TR ÷ change in Q.
Normal vs supernormal profit: Normal profit: the least return that keeps resources in their present use; counted within TC. Supernormal profit: TR above TC.

Internal vs external economies of scale: Internal: LRAC falls as the firm itself grows (a movement along LRAC). External: every firm's costs fall as the industry grows (LRAC shifts down).
Types of internal economies of scale: Technical (larger, more efficient machinery), purchasing (bulk buying), financial (cheaper borrowing), managerial (specialist managers), marketing and risk-bearing.
Diseconomies of scale: A rise in LRAC as scale rises, from communication and coordination problems, slower decisions and poor motivation in very large firms.
Minimum efficient scale (MES): The smallest output at which LRAC reaches its lowest level.
Economies of scale vs diminishing returns: Economies of scale: long run, all factors varied. Diminishing returns: short run, at least one factor fixed.