A2 Micro Winter 2012 - pdf

8/11/2019 A2 Micro Winter 2012 - pdf

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Welcome to the

A2 Micro WorkshopNovember 2012


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Get help from fellowstudents, teachers andtutor2u on Twitter:

#econ3@tutor2u_econ


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Examiners like answers that make

connections


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These are good connective phrases

by contrast

A consequence ofthis might be

therefore

this mightmean

on the otherhand this is because


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Examiners rewardanswers that provide

chains of

reasoning


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1. Knowledge of economic concepts andfacts.

2. Application of knowledge andunderstanding

3. Analysis : explain economic theory4. Evaluation : prioritise evidence and

arguments; make reasoned judgements and recommendations;

reach and present supported

conclusions


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Efficiency & Welfare inContestable Markets

Session 1

P3Page number in yourworkshop brochure


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Build lots of real worldexamples into your notes

Common industries usedinclude food retailers,energy, banks, airlines,

technology sectors


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Contestable markets

Where an entrant has accessto all production techniques

available to existingbusinesses and entry

decisions can be reversedwithout cost


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Key Contestability FactorsAbsence of sunk costs Access to technology

Low consumer loyaltySize of legal entrybarriers


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Contestable Markets?

StreamedMovies onDemand

RetailCoffeeStores

Home-Delivered

Pizza

Budget"Value"Hotels

City Bus andCoachTransport

HouseholdMail Services

For each ofthe industries,choosewhether theyhave LowContestability(LC) or HighContestability(HC)

P3


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Movies on Demand


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RetailCoffeeStores

Home-Delivered

Pizza

Budget"Value"Hotels




P3

LC ButRising!


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RetailCoffeeStores

Home-Delivered

Pizza

Budget"Value"Hotels




LC

HC

HC

P3


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RetailCoffeeStores

Home-Delivered

Pizza

Budget"Value"Hotels




LC

HC

HC

HC

P3


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RetailCoffeeStores

Home-Delivered

Pizza

Budget"Value"Hotels




LC

HC

HC

HC

LC

P3


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RetailCoffeeStores

Home-Delivered

Pizza

Budget"Value"Hotels




LC

HC

HC

HC

LC

LC

P3


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Great diagrams lift yourscript!

Poor ones testexaminer patience

Diagrams must be big


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Cost & Price

Output (Q)

Pricing in a Contestable Market Possible Long Run Equilibrium?

Highly Contestable Market

Profit Maximising Output

AC

AR

MR

MC

In the long run ifthe market is highlycontestable whichlevel of price andoutput is probable?

(Label this Q2 andP2).

Q1

P1

C1

When AC = AR,normal profits made,a return sufficient tokeep factor inputs intheir present use

P2

Q2

P4


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Pricing in a Contestable Market Some Alternatives

Cost & Price

Output (Q)

Highly Contestable Market Pricing to Maximise Revenue

AC

AR

MR

MC

In the right handdiagram show theprice and outputfor a firm thatseeks to maximisetotal revenue

P4


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Cost & Price

Output (Q)


AC

AR

MR

MC


P1

Revenue maximisedwhen marginalrevenue = zero

P4


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Cost & Price

Output (Q)


AC

AR

MR

MC


P1

C1

Revenue maximisedwhen marginalrevenue = zero

Still some supernormal profits made

Lower price and

higher output thanMC=MR

Revenue max meansa lower profit marginis made usuallygood for consumerwelfare but profithas value too!

P4


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Hit and Run Entry

Entry to a market inexpectation of making animmediate profit

Can only occur if theentrant does not incursunk costs

Economies of scope helphere i.e. Extending abrand name into a newmarket

P4


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Hit and Run Entry

P4


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Strong brands can make it easier to enter a new market!


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Barriers to Entry and Exit

P5


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Barriers to entry and exit

Block potential entrantsfrom making a profit Protect the monopoly

power of existing firms Maintain supernormal

profits in the long run Barriers to entry make a

market less contestable

P5


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Barriers to Entry?

V

P5


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Barriers to Entry

Economies of scale Vertical integration Brand loyalty

Control of importanttechnologies

Expertise andreputation

P5


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Strategies to Limit Competition

Limit pricing tactics Predatory pricing tactics

Brand proliferation


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Brand proliferation

When a firm sets pricelow enough to

discourage newentrants into themarket


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Brand proliferation

When a firm sets pricelow enough to

discourage newentrants into themarket

Setting an artificiallylow price for a product

in order to drive outcompetitors


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Legal Entry Barriers

Market licences Patent protection

State awarded franchises Import controls


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Examples of Exit Barriers

P5

Asset write-offs Lost consumer goodwill

Redundancy costs

Costs


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Double DiagramsTwo diagrams can lift

your analysis e.g.showing different costcurves in the long run


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Cost & Price

Output (Q)

Costs and contestability in different industries

Cost & Price

Output (Q)

Low MES, limited scaleeconomies, contestable market

High MES, falling LRAC, barriers tocontestability

LRAC

LRAC

P6


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Cost & Price

Output (Q)



LRAC

Q1

Minimumefficientscale (MES)

Scope for many firms to

reach the MES

P6


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Q3Q2Q1

Cost & Price

Output (Q)



LRAC

Q1 Output (Q)

High MES, falling LRAC, barriers tocontestability

Extensive internaleconomies of scaleleading to lower LRAC

LRAC

Natural Monopoly

Minimumefficientscale (MES)

Scope for many firms to

reach the MES

Q4

P6


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Cost & Price

Output (Q)

Cost Advantages for Existing / Established Businesses

Cost advantage for Firm A overa potential rival Firm B

At output Q1 firm A has a bigcost advantage over a

potential rival firm B

Reasons?

Firm B

Firm A

Q1

AC (B)

AC (A)

P6


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Cost & Price

Output (Q)

Cost Advantages for Existing / Established Businesses

Cost advantage for Firm A overa potential rival Firm B

At output Q1 firm A has a bigcost advantage over apotential rival firm B

1. Learning economies2. Vertical integration

3. Lower customer churn4. Monopsony power

Firm B

Firm A

Q1

AC (B)

AC (A)

P6


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Cost ,Price

Quantity of output

Plant close-downs and market exit

MC

AC

AVC

P7


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Cost ,Price

Quantity of output


MC

AC

AVC

P7

AR

MR

Q1

P1


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Cost ,Price

Quantity of output


MC

AC

AVC

P7

AR

MR

Q1

P1

C1


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Cost ,Price

Quantity of output


MC

AC

AVC

P7

AR

MR

Q1

P1

C1

Business is making a losshere because P < ACi.e. sub-normal profit


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Cost ,Price

Quantity of output

Showing the shut down price and the normal profit price on a diagram assume this firm is operating in a perfectly competitive market

MC

AC

AVC

P8


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Cost ,Price

Quantity of output


MC

AC

AVCP1

P1: Price = average cost,normal profits made

P8


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Cost ,Price

Quantity of output


MC

AC

AVC

P2

P1

P1: Price = average cost,normal profits made

P2: Price = averagevariable cost P=Min AVC is the shut down

price for a competitive firmin short run

P8


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Business ObjectivesMost businesses are

profit -seeking butnot necessarily profit

maximising


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Moving Away from ProfitMaximisation


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1. The condition for profit maximisation isthat the firm produces where Marginal Cost(MC) equals Marginal Revenue (MR)

2. Producing less than this means the firm ismissing out on revenue which is could gain.

3. Producing more than this means the extraproduction costs the firm more than it isreceiving in revenue.

Satisficing


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Satisficing

behaviour

SocialEnterprises

Recession

NationalisedIndustries

Response toNew Rivals

GovernmentIntervention

P9


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Network Rail State-Owned Business

Aim - deliver a safe, reliableand efficient railway

Profits are invested in

the railway networkTrain operating companies pay Network

Rail for use of the rail infrastructure

In 2011 Network Rail madeprofits of 750 million


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Download all of todaysresources, including

suggested answers from

www.tutor2u.net/a2micro2012.pdf


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http://www.scoop.it/t/unit-3-micro-business-economics


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Session 2Market Power, PricingStrategies, Economic

Efficiency and Welfare

P10


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Market Shares in Retail Banking

Personal current accounts March 2010 marketshare (%)

Lloyds TSB / Halifax Bank of Scotland 30Royal Bank of Scotland Group (RBS) 16HSBC (including First Direct) 14Barclays 13Santander (Abbey, Alliance & Leicester) 12Nationwide Building Society 7

Co-operative Bank 3National Australia Group Europe (Clydesdale Bank& Yorkshire Bank)

2

Source: Office of Fair Trading

P10


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The Reality of Market Power

PricingPower

EntryBarriers

MonopsonySupplyChain

Control

Economiesof Scale

Industry Leadership Benchmark Businesses

Profits to re-invest Habitual consumption

P11


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Economic EfficiencyP10


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The main types of economic efficiency

Allocative Productive Dynamic

Where price = MCProducing at the lowest

point of theaverage cost curve

Changes in the

choices available in amarket over time


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Cost & Price

Output (Q)

Allocative Efficiency Competition / Pure Monopoly

Perfectly Competitive Market

S1

D1

P1

P2

Entry ofnew firms

drivespricelower

MC

P12

S2

AC


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Cost & Price

Output (Q)


Perfectly Competitive Market

S1

D1

P1

P2

Entry ofnew firms

drivespricelower

MC

P1 P1

AC

Q1

P12

S2

ll ff l


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Cost & Price

Output (Q)


Cost & Price

Output (Q)

Perfectly Competitive Market Pure Monopoly Market

S1

D1

P1

P2

Entry ofnew firms

drivespricelower

AC

MC

AC

MC

Monopolydemand

(AR)MR

P1 P1

Q1 Q2

P2

P12

S2

All i Effi i C i i / P M l


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Cost & Price

Output (Q)


Cost & Price

Output (Q)


S1

D1

P1

P2

Entry ofnew firms

drivespricelower

AC

MC

AC

MC

Monopolydemand

(AR)MR

P1 P1

Q1 Q2

P2

C2

P12

S2

All i Effi i C i i / P M l


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Cost & Price

Output (Q)


Cost & Price

Output (Q)


S1

D1

P1

P2

Entry ofnew firms

drivespricelower

AC

MC

AC

MC

Monopolydemand

(AR)MR

P1 P1

Q1 Q2

P2

C2

Monopoly ProfitP>MCLoss of allocativeefficiency

P12

S2

Monopoly pricing can leadto deadweight loss of

consumer welfare

P i Di i i iP12


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Price DiscriminationP12


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Aims of Price Discrimination

P13

Extra Revenue Higher Profit Improved Cash Flow

Use Up SpareCapacity


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Types of Price Discrimination

1. Third-degree price discrimination occurs whendifferent prices are charged to groups of buyers intotally separate markets.

2. First-degree price discrimination occurs when eachunit of output is sold at a different price such that allconsumer surpluses go to the seller.

3. Second-degree price discrimination occurs when theseller prices the first block of output at a higher pricethan subsequent blocks of output.

4. The hurdle method of price discrimination existswhen the seller offers a lower price, coupled with aninconvenience that rich consumers prefer to avoid.


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Price Discrimination in Action: Segmenting the Market


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Cost & Price

Output (Q)


Cost & Price

Output (Q)

Market A Market B

AR

MR

MR

AR

LRAC = LRMCLRAC = LRMC

P13



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Cost & Price

Output (Q)


Cost & Price

Output (Q)

Market A Market B

AR

MR

MR

AR

LRAC = LRMC

P1

Q1

LRAC = LRMC

P13



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Cost & Price

Output (Q)


Cost & Price

Output (Q)

Market A Market B

AR

MR

MR

AR

LRAC = LRMC

P1

Q1

LRAC = LRMC

Supernormalprofit

P13



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Cost & Price

Output (Q)


Cost & Price

Output (Q)

Market A Market B

AR

MR

MR

AR

LRAC = LRMC

P1

Q1

LRAC = LRMC

Supernormalprofit

Q2

Supernormalprofit

P2

P13



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Cost & Price

Output (Q)


Cost & Price

Output (Q)

Market A Market B

AR

MR

MR

AR

LRAC = LRMC

P1

Q1

LRAC = LRMC

Supernormalprofit

Q2

Supernormalprofit

P2

P3

P3 prices thisgroup out ofthe market

P3

P13


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Evaluation Question

Evaluate the view thata strategy of pricediscrimination by aproducer always worksmore in the interestsof producers ratherthan consumers andsociety as a whole

P14

P14


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Pricing in interests of producers

Exploitation of the consumer themajority still pay > marginal cost

Extraction of consumer surplus turned

into higher producer surplus / profit

Possible use as a limit pricing tactic /and a barrier to entry

Reinforces the monopoly power /dominance of existing firms

P14

f dP14


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P14

f dP14


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P14

P i i i i f dP14


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P14

E l i CP14


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Evaluation: Counter-arguments

Potential for cross subsidy ofactivities that bring social benefits

Making better use of spare capacity

Bringing some new consumers intomarket otherwise excluded by price

Use of monopoly profit for research this is a stimulus to innovation

P14

E l i CP14


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P14

E l i CP14


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P14

E l i CP14


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P14

S A l i H k h


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Smart Analysis : Huge market growth

P15

Falling prices for smartphones P15


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Falling prices for smartphones

According to one forecast,the global smartphonemarket will grow 34 percent over the next twelvemonths with sales of 285munits in 2013 but averageselling prices ofsmartphones will fall 9 percent to $273.

P15

S t h M k t Sh (2012)


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Smartphone Market Share (2012)

Samsung 22%

Nokia 19%

Apple 5%

RIM (Blackberry)2%

HTC 4%

SmartphoneMarket Share (%

of Global Sales,Q3 2012)


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Smartphones A Decreasing Cost Industry?


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Cost & Price

Output (Q)

p g y

Internal Economies of Scaleand the Price of Smartphones

AC1

AC2

MC1

MC2

AR

MR

Profit maximising price when costs

are high is P1 and Q1

When economies of scale areachieved, the profit-maximisingprice falls to P2 and outputexpands to Q2

P1

Q1

P2

Q2

P15



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Cost & Price

Output (Q)

p g y

Internal Economies of Scaleand the Price of Smartphones

AC1

AC2

MC1

MC2

AR

MR

Profit maximising price when costs

are high is P1 and Q1

When economies of scale areachieved, the profit-maximisingprice falls to P2 and outputexpands to Q2

Economies of scale mean lowerprices for consumers

And higher profits formanufacturers of smartphones!

P1

Q1

P2

Q2

C2

Supernormalprofit!

P15



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p g y

Cost & Price

Output (Q)

External Economies of Scale inSmartphone industry

LRAC1

External economies of scale (EEoS)

When the long-term expansion ofan industry leads to thedevelopment of ancillary serviceswhich benefit suppliers in theindustry

Industry expertise / skilledlabour

Relocation of key supplybusinesses

Investment in infrastructure Links with universities and

other research businesses

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p g y

Cost & Price

Output (Q)

External Economies of Scale inSmartphone industry

LRAC1

External economies of scale (EEoS)

When the long-term expansion ofan industry leads to thedevelopment of ancillary serviceswhich benefit suppliers in theindustry

Industry expertise / skilledlabour

Relocation of key supplybusinesses

Investment in infrastructure Links with universities and

other research businessesLRAC1 with externaleconomies of scale

P15

Intense competition Emerging Markets


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What factors other than

cost might help to explainwhy average selling pricesof smartphones areexpected to fall by nearly10 per cent in 2013? Substitute Devices Satisficing Behaviour

P15

Monopsony Power in Markets


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Monopsony Power in Markets

P16

Effects of Monopsony on Welfare P16


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Effects of Monopsony on Welfare

Monopsony power

1: Food retailers 2: Electricity generators 3: Coffee / cocoa roasters 4: Amazon / Apple 5: National Health Service

The Book Market Supply Chain


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Authors/Agents

Wholesalers

Retailers

Consumers

Publishers/Distributors

BookstoresChains

IndependentBookstores Supermarkets

InternetRetailers

Book Clubs

monopsony power for major buyers

P16

Amazon Market PowerP16


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Amazon Market PowerVolume Value

% %

Chain bookshops* 29 36

Independent bookshops 4 5

Bargain bookshops 9 4

Supermarkets 13 10

Other shops 12 8

Book clubs 6 6

Internet-only retailers# 27 31

* Waterstones, WHSmith, Blackwell# Internet only e.g. Amazon, Play.com

Internet Only Book Salesin UK (2011)

Marketshare

Amazon 70%

The Book Depository 4-5% Play.com 3-4% Others (includingpublishers direct)

22%

Amazon and Monopsony Power


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Amazon and Monopsony Power

Application: How doesAmazon gain frommonopsony power?

1: Cheaper prices frompublishers

2: Charge a premium forsellers on Market Place

3: Ability to under cutother book retail channels


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The effect of monopsony on welfare


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The effect of monopsony on welfare

Evaluation: What can producers do iffaced with monopsony power?

1: Form co-operatives 2: Lobby competition authorities 3: Build their own retail channels

e.g. small bookshops going online

P16

Monopsony Power in Labour Markets P17


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Monopsony Power in Labour Markets Lower Wages?


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Wage

Labour(Employment)

Monopsony Employer

MC labour

LabourDemand

(MRPL)

Laboursupply

Profit maximising employment

level is where MRPL = MC labour

This gives employment of E1 themarginal revenue product is W1

But employer needs only pay an

average weekly wage of W2 tohire these workers

Monopsony employer using theirbuying wage to pay wages belowthe fair value of output from theiremployees

An abuse of market power?A cause of relative poverty?

W1

W2

E1

P17


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Monopsony Power in Labour Markets Minimum Wages


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Wage Possible Effects of a Minimum Wage

Labour(Employment)

MC labour

LabourDemand

(MRPL)

Laboursupply

Minimum wage is a pay floor

Minimum hourly pay rate

Must be set above usual freemarket wage

Monopsonist must pay this wage

Employment rises to E2

More people employed at a higherwage

Other factors affecting wages areheld constant in this analysis

MinWage

E2

W2

E1

P17


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Download all of todays

resources, includingsuggested answers from



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Session 3

The Economicsof Oligopoly

P19

Oligopoly Behaviour


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Oligopoly Behaviour

Main characteristics of an oligopoly P19


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Main characteristics of an oligopoly

Best defined by the actual behaviour of firms

A market dominated by a few large firms

High market concentration

Each firm supplies branded products

Barriers to entry

Interdependent decisions

Oligopoly (O) , duopoly (D) or a highly


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competitive (C) market you decide!

Household detergentsuppliers in the UK

UK High Street Banks

Plumbers and decorators inManchester

P19


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Pharmacies in Bristol


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Pharmacies in Bristol

Pharmacies incentralBirmingham

The Kinked Demand Curve Model


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Cost & Price

Output (Q)

MR AR

MC

P1

Q1

Importance of Non-PriceCompetition in Oligopoly

Price stickiness observed in oligopoly

Price may remain close to P1

Non price competition important ingrowing / protecting market share

Lots of different examples of non-price competition evident in this

market structure

P20

Non-Price Competition is key to market share and profitability


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Cost & Price

Output (Q)

MR AR

MC

P1

Q1

Non-Price Competition in Oligopoly

Innovation Quality of service

Upgrades Exclusivity

P20

Oligopolistic Energy Market in the UK


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Oligopolistic Energy Market in the UK

Three million EDF Energy customerswill see their gas and electricity billsrise by nearly 11 per cent on averagefrom December 7. The company, whichis blaming high wholesale energy costsfor the price rise, is the fifth majorenergy firm to announce an increase inrecent months, following ScottishPower, nPower, British Gas and SSE.P20

Overt collusion


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Overt collusion

P21

What is meant by tacit collusion?


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What is meant by tacit collusion?

P21

What are the main aims of price fixingb fi i li l ?


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by firms in an oligopoly?

Businesses recognise their interdependence andact together aim to maximise joint profits

Cut the costs of competition e.g. wastefuladvertising / marketing wars

Reduces uncertainty higher profits increasesproducer surplus / shareholder value

P21

Pricing Fixing


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g g

Price-Fixing Cartel in an Oligopoly


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Cost & Price

Output (Q)

Cost & Price

Output (Q)

Industry Demand and Costs Cartel Price and the Individual Member

MC

MR AR

Q1

P1P1 becomes cartel price

P21



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P1

Q1

Cost & Price

Output (Q)

Cost & Price

Output (Q)


MC

MR AR

MC Firm A

AC Firm AP1 becomes cartel price

P1

P21



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P1

Q1

Cost & Price

Output (Q)

Cost & Price

Output (Q)


MC

MR AR

MC Firm A


P1

Outputquota for

firmP21



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P1

Q1

Cost & Price

Output (Q)

Cost & Price

Output (Q)


MC

MR AR

MC Firm A


P1

Outputquota for

firm

C1

Super-normalprofit for thisfirm in the cartel

Profit atcartel priceand stayingwithin the

quota

P21



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P1

Q1

Cost & Price

Output (Q)

Cost & Price

Output (Q)


MC

MR AR

MC Firm A


P1

Outputquota for

firm

C2

Cheating exceedingthe quota

Higher profitfrom producingin excess of theoutput quota

Increasingoutput toachievehigherprofits

P21



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P1

Q1

Cost & Price

Output (Q)

Cost & Price

Output (Q)


MC

MR AR

MC Firm A


P1

Outputquota for

firm

C2

Cheating exceedingthe quota

RISK!Over-supply

threatensstability of

cartel

P21

Why are many producer cartel agreementsunstable and tend to collapse or break down?


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unstable and tend to collapse or break down?

Falling market demand Over-production

Exposure by authorities Entry of non-cartel firmsP21

Economic cost of collusion


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Damages consumer welfare Higher prices / lost consumer surplus Hits lower income families

Absence of competition hits efficiency X-inefficiencies / higher costs Less incentive to innovate

Reinforces monopoly power

Harder for new businesses to enter

P21

Collusion can bring benefits


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gIndustry standards Pharmaceutical research Car safety technology

Fair Prices for producer cooperatives Competing with monopsonistic corporations

Profits have value how are theyused? Capital investment

P21


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Pricing Games


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g

In this two firm game, each decides whether to

charge a low price or a high price

( profit) Firm B

Low Price 6 High price 8

Firm A Low price 6 (2, 2) (5, 1)

High price 8 (1, 5) (3, 3)

The dominant strategy for each player in this game isto charge? Low Price / High Price

P23

Pricing Games


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1. Does A have a dominant strategy?2. Does B have a dominant strategy?3. Is there Nash equilibrium in this game?

( profit or loss) Firm B

Low Price High price

Firm A Low price (1, 1) (3, -1)

High price (-1, 3) (4, 2)

P23

Game theory and entry deterrence


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P23

Entry Deterrence in a Market


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1. Does Firm A have a dominant strategy in this game?2. If B enters the market does it charge a low or a high price?3. Will the threat of A to charge a lower price deter firm B?4. How can Firm A create a credible threat to firm B that

might prevent it from entering the market?

( profit or loss) Firm B

Enter market Do not enter

market Firm A Low price 6 (3, -1) (3, 1)

High price 8 (4, 5) (6, 3)

Firm A is already in a market and can choose a low or a high price. Firm B is apotential entrant / competitor in the market. The payoffs show the profits or

losses arising from decisions taken in the game

P23

Co-operation in MarketsP24


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JointVentures

IndustryStandards

Open SourceMovement

Co-operatives

V d f

P24


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NETWORK SHARING

VodafoneandTelefonica

FUEL CELL RESEARCH

Toyotaand BMW AIRLINES

Star

Alliance

Business / Industry Co-operation


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Gains from Co-operationP24


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ProductiveEfficiency

DynamicEfficiency

Poverty

Reduction

SocialWelfare

Gains

EthicalBusiness

D l d ll f t d


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D l d ll f t d


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P25


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Session 4Competition Policy in

Action UK andEuropean Focus

Economic EfficiencyP25


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The main types of economic efficiency


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Allocative Productive Dynamic

Competition Policy OverviewP25


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Sector / Industry Price caps forwholesale prices?

Price caps for retailprices?

Length of pricecontrol period

Form of pricecapping used

Water and sewerage No Yes Five years RPI + K

Telecommunications Yes caps on mobiletermination charges(roaming fees)

No On-going no fixedprice cappingperiod

Long runincremental cost

Electricity Yes price caps fortransmission anddistribution

No Five years, soon tobe eight years

RPI-X soon to beRIIO

Gas Yes transportationand distribution

No Five years, soon tobe eight years

RPI-X soon to beRIIO

Postal Services Yes for pre-sortservices and pricespaid by non-Royal-Mail businesses foraccess to mailnetwork

Yes prices capped periodicincreases in pricesallowed

Two-year pricefreeze after a pricereview large risein stamp prices in2012

RPI-X for retailpostal charges butthis price control isset to be abolished

Judging Effectiveness of Regulation


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Real prices Size of profits Jobs Performance

targets

Researchspending

Productivity Environmentalindicators

Investment innew capacity

P25


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BAA Case Study


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P26

BAA and Airport Sales


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P26

Airports close to capacityP27


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Heathrow and Gatwick are two of the worlds busiest airports and bothoperate very close to full-capacity. Explain what operating at near-capacitymight mean for their costs of production. Use an appropriate diagram if youfeel it helps your answer


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157/222

Airports Operating Close to Capacity

P27


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Price ofairport

landingfees

Output (Q)Volume of flights /

passengers

Reaching Capacity LimitsSupply

Demandoff-peak

Demand

peak-times

P1 (offpeak)

P2(peak)

Water Industry Economics

P28


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160/222

Water Industry Profits Using Double Diagrams

P29


161/222

Price, Cost

Output (Q)

Price, Cost

Output (Q)

P1

Q1

MR

AR

MC

ACC1

Short RunMonopoly


P29


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Price, Cost

Output (Q)

Price, Cost

Output (Q)

P1

Q1

MR

AR

MC

ACC1

Monopolyprofit

Short RunMonopoly


163/222


C

P29


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Price, Cost

Output (Q)

Price, Cost

Output (Q)

P1

Q1

MR

AR

MC

ACC1

Monopolyprofit

Consumersurplus

Short RunMonopoly

Long RunMonopoly

AR

MR

LRACLRMC


C

P29


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Price, Cost

Output (Q)

Price, Cost

Output (Q)

P1

Q1

MR

AR

MC

ACC1

Monopolyprofit

Consumersurplus

Short RunMonopoly

Long RunMonopoly

AR

MR

LRACLRMC

Q2

P2

C2


C

P29


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Price, Cost

Output (Q)

Price, Cost

Output (Q)

P1

Q1

MR

AR

MC

ACC1

Monopolyprofit

Consumersurplus

Short RunMonopoly

Long RunMonopoly

AR

MR

LRACLRMC

Q2

P2

C2

Economiesof scale

Higherprofits

EU Mobile Price Caps

P31


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Capping Mobile Charges


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Cost &

In the diagram below, draw in the unregulated profit maximisingprice and output

P32


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Price

Output (Q)

AC1MC1

D=ARMR1

Cost &


P32


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Price

Output (Q)

AC1MC1

D=ARMR1

P1

Q1

Profit max

price

Cost &


P32


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Price

Output (Q)

AC1MC1

D=ARMR1

P1

Q1

C1

Monopolyprofit

Cost &

Where must a price cap be set to have any impact on the market?Draw this onto your diagram

P32


172/222

Price

Output (Q)

AC1MC1

D=ARMR1

P1

Q1

Price Cap (ceiling)Price Cap


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Cost &

Where must a price cap be set to have any impact on the market?Draw this onto your diagram

P32


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Price

Output (Q)

AC1MC1

D=AR

MR1P1

Q1

Price Cap

Q2

Lower price leads to an

expansion of demand

Price Cap (ceiling)

Cost &

Price caps (ceteris paribus) lead to lower profit margins

P32


175/222

Price

Output (Q)

AC1MC1

D=AR

MR1P1

Q1

Price Cap

Q2

Lower price leads to anexpansion of demand

C2

Cut in profitper unit

Price Cap (ceiling)

Evaluating Price Caps in MarketsP33


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Benefits A surrogate for

competition Holds pricesdown consumerwelfare gains

Incentives to cutcosts to maintainprofits

Downsides Reduces profits

and incentive toinvest May dissuade

new entrants Mobile firms

might raise pricesin other ways

Alternatives mightwork better

Measures to

reduce entrybarriers

Higher taxes onmonopoly profits

Mobile Profits


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178/222

Evaluation in a ParagraphEvaluation must relate tothe point / argument thathas already been made in

your paragraph

Aviation and Intervention

P34


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180/222

Evaluation in a ParagraphEvaluation should be

backed up with evidenceand/or knowledge to gain

full credit

Carbon Trading and Carbon Taxation - Business Impact P35

Carbon price


181/222

Recessioncauses price ofpermits tocollapse

recovers but

high enough tomake adifference?

2012 price stuckbelow Euro 10 pertonne excesssupply of carbonpermits

Price of

Carbon Trading and Carbon Taxation - Business Impact

Carbon Trading Market

P35


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carbonpermit

Quantity of permits(1 permit = 1 tonne

CO2)

Supply ofPermits

Euro 20

Q1

Demand forPermits

Price of



P35


183/222

carbonpermit


CO2)

Supply ofPermits

Euro 20

Q1

Demand forPermits

D2

Euro 30

Price ofb



P35


184/222

carbonpermit


CO2)

Supply ofPermits

Euro 20

Q1

Demand forPermits

D2

Euro 30

Q2

S2Euro 35


Cost, Price The Effect of a Carbon Tax on Producers

P35


185/222

Output (Q)

MC

MR

AR

AC



P35


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Output (Q)

MC

MR

AR

AC AC2

MC2



P35


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Output (Q)

MC

MR

AR

AC AC2

MC2

Q1Q2

P1P2

Costs,Benefits

Externalities in the Airline Industry P35


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Benefits

Output (Q)Volume of flights

By 2020, global international aviationCO2 emissions are projected to be

around 70% higher than in 2005even if fuel efficiency improves by

2% per year.

Direct emissions from aviationaccount for about 3% of the EUs

total greenhouse emissions.

Including aviation in the EUemissions trading scheme is forecastto save around 176 million tonnes ofCO2 emissions over the period up to

2015.

MPC

MPB

Costs,Benefits



189/222

Benefits


MPC

MPB

MSC

Qp

Using an appropriate diagramexplain how the EU airline industry

leads to a divergence betweenprivate and social costs and benefits

Externalities are third partyeffects arising from production

and consumption of goods andservices for which no appropriatecompensation is paid

Costs,Benefits



190/222

Benefits


MPC

MPB

MSC

External Cost

Qp

Using an appropriate diagramexplain how the EU airline industry

leads to a divergence betweenprivate and social costs and benefits

Externalities are third partyeffects arising from production

and consumption of goods andservices for which no appropriatecompensation is paid

Costs,Benefits



191/222

Benefits


MPC

MPB

MSC

External Cost

QpQs

SocialOptimumOutput

Free market equilibrium (at Qp) isdifferent from the social optimum

(we are not showing possible positive externalities from

consumption here)

Market failure when the market pricefails to take into account the externalcosts

Evaluate the argument that participation in the EU carbontrading scheme is likely to be most effective policy for reducing

b i i f th E i li i d t

P36


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carbon emissions from the European airline industry

The EU brought in the Emissions TradingScheme for airlines on 1 January. Thisapplies to internal flights, that begin andend within the 27-country single market

Aircraft using airports within the EU mustpay a tax on each tonne of CO2 emitted.The airlines have said that this will costthem 14.0bn over eight years

Evaluate the argument that participation in the EU carbon trading scheme islikely to be most effective policy for reducing carbon emissions from the

European airline industry


193/222

P36

Explain &AnalyseCarbonTrading

Conditions

for carbontrading to beeffective

Criticalevaluation problems

with trading

Viablealternatives

moreeffective?

KnowledgeAnalysis

Analysis

Evaluation

Evaluation


194/222




195/222

P36

Collapse of EU carbon price makes it ineffective

Imposes extra costs on EU airlines already struggling

Government failure e.g. fraud from allocating permits

Might cost jobs in an important industry for the EU

Variable / uncertain price of carbon limits incentive to invest

Criticisms ofcarbontrading


196/222

In the long run.. Strong evaluation mightcompare short run v longrun effects from a policy

intervention




197/222

P36

Carbon or fuel taxation gives more certainty

Tougher industry regulations

Tax incentives for innovation

Market forces work in long run

Global approach needed to cut emissions

Alternativesand a LongRun

Perspective


198/222

The KnowledgeStudents with currentknowledge invariably

outscore those who dont true for micro and macro!



199/222



Session 5P37


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Session 5Improving your examtechnique and scoresin the A2 micro paper

Quick Advice on EdExcel Unit 3P37


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Quick Advice on EdExcel Unit 3P37


202/222

1. Define term2. Explain answer3. Draw or annotate diagram4. One knock-out (rejection)

Another structured MC example


203/222

P38

Another structured MC example

1. Define term2 E l i


204/222

2. Explain answer3. Draw or annotate diagram4. One knock-out (rejection)

1. Revenue maximised when MR = zero2. Unsold flowers can be offered at a price

discount to run down stocks. This is a formof second-degree price discrimination

3. Likely to be elastic demand, flowers haveto be disposed of anyway

4. Draw a diagram to illustrate. P1 is profit

maximising price, P2 is a revenuemaximising price Q1-Q2 sold at thelower price adding to revenue

5. One knock-out, predatory pricing is illegalin UK

Price

Qty

MC

AR

MR

P1

Q1 Q2

P2

P38

Building a Good AnswerIntroduction


205/222

Introduction

Paragraph

Points

Conclusion

An effective paragraph..


206/222

Makes 1 relevant pointto an

appropriate depth

= 6 to 8 sentences

Explain how both a firm and its consumers may beaffected by economies of scale


207/222

P40


208/222



209/222

Defineyour terms

Internal EoS External EoS

InternalEconomies

Falling long rununit cost

Increasingreturns to scale

ExternalEconomies

Growth of anindustry

Lowers unit costsfor mostbusinesses

P40



210/222

Analyse Good diagram Bring in MES

Impact onfirms

Lower averagecost from rising Q

Higher profits(producer surplus)

Impact onconsumers

Reduction in realprices

Increasedaffordability consumer surplus

No evaluationneeded in thisquestion! P40



211/222

Price

Output (Q)

Economies of Scale Benefitsfor Businesses and Consumers

LRAC

AR =demand

P40



212/222

Price

Output (Q)

Economies of Scale Benefitsfor Businesses and Consumers

LRAC

AR =demand

P1

C1

Profit atoutput Q1

Q1 P40



213/222

Price Economies of Scale Benefitsfor Businesses and Consumers

LRAC

AR =demand

P1

C1

P2

C2

Q1 Q2

Profit atoutput Q1

Profit atoutput Q2

P40



214/222


LRAC

AR =demand

P1

C1

P2

C2

Q1 Q2

Profit atoutput Q1

Profit atoutput Q2

Gain inconsumersurplus

P40



215/222


LRAC

AR =demand

P1

C1

P2

C2

Q1 Q2

Profit atoutput Q1

Profit atoutput Q2


Economies of scale havethe potential to benefitboth producers andconsumers higherprofits and lower prices

P40



216/222


LRAC

AR =demand

P1

C1

P2

C2

Q1 Q2

Profit atoutput Q1

Profit atoutput Q2


LRAC2Externaleconomies ofscale here

P40


217/222

Discuss whether utilities such as train operating companies, water, andtelecoms businesses are better left in the private sector or whether all, or

some, should be taken back into public ownership


218/222

Deeper evaluation (4+1 approach)Outline (explain/analyse) and then evaluate 4 separate points with a brief finalreasoned evaluative paragraph


219/222

reasoned evaluative paragraph

1/ Case forprivate sector

Profitmotive

Dynamicefficiency

2/ Stateownership

option Objectives? Outcomes?

3/ Impact onstakeholders

Consumers Employees Taxpayers

4/ Alternativesto public

sector

Competitionpolicy

Businesstaxation

Evaluate the case for stronger action by governments to protectconsumers from the monopoly power of firms involved insupplying gas and electricity to UK homes and businesses


220/222

Please notethe error inthe workbook

Significant rise in average energy bills in the UK this is amajor policy issue directly affects millions of consumersand businesses.

Evaluate the case for stronger action by governments to protectconsumers from the monopoly power of firms involved insupplying gas and electricity to UK homes and businesses

l One main point per paragraph


221/222

Please notethe error inthe workbook

Build theeconomiccase foraction

High prices /allegationsof collusion

Tougherprice caps?

Createcompetitionin thewholesalemarket?

Supernormalprofits

Windfall Taxon profits

StateOwnership

Rising fuelpoverty /complexprices

Cheapesttariff asdefault

Usingwindfall taxto fundinsulation

One main point per paragraphBuild an argument, support, then evaluateEvaluation must relate to the point that has already been made

Evaluation1. Large barriers to entry2. Huge economies of scale3. Limited contestability is a

feature of the market

Evaluation1. Abnormal profits used to

fund capital investment2. Long term energy security3. Nationalisation &

inefficiency

Evaluation1. Fewer tariffs but higher

average prices2. Windfall tax discourages

investment & research3. Government failure when

using revenues



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