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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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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
LC ButRising!
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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)
LC
HC
HC
P3
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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)
LC
HC
HC
HC
P3
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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)
LC
HC
HC
HC
LC
P3
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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)
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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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
P1
Revenue maximisedwhen marginalrevenue = zero
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
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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Strategies to Limit Competition
Limit pricing tactics Predatory pricing tactics
Brand proliferation
When a firm sets pricelow enough to
discourage newentrants into themarket
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Strategies to Limit Competition
Limit pricing tactics Predatory pricing tactics
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)
Costs and contestability in different industries
Low MES, limited scaleeconomies, contestable market
LRAC
Q1
Minimumefficientscale (MES)
Scope for many firms to
reach the MES
P6
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Q3Q2Q1
Cost & Price
Output (Q)
Costs and contestability in different industries
Low MES, limited scaleeconomies, contestable market
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
Plant close-downs and market exit
MC
AC
AVC
P7
AR
MR
Q1
P1
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Cost ,Price
Quantity of output
Plant close-downs and market exit
MC
AC
AVC
P7
AR
MR
Q1
P1
C1
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Cost ,Price
Quantity of output
Plant close-downs and market exit
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
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
AVCP1
P1: Price = average cost,normal profits made
P8
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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
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)
Allocative Efficiency Competition / Pure Monopoly
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)
Allocative Efficiency Competition / Pure Monopoly
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)
Allocative Efficiency Competition / Pure Monopoly
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
C2
P12
S2
All i Effi i C i i / P M l
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Cost & Price
Output (Q)
Allocative Efficiency Competition / Pure Monopoly
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
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)
Price Discrimination in Action: Segmenting the Market
Cost & Price
Output (Q)
Market A Market B
AR
MR
MR
AR
LRAC = LRMCLRAC = LRMC
P13
Price Discrimination in Action: Segmenting the Market
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Cost & Price
Output (Q)
Price Discrimination in Action: Segmenting the Market
Cost & Price
Output (Q)
Market A Market B
AR
MR
MR
AR
LRAC = LRMC
P1
Q1
LRAC = LRMC
P13
Price Discrimination in Action: Segmenting the Market
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Cost & Price
Output (Q)
Price Discrimination in Action: Segmenting the Market
Cost & Price
Output (Q)
Market A Market B
AR
MR
MR
AR
LRAC = LRMC
P1
Q1
LRAC = LRMC
Supernormalprofit
P13
Price Discrimination in Action: Segmenting the Market
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Cost & Price
Output (Q)
Price Discrimination in Action: Segmenting the Market
Cost & Price
Output (Q)
Market A Market B
AR
MR
MR
AR
LRAC = LRMC
P1
Q1
LRAC = LRMC
Supernormalprofit
Q2
Supernormalprofit
P2
P13
Price Discrimination in Action: Segmenting the Market
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Cost & Price
Output (Q)
Price Discrimination in Action: Segmenting the Market
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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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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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
P i i i i f dP14
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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
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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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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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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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
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
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
Economies of scale mean lowerprices for consumers
And higher profits formanufacturers of smartphones!
P1
Q1
P2
Q2
C2
Supernormalprofit!
P15
Smartphones A Decreasing Cost Industry?
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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
P15
Smartphones A Decreasing Cost Industry?
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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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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
Price-Fixing Cartel in an Oligopoly
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P1
Q1
Cost & Price
Output (Q)
Cost & Price
Output (Q)
Industry Demand and Costs Cartel Price and the Individual Member
MC
MR AR
MC Firm A
AC Firm AP1 becomes cartel price
P1
P21
Price-Fixing Cartel in an Oligopoly
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P1
Q1
Cost & Price
Output (Q)
Cost & Price
Output (Q)
Industry Demand and Costs Cartel Price and the Individual Member
MC
MR AR
MC Firm A
AC Firm AP1 becomes cartel price
P1
Outputquota for
firmP21
Price-Fixing Cartel in an Oligopoly
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P1
Q1
Cost & Price
Output (Q)
Cost & Price
Output (Q)
Industry Demand and Costs Cartel Price and the Individual Member
MC
MR AR
MC Firm A
AC Firm AP1 becomes cartel price
P1
Outputquota for
firm
C1
Super-normalprofit for thisfirm in the cartel
Profit atcartel priceand stayingwithin the
quota
P21
Price-Fixing Cartel in an Oligopoly
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P1
Q1
Cost & Price
Output (Q)
Cost & Price
Output (Q)
Industry Demand and Costs Cartel Price and the Individual Member
MC
MR AR
MC Firm A
AC Firm AP1 becomes cartel price
P1
Outputquota for
firm
C2
Cheating exceedingthe quota
Higher profitfrom producingin excess of theoutput quota
Increasingoutput toachievehigherprofits
P21
Price-Fixing Cartel in an Oligopoly
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P1
Q1
Cost & Price
Output (Q)
Cost & Price
Output (Q)
Industry Demand and Costs Cartel Price and the Individual Member
MC
MR AR
MC Firm A
AC Firm AP1 becomes cartel price
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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resources, includingsuggested answers from
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D l d ll f t d
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resources, includingsuggested answers from
www.tutor2u.net/a2micro2012.pdf
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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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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Water Industry Profits Using Double Diagrams
P29
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Price, Cost
Output (Q)
Price, Cost
Output (Q)
P1
Q1
MR
AR
MC
ACC1
Short RunMonopoly
Water Industry Profits Using Double Diagrams
P29
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Price, Cost
Output (Q)
Price, Cost
Output (Q)
P1
Q1
MR
AR
MC
ACC1
Monopolyprofit
Short RunMonopoly
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Water Industry Profits Using Double Diagrams
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
Water Industry Profits Using Double Diagrams
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
Water Industry Profits Using Double Diagrams
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 &
In the diagram below, draw in the unregulated profit maximisingprice and output
P32
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Price
Output (Q)
AC1MC1
D=ARMR1
P1
Q1
Profit max
price
Cost &
In the diagram below, draw in the unregulated profit maximisingprice and output
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
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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
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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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Evaluation in a ParagraphEvaluation must relate tothe point / argument thathas already been made in
your paragraph
Aviation and Intervention
P34
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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
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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
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
D2
Euro 30
Price ofb
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
D2
Euro 30
Q2
S2Euro 35
Carbon Trading and Carbon Taxation - Business Impact
Cost, Price The Effect of a Carbon Tax on Producers
P35
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Output (Q)
MC
MR
AR
AC
Carbon Trading and Carbon Taxation - Business Impact
Cost, Price The Effect of a Carbon Tax on Producers
P35
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Output (Q)
MC
MR
AR
AC AC2
MC2
Carbon Trading and Carbon Taxation - Business Impact
Cost, Price The Effect of a Carbon Tax on Producers
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
Externalities in the Airline Industry P35
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Benefits
Output (Q)Volume of flights
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
Externalities in the Airline Industry P35
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Benefits
Output (Q)Volume of flights
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
Externalities in the Airline Industry P35
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Benefits
Output (Q)Volume of flights
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
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P36
Explain &AnalyseCarbonTrading
Conditions
for carbontrading to beeffective
Criticalevaluation problems
with trading
Viablealternatives
moreeffective?
KnowledgeAnalysis
Analysis
Evaluation
Evaluation
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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
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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
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In the long run.. Strong evaluation mightcompare short run v longrun effects from a policy
intervention
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
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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
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The KnowledgeStudents with currentknowledge invariably
outscore those who dont true for micro and macro!
Download all of todays
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resources, includingsuggested answers from
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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
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1. Define term2. Explain answer3. Draw or annotate diagram4. One knock-out (rejection)
Another structured MC example
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P38
Another structured MC example
1. Define term2 E l i
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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
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Introduction
Paragraph
Points
Conclusion
An effective paragraph..
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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
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P40
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Explain how both a firm and its consumers may beaffected by economies of scale
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Defineyour terms
Internal EoS External EoS
InternalEconomies
Falling long rununit cost
Increasingreturns to scale
ExternalEconomies
Growth of anindustry
Lowers unit costsfor mostbusinesses
P40
Explain how both a firm and its consumers may beaffected by economies of scale
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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
Explain how both a firm and its consumers may beaffected by economies of scale
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Price
Output (Q)
Economies of Scale Benefitsfor Businesses and Consumers
LRAC
AR =demand
P40
Explain how both a firm and its consumers may beaffected by economies of scale
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Price
Output (Q)
Economies of Scale Benefitsfor Businesses and Consumers
LRAC
AR =demand
P1
C1
Profit atoutput Q1
Q1 P40
Explain how both a firm and its consumers may beaffected by economies of scale
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Price Economies of Scale Benefitsfor Businesses and Consumers
LRAC
AR =demand
P1
C1
P2
C2
Q1 Q2
Profit atoutput Q1
Profit atoutput Q2
P40
Explain how both a firm and its consumers may beaffected by economies of scale
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Price Economies of Scale Benefitsfor Businesses and Consumers
LRAC
AR =demand
P1
C1
P2
C2
Q1 Q2
Profit atoutput Q1
Profit atoutput Q2
Gain inconsumersurplus
P40
Explain how both a firm and its consumers may beaffected by economies of scale
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Price Economies of Scale Benefitsfor Businesses and Consumers
LRAC
AR =demand
P1
C1
P2
C2
Q1 Q2
Profit atoutput Q1
Profit atoutput Q2
Gain inconsumersurplus
Economies of scale havethe potential to benefitboth producers andconsumers higherprofits and lower prices
P40
Explain how both a firm and its consumers may beaffected by economies of scale
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Price Economies of Scale Benefitsfor Businesses and Consumers
LRAC
AR =demand
P1
C1
P2
C2
Q1 Q2
Profit atoutput Q1
Profit atoutput Q2
Gain inconsumersurplus
LRAC2Externaleconomies ofscale here
P40
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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
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Deeper evaluation (4+1 approach)Outline (explain/analyse) and then evaluate 4 separate points with a brief finalreasoned evaluative paragraph
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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
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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
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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
Download all of todays
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resources, includingsuggested answers from
www.tutor2u.net/a2micro2012.pdf