Top Posts of 2012

Happy new years everyone! Like last year when I posted the top 10 posts of 2011, its time to reveal the most viewed posts of 2012.

10. Once again its Trade Unions, posted on 16 November 2011

9. Word of the Day: Economic Growth posted on 3 August 2011

8. New entry Production Possibility Frontier and Long Run Aggregate Supply posted on 5 August 2011

7. Oligopoly, up from last year posted on 21 April 2012

6. Negative Externalities posted on 16 September 2011

5. Monopoly posted on 23 August 2011

4. Another new entry! Unemployment notes posted on 22 January 2012

3. Non mover Word of the Day: Elasticity posted on 13 August 2011

2. Another non mover Perfect Competition Long Run Equilibrium posted on 11 August 2011

1. A further non mover! The most viewed entry in 2012 was Perfect Competition Short Run Equilibrium posted on 10 August 2011

Seems market structures are popular topics that a lot of you are struggling with, but I'm glad that my posts are being viewed to help you out.

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Profit Maximisation Point

The profit maximisation point is MR=MC. Below are the diagrams for the profit maximisation point for both monopoly and perfect competition markets. The profit maximisation point is the quantity and price level that the firm will produce at to ensure the most benefit. Before point X, MR is greater that MC thus profits will rise and rise. After point X, MC is greater than MR, thus firms do not see it profitable to produce after that point because they lose money.


For a monopolist, firms charge a price level higher than profit maximisation because it maximises producer surplus and consumers are still willing to purchase at that price level (See notes here). The quantity produced remains at Q1. For a firm in perfect competition, the level of output produced is at X and the price charged to consumers is P1, making the firm productively and allocatively efficient. For more notes, see here.

For more notes on perfect competition and monopoly markets, see here and here, respectively.

Top 10 Posts This Year

Today is a very special day, not just because it is New Year's Eve eve, but because it is the blog's five month anniversary with my first post being on purchasing power parity! Below I have compiled a list of the top 10 posts so far. If these are popular, I am assuming they have been most helpful to you guys, so please have a look at all 10, and good luck with your revision.

10. Trade Unions posted on 16th November

9. Oligopoly Case Study  posted on 16th October. Although it was a few months ago, the case study can still be used as an example.

8. Word of the Day: Economic Growth on a PPF posted on 3rd August

7. Notes on Supply Side Economics and Crowding Out posted on 16th October

6. Word of the Day: Backward Bending Supply Curve  posted on 25th August

5. Negative Externalities posted on 16th September

4. Monopoly posted on 23rd August

3. Word of the Day: Elasticity posted on 13th August

2. Perfect Competition Long Run Equilibrium posted on 11th August

1. Perfect Competition Short Run Equilibrium posted on 10th August

It seems perfect competition is the most popular, not surprising because even I had difficulties with this one.

Keep looking out for more revision notes to come soon!

Trade Unions

A collective association of workers whose aim is to improve the pay and conditions of member workers.

Aim to:

·     Improve real incomes

·     Working conditions

·     Pensions

·     Security

·     Unfair dismissal

·     Counter monopsony power

·     Protect against discrimination

Trade union membership has declined to less than 30% of all those employed in the UK (2007). Reasons for this include:

·     Membership is considered to be a waste since the economy was in a boom creating less of a need to bargain for higher wages

·     Tougher employment laws

·     Little evidence for significant mark-ups in wage levels bought about by trade unions

·     You become less employable if you belong to a trade union

·     Changes to the labour market: decline in jobs in heavy industry to more service sector based, shifts towards shorter employment contracts and more people working part-time/flexible hours

·     Some employers restricted trade unions in their work place

Unions influence pay by:

Ø     Collective bargaining

o      negotiate pay levels above the current levels that exist. This is only effective if the union has control over the total labour supply available in the industry.

Ø     Closed shop agreement – employer and union agree that all workers be part of the union

o      Pre-entry: workers must join the union before starting employment

o      Post-entry: non trade union members get the job but have to join to keep the job. This prevents free-riders benefiting from the mark up bought by the union on wages

o      This was considered to be a labour restrictive practice and is now illegal in the UK

Pre-entry closed shop

The diagram below briefly displays a pre-entry closed shop agreement made by unions.

S1 shows the supply for labour in the market before the closed shop agreement. Supply shifts to the left and becomes more inelastic because the increase in wages has minimal effect on employment if the workers have already been employed by the firm. Employment still, however, falls from L1 to L2 when wages rise from W1 to W2.

Perfectly competitive market

To refresh your memory of the PC market, click on the revision notes of the PC market in the short run and long run.

This diagram shows the effects of a trade union in a perfectly competitive market. The equilibrium wage rate is W1 where the number of workers employed is L1. The effect of the trade union is that wages are pushed up to W2 à the acceptable wage rate for union members. The supply curve becomes W2XS. From W2X, the supply curve is perfectly elastic. Along XS, the curve is upwards sloping because more workers are attracted to higher wage rates. The employer wishes to hire L3 workers but the number of workers willing to work at the wage rate of W2 is L2. Thus there is excess supply of labour, causing classical unemployment between L2- L3. 

This diagram argues that the trade union causes unemployment, however one can counter-argue, as in the Keynesian view. It is unrealistic to assume that demand conditions remain unchanged because higher wages would normally increase demand for output, thus increasing output and increasing demand for workers to produce more output.

This diagram can also be used to explain the effect of the National Minimum Wage, as well as trade union mark-ups.

Look out for more on the effects of trade unions in a monopsonistic market soon! (To prepare yourself, you could read Word of the Day)

Word of the Day

Monopsony

A type of market structure where there is only ONE buyer and many sellers. An example of pure monopsony is a firm that is the only buyer of labour in an isolated town. Such a firm is able to pay lower wages than it would under competition. Although cases of pure monopsony are rare, monopsonistic elements are found wherever there are many sellers and few buyers. Monopsonies, like monopolies and oligopolies, are a form of imperfect competition.

Monopoly

·     A few firms dominating the market. Actual monopolies (only one firm in the market) are very rare.

Monopoly Equilibrium

The profit maximisation point is Q1 and P1, where MR=MC. The equilibrium quantity is Q1, however the equilibrium price is not P1. Instead the firm charges P3 since P3 is the maximum price the monopolist firm can charge while succeeding at selling quantity Q1.

Therefore the total revenue gained by the firm is rectangular area P3XQ1O. The total costs the firm incurs is the rectangular area P2YQ1O. The supernormal profits that the monopoly firm makes is P3XQ1O - P2YQ1O (total revenue minus total costs), which equals P3XYP2. This profit is the monopoly profit that the firm makes.

The monopoly IS the industry and therefore there is no separate market demand and supply diagram (like with perfect competition, see here and here). They get combined and put together because the market is the monopoly. AR is downward sloping because if they set a large price, following the law of demand, the number of units they will sell will fall and vice versa.

This diagram is the long run equilibrium and the short run equilibrium. Barriers of entry prevent new firms entering the market, thus monopoly profits are sustained in the long run as well. Firms want to be monopolies because monopoly firms sustain supernormal profits in the long run.

Efficiency

For a monopolistic market, the firm is…

·     NOT allocatively efficient. The firm does not produce above quantity Q1. Price does NOT equal MC.

·     Not productively efficient because it is not producing at its cost minimising point (the lowest point on the AC curve).

Benefits of a monopoly:

·     Market can benefit from economies of scale due to lower ACs.

·     Supernormal profits can be used for R&D.

This model, like perfect competition, can be used to compare real life markets with.

Word of the Day

Perfect Competition

A type of market structure where there are many firms in the market selling a homogenous product. See perfect competition notes short run and long run to learn a more detailed view of perfect competition.

Perfect Competition Long Run Equillibrium

Long run equilibrium

Because supernormal profits can be made in the short run, new firms enter the market.

When new firms enter the market, market supply increases from MS1 to MS2 which drives the price down from P1 to P2. There is a new equilibrium of price P2 and quantity Q2. For the individual firm in the market (diagram on the right), the firm now charges price P2 leading to MR and AR moving down to P2 as well. Point Y is the profit maximisation point (MR2=MC), therefore the firm will sell at quantity Q2 and total revenue gained is the rectangular area P2YQ2O. Because AC=MC, the rectangular for the firm’s total costs is P2YQ2O as well. This means that supernormal profits are not being made, only normal profits are being made. Costs per unit are equal to revenue per unit and so the firm is unable to make supernormal profits in the long run. Price = Long run ACs as well.

Furthermore, the firm is producing fewer units of output. Because there are no supernormal profits being made by firms within the market, there is no incentive for firms to enter or exit the market and the market is said to be at rest.

Efficiency

In the LR in a perfectly competitive market, there is….

·       Productive efficiency because the firm is producing at AC’s lowest point (Q2). The firm is producing at its cost minimising point. Resources are used efficiently.

·       Allocative efficiency because firms are allocating the same amount of extra cost (MC) to customers as customers are allocating extra revenue to firms (P). Therefore P=MC, so it is allocatively efficient.

A perfectly competitive market is the only type of market structure where it is possible to be both allocatively and productively efficient.

This model of a perfectly competitive market is a theoretical extreme and is used to judge how closely real world industries approximate to this even if they are not truly competitive. This model, although unrealistic, holds the strong argument that resources are allocated efficiently and firms make beneficial exchanges which enable it to be efficient. The model provides a benchmark in which imperfectly competitive markets can be compared and contrasted.

Perfect Competition Short Run Equilibrium

Assumptions behind a perfectly competitive market (conditions):

·       Large number of buyers and sellers with insignificant market share.

·       Freedom of entry and exit into the market. There are no barriers to entry and exit in the long run, the market is open to new suppliers.

·       Consumers have perfect knowledge about prices.

·       All firms have equal access to resources (e.g. technology) – perfect factor mobility.

·       Homogenous products that are perfect substitutes for one another.

·       Independent action by firms will not influence the market price as each individual firm is too small. This means that the firm is a price taker.

·       No externalities of production or consumption.

Perfectly competitive markets are rare, however close examples include:

·       Foreign currency – homogenous product, each trader is relatively small in the market and the trader has to take the given price.

·       Fruits and vegetables – homogenous product, firms are price takers, large number of buyers and sellers…etc.

When the firm is a price taker, there is little percentage difference in prices within the market. But most firms sell at the prevailing, ruling market price.

Short run equilibrium

The market ruling price is P1, at equilibrium. The diagram on the left illustrates the whole market, while on the right is the diagram showing the individual firm in the market. As the firm is a price taker, AR=MR=P which also equals market demand because there is lack of brand loyalty, making the demand curve perfectly elastic, and because the firm cannot influence the price.

From the diagram on the right of the individual firm, the firm is producing at profit maximisation, Q1. The shaded area shows the abnormal/supernormal profits being made since the area OP1XQ1 shows total revenue and OP2YQ1 shows total costs. Profits = revenue – costs, therefore profits are equal to OP1XQ1 - OP2YQ1, supernormal profits. The firm is only able to make abnormal profits in the short run in a perfectly competitive market because new firms are attracted by the prospects of making abnormal profits in the long run and enter the market, this erodes the abnormal profits.

However, not all firms make abnormal profits in a perfectly competitive market in the short run. This depends on the position of the AC curve.

For the firm above, there are subnormal profits being made because average costs are greater than average revenues. Selling at the market ruling price of P1 will therefore only enable the firm to make subnormal profits.

Great Perfect Competition Video

Okay, so here's a really good video on Perfect competition.

The first diagram drawn shows abnormal/supernormal profits.
Second diagram drawn shows normal profits.
Third diagram shows subnormal profits.