EconomicsNotes

  A firm’s costs are made up of fixed and variable costs. Fixed costs do not change with output, and therefore fall when averaged. Variable costs do change with output, and will eventually always increase because of rising marginal costs, which in turn cause returns to diminish with each extra item of output before becoming negative.   The lowest point of each short-run average cost curve forms a point on the long-run average cost curve (the short run being the period when at least one factor of production is fixed and the long run being that when all factors can be varied.) It follows that there will be a point on the Long-run average cost curve when a firm reaches its lowest LRAC, and that the LRAC will have been falling as each successive SRAC falls ‘downwards’ along it.  The explanation for why this process occurs is not linked to any one cause, and could involve falls in wage, raw material, regulatory, or business costs.  They could also be the result of econo...

  A perfect market is one in which an homogenous product is freely traded to sovereign consumers. Perfect knowledge and perfect information exist, so that all sellers, of whom there are many, know the production and sales techniques of all others and can replicate them, and all consumers know where they can always obtain the cheapest products. There are no legal, supply chain, or cost barriers to entry or exit into the market, and consumers are completely elastic, so that average revenue is equal to marginal revenue at the equilibrium price. The price is set purely by the meeting of supply and demand. In such circumstances, normal economic rules apply. Consumers would be seeking to maximise their utility and producers would be seeking to maximise their profits. Profit is the difference between revenue and cost and is maximised where marginal revenue is equal to marginal cost. This means that in a perfect market all profits are normal profits. Firms will only operate to cover oppo...

  Economic theory holds that competition between many small firms, with no barriers to entry or exit and an homogenous product, is an ideal state. This is because the consumer will be sovereign in such a situation, and each individual firm will face an horizonal AR and MR line corresponding to the market equilibrium price. In order to exist and make normal profit, a firm will therefore push costs down to the lowest average cost or leave the market, which is also the point where average cost will equal marginal cost and marginal revenue. This will result in allocative and productive efficiency and create an incentive for anyone with innovative ideas to temporarily push costs lower, making an abnormal profit. In the long run, however, since perfect knowledge and perfect information might exist in such circumstances, every supplier will copy the original breakout firm, and customers will gain more goods at a lower price because of the increase of supply. In this perspective, merger...

The theory of oligopoly is focussed on a stable market in which a few large firms dominate the supply of items and can have power over price or supply. This may be because of economies of scale or high barriers to entry. Barriers to entry can include sunk costs, legal and regulatory protections and requirements such as patents or performance rules, and resource availability. Within such a market, the theory assumes that the Demand curve for the individual firms corresponds to their Average revenue curves. These lines are ‘kinked.’ This means that the AR is inelastic and stable below a certain price point, because customers are not purchasing below the kink based on price, and elastic above the point, because the customers are price sensitive. Very few oligopoly models assume that the AR line is vertical below the kink, which means that there is some scope for different prices at different levels of output. Given that customers are highly inelastic, any price cuts would nevertheless...

    Defining a large business is not easy. Vladimir Lenin, who is not usually viewed as a business guru, did it by default when he wrote that a small business employed five people or fewer. [1] Most economists would point to a variety of metrics, including market share, capitalisation, the overall value of assets or profits, or both, or turnover. Economists argue that businesses want to grow however. This is because larger businesses benefit from economies of scale, either physically, internally, or externally. Larger businesses are thought able to lower long run average costs (LRAC) to their lowest point, the minimum efficient scale (MES), and can hold them there across a range of output. This means that they can ‘stretch out’ the moment of lowest LRAC. Eventually, diseconomies of scale set in as the business gets too big. There are too many managers, or company structures are too complicated, or the business is complacent and develops x-inefficiency and y-inefficiency...

    A firm is an economic entity engaged in business. Economic theory assumes that the firm, like the consumer, maximises its self-interest. This self interest is however the product of the interplay of market structure, business organisation, and chosen or required objective. So, for instance, some firms might choose to profit-maximise, some to profit satisfy, some to revenue maximise, and some to sales-maximise, or even engage in loss-leading predatory behaviours. Oligopoly firms might take their cue from other firms, and find that price-maximisation is only really possible if they can join a cartel; imperfectly competitive firms might sustain a loss in the short run, covering their variable costs and making a contribution to fixed ones, if they think that this will lead to ultimate survival in a temporarily tough market. These decisions often relate to the nature of the firms. A sole trader’s objective, for instance, may include the freedom and control that working for on...

  Nationalisation means the process whereby a business is taken into government ownership and is run by a public authority. Between 1945 and 1985, many British companies were nationalised ones. Governments, starting consistently in the 1980s, sold these companies to the private sector with the aim of changing companies which required public funding into ones that generated tax revenue. In addition, attempts were made to create or emulate markets in the areas where the firms operated, often by breaking the firms up into a number of new ones, so as to introduce choice for customers, competition, and dynamic efficiency. A trade-off was accepted in which formerly public companies made private profits, often accompanied by subsidy, for shareholders, but where shareholders invested in infrastructure and capital. This was accompanied by government regulation of price and services. It was the case, however, that many industries were originally natural monopolies. This is a situation in w...

  Evaluating the likely micro- and macro-economic effects of price controls. Price controls are legal restrictions on the maximum or minimum prices that can be charged for a good. They are imposed by governments either in for the long-term  because of structural problems in a market or political choices, or as short-term provisions in an emergency. They work by making it illegal for traders and consumers to buy or sell goods outside of the set price. If a government imposes a maximum price above the market equilibrium, or a minimum price below the market equilibrium, this should not have any effect on the market equilibrium. Instead, a maximum price for rent, for instance, set above the equilibrium, would in theory restrain bad landlords from exploiting renters. Those economists who believe in free markets would say that landlords should be allowed to practise first degree price discrimination and to charge whatever the market will bear (whatever someone is prepared to...