Unit 3: Consequences of Price Discrimination

Who gains and who loses out from persistent and pervasive price targeting by businesses? To what extent does price discrimination help to achieve an efficient allocation of resources? There are many arguments on both sides of the coin – indeed the impact of price discrimination on welfare seems bound to be ambiguous.


Impact on consumer welfare

Consumer surplus is reduced in most cases - representing a loss of welfare. For the majority of buyers, the price charged is well above the marginal cost of supply.

However some consumers who can now buy the product at a lower price may benefit. Lower-income consumers may be “priced into the market” if the supplier is willing and able to charge them less. Good examples might include legal and medical services where charges are dependent on income levels.

Greater access to these services may yield external benefits (positive externalities) that then affect social welfare and equity. Drugs companies might justify selling their products at inflated prices in countries where incomes are higher because they can then sell the same drugs to patients in poorer countries.

Producer surplus and the use of profit

Price discrimination benefits businesses through higher profits. A discriminating monopoly is extracting consumer surplus and turning it into supernormal profit. Price discrimination also might be used as a predatory pricing tactic to harm competition at the supplier’s level and increase a firm’s market power.

A counter argument to this is that price discrimination might be a way of making a market more contestable. For example, the low cost airlines have been hugely successful by using price discrimination to fill their planes.

Profits made in one market may allow firms to cross-subsidise loss-making activities/services that have important social benefits. For example money made on commuter rail or bus services may allow transport companies to support loss-making rural or night-time services. Without the ability to price discriminate, these services may have to be withdrawn and jobs might suffer.

In many cases, aggressive price discrimination is a means of business survival during a recession. An increase in total output resulting from selling extra units at a lower price might help a monopoly to exploit economies of scale thereby reducing long run average costs.

Unit 4: Development Economics: My country is better than your country!

This website is an excellent addition to the many online resources available for teaching development economics. Using 10 indicators, it allows any two countries to go “head to head” to see which is the better place to live. It is superb for reinforcing evaluation skills as students can discuss whether the final score is a fair reflection or whether some indicators should be given more weight than others.

Click to access excellent link.

In addition to comparing developing to developed economies, it is a great website for encouraging some class banter as you compare countries that your students may be originally from or have links with. The colour coding of the website makes it easy to see which indicator is more positive or negative although some could be debated, for example electricity use is obviously going to be less in developing countries. And birth rate is given a blue coding as it can be difficult to distinguish between too low, the right amount, or too high and any judgement would be normative anyway. Each indicator can then be further explored for more information, including the source.

Putting in New Zealand against the UK, I was surprised (perhaps I shouldn’t have been) to find out we were on the losing side - six to four. Definitely the need for some evaluation on the relative weights of the indicators!

Needing some reassurance that there are countries worse off, I decided to go for Mali and that was a comfortable six to three victory - but how I wish we used 99% less oil!

Unit 4: Do Tariffs actually cut Imports?

The answers is yes and no!

In 2005 the US government slapped anti-dumping tariffs on the imports of Chinese furniture. At the time, imports accounted for 58% of the market for beds and similar items.


What happened next was probably not in the plans of US lawmakers and the local furniture manufacturers who supported the tariffs. Although imports from China did fall sharply, a number of Chinese manufacturers moved their plants to different countries, Vietnam being the main choice. The result was that as of 2010, imports now account for 70% of the total market!

The full story, including some insightful comments from a Chinese furniture manufacturer can be seen in this Washington Post article.


Rather depressingly, the article reveals a problem that often occurs with government intervention.... “The only Americans getting more work as a result of the tariffs are Washington lawyers, who have been hired by both U.S. and Chinese companies. Their work includes haggling each year over private “settlement” payments that Chinese manufacturers denounce as a “protection racket.”

Fearful of having their tariff rates jacked up, many Chinese furniture makers pay cash to their American competitors, who have the right to ask the Commerce Department to review the duties of individual companies. Those who cough up get dropped from the review list.”

Unit 2: Suppy Side Policies - Revision Notes

Here is a streamed presentation of a revision talk on the economics of supply-side policies. The Unit 2 macro syllabus places a heavy emphasis on the supply-side as a driver of economic growth, improved trade balances as a better trade-off between unemployment and inflation. Make sure that you are secure on the main supply-side policy approaches and also the impact of such policies on LRAS. You ought to be aware too of some of the limitations of supply-side policies - and the importance of having a sufficiently high level of aggregate demand. I have linked below to some revision blogs on supply-side topics.


Revision presentation on supply-side policies

Supply-side policies are mainly micro-economic policies designed to make markets and industries operate more efficiently and thereby contribute to a faster rate of growth of real national output.

Policies include:

• Competition policy including privatisation/nationalisation. Deregulation and regulation.

• Policies aimed at stimulating entrepreneurship and the expansion of smaller businesses

• Labour market reforms including tax and benefit changes, migration policy

• Trade policies including membership of the EU single market and WTO commitments

• Policies designed to increase spending on investment and research

Supply-side objectives

The key supply-side concepts to focus on are incentives, enterprise, technology, mobility, flexibility and efficiency.

1. Improve incentives for people to find work

2. Increase labour and capital productivity

3. Increase the occupational and geographical mobility of labour to reduce unemployment

4. Increase capital investment and research and development spending by firms

5. Promoting more competition and stimulate a faster pace of invention and innovation

6. Provide a platform for sustained non-inflationary growth of an economy

If supply-side policies are effective then the British economy can

• Achieve a sustained improvement in the trade-off between inflation and unemployment

• Be more flexible in response to external demand and supply-side shocks

• Raise living standards through stronger long term economic growth

• Reduce unemployment by lowering the natural rate of unemployment and the NAIRU

• Improve competitiveness in global markets and achieve a stronger performance in international trade in goods and services

Unit 2: Demand Pull Inflation - Revision Notes

Demand pull inflation occurs when aggregate demand and output is growing at an unsustainable rate leading to increased pressure on scarce resources and a positive output gap. When there is excess demand in the economy, producers are able to raise their prices and achieve bigger profit margins because they know that demand is running ahead of supply. Typically, demand-pull inflation becomes a threat when an economy has experienced a strong boom with GDP rising faster than the long run trend growth of potential GDP. Demand-pull inflation is likely when there is full employment of resources and aggregate demand is increasing at a time when SRAS is inelastic.


UK Output Gap


The main causes of demand-pull inflation

1. A depreciation of the exchange rate which increases the price of imports and reduces the foreign price of UK exports. If consumers buy fewer imports, while exports grow, AD in will rise – and there may be a multiplier effect on the level of demand and output

2. Higher demand from a fiscal stimulus e.g. via a reduction in direct or indirect taxation or higher government spending. If direct taxes are reduced, consumers will have more disposable income causing demand to rise. Higher government spending and increased government borrowing feeds through directly into extra demand in the circular flow

3. Monetary stimulus to the economy: A fall in interest rates may stimulate too much demand – for example in raising demand for loans or in causing sharp rise in house price inflation. Monetarist economists believe that inflation is caused by “too much money chasing too few goods” and that governments can lose control of inflation if they allow the financial system to expand the money supply too quickly.

4. Fast economic growth in other countries – providing a boost to UK exports overseas. Export sales provide an extra flow of income and spending into the UK circular flow – so what is happening to the economic cycles of other countries definitely affects the UK

Controlling inflation

Inflation can be reduced by policies that (i) slow down the growth of AD or (ii) boost the rate of growth of aggregate supply (AS). The main anti-inflation controls available to a government are:

1. Fiscal policy: If the government believes that AD is too high, it may choose to ‘tighten fiscal policy’ by reducing its own spending on public and merit goods or welfare payments. Or it can choose to raise direct taxes, leading to a reduction in real disposable income. The consequence may be that demand and output are lower which has an effect on jobs and real economic growth in the short-term.

2. Monetary policy: A ‘tightening of monetary policy’ involves the central bank introducing a period of higher interest rates to reduce consumer and investment spending. Monetary policy is designed mainly to control demand-pull inflationary pressures. But it also has an effect on costs, not least through the effect of changes in interest rates on the value of the currency.

3. Supply side economic policies: Supply side policies include those that seek to increase productivity, competition and innovation – all of which can maintain lower prices. These are important ways of controlling inflation in the medium term.

The most appropriate way to control inflation in the short term is for the government and the central bank to keep control of aggregate demand to a level consistent with our productive capacity.

The consensus among economists is that AD is probably better controlled through the use of monetary policy rather than an over-reliance on using fiscal policy as an instrument of demand-management. But in the long run, it is the growth of a country’s supply-side productive potential that gives an economy the flexibility to grow without suffering from acceleration in cost and price inflation.

Unit 2: Cost Push Inflation - Revision Notes

Cost-push inflation occurs when firms respond to rising costs, by increasing prices to protect their profit margins. There are many reasons why costs might rise:

1. Component costs: e.g. an increase in the prices of raw materials and other components used in supplying goods and services. This might be because of a rise in commodity prices such as oil, copper and agricultural products used in food processing. A good recent example is the surge in the world price of wheat


2. Rising labour costs - caused by wage increases, which are greater than improvements in productivity. Wage costs often rise when unemployment is low because skilled workers become scarce and this can drive pay levels higher wages might increase when people expect higher inflation so they bid for higher pay in order to protect their real incomes.

3. Expectations of inflation are important in shaping what actually happens to inflation! When people see prices are rising for the everyday items they purchase they start to get concerned about the effects of inflation on their real standard of living. One of the dangers of a pick-up in inflation is what the Bank of England calls “second-round effects” i.e. an initial rise in prices triggers a burst of higher pay claims as workers look to protect their way of life.

4. Higher indirect taxes imposed by the government – for example a rise in the specific duty on alcohol and cigarettes, an increase in fuel duty or a rise in Value Added Tax. Depending on the price elasticity of demand and supply for their products, suppliers may choose to pass on the burden of the tax onto consumers.

5. A fall in the exchange rate – this can cause cost push inflation because it normally leads to an increase in the prices of imported products. For example during 2007-08 the pound fell heavily against the Euro leading to a jump in the prices of imported materials from Euro Zone countries.

Cost-push inflation such as that caused by a large and persistent rise in the world price of crude oil can be shown in a diagram by an inward shift of the short run aggregate supply curve. The fall in SRAS causes a contraction of national output together with a rise in the level of prices

Unit 2: Recession - Revision Notes

A recession is a hard-landing and means a fall in the level of real national output i.e. a period when the rate of growth is negative, leading to a contraction in employment, incomes and profits. There is in fact more than one definition and measurement of a recession.

The simple definition: A fall in real GDP for two consecutive quarters i.e. six months

The more detailed definition: A recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.


After 16 years of growth, Britain dropped into recession in the second half of 2008. By the summer of 2009 UK GDP was already 5 per cent lower than the fourth quarter of 2007 - a recovery started in 2009 but growth has remained weak since then

There are many symptoms of a recession – here is a selection of twelve key indicators:

1. A fall in purchases of components and raw materials from supply-chain businesses

2. A fall in real national output (GDP)

3. Rising unemployment

4. A rise in the number of business failures

5. A decline in consumer and business confidence

6. A contraction in total consumer spending & a rise in the percentage of income saved

7. Falling business capital spending

8. A sharp drop in the value of exports and imports of goods and services

9. Deep price discounts offered by businesses

10. Heavy de-stocking as businesses look to cut unsold stocks when demand is weak

11. Government tax revenues are falling

12. The budget (fiscal) deficit is rising quickly

Real GDP growth for Greece


A slump or a depression is a prolonged and deep recession leading to a significant fall in output and average living standards.

Recessions are unusual. To some economists they are an inevitable feature of a market economy because of the cyclical nature of output, demand and employment.

Every recession is different! It is undeniable that the global credit crunch has been hugely significant in causing the downturn even though macroeconomic policy has tried hard to prevent it.

The 2009 recession in the UK was the result of a combination of domestic and external economic factors and forces:

1. The end of the property boom – falling house prices hit wealth and led to a large contraction in new house building

2. Reductions in real disposable incomes due to wages rising less quickly than prices

3. The lagged effects of rising interest rates in 2007-08 (a tightening of monetary policy)

4. A sharp fall in consumer confidence – made worse by rising unemployment – leading to an increase in saving – Keynes called this the ‘paradox of thrift.’

5. External events – such as recession in the UK’s major trading partners including the USA (which accounts for 15% of UK trade) and the Euro Area (which has 55% of UK trade)

6. UK exports declined and this hit manufacturing industry hard

7. Cut-backs in production have led to a negative multiplier effect causing a decline in demand for consumer / household services and lower sales and profits for supply-chain businesses

8. The credit crunch caused the supply of credit to dry up affecting millions of businesses and home-owners

9. Falling profits and weaker demand caused a fall in business sector capital investment – known as the negative accelerator effect.

10. Unemployment started to rise early in the downturn – a reflection of our flexible labour market and sticky wages

An important evaluation point is that, in a recession, some businesses are affected more than others. The extent of the effects will depend on the type of business, the market it operates in and the nature of the product sold. When average incomes are falling, we would expect to see a decline in demand for products with a high income elasticity of demand – typically these goods and services are regarded as luxury items by consumers, things that they might choose to do without when the economy is going through a bad time. The demand for products with a negative income elasticity of demand (i.e. inferior goods) might actually rise during a recession!

Unit 2: The Output Gap - Revision Notes

How much spare capacity does an economy have to meet a rise in demand? How close is an economy to operating at its productive potential? Has the recession damaged the economy’s productive potential? These sorts of questions all link to an important concept – the output gap. The output gap is the difference between the actual level of national output and its potential level and is usually expressed as a percentage of the level of potential output.


Negative output gap – downward pressure on inflation

• The actual level of real GDP is given by the intersection of AD & SRAS – the short run equilibrium.

• If actual GDP is less than potential GDP there is a negative output gap. Some factor resources such as labour and capital machinery are under-utilized and the main problem is likely to be higher than average unemployment.

• A rising number of people out of work indicate an excess supply of labour, which causes pressure on real wage rates.

• In the next time period, a fall in real wage rates shifts SRAS downwards until actual and potential GDP are identical – assuming labour markets are flexible.

Positive output gap – upward pressure on inflation

• If actual GDP is greater than potential GDP then there is a positive output gap.

• Some resources including labour are likely to be working beyond their normal capacity e.g. making extra use of shift work and overtime.

• The main problem is likely to be an acceleration of demand-pull and cost-push inflation.

• Shortages of labour put upward pressure on wage rates, and in the next time period, a rise in wage rates shifts

• SRAS upwards until actual and potential GDP are identical – assuming labour markets are flexible.

Sample economics papers (Units 1-4) & Mark Schemes

Sample economics papers (Units 1-4) & Mark Schemes

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Unit 2: June 2010 Mark Scheme

Unit 2: Jun 2010 - Mark Scheme

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Unit 3: Monopoly & Barriers to Entry: Revision Notes

Monopoly & Barriers to entry: Revision Notes

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Barriers to entry are designed to block potential entrants from entering a market profitably. They seek to protect the power of existing firms and maintain supernormal profits and increase producer surplus. These barriers have the effect of making a market less contestable - they are also important because they determine the extent to which well-established firms can price above marginal and average cost in the long run.


The 1982 Nobel Prize winning economist George Stigler defined an entry barrier as “A cost of producing which must be borne by a firm which seeks to enter an industry but is not borne by businesses already in the industry”.

Another Economist, George Bain defined entry barriers as “The extent to which established firms elevate their selling prices above average cost without inducing rivals to enter an industry”.

The Bain interpretation of entry barriers emphasises the asymmetry in costs that often exists between the incumbent firm and the potential entrant. If the existing businesses have managed to exploit economies of scale and developed a cost advantage, this might be used to cut prices if and when new suppliers enter the market. This is a move away from short-run profit maximisation objectives – but it is designed to inflict losses on new firms and protect a dominant position in the long run. The monopolist might then revert back to profit maximization once a new entrant has been sent packing!

Another way of categorising entry barriers is summarised below

o Structural barriers (also known as ‘innocent’ entry barriers) – arising from differences in production costs.

o Strategic barriers (see the notes below on strategic entry deterrence).

o Statutory barriers – these are entry barriers given force of law (e.g. patent protection of franchises such as the National Lottery or television and radio broadcasting licences).

Entry barriers exist when costs are higher for an entrant than for the incumbent firms.

Theory of Early Mover or First Mover Advantage

Sometimes there are sizeable advantages to being first into a market – first-movers can establish themselves, build a customer base and make life difficult for new firms on the scene.

Barriers to Exit – (Sunk Costs)

Whilst textbooks tend to concentrate on the costs of entering a market, often it is the financial implications of leaving an industry that act as one of the most important barriers – hence we need to consider exit costs. A good example of these is the presence of sunk costs.

Sunk costs cannot be recovered if a business decides to leave an industry. Examples include:

o Capital inputs that are specific to an industry and which have little or no resale value.

o Money spent on advertising, marketing and research and development projects which cannot be carried forward into another market or industry.

When sunk costs are high, a market becomes less contestable. High sunk costs act as a barrier to entry of new firms because they risk making huge losses if they decide to leave a market. In contrast, markets such as fast-food restaurants, sandwich bars, hairdressing salons and local antiques markets have low sunk costs so the barriers to exit are low.

o Asset-write-offs – e.g. the expense associated with writing-off items of plant and machinery, stocks and the goodwill of a brand

o Closure costs including redundancy costs, contract contingencies with suppliers and the penalty costs from ending leasing arrangements for property

o The loss of business reputation and goodwill - a decision to leave a market can seriously affect goodwill among previous customers, not least those who have bought a product which is then withdrawn and for which replacement parts become difficult or impossible to obtain.

o A market downturn may be perceived as temporary and could be overcome when the economic or business cycle turns and conditions become more favourable

Strategic Entry Deterrence

Strategic entry deterrence involves any move by existing firms to reinforce their position against other firms of potential rivals. There are plenty of examples of this – including the following:

o Hostile takeovers and acquisitions – taking a stake in a rival firm or buying it up!

o Product differentiation through brand proliferation (i.e. investment in developing new products and spending on marketing and advertising to reinforce consumer / brand loyalty).

o Capacity expansions to achieve lower unit costs from exploiting internal economies of scale.

o Predatory pricing: Predatory behaviour is defined as a dominant company sustaining losses in the short run with the knowledge it will be able to recoup them once the competition is forced to exit, and is in breach of the Competition Act 1998. We return to this in the chapter on oligopoly and cartels.

Strategic barriers may be deemed anti-competitive by the British and EU competition authorities - The EU Competition Commission has been active in recent years in building cases against European businesses that have engaged in anti-competitive practices including price fixing cartels.

Despite the inevitability of entry and exit barriers markets are constantly evolving and we often do witness the entry of new suppliers even when one or more firms have a clear position of market power. Entry can occur in a variety of ways:

1. A takeover from outside the industry (sometimes known as the “Trojan-horse route” to by-pass any structural entry barriers that might exist within an industry.)

2. A transfer of brand names from one sector of the economy to another (for example the diversification practiced by both EasyGroup, Virgin and Stagecoach in recent years.)

3. Increasing competition from overseas – i.e. the liberalisation of markets around the world

Unit 3: Price Discrimination - Revision Notes

Price Discrimination - Revision Notes

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Most businesses charge different prices to different groups of consumers for the same good or service! This is price discrimination. Businesses could make more money if they treated everyone as individuals and charged them the price they are willing to pay. But doing this involves a cost – so they have to find the right pricing strategy for each part of the market they serve – their revenues should rise, but marketing costs will also increase.


It is important that you understand what price discrimination is, the conditions required for it to happen and also some of the economic and social consequences of this type of pricing tactic.

What is price discrimination?

Price discrimination occurs when a business charges a different price to different groups of consumers for the same good or service, for reasons not associated with costs.

It is important to stress that charging different prices for similar goods is not pure price discrimination. Product differentiation – gives a supplier greater control over price and the potential to charge consumers a premium price because of actual or perceived differences in the quality or performance of a good or service.

Conditions necessary for price discrimination to work
o Differences in price elasticity of demand: There must be a different price elasticity of demand for each group of consumers. The firm is then able to charge a higher price to the group with a more price inelastic demand and a lower price to the group with a more elastic demand. By adopting such a strategy, the firm can increase total revenue and profits (i.e. achieve a higher level of producer surplus). To profit maximise, the firm will seek to set marginal revenue = to marginal cost in each separate (segmented) market.

o Barriers to prevent consumers switching from one supplier to another: The firm must be able to prevent “consumer switching” – a process whereby consumers who have purchased a product at a lower price are able to re-sell it to those consumers who would have otherwise paid the expensive price. This can be done in a number of ways, – and is probably easier to achieve with the provision of a unique service such as a haircut, dental treatment or a consultation with a doctor rather than with the exchange of tangible goods such as a meal in a restaurant.

o Switching might be prevented by selling a product to consumers at unique moments in time – for example with the use of airline tickets for a specific flight that cannot be resold under any circumstances or cheaper rail tickets that are valid for a specific rail service.

o Software businesses such as Microsoft often offer heavy price discounts for educational users. Office 2007 for example was made available at a 90% discount for students in the summer of 2009. But educational purchasers must provide evidence that they are students

Unit 3: Oligopoly - Revision notes

An oligopoly is a market dominated by a few producers. An oligopoly is an industry where there is a high level of market concentration. Examples of markets that can be described as oligopolies include the markets for petrol in the UK, soft drinks producers and the major high street banks. Another example is the global market for sports footwear – 60% of which is held by Nike and Adidas. However, oligopoly is best defined by the conduct (or behaviour) of firms within a market.


The concentration ratio measures the extent to which a market or industry is dominated by a few leading firms. A rule of thumb is that an oligopoly exists when the top five firms in the market account for more than 60% of total market sales.

Characteristics of an oligopoly

There is no single theory of price and output under conditions of oligopoly. If a price war breaks out, oligopolists may choose produce and price much as a highly competitive industry would; whereas at other times they act like a pure monopoly.

An oligopoly usually exhibits the following features:

1. Product branding: Each firm in the market is selling a branded product.

2. Entry barriers: Entry barriers maintain supernormal profits for the dominant firms. It is possible for many smaller firms to operate on the periphery of an oligopolistic market, but none of them is large enough to have any significant effect on prices and output

3. Inter-dependent decision-making: Inter-dependence means that firms must take into account the likely reactions of their rivals to any change in price, output or forms of non-price competition.

4. Non-price competition: Non-price competition is a consistent feature of the competitive strategies of oligopolistic firms.

Duopoly

Duopoly is a form of oligopoly. In its purest form two firms control all of the market, but in reality the term duopoly is used to describe any market where two firms dominate with a significant market share. There are many examples of duopoly; including Coca-Cola and Pepsi (soft drinks), Unilever and Proctor & Gamble (detergents), Bloomberg and Reuters (Financial information services), Sotheby’s and Christie’s (auctioneers of antiques/paintings), Standard and Poor’s and Moody’s (credit rating agencies), BSkyB and ESPN (live Premiership football), and Airbus and Boeing (aircraft manufacturers).

In these markets entry barriers are high although there are usually smaller players in the market surviving successfully.

The high entry barriers in duopolies are usually based on one or more of the following: brand loyalty, product differentiation and huge research economies of scale.

The importance of non-price competition under oligopoly

Non-price competition assumes increased importance in oligopolistic markets. This involves advertising and marketing strategies to increase demand and develop brand loyalty among consumers. Businesses will use other policies to increase market share:

o Better quality of service including guaranteed delivery times for consumers and low-cost servicing agreements.

o Longer opening hours for retailers, 24 hour online customer support.

o Discounts on product upgrades when they become available in the market.

o Contractual relationships with suppliers - for example the system of tied houses for pubs and contractual agreements with franchises (offering exclusive distribution agreements). For example, Apple has signed exclusive distribution agreements with T-Mobile of Germany, Orange in France and O2 in the UK for the iPhone. The agreements give Apple 10 percent of sales from phone calls and data transfers made over the devices.

Advertising spending runs in millions of pounds for many firms. Some simply apply a profit maximising rule to their marketing strategies. A promotional campaign is profitable if the marginal revenue from any extra sales exceeds the cost of the advertising campaign and marginal costs of producing an increase in output. However, it is not always easy to measure accurately the incremental sales arising from a specific advertising campaign. Other businesses see advertising simply as a way of increasing sales revenue. If persuasive advertising leads to an outward shift in demand, consumers are willing to pay more for each unit consumed. This increases the potential consumer surplus that a business might extract.

High spending on marketing is important for new business start-ups and for firms trying to break into an existing market where there is consumer or brand loyalty to the existing products

Unit 3: Oligopoly & Collusion

Collusive behaviour is thought to be a common feature of many oligopolistic markets. Collusion is often explained by a desire to achieve joint-profit maximisation within a market or prevent price and revenue instability in an industry.


Tacit collusion

Price leadership refers to a situation where prices and price changes established by a dominant firm, or a firm are usually accepted by others and which other firms in the industry adopt and follow. When price leadership is adopted to facilitate tacit (or silent) collusion, the price leader will generally tend to set a price high enough that the least cost-efficient firm in the market may earn some return above the competitive level.

We see examples of this with the major mortgage lenders and petrol retailers where many suppliers follow the pricing strategies of leading firms. If most firms in a market are moving prices in the same direction, it can take some time for relative price differences to emerge which might cause consumers to switch their demand.

Firms who market to consumers that they are “never knowingly undersold” or who claim to be monitoring and matching the cheapest price in a given geographical area are essentially engaged in tacit collusion.

Tacit collusion occurs where firms undertake actions that are likely to minimise a competitive response, e.g. avoiding price cutting or not attacking each other’s market It is often observed that when a market is dominated by a few large firms, there is always the potential for businesses to seek to reduce uncertainty and engage in some form of collusive behaviour. When this happens the existing firms engage in price fixing cartels. This behaviour is deemed illegal by UK and European competition law. But it is hard to prove that a group of firms have deliberately joined together to raise prices.

Explicit Price Fixing

Price fixing represents an attempt by suppliers to control supply and fix price at a level close to the level we would expect from a monopoly.

To collude on price, producers must be able to exert some control over market supply. In the diagram below a producer cartel is assumed to fix the cartel price at price Pm. The distribution of the cartel output may be allocated on the basis of an output quota system or another process of negotiation.

Although the cartel as a whole is maximising profits, the individual firm’s output quota is unlikely to be at their profit maximising point. For any one firm, expanding output and selling at a price that slightly undercuts the cartel price can achieve extra profits! Unfortunately if one firm does this, it is in each firm’s interests to do exactly the same and, if all firms break the terms of their cartel agreement, the result will be excess supply in the market and a sharp fall in the price. Under these circumstances, a cartel agreement can break down.

Collusion in a market or industry is easier to achieve when:

1. There are only a small number of firms in the industry and barriers to entry protect the monopoly power of existing firms in the long run.

2. Market demand is not too variable (or cyclical) i.e. it is reasonably predictable and not subject to violent fluctuations which may lead to excess demand or excess supply.

3. Demand is fairly inelastic with respect to price so that a higher cartel price increases the total revenue to suppliers – this is easier when the product is viewed as a necessity.

4. Each firm’s output can be easily monitored (this is important!) – This enables the cartel more easily to control total supply and identify firms who are cheating on output quotas.

5. Incomplete information about motivation of other firms may induce tacit collusion.

Possible break-downs of cartels

Most cartel arrangements experience difficulties and tensions and some cartels collapse completely. Several factors can create problems within a collusive agreement between suppliers:

1. Enforcement problems: The cartel aims to restrict production to maximize total profits of members. But each individual seller finds it profitable to expand production. It may become difficult for the cartel to enforce its output quotas and there may be disputes about how to share out the profits. Other firms – not members of the cartel – may opt to take a free ride by producing close to but just under the cartel price.

2. Falling market demand creates excess capacity in the industry and puts pressure on individual firms to discount prices to maintain their revenue. There are good recent examples of this in commodity markets including the collapse of the coffee export cartel.

3. The successful entry of non-cartel firms into the industry undermines a cartel’s control of the market – e.g. the emergence of online retailers in the book industry in the mid 1990s led ultimately to the end of the Net Book Agreement in 1995.

4. The exposure of illegal price fixing by market regulators such as UK Office of Fair Trading and the European Competition Commission

Unit 3: Competition Policy

The aim of competition policy is promote competition; make markets work better and contribute towards improved efficiency in individual markets and enhanced competitiveness of UK businesses within the European Union single market.


Competition policy aims to ensure:-

o Wider consumer choice

o Technological innovation which promotes dynamic efficiency

o Effective price competition between suppliers

There are four key pillars of competition policy in the UK and in the European Union

1. Antitrust & cartels: This involves the elimination of agreements that seek to restrict competition including price-fixing and other abuses by firms who hold a dominant market position (defined as having a market share in excess of forty per cent).

2. Market liberalisation: Liberalisation involves introducing fresh competition in previously monopolistic sectors such as energy supply, postal services, mobile telecommunications and air transport.

3. State aid control: Competition policy analyses examples of state aid measures to ensure that such measures do not distort competition in the Single Market

4. Merger control: This involves the investigation of mergers and take-overs between firms (e.g. a merger between two large groups which would result in their dominating the market).

The Regulators
Regulators are the rule-enforcers and they are appointed by the government to oversee how a market works and the outcomes that result for both producers and consumers. Examples of regulators include the Office of Fair Trading and the Competition Commission. The European Union Competition Commission is also an important body for the UK economy.

What do the regulators regulate?

1. Prices: Regulators aim to ensure that companies do not exploit monopoly power by charging excessive prices. They look at evidence of pricing behaviour and also the rates of return on capital employed to see if there is evidence of ‘profiteering.’ Recently the EU Competition Commission made a ruling on the ‘roaming’ charges of mobile phone operators in the EU and helped to enforce a new maximum price on such charges.

2. Standards of customer service: Companies that fail to meet specified service standards can be fined or have their franchise / licence taken away. The regulator may also require that unprofitable services are maintained in the wider public interest e.g. BT keeping phone booths open in rural areas and inner cities; the Royal Mail is still required by law to provide a uniform delivery service at least once a day to all postal addresses in the UK

3. Opening up markets: The aim here is to encourage competition by removing barriers to entry. This might be achieved by forcing the dominant firm in the industry to allow others to use its infrastructure network. A key task for the regulator is to fix a fair access price for firms wanting to use the existing infrastructure. Fair both to the existing firms and also potential challengers.

4. Regulation can act as a form of surrogate competition – attempting to ensure that prices, profits and service quality are similar to what could be achieved in competitive markets.

In a nut shell the role of competition authorities around the world is to protect the public interest, particularly against firms abusing their dominant positions

Anti-Trust Policy - Abuses of a Dominant Market Position

A firm holds a dominant position if its power enables it to operate within the market without taking account of the reaction of its competitors or of intermediate or final consumers.

Competition authorities consider a firm’s market share, whether there are credible competitors, whether the business has ownership and control of its own distribution network (achieved through vertical integration) and whether it has favourable access to raw materials.

Holding a dominant position is not wrong if it is the result of the firm’s own competitiveness against other businesses! But if the firm exploits this power to stifle competition, this is deemed to be an anti-competitive practice.

Anti-competitive practices are designed to limit the degree of competition inside a market.

Examples of anti-competitive practices

1. Predatory pricing also known as ‘destroyer pricing’ happens when one or more firms deliberately sets prices below average cost to incur losses for a sufficiently long period of time to eliminate or deter entry by a competitor – and then tries to recoup the losses by raising prices above the level that would ordinarily exist in a competitive market.

2. Vertical restraint in the market: This can happen in a number of ways:

a. Exclusive dealing: This occurs when a retailer undertakes to sell only one manufacturers product. These may be supported with long-term contracts that “lock-in” a retailer to a supplier and can only be terminated by the retailer at high financial cost. Distribution agreements may seek to prevent instances of parallel trade between EU countries (e.g. from lower-priced to higher priced countries).

b. Territorial exclusivity: This exists when a particular retailer is given the sole rights to sell the products of a manufacturer in a specified area.

c. Quantity discounts: Where retailers receive larger price discounts the more of a given manufacturer’s product they sell - this gives them an incentive to push one manufacturer’s products at the expense of another’s.

d. A refusal to supply: Where a retailer is forced to stock the complete range of a manufacturer’s products or else he receives none at all, or where supply may be delayed to the disadvantage of a retailer.

3. Collusive practices: These might include agreements on market sharing, price-fixing and agreements on the types of goods to be produced.

Not all instances of collusive behaviour are deemed to be illegal by the European Union Competition Authorities. Practices are not prohibited if the respective agreements “contribute to improving the production or distribution of goods or to promoting technical progress in a market.”

o Development of improved industry standards /technical standards of production and safety which eventually benefit the consumer.

o Research joint-ventures and know-how agreements which seek to promote innovative and inventive behaviour in a market

A2: Debate - A lottery millionaire who still receives food stamps!

After the exams have finished and you guys return to class, we need to start thinking about next years course. I intend to start the unit 3 syllabus almost straight away. However, before that I thought we would spend a lesson or two debating real issues. This will sharpen up your evaluative skills, essential for A2 study...

The story of Leroy Fick makes for a class discussion on who should be entitled to receive state help.

Q. What criteria should be used for deciding who receives financial assistance from the government.


We will discuss this in class and then I will post the Leroy Fick article/video.....

Unit 1: Market failure - Tackling obesity - some alternative approaches

So far, governments in the developed world seem to have failed in terms of developing and implementing effective policies that might reduce the negative externalities associated with the ‘obesity epidemic’.

However, based on various different news reports this weekend, it seems that the private sector may actually have come up with some strategies that could be worth a try.

My favourite is the ‘pay what you weigh’ approach in a new style of restaurant in Brazil - the heavier the food on your plate, the higher the price. There’s an interesting short clip on this: Click here.

Another approach, this time from Pizza Hut, is to offer unlimited free salad with all meals to all customers - apparently they expect to give away 50m cherry tomatoes and 1.3m million cucumbers over the next year!

And, whilst I haven’t yet seen evidence of this, there is, apparently, an agreement by supermarkets to include portions of vegetables in ready meals in order to help consumers to eat their recommended 5 a day.

Whether these approaches will actually make the nation healthier is unclear, but getting students to think of possible unintended consequences of this might be a useful pre-exam evaluative exercise.

Unit 2: Hyper inflation

AS Revision: Unit 1 & 2 full list of revision materials below

A couple of links to other blogs below...they have all the required revision topics for AS Micro (Unit 1) and Macro (Unit 2) topics.

Click on the links and enjoy.....

Unit 1 - Revision Material

Unit 2 - Revision Material

Unit 4: Development; China is changing - China’s Rising Wages Propel U.S. Prices

Great video and article found here in WSJ about the economic effects of rising wages of China’s workers. China’s government, the report says, is trying to shift its economy towards higher value added manufacturing as it loses its status as the world’s “dirt cheap” producer of consumer goods.


Linked to this idea is Geoff’s interesting blog of this morning which looks at how economies can develop a comparative advantage and how difficult it is for governments to “kick start” new industries (The Art of Economic Complexity). However, this rise in the wage bill of Chinese manufacturers will mean higher prices of goods made in China and the macroeconomic implications of this development are many.

You’d expect to see a fall in China’s trade surplus as their exports become more expensive especially as the Yuan has strengthened against the dollar. Although looking at the graph below and article here, China’s surplus is actually on the rise. Also the Chinese government is keen for the living standards of its people to rise and so higher wages is a way to boost domestic consumption and reduce reliance on exports to expand the economy. With these higher wages, Chinese workers` demand for goods rises and this in turn pushes up demand for and the prices of the commodities used to produce them. So will we see further inflationary pressures in the west as even higher commodity prices coupled with higher prices for Chinese exports work their way through the system?


On the other hand, as the gap between western and Chinese workers closes, there may be less incentive for multinationals to export their production facilities and work to China and stay put, creating more jobs in manufacturing in those parts of the US and Europe where wages are generally lower.

Unit 2: CPI Vs RPI - What are the differences?

How are they calculated?


Both the CPI and RPI are an attempt to measure the changes in the cost of buying a representative basket of UK goods and services.

The methods used to calculate both indexes are similar. Each month thousands of prices for a selection of goods and services are analysed to check on any increases.

Some of the goods and services will carry a higher weighting, reflecting the fact that we spend more on some items than others.

Each year, the make-up of the "basket" of good and services, and the weightings assigned to them, are revised to take into account changes in spending patterns.

For example, in recent years people have tended to spend more of their money on electrical goods, travel and leisure, while the proportion they have spent on basic items such as food has fallen.

So why do the CPI and RPI values differ?

Not all the items covered by the RPI are included in the CPI measure.

For example, the CPI does not include Council Tax, mortgage interest payments and some other housing costs.

The CPI measure also includes some items - such as charges for financial services - which are not in the RPI.

Another difference is that the CPI measure covers a broader sample of the population in its calculations than RPI.

There is also a difference in the mathematical methods used to calculate the price changes which, the Office for National Statistics says, means that in practice the CPI always shows a lower inflation rate than the RPI rate for given price data.

Why does the government target the CPI rate?

Until 2003, the government targeted a rate of inflation known as RPIX - which, unlike the RPI measure, excludes mortgage interest payments.

However, in his pre-Budget speech in December 2003, Chancellor Gordon Brown said the inflation target would be switched to the CPI measure with immediate effect.

The government cited three reasons why CPI was a better measure for the purposes of setting monetary policy:

•it gives a more realistic characterisation of consumer behaviour

•it gives a better picture of spending patterns in the UK

•it is a more comparable measure of inflation internationally and represents international best practice

The government's current target for CPI is 2%, which the Bank of England is tasked with hitting.

If the rate moves by more than one percentage point either way - that is, it breaks out of the range 1-3% - the governor of the Bank of England must write to the chancellor to explain why.

Unit 1: Commodity Prices

The economics of volatile commodity prices are a common feature of most Unit 1 Micro papers - it gives you a chance to apply your understanding of supply and demand factors and the importance of elasticities of demand and supply in explaining price movements.

And also understand some of the consequences of volatile price and output movements for different stakeholders - including consumers, producers and the government.

This BBC news article takes a look at the likely direction of world commodity prices and embraces a number of different markets that have appeared on exam papers in the past - so a useful exercise to test your revision is to read through and see how much you get first time.

Check out the revision presentation on price volatility in markets below - (it does the job for a really good AS micro answer)

Commodity Prices

View more presentations from mattbentley34.

Unit 3: Is the bus market contestable?

One of the aims of deregulation is to encourage competition.


The Office of Fair Trading (OFT) referred the local bus market to the Competition Commission (CC) in January 2010 because they had reasonable grounds for suspecting that competition is not working effectively in that market

Buses matter providing a daily service for millions of people in the UK, carrying twice the number of passengers as do trains.

This is particularly true at a time when commuters are switching from cars to buses in response to record petrol prices – inter modal shift in action

There are equity issues. Buses are used by low income households those who cannot afford a car. Many passengers are dependent on the bus and do not have a realistic or desirable alternative, such as getting into a car or a train, if fares rise or services deteriorate.

Their provisional findings published today make interesting reading:

•the great majority of routes and local areas experience a high degree of concentration. Evidence: The five largest operators (Arriva, FirstGroup, Go-Ahead, National Express and Stagecoach) provide 69 per cent of local bus services

•Consequently in many local areas, the largest operator has consistently faced little or no competition

Socially necessary loss making services are put out to tender by local authorities. The winning operator is the one offering the highest bid or the lowest subsidy. The CC notes the limited number of potential bidders in local areas can restrict competition and increase the cost of supporting these services. Why so few bidders? Economic theory suggests the presence of barriers to entry as the explanation

Helpfully the report identifies factors restricting new entry or expansion:-

•the tendency for instability in head-to-head competition, which means that competition is unlikely to be sustained and one or other rival is likely to exit. This prevents lasting competition developing in these areas and also deters potential entrants.

•Incumbent operators can benefit where multi-operator network tickets are inferior to their own network tickets

•Entrants can sometimes have difficulties in accessing bus stations on fair terms and developing depots.

•The great majority of urban areas have not experienced any large-scale entry in recent years—risks and costs are likely to increase with the scale of entry.

The CC is now consulting on measures to open up more markets by tackling the factors which can hinder competition:

•measures to increase the number of multi-operator ticket schemes and to ensure that these are effective and attractive to customers;

•restrictions on aggressive behaviour, such as ‘over bussing’ on particular routes and other obstructive behaviour aimed at reducing a rival’s ability to compete;
•ensuring fair access to privately owned and managed bus stations for all operators.

Unit 4: June 2010 Mark Scheme

Unit 4: June 10

View more documents from mattbentley34.

Unit 2: The UK Economy (May 2011)

Click here to access an excellent presentation of the UK economy. The slides chart the progress (or lack of it) of all the macro economic objectives.

It will rally help you understand the issues faced by UK governments....you never know, it may even help you pass Unit 2 exam.