Why is Competition Good?

Firms have to be competitive in order to keep profits up and to remain in business. If they didn’t keep prices low then other firms could enter the market and undercut the incumbent firm, thus taking away its market share and supernormal profit. Alternatively rivals may do the same. These low prices benefit consumers and should result in more consumer surplus. Because prices are lower more of the good is demanded and hence the firm will produce more, this reduces allocative inefficiency as more resources are going towards the production of goods and services demanded by consumers (a definition of allocative efficiency). [...]

Limitations of the Concentration Ratio

An evaluative point to the use of the concentration ratio is that there may be problems defining the market. If a competition watchdog used the ratio to measure whether or not a firm is defined as a monopoly (if the ratio produces a result greaterthan 25%) how does it decide the width and depth of the market.

For example when trying to identify the market that Facebook lies in, would the watchdog include photo-sharing websites (as Facebook owns Instagram), does it also include phone apps. Calculating the size of the market may not be as simply as it first seems!

Also concentration ratios may provide a misleading result. [...]

Marginal Costs

Marginal cost is the rate of change of the total cost (ΔTC/ΔQ) and is dependent on the variable cost. This is because fixed cost is a constant and doesn’t affect the rate of change (remember, rate of change is effectively the differential of a function, in this case it would be the differential of the total cost function). Therefore any increase in fixed costs will have a 0 effect on Marginal Cost.

This can be shown in the tables below:

A firm’s fixed costs increase by 20%, what will marginal costs increase by?

Before FC Rise:

0 10 5 15
1 10 7 17 2
2 10 9 19 2

After FC Rise:

0 12 5 17
1 12 7 19 2
2 12 9 21 2

As we can see the 20% increase in fixed costs has no affect on the marginal costs. [...]

Limit Pricing

Here is a picture to show how an incumbent firm can take advantage of economies of scale in order to drive out competition. If it sets a price below CNE (the cost to new entrants) and above CI (the cost to the incumbent) then it can continue to make a supernormal profit whilst the new entrant will make a loss. In the short run it may make lower supernormal profits but in the long run it is likely to benefit from a more inelastic demand curve (as there is less competition, since they have been driven out by limit pricing) and can make a larger supernormal profit. [...]

Quiz Answers

1. PED = %Change in QD / %Change in Price

2. The price elasticity of demand is the responsiveness (how they change their demand) of consumers to a change in the price of a good.

3. The good is inelastic

4. Perfectly Elastic = -Infinite; Perfectly Inelastic = 0; Unit Elastic = 1; A value between 0 and -1 is inelastic; A value between -1 and -Infinite is elastic.

5. If there is derived demand for a good then it means that the good is demanded for what it produces. For example labour isn’t demanded for labour but for what it produces. [...]

Unit 1 Quiz: Microeconomics (Basics)

I have created a quiz for the Edexcel Unit 1 Exam; you won’t be asked these questions in the exam, but you need to know the answers. The answers are in a separate blog post (see here).

1. How do you calculate PED?

2. Define PED

3. If the value produced by a PED calculation was -0.6 what would it mean?

4. What values would be needed from the PED calculation to say a good is a.) elastic b.) inelastic c.) unit elastic

5. What does derived demand mean?

6. If I have a vertical demand curve what price elasticity does it have? [...]

Methods to spot Collusion


The article above shows some different methods that anti-trust economists are now adopting in order to identify cartels. The main bulk of the article is based on the Benford Law which states that in a large number of populations the leading number is not uniformly correlated as one may expect. Instead the number 1 is much more likely to be a leading number than the number 9. This can be seen from the graph below which shows the probability that the leading number will be the given constant.









Anti-trust agencies can use this law to spot whether a firm is creating dubious numbers. [...]

Television Collusion

6 television firms were recently fined £1.2 Billion for colluding to fix prices of cathode rays in televisions. The result of this collusion was higher prices for consumers and thus larger profits for the television firms.

The article can be read here.

This shows the EU Competition Commission using its powers to prevent consumers losing out. It is also worth noting that the television firms undertook this price fixing by increasing the price of cathode rays, as oppose to the price of TVs themselves. Perhaps one reason behind this decision was because it is easier to monitor the price of cathode rays and hence this prevents cheating by any one member of the cartel. [...]

Why does the UK Government have such low interest rates on its debt?

Like the US the UK is facing low interest rates, despite having a high budget deficit and public debt. Why is this?

The UK Government issues its debt in the form of Guilts, currently the interest rate the government has to pay on a year guilt is 0.32%. This is lower even than the base rate, surely investors would be better off just putting their money in a bank account? Well to start with large financial institutions and investors can’t simply put all their money in a bank account, if the bank collapses they will loose all their money (and the government only insures £85,000). [...]