AQA A Level Economics - Paper 1 study guide:
Based on the 2022 advanced information including but not limited to the following overarching topics: Market structures, market failure, government intervention, government failure
Invention refers to new knowledge developed in pure science. It doesn’t involve “producing”
anything because of that new knowledge (that’s where innovation comes in).
Faraday’s discovery that an electric wire will rotate when placed near a magnetic pole was
an invention as this was new knowledge discovered in 1821 (no one else knew this at the
time) from pure science. This invention eventually led to the production of the electric
motor which is an example of innovation.
Innovation is the application of new knowledge created by invention to production.
Using the scientific discovery of X-rays in order to produce a new machine is an example of
innovation.
Effects of technological change caused by invention and innovation:
1. Increasing productivity - like when companies use automated machines instead of humans
2. Decreasing costs - as a result of the increased productivity
3. Increase contestability - as costs of production fall, it becomes much cheaper for new firms
to enter big markets and contest big firms
4. Affecting methods of production as technology improves- like when companies are able to
use Just In Time production methods because of new technology
5. Create new products and services - like smartphones
Technological change can influence the structure of markets:
Monopolies do not have an incentive to innovate, since they have no competition. This
means they are often inefficient, and their costs are higher than they could be.
Oligopolies tend to have more of an incentive to innovate, since they are earning
supernormal profits and are trying to get ahead of their competitors. This means that
technological change is quite fast in oligopolies.
Creative destruction is when the creation of new technologies destroys and replaces old
technologies - first proposed by an economist called Joseph Schumpeter. This is the idea that new
entrepreneurs are innovative, which challenges existing firms. The more productive firms then grow,
whilst the least productive are forced to leave the market. This results in an expansion of the
economy’s productive potential.
E.g. Netflix has used the new technology of the internet to move TV shows and films online. This has
replaced and destroyed the old technology of DVDs which are now increasingly difficult to buy.
It is a big advantage of free markets because old technologies get replaced with new
technologies which are much more efficient and increase productivity.
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However, it can create problems such as job losses for those working in jobs relying on the
old technology which has been destroyed.
For example, Uber has brought new technology to the taxi market, but this has led to lower
wages and job losses for traditional black cab drivers.
4.1.5.1 Market structures
There are a range of market structures. The market structure is concerned with how the market is
organised.
Spectrum of competition in markets:
Each market structure is characterised by:
The number of firms in the market.
o The more firms there are, the more competitive the market is. This also includes the
extent of competition from abroad.
The degree of product differentiation.
o The more differentiated the products, the less competitive the market. In a perfectly
competitive market, products are homogenous. Products can be differentiated using
price, branding and quality. This affects cross price elasticity of demand.
Ease of entry into the market.
o This is the number and degree of the barriers to entry. Barriers to entry are designed
to prevent new firms entering the market profitably. This increases producer
surplus. The higher the barriers to entry, the less competitive the market. Examples
include:
Economies of scale.
Brand loyalty, which makes demand more inelastic. It is hard for new firms
to gain consumer loyalty, when one firm’s brand name is already strong.
Controlling the important technologies in the market.
Having a strong reputation.
Backwards vertical integration, which controls supply, means firms can
control the price they pay their suppliers. This makes it hard for new firms to
compete on price, which is a barrier to entry.
Barriers to entry can be structural, where they arise due to differences in
production costs, strategic, where firms use different pricing policies, such
as undercutting another firm’s price, or statutory, where patents protect a
franchise. An example of this is a television broadcasting licence.
4.1.5.2 The objectives of firms
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The main objectives of firms are:
1. Profit maximisation
2. Sales maximisation
3. Increased market share/market
dominance
4. Social/environmental concerns
5. Profit satisficing
6. Co-operatives
Sometimes there is an overlap of objectives. For example, seeking to increase market share, may
lead to lower profits in the short-term, but enable profit maximisation in the long run.
1. Profit maximisation
Usually, in economics, we assume firms are concerned with maximising profit. Higher profit means:
Higher dividends for shareholders.
More profit can invested into research and development.
Higher profit makes the firm less vulnerable to takeover.
Higher profit enables higher salaries for workers
Alternative aims of firms - However, in the real world, firms may pursue other objectives apart from
profit maximisation.
2. Sales maximisation -
Firms often seek to increase their market share – even if it means less profit. This could occur for
various reasons:
Increased market share increases monopoly power and may enable the firm to put up prices
and make more profit in the long run.
Managers prefer to work for bigger companies as it leads to greater prestige and higher
salaries.
Increasing market share may force rivals out of business. E.g. the growth of supermarkets
have led to the demise of many local shops. Some firms may actually engage in predatory
pricing which involves making a loss in the short term to force a rival out of business.
3. Growth maximisation
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This is similar to sales maximisation and may involve mergers and takeovers. With this objective, the
firm may be willing to make lower levels of profit in order to increase in size and gain more market
share. More market share increases its monopoly power and ability to be a price setter.
4. Social/environmental concerns
A firm may incur extra expense to choose products which don’t harm the environment or products
not tested on animals. Alternatively, firms may be concerned about local community/charitable
concerns.
Some firms may adopt social/environmental concerns as part of their branding. This may
help profitability as the brand becomes more attractive to consumers.
Some firms may adopt social/environmental concerns on principal alone – even if it does
little to improve sales/brand image.
5. Profit satisficing –
In many firms, there is a separation of ownership and control.
Those who own the company (shareholders) often do not get
involved in the day to day running of the company.
This is a problem because although the owners may want to
maximise profits, the managers have much less incentive to
maximise profits because they do not get the same rewards,
(share dividends)
Therefore, managers may create a minimum level of profit to keep the shareholders happy,
but then maximise other objectives, such as enjoying work, getting on with other workers.
(e.g. not sacking them) This is the problem of separation between owners and managers.
This ‘principal-agent‘ problem can be overcome, to some extent, by giving managers share
options and performance related pay although in some industries it is difficult to measure
performance.
The principal-agent problem occurs when a principal delegates an action to another
individual (agent), but the principal does not have full information about how the
agent will behave. Secondly, the interests of the principal diverge from that of the
agent, meaning that the outcome is less desirable than the principal expects.
Performance related pay is a system where employers pay employees depending on
the quality of their work.
6. Co-operatives
Co-operatives may have completely different objectives to a typical PLC (public limited company –
shareholders are members of general public).
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