DISECONOMIES OF SCALE
Point 1: One reason for diseconomies of scale could be due to a merger (inorganic growth)
that leads to cultural clashes. Take Amazon and Whole Foods' 2017 merger for example,
where Amazon vertically integrated with the wholesaler. However, the merger was
ultimately a failure as Amazon's corporate culture was rooted in efficiency and technology,
whilst Whole Foods' culture was rooted in idealistic labour practices and job security. This,
as a result, led to cultural clashes which created logistical complexities that affected
employee morale and therefore their productivity. As workers become less productive,
output fell whilst average costs began to rise, resulting in diseconomies of scale, shown by
a loss of productive efficiency as costs rise from c1 to C* as the firm scales from q1 to q*.
Therefore, inorganic growth, such as a merger, can lead to diseconomies of scale.
Point 2: Another reason for DoS could be due to an increase in organisational complexity
as the firm scales. Take Boeing for example, who have been expanding their production
lines for many different aircraft, including the 737 and 777, whilst employing many new
managers and engineers. As a result, Boeing's chains of commands have become wider
with many layers of management which creates difficulties in overseeing quality control,
such as the faulty door bolt, whilst also suffering from supply-chain bottlenecks, with
suppliers unable to meet Boeing's rate of production. Ultimately, due to a lack of
coordination and higher regulatory compliance costs, Boeing has scaled past their optimal
rate of production from Q1 to Q* and is facing diseconomies of scale as LRAC rises from
,C1 to C*. Therefore, organic growth can often lead to organisational bureaucracy and x-
inefficiency, contributing to diseconomies of scale.
INFLATION AND DEFLATION
The UK govt should give higher priority to preventing deflation in order to avoid lowering
business profits, corporation tax receipts and investment. This is because during deflation
the average price level falls, meaning that goods and services are becoming cheaper as
firms cut their prices in order to ration away any excess supply/capacity because of weaker
AD. As a result, firms may see a fall in their net profit margins. Therefore, as corporation tax
is a % of the business' operating profits that are paid to the government, this may reduce
tax revenues to the government, making it more difficult to ease pressure on government
finances and fund critical investment projects, such as the funding for Heathrow's runway
expansion. Also, as firms have lower retained profits, they may be discouraged to reinvest
and improve their dynamic efficiency. This may mean that the quality and quantity of the
capital stock may shrink, resulting in damage to long-run growth, as illustrated by a
leftward shift of LRAS. (INSERT DIAGRAM) As a result, this may be harmful to long-run
growth and unemployment as firms would need less workers to work machines and
facilitate the running of the business. Ultimately, low and steady inflation, perhaps at 2%,
is more desirable as the sustained increase in the average price level means that business
profits are steadily rising which may increase in corporation tax revenues, facilitate less
debt-fuelled government spending and further business investment.
However, it is important to consider the cause and type of deflation. Benign deflation,
which is beneficial to the economy, comes about as a result of supply-side productivity
improvements in the economy. If deflation occurs due to the implementation of a specific
supply-side stimulus, such as Jeremy Hunt's £360mn funding package for pharmaceutical
packages, zero-carbon aircraft technology and sustainable automotive technology, this
can shift the LRAS to the right, from LRAS1 to LRAS2, due to an increase in the quality of
technology that can be utilised to improve the productivity of high-value sectors, such as
pharma and aerospace. As a result, the average price level would fall from PL1 to PL2 as
firms can benefit from lower costs of production, therefore charging lower prices as they
can pass on cost-savings. This may result in benign deflation which is accompanied by
greater actual and potential GDP growth. Therefore, firms may not actually see a fall in
business profits and may actually see improvements in profitability as they become more
efficient. This can ultimately boost corporation tax revenues and enhance business
investment, which has been persistently weak in the UK
,On the other hand, the UK may want to prioritise controlling inflation when it is well above-
target and ever-increasing. This is because it can lead to a more stable and less uncertain
economic environment. For example, in 2022, inflation peaked at 11.1%, well above the
2% target, creating the most damaging cost-of-living crisis in recent times. For example,
due to higher bills as a result of the energy crisis, consumers were spending a higher
percentage of their incomes on energy bills, diminishing their purchasing power for other
goods/services. This can widen the gap between the poorest and richest in society,
deepening income inequality. As a result, controlling unstable and rapid inflation is
perhaps more important as it can help create a more sustainable and favourable
environment for firms and individuals. This can boost animal spirits, perhaps creating
further jobs. This may boost real incomes which can provide a fiscal dividend to the
government by generating more income tax revenue. This would also help the UK
government prevent widening income inequality, which is also a minor macroeconomic
objective. Therefore, when inflation is high and well above-target, the government should
give greater priority to taming inflation to preserve purchasing power, animal spirits and
living standards.
However, the viability of controlling inflation depends on the root cause of it. For example,
the cost-of-living crisis in 2022 was caused by external cost-push pressures, such as the
energy crisis that stemmed from global supply-side shocks, rather than domestic demand-
pull pressure. As a result of external global shocks, the Bank of England may not be able to
implement suitable measures that dampen these effects of inflation as it is mostly out of
their control. The UK government's ability to help through fiscal policy, as well, is also
limited as it does not tackle the underlying cause of the inflationary pressure. Therefore,
the extent to which high inflation can effectively be controlled depends on the root cause
of the inflation.
Overall, persistent malignant deflation may be important to prevent as it can avoid an
increase in the real value of debt for borrowers. This is because individuals with fixed debts
such as mortgages would be repaying more in real terms for their mortgage. Take an
individual with a fixed mortgage of £500,000. With inflation of say 2%, the borrower would
pay back roughly £490,196 in real terms - calculated by doing the nominal debt
value/(1+inflation rate). However, with deflation of 2%, the real value of this mortgage
would rise to around £510,204. This can make paying off a fixed mortgage more
burdensome for lower-income borrowers in a period of deflation, perhaps widening
income inequality. Alternatively, keeping inflation positive but steady, in this case, may be
a priority as it can lead to a fall in the real value of debt and be a sign of strong growth. Also,
this may maintain international competitiveness as different economies may engage in
, trade with the UK if the UK's inflation is relatively lower than other trading partners, making
the UK's exports more price competitive and thus more attractive, therefore helping to
improve the current account deficit in the UK. Ultimately, it is important that preventing
deflation or controlling inflation depends on the state of the economy and the type of
inflation or deflation.
FACTORS DETERMINING NATIONAL RATE OF UNEMPLOYMENT
An increase in the NMW can affect the NRU. The NMW (currently set to rise from £12.21 to
£12.71) is set above the equilibrium wage (assuming a perfectly competitive labour market
for cleaners). This NMW makes it illegal for employers to pay below. An increase from
NMW1 (£12.21) to NMW2 (£12.71) can lead to a further contraction along the labour
demand curve as employers may not want to hire the same number of cleaners at an even
higher NMW to avoid even higher input costs. As a result, the quantity of cleaners
demanded falls. At this higher wage rate, there will be more cleaners who want to supply
their labour, incentivised by a higher wage but because the NMW is a legal price-floor,
wages cannot adjust downwards to restore equilibrium. This worsens the excess supply,
with the initial level of real-wage unemployment, of E2 minus E3, widening to a larger area
of E4 minus E5, leaving behind a larger amount of RWU, which forms the natural rate of
unemployment. This increased amount of RWU still persists even when the economy is
operating at Yfe.
Labour immobility can affect the NRU. Geographical immobility may mean that a worker in
one region of the UK is unable to relocate to another region where an employer is
demanding their labour. This is perhaps because a shortage of affordable housing in
economic hubs, such as London, or close familial ties prevent a worker from relocating.
There may also be occupational immobility, which may limit the workers ability to switch
between occupations because of a lack of transferable skills/education. Individuals in
vocational jobs are not able to respond to higher wage signals in advanced sectors as a
Point 1: One reason for diseconomies of scale could be due to a merger (inorganic growth)
that leads to cultural clashes. Take Amazon and Whole Foods' 2017 merger for example,
where Amazon vertically integrated with the wholesaler. However, the merger was
ultimately a failure as Amazon's corporate culture was rooted in efficiency and technology,
whilst Whole Foods' culture was rooted in idealistic labour practices and job security. This,
as a result, led to cultural clashes which created logistical complexities that affected
employee morale and therefore their productivity. As workers become less productive,
output fell whilst average costs began to rise, resulting in diseconomies of scale, shown by
a loss of productive efficiency as costs rise from c1 to C* as the firm scales from q1 to q*.
Therefore, inorganic growth, such as a merger, can lead to diseconomies of scale.
Point 2: Another reason for DoS could be due to an increase in organisational complexity
as the firm scales. Take Boeing for example, who have been expanding their production
lines for many different aircraft, including the 737 and 777, whilst employing many new
managers and engineers. As a result, Boeing's chains of commands have become wider
with many layers of management which creates difficulties in overseeing quality control,
such as the faulty door bolt, whilst also suffering from supply-chain bottlenecks, with
suppliers unable to meet Boeing's rate of production. Ultimately, due to a lack of
coordination and higher regulatory compliance costs, Boeing has scaled past their optimal
rate of production from Q1 to Q* and is facing diseconomies of scale as LRAC rises from
,C1 to C*. Therefore, organic growth can often lead to organisational bureaucracy and x-
inefficiency, contributing to diseconomies of scale.
INFLATION AND DEFLATION
The UK govt should give higher priority to preventing deflation in order to avoid lowering
business profits, corporation tax receipts and investment. This is because during deflation
the average price level falls, meaning that goods and services are becoming cheaper as
firms cut their prices in order to ration away any excess supply/capacity because of weaker
AD. As a result, firms may see a fall in their net profit margins. Therefore, as corporation tax
is a % of the business' operating profits that are paid to the government, this may reduce
tax revenues to the government, making it more difficult to ease pressure on government
finances and fund critical investment projects, such as the funding for Heathrow's runway
expansion. Also, as firms have lower retained profits, they may be discouraged to reinvest
and improve their dynamic efficiency. This may mean that the quality and quantity of the
capital stock may shrink, resulting in damage to long-run growth, as illustrated by a
leftward shift of LRAS. (INSERT DIAGRAM) As a result, this may be harmful to long-run
growth and unemployment as firms would need less workers to work machines and
facilitate the running of the business. Ultimately, low and steady inflation, perhaps at 2%,
is more desirable as the sustained increase in the average price level means that business
profits are steadily rising which may increase in corporation tax revenues, facilitate less
debt-fuelled government spending and further business investment.
However, it is important to consider the cause and type of deflation. Benign deflation,
which is beneficial to the economy, comes about as a result of supply-side productivity
improvements in the economy. If deflation occurs due to the implementation of a specific
supply-side stimulus, such as Jeremy Hunt's £360mn funding package for pharmaceutical
packages, zero-carbon aircraft technology and sustainable automotive technology, this
can shift the LRAS to the right, from LRAS1 to LRAS2, due to an increase in the quality of
technology that can be utilised to improve the productivity of high-value sectors, such as
pharma and aerospace. As a result, the average price level would fall from PL1 to PL2 as
firms can benefit from lower costs of production, therefore charging lower prices as they
can pass on cost-savings. This may result in benign deflation which is accompanied by
greater actual and potential GDP growth. Therefore, firms may not actually see a fall in
business profits and may actually see improvements in profitability as they become more
efficient. This can ultimately boost corporation tax revenues and enhance business
investment, which has been persistently weak in the UK
,On the other hand, the UK may want to prioritise controlling inflation when it is well above-
target and ever-increasing. This is because it can lead to a more stable and less uncertain
economic environment. For example, in 2022, inflation peaked at 11.1%, well above the
2% target, creating the most damaging cost-of-living crisis in recent times. For example,
due to higher bills as a result of the energy crisis, consumers were spending a higher
percentage of their incomes on energy bills, diminishing their purchasing power for other
goods/services. This can widen the gap between the poorest and richest in society,
deepening income inequality. As a result, controlling unstable and rapid inflation is
perhaps more important as it can help create a more sustainable and favourable
environment for firms and individuals. This can boost animal spirits, perhaps creating
further jobs. This may boost real incomes which can provide a fiscal dividend to the
government by generating more income tax revenue. This would also help the UK
government prevent widening income inequality, which is also a minor macroeconomic
objective. Therefore, when inflation is high and well above-target, the government should
give greater priority to taming inflation to preserve purchasing power, animal spirits and
living standards.
However, the viability of controlling inflation depends on the root cause of it. For example,
the cost-of-living crisis in 2022 was caused by external cost-push pressures, such as the
energy crisis that stemmed from global supply-side shocks, rather than domestic demand-
pull pressure. As a result of external global shocks, the Bank of England may not be able to
implement suitable measures that dampen these effects of inflation as it is mostly out of
their control. The UK government's ability to help through fiscal policy, as well, is also
limited as it does not tackle the underlying cause of the inflationary pressure. Therefore,
the extent to which high inflation can effectively be controlled depends on the root cause
of the inflation.
Overall, persistent malignant deflation may be important to prevent as it can avoid an
increase in the real value of debt for borrowers. This is because individuals with fixed debts
such as mortgages would be repaying more in real terms for their mortgage. Take an
individual with a fixed mortgage of £500,000. With inflation of say 2%, the borrower would
pay back roughly £490,196 in real terms - calculated by doing the nominal debt
value/(1+inflation rate). However, with deflation of 2%, the real value of this mortgage
would rise to around £510,204. This can make paying off a fixed mortgage more
burdensome for lower-income borrowers in a period of deflation, perhaps widening
income inequality. Alternatively, keeping inflation positive but steady, in this case, may be
a priority as it can lead to a fall in the real value of debt and be a sign of strong growth. Also,
this may maintain international competitiveness as different economies may engage in
, trade with the UK if the UK's inflation is relatively lower than other trading partners, making
the UK's exports more price competitive and thus more attractive, therefore helping to
improve the current account deficit in the UK. Ultimately, it is important that preventing
deflation or controlling inflation depends on the state of the economy and the type of
inflation or deflation.
FACTORS DETERMINING NATIONAL RATE OF UNEMPLOYMENT
An increase in the NMW can affect the NRU. The NMW (currently set to rise from £12.21 to
£12.71) is set above the equilibrium wage (assuming a perfectly competitive labour market
for cleaners). This NMW makes it illegal for employers to pay below. An increase from
NMW1 (£12.21) to NMW2 (£12.71) can lead to a further contraction along the labour
demand curve as employers may not want to hire the same number of cleaners at an even
higher NMW to avoid even higher input costs. As a result, the quantity of cleaners
demanded falls. At this higher wage rate, there will be more cleaners who want to supply
their labour, incentivised by a higher wage but because the NMW is a legal price-floor,
wages cannot adjust downwards to restore equilibrium. This worsens the excess supply,
with the initial level of real-wage unemployment, of E2 minus E3, widening to a larger area
of E4 minus E5, leaving behind a larger amount of RWU, which forms the natural rate of
unemployment. This increased amount of RWU still persists even when the economy is
operating at Yfe.
Labour immobility can affect the NRU. Geographical immobility may mean that a worker in
one region of the UK is unable to relocate to another region where an employer is
demanding their labour. This is perhaps because a shortage of affordable housing in
economic hubs, such as London, or close familial ties prevent a worker from relocating.
There may also be occupational immobility, which may limit the workers ability to switch
between occupations because of a lack of transferable skills/education. Individuals in
vocational jobs are not able to respond to higher wage signals in advanced sectors as a
