A LEVEL ECONOMICS
NOTES
Evaluate possible methods the government can use to promote competition and contestability
Point 1: Encourage growth of small businesses
One way the government may promote competition and contestability in markets is by encouraging
the growth of small businesses=
This may be in the form of tax incentives such as lower business rates or even no business rates for
the first 6 months of being a business (Small Business Rate Relief - Full relief if rateable value is
under £12,000 ) (No VAT until turnover exceeds £90,000) =
It could also be start-up grants to help push down costs as they don’t have start up costs=
This would mean that start-up (government backed personal loans to start ups of up to £25,000)
small firms do not have to pay business rates on their property meaning that their fixed costs are
lower=
As a result AC1 shifts down to AC2 moving the firm from a loss-making business to making a profit=
Prices fall from P1 to P2=
As a result of this, more small firms are likely to join the market because they can push down their
costs and make supernormal profits for the first 6 months in operation=
These profits can then be used to reinvest back into the business such as by investing into capital
machinery=
Thus, these small firms can become more productively efficient in the long-run and dynamically
efficient=
As these small firms are able to grow in the first 6 months, they may be able to start exploiting
economies of scale as they increase output due to growth=
This means they may be able to exploit purchasing economies of scale such as bulk buying raw
materials for their production=
As a result, long-run average costs fall even further as there is a movement along the LRAC curve
closer to the MES and productive efficiency=
, This means these small business will be able to grow in the short-term to make enough profits for
reinvestment and to exploit economies of scale allowing for competition in the market
(DRAW A COST AND REVENUE DIAGRAM DEPICTING AC SHIFTING DOWN)
Evaluation Point 1: Effectiveness of intervention
The cut in business rates for start-up firms may not necessarily mean that small firms will enter the
market=
Costs may still be too high despite this and incumbent firms in the market may have such significant
market share due to marketing and brand loyalty=
New firms joining the market will receive very little demand for their products as demand may be
inelastic for the existing firms=
Also, these existing firms may be very large so can exploit economies of scale to a greater extent
than these small firms which experience little growth=
Thus, the costs may be so low for existing firms in the market that they are able to have such low
prices=
May be able to implement limit pricing which means dropping prices so low to prevent new entrants
joining the market=
Even a cut in fixed costs such as business rates for small firms entering the market, will not be
enough to drive down costs to the point where small firms joining the market can make enough profits
to be sustainable in the long-run=
The new firms joining the market may still operate where AVC>AR so in the long-run they should
shut-down meaning small firms may not actually be able to compete in the market despite this cut in
business rates
(DRAW A SHUT DOWN POINT DIAGRAM SHOWING AVC GREATER THAN AR)
NOTES
Evaluate possible methods the government can use to promote competition and contestability
Point 1: Encourage growth of small businesses
One way the government may promote competition and contestability in markets is by encouraging
the growth of small businesses=
This may be in the form of tax incentives such as lower business rates or even no business rates for
the first 6 months of being a business (Small Business Rate Relief - Full relief if rateable value is
under £12,000 ) (No VAT until turnover exceeds £90,000) =
It could also be start-up grants to help push down costs as they don’t have start up costs=
This would mean that start-up (government backed personal loans to start ups of up to £25,000)
small firms do not have to pay business rates on their property meaning that their fixed costs are
lower=
As a result AC1 shifts down to AC2 moving the firm from a loss-making business to making a profit=
Prices fall from P1 to P2=
As a result of this, more small firms are likely to join the market because they can push down their
costs and make supernormal profits for the first 6 months in operation=
These profits can then be used to reinvest back into the business such as by investing into capital
machinery=
Thus, these small firms can become more productively efficient in the long-run and dynamically
efficient=
As these small firms are able to grow in the first 6 months, they may be able to start exploiting
economies of scale as they increase output due to growth=
This means they may be able to exploit purchasing economies of scale such as bulk buying raw
materials for their production=
As a result, long-run average costs fall even further as there is a movement along the LRAC curve
closer to the MES and productive efficiency=
, This means these small business will be able to grow in the short-term to make enough profits for
reinvestment and to exploit economies of scale allowing for competition in the market
(DRAW A COST AND REVENUE DIAGRAM DEPICTING AC SHIFTING DOWN)
Evaluation Point 1: Effectiveness of intervention
The cut in business rates for start-up firms may not necessarily mean that small firms will enter the
market=
Costs may still be too high despite this and incumbent firms in the market may have such significant
market share due to marketing and brand loyalty=
New firms joining the market will receive very little demand for their products as demand may be
inelastic for the existing firms=
Also, these existing firms may be very large so can exploit economies of scale to a greater extent
than these small firms which experience little growth=
Thus, the costs may be so low for existing firms in the market that they are able to have such low
prices=
May be able to implement limit pricing which means dropping prices so low to prevent new entrants
joining the market=
Even a cut in fixed costs such as business rates for small firms entering the market, will not be
enough to drive down costs to the point where small firms joining the market can make enough profits
to be sustainable in the long-run=
The new firms joining the market may still operate where AVC>AR so in the long-run they should
shut-down meaning small firms may not actually be able to compete in the market despite this cut in
business rates
(DRAW A SHUT DOWN POINT DIAGRAM SHOWING AVC GREATER THAN AR)
