Key Definitions Flashcards
Allocative efficiency
Optimal allocation of supply to meet consumer demand
Price = Marginal Cost = Marginal Utility
Average cost
The cost per unit – total costs divided by quantity of output.
Average Revenue
The average selling price – total revenue divided by the number of units of output sold.
Backward vertical integration
Where a firm merges or takes over a business that is one stage further away from the consumer in the production process.
Barriers to entry
Anything that prevents new firms entering a market such as brand loyalty, economies of scale, technical know-how and patents.
Cartel
A group of firms that agree to act together as though they were a monopoly in order to raise profits.
Competition policies
Policies designed to restrict the acquisition and exercise of monopoly power by firms.
Conglomerate merger
When firms producing related products merge
De-merger
When a firm is divided up into separate businesses
Diminishing marginal returns
An economic law stating that if increasing quantities of variable factor are applied to a given quantity of a fixed factor, the marginal production of the variable factor will eventually decrease.
Diseconomies of scale
A situation where increasing the scale of producing further leads to an increase in the long run average costs of production.
External economies of scale
Cost savings that arise from sources outside the firm due to a growth of the industry as a whole
First-mover advantage
The advantages that accrue to a firm by being the first to enter a market such as market power or supernormal profit
Fixed costs
Cost that do not vary with output and exist only in the short run.
Forward vertical integration
When a firm merges or takes over a business that is one stage closer to the consumer in the production process
Game theory
Game theory is used to predict a firm’s decision when faced with a set of choices whose payoffs are influenced by the choices of other firms in the market.
Homogenous products
A product tis homogenous when consumers perceive each unit to be identical
Horizontal integration
The joining of two firms together which produce similar products at the same stage of production
Imperfect competition
When firms have some price setting market power and thus face a downward sloping demand curve
Examples include duopoly, oligopoly and monopolistic competition.
Incumbent firms
Firms that are established in a market and therefore do not face sunk costs.
Indivisibility
When a firm would not use a resource to its full capacity and therefore will not achieve the lowest unit costs of production -e expanding the scale of production allows firms to utilise more efficient, larger machines and therefore reduce average costs.
Interdependence
Where the outcome from a decision is dependent upon the decisions of other rival firms.
Internal economies of scale
A situation where increasing the scale of production leads to a decrease in the long run average costs of production
Limit pricing
Where a firm sets its price below the average cost of potential entrants in order to discourage entry.
Long run
The period of time required for all input costs to be variable.
Marginal cost
The additional cost of producing one more unit of output
Marginal revenue
The additional revenue from selling one more unit of output
Market share
A firm’s percentage share of the total market, normally measured using sales.
Merger
When two formerly independent firms unite.
Monopolistic competition
A market structure in which there are many buyers and sellers, free entry and exit but heterogeneous products giving each firm some price setting power.
Monopoly
A pure monopoly is one where the market has only one supplier.
In the UK, the legal definition of a monopoly is when a firm has 25% or more market share.
Monopsony
A market with only one purchaser
Multinational
A firm that has operations in more than one country
multi national company
New entrants
New firms in a market normally attracted by the existence of supernormal profits.
Non-price competition
Competitive activity that doesn’t involve reducing prices such as brand promotion, production differentiation, innovation and customer service.
Normal profit
The level of profit that represents the opportunity cost of the resources used to achieve it. If normal profits are not attained, resources will leave the market to be used more productively in an alternative market.
Oligopoly
An oligopoly is a market where there are a few independent firms dominating the market.
Perfect competition
A market structure in which there are many buyers and sellers, free entry and exit, perfect information and homogeneous products thus making all firms price takers.
Predatory pricing
Predatory pricing occurs when a firm incurs short-term losses with the intention of removing a rival and/or deterring other potential competitors. It considered anti-competitive.
Price discrimination.
The sale of the same good or service to different consumer groups at different prices.
Three conditions are necessary: effective separation of markets to prevent resale, different PEDs for the separated markets and and agree of monopoly power.
Price elasticity of demand
The responsiveness of quantity demanded to a change in price.
Price leader
A firm with sufficient market power to decide on a price change which its competitors will tend to follow
Price taker
A firm that can alter its output without having any effect on the price of the product it sells.
Prisoner’s dilemma
A model used to help show how two interdependent firms may rationally produce where both firms are worse off if collusion does not take place.
Privatisation
The transferring of economic activity out of the public sector and into the private sector in order to improve the productive efficiency of provision , improve innovation and increase investment.
Product differentiation
The existence of close substitutes within a market as firms try and establish a degree of price setting power.
Productive efficiency
When a firm produces at the lowest point on its average cost curve it is impossible to produce more of one good without producing less of another.
(When a firm is most efficient, it must be on its PPF)
Profit maximisation
Profit maximisation is achieved at the level of output where marginal revenue is equal to marginal cost. It is often assumed that this is the primary objective of firms.
Public-private partnerships?
The use of private firms by the government to improve the provision of public services through higher and more efficient investment.
Private Finance Initiatives uses private capital and private sector companies to finance and operate infrastructure that was previously publicly funded and managed.
Revenue maximisation
An alternative objective in order to increase market share- it is the level of output where marginal revenue=0
Sales maximisation
An alternative objective in order to achieve the highest levels of sales whilst only making normal profit - it is the level of output where P(AR)=AC
Satisficing
A business that pursues other objectives once a satisfactory level of profit has been attained.
Short run
The period of time over which the inputs of some factors cannot be varied and thus the quantity of firms in a market is constant.
Shutdown point
The level of output where total revenue is equal to total variable costs - below this point a firm would choose zero output to minimise the loss made.
Shutdown price
The price that is equal to average variable cost, below which a firm would choose zero output to minimise the loss made.
Sunk costs
A sunk cost of entry is a cost that a firm must incur to enter a market and that cannot be recovered if the firm subsequently exits.
Supernormal profit
A level of profit that is higher than the required level of profit to keep the firm in the market. The existence of such excess profits will attract the entry of firms in the long run.
Tacit collusion
When firms behave in each other’s mutual interest and restrict their competitive actions without any agreement in place.
Takeover bid
The offer made by the potential buyer for the shares of another firm in order to achieve control of the business.
X-inefficiency
The failure of firm to minimise costs at a given level of output and thus produce above its own average cost curve.
Contestable market
A market with no entry / exit barriers due to an absence of sunk costs. This leads to ‘hit and run’ competition whenever there are supernormal profits to be made.
Cost plus pricing
Where price is set at average cost plus a certain percentage mark-up
Cartel
A formal agreement between two or more firms to fix price and or output, thereby avoiding a price war.
Internal growth
Where the firm increases the sales and total revenue of its existing business
External growth
Where the firm grows through mergers and acquisitions
Conglomerate integration
Merging of two firms from completely unrelated markets
Competition policy
To promote competition, thereby protecting consumer interests int he form of lower prices and greater quality, variety and choice.
Regulatory capture
Where the regulator beings to sympathise with the regulated firm, leading to lenient price caps and performance targets.
Deregulation
Where the government removes or simplifies restrictions in entering an industry, with the aim of stimulating new competition.
Normative statement
It is a statement that contains a value judgement and cannot bee tested.
Positive statement
It is a statement that is testable.
PPF
A graphical representation of the maximum output an economy can produce given a finite combination of resources.
Movement along the frontier implies an opportunity cost in terms of the output of one good forgone to gain the output of another.
Opportunity cost
The value of the next best alternative foregone
Division of labour
Breaking the production process into separate, sequential tasks leading to workers specialising
Specialisation
A system of organisation where individuals specialise in the production of particular goods or services.
Price mechanism
An economic system which allocates resources using price to transmit information, provide incentives and distributes rewards.
Rationing function of the price mechanism
The price mechanism allocates scarce resources to those buyers who are prepared to pay a high enough price
Signalling function of the price mechanism
Prices help to determine where and how resources should be allocated e.g. if prices increase, this suggests more sources should be allocated to the market.
Incentive function of the price mechanism
Prices act as an incentive to both buyers and sellers e.g. a rising price may encourage sellers to supply more of a product and buyers to purchase less.
Market equilibrium
A position where the market price has no tendency to change, assuming ceteris paribus, because demand equals supply.
Ceteris paribus
An assumption that all other factors are held constant.
Free-market economy
An economy which tackles the basic economic problems, the co-existence of infinite wants and finite resources, predominately through the price mechanism.
Command economy
An economy which allocates its resources predominately through the direction of a central planning authority.
Mixed economy
An economy where both the price mechanism and the planning authority have a significant role in allocating resources.
Consumer surplus
The difference between the amount a consumer is willing to pay for a product and the amount they actually pay.
(Represented by the area below the demand curve and above the price line)
Producer surplus
The different between the price a firm is willing to sell a good or service for and the actual price they sell the good or service for.
(Represented by the area above the supply curve and below the price line)
Indirect tax
A tax on expenditure collected by the producer on behalf of the government.
(Tax shifts the supply curve up vertically by the tax per unit. Multiply this by the number of units Q1, gives the total tax revenue)
Subsidies
A payment made by the government to producers which they receive in addition to the market price to encourage the supply of a good or service.
(Subsidy shifts the supply curve down vertically by the subsidy per unit. Multiply this by the number of units, Qn, gives total expenditure).
Incidence of tax
The distribution of the burden of an indirect tax between buyers and sellers.
(The difference between the new and old price is paid for by the consumer, the area below the original price touching the supply curve is paid for by the producer)
Price elasticity of demand
Measures the responsiveness of quantity demand to a change in price
%Change QD / %Change Price
Income elasticity of demand
Measures the responsiveness of quantity demand to a change in income.
%Change QD / %Change Income (Y)
Cross-price elasticity of demand
Measures the responsiveness of quantity demand of good A to a change in the price of good B.
%Change QD of good A /
%Change P of good B
Substitutes
A pair of goods which are considered to be alternatives to each other.
Complements
A pair of goods that are consumed together.
Normal good
A good whose demand increases when income increases
Inferior good
A good whose demand falls when income increases.
This relationship may arise as consumers buy more desirable alternatives as their income rises.
Cross price elasticity of demand for substitute goods
Positive
Cross price elasticity of demand for complement goods
Negative.
Income elasticity of demand for normal goods
Positive
Income elasticity of demand for inferior goods
Negative
Derived demand
The demand for a factor of production that results from the demand for the product that it is used to make.
Price elasticity of supply
Measures the responsiveness of supply to a change in price
%Change in QS /
%Change in price
Short run
The period of time over which the quantity of some factor of production is fixed.
Long run
The period of time over which the quantity of all factors of production can be changed.
Market failure
Occurs when a free market produces a misallocation of scarce resources
Government failure
Occurs when government intervention leads to an even greater misallocation of resources and a movement away from the socially optimal point of production than if there was no intervention.
Public-choice theory
The failure of government to act in the interests of the population because public servants pursue their own private interests ahead of the wider public interest; i.e. salary, power.
Asymmetric information
When one party in an economic relationship has more information than another; e.g. doctors and patients.
Moral hazard
When people take actions that increase social costs because they are insured against private loss: sometimes it is called hidden action due to the agent’s actions being hidden form the principal.
Buffer stock scheme
A scheme that buys surplus produce in periods of abundance and sells stock in periods of shortage, in order to stabilise the market price.
Price ceiling
A maximum price set by a regulator above which suppliers cannot sell; i.e. rent controls for low-cost housing.
Price floor
A minimum price set by a regulator below which buyers cannot purchase; i.e. the national minimum wage.
Public goods
Goods and services that, one produced, can be consumed by everyone in society, they are non-rivalry and non-excludability.
Free riders
People who use public goods but don’t pay for them
Externalities
The costs or benefit received by a third party to an economic transaction outside of the market mechanism, i.e. the spillover effects of an economic activity.
External costs
The costs received by a third party to an economic transaction outside of the market mechanism
External benefits
The benefit received by a third part to an economic transaction outside of the market mechanism.
Pigouvian tax
A tax placed on a good with negative externalities so that the external cost is internalised: the polluter pays principle.
The tax is set equal to the marginal negative externality.
Tradeable permits
A market-oriented solution to regulating the quantity of pollution, where the rights to pollute a given amount are traded so that a pre-determined level of pollution abatement is achieved for the least cost.
Property rights
A legal right to the ownership of a resource. If this remains undefined, the resource may be overexploited, i.e. fishing.
Command-and-control
The use of law and regulation backed up by inspection and penalties for non-compliance.
Competition policy
Government policy directed at encouraging competition in the private sector: e.g. the investigation of takeovers or restrictive practices.
Trade union
An organisation of workers with the primary purpose of collectively bargaining for improved pay and conditions for its members.
Geographical immobility
The inability of workers to move location to attain work due to the cost of commuting or relocating and non-pecuniary factors.
Occupational immobility
The inability of workers to move occupation or find work due to a shortage of the required skills.
Cost benefit analysis
An investment appraisal tool used to weigh up the social benefits of a project against the social costs.
