Economics test 1

Economics

The study of how scarce resources are allocated to satisfy unlimited human wants.

Scarcity

The condition in which resources are limited and unable to meet unlimited wants.

Choice

Decisions made because resources are scarce and not all wants can be satisfied.

Opportunity cost

The value of the next best alternative forgone when a choice is made.

Factors of production

The resources used to produce goods and services: land, labour, capital and entrepreneurship.

Land

All natural resources used in production.

Labour

The physical and mental human effort used in production.

Capital

Man-made resources used to produce other goods and services.

Entrepreneurship

The ability to organise the other factors of production and take risks to produce goods and services.

Economic good

A good or service that is scarce and therefore has an opportunity cost.

Free good

A good that is not scarce and has no opportunity cost.

Resource allocation

The assignment of scarce resources to the production of different goods and services.

Production possibilities curve (PPC)

A curve showing the maximum combinations of two goods that can be produced using all resources fully and efficiently at a given state of technology.

Efficiency

Producing the maximum possible output from available resources; no resources are wasted.

Market

Any arrangement where buyers and sellers meet to carry out an economic transaction.

Demand

The quantity of a good or service that consumers are willing and able to buy at various prices in a given period of time, ceteris paribus.

Quantity demanded

The quantity of a good or service that consumers are willing and able to buy at a specific price in a given period of time.

Supply

The quantity of a good or service that producers are willing and able to sell at various prices in a given period of time, ceteris paribus.

Quantity supplied

The quantity of a good or service that producers are willing and able to sell at a specific price in a given period of time.

Law of demand

As the price of a good falls, the quantity demanded normally increases, ceteris paribus.

Law of supply

As the price of a good rises, the quantity supplied normally increases, ceteris paribus.

Ceteris paribus

“Other things being equal”; all other factors are assumed constant when one variable changes.

Individual demand

The demand for a good or service by one consumer.

Market demand

The sum of all individual demands for a good or service.

Individual supply

The supply of a good or service by one producer.

Market supply

The sum of all individual supplies for a good or service.

Movement along the demand curve

A change in quantity demanded caused only by a change in the price of the good itself.

Shift of the demand curve

A change in demand caused by a non-price determinant of demand.

Movement along the supply curve

A change in quantity supplied caused only by a change in the price of the good itself.

Shift of the supply curve

A change in supply caused by a non-price determinant of supply.

Non-price determinant of demand

A factor other than the good’s own price that affects demand (e.g. income, tastes, price of related goods).

Non-price determinant of supply

A factor other than the good’s own price that affects supply (e.g. costs of production, technology).

Substitute good

A good that can be used in place of another; an increase in the price of one increases demand for the other.

Complementary good

A good that is used together with another; an increase in the price of one decreases demand for the other.

Normal good

A good for which demand increases as income increases.

Inferior good

A good for which demand decreases as income increases.

Joint supply

When two or more products are derived from the same resource so that producing more of one automatically produces more of the other.

Competitive supply

When a producer can use the same resources to produce different goods, so producing more of one means producing less of another.

Market equilibrium

The situation where quantity demanded equals quantity supplied at a particular price.

Equilibrium price

The price at which quantity demanded equals quantity supplied.

Equilibrium quantity

The quantity bought and sold at the equilibrium price.

Excess demand

A situation where quantity demanded is greater than quantity supplied at a given price, causing upward pressure on price.

Excess supply

A situation where quantity supplied is greater than quantity demanded at a given price, causing downward pressure on price.

Price mechanism

The system where prices are determined by changes in demand and supply to allocate resources.

Signalling function of price

The way changing prices communicate information to producers and consumers about changing market conditions.

Incentive function of price

The way changing prices create incentives for producers and consumers to change their behaviour.

Rationing function of price

The way prices distribute goods and services among buyers when there is scarce supply.

Consumer surplus

The extra benefit received by consumers because they pay a price lower than the maximum they are willing to pay.

Producer surplus

The extra benefit received by producers because they receive a price higher than the minimum they are willing to accept.

Community surplus

The sum of consumer surplus and producer surplus; also called social surplus.

Allocative efficiency

When resources are distributed so that social surplus is maximised; where marginal social benefit equals marginal social cost.

Productive efficiency

Producing goods at the lowest possible cost per unit.

Marginal benefit

The extra benefit received from consuming one more unit of a good or service.

Marginal cost

The extra cost of producing one more unit of a good or service.

Utility

The satisfaction or enjoyment a consumer gains from consuming a good or service.

Marginal utility

The extra satisfaction gained from consuming one more unit of a good or service.

Elasticity

The measure of responsiveness of one variable to a change in another variable.

Price elasticity of demand (PED)

The responsiveness of quantity demanded to a change in price.

Elastic demand

Demand where the absolute value of PED is greater than 1.

Inelastic demand

Demand where the absolute value of PED is less than 1.

Unit elastic demand

Demand where the absolute value of PED equals 1.

Perfectly inelastic demand

Demand where PED equals 0; quantity demanded does not change when price changes.

Perfectly elastic demand

Demand where PED is infinite; any change in price leads to an infinite change in quantity demanded.

Determinants of PED

The non-price factors that influence PED, such as number of substitutes, proportion of income spent, necessity versus luxury and time.

Total revenue

The total income a firm receives from selling its product; price multiplied by quantity sold.

Price elasticity of supply (PES)

The responsiveness of quantity supplied to a change in price.

Elastic supply

Supply where the absolute value of PES is greater than 1.

Inelastic supply

Supply where the absolute value of PES is less than 1.

Determinants of PES

The non-price factors that influence PES, such as time period, spare capacity, ability to store stock and mobility of factors of production.

Cross price elasticity of demand (XED)

The responsiveness of demand for one good to a change in the price of another good.

Substitutes (XED)

Two goods with positive XED; an increase in the price of one increases demand for the other.

Complements (XED)

Two goods with negative XED; an increase in the price of one decreases demand for the other.

Income elasticity of demand (YED)

The responsiveness of demand for a good to a change in consumer income.

Normal good (YED)

A good with positive YED; demand increases when income increases.

Inferior good (YED)

A good with negative YED; demand decreases when income increases.

Luxury good

A good with YED greater than 1; demand increases more than proportionately as income increases.

Government intervention

Actions by the government to affect market outcomes, such as through taxes, subsidies and price controls.

Indirect tax

A tax imposed on expenditure on goods and services.

Specific tax

An indirect tax of a fixed amount per unit of the good.

Ad valorem tax

An indirect tax calculated as a fixed percentage of the price of the good.

Direct tax

A tax imposed directly on income or wealth.

Subsidy

A payment by the government to producers to lower their costs of production and encourage increased output.

Price ceiling (maximum price)

A legal maximum price set by the government below the equilibrium price.

Price floor (minimum price)

A legal minimum price set by the government above the equilibrium price.

Minimum wage

A price floor in the labour market; the minimum legal wage a firm can pay a worker.

Black market

Unrecorded, unofficial markets where goods are traded at prices that violate legal price controls.

Tax incidence

The way the burden of a tax is shared between consumers and producers.

Deadweight loss

The loss of social surplus that occurs when the market is not producing at the socially optimal level of output.

Government failure

When government intervention in the market leads to a more inefficient allocation of resources than before.

Market failure

When the free market, left to itself, fails to allocate resources efficiently.

Private cost

The cost of production borne by producers of a good or service.

Private benefit

The benefit received by consumers of a good or service.

External cost

A cost of production or consumption that is borne by third parties not directly involved in the economic activity.

External benefit

A benefit of production or consumption that is received by third parties not directly involved in the economic activity.

Marginal private cost (MPC)

The cost to producers of producing one more unit of a good or service.

Marginal private benefit (MPB)

The benefit to consumers of consuming one more unit of a good or service.

Marginal social cost (MSC)

The cost to society of producing one more unit of a good, including both private and external costs.

Marginal social benefit (MSB)

The benefit to society of consuming one more unit of a good, including both private and external benefits.

Negative externality of production

A situation where production imposes external costs on third parties.

Negative externality of consumption

A situation where consumption imposes external costs on third parties.