Theme 3 Key Definitions

Abnormal profit

The profit over and above normal profit- can also be a loss

Allocative efficiency

Allocative occurs when resources are distributed in such a way that no consumers could be better off without other consumers becoming worse off. It exists in an economy if price = marginal cost in all industries. Allocative efficiency occurs when a firm produces at P = MC. Resources are used to produce what consumers want in the quantities demanded.

AC

TC/Q

AFC

TFC/Q

AVC

TVC/Q

AR

TR/Q = P

Barriers to entry

Factors which make it difficult or impossible for firms to enter an industry and compete with existing producers

Barriers to exit

Factors which make it difficult or impossible for firms to cease production and leave an industry

Break-even point

The level of output where total revenue equals total cost

Cartel

An organisation of producers which exists to further the interests of its members, often b restricting output through the imposition or quotas, leading to a rise in price

Collusion

Collective agreements between producers which restrict competition

Competitive Tendering

Introducing competition amongst private sector firms which put in bids for work which is contracted out by the public sector

Concentrated Market

A market where most of the output is produced by a few firms. 

 

Concentration Ratio

The market share of the largest firms in the industry. For instance, a five firm concentration ratio of 60% shows that the five largest firms in the industry have a combined market share of 60% 

 

Conglomerate Merger

A merger between two firms producing unrelated products

Contestable Market

A market where there is freedom of entry to the industry and where costs of exit are low

Contracted Out

Getting private sector firms to produce the goods and services which are then provided by the state for its citizens

Deadweight welfare loss

A loss to society due to market failure

Decreasing returns to scale

A doubling of input leads to a less than doubling of output

Demerger

When a firm splits into tow or more independent businesses

Deregulation

The process of removing government controls from markets

Diseconomies of Scale

A rise in the long run average costs of production as output rises

Dynamic Efficiency

A firm is dynamically efficient if it invests in R&D to innovate and produce new and better products/technologies for consumers

Economies of Scale

A fall in the long run average costs of production as output rises

External economies of scale

External EoS occurs when an industry grows and its long run average costs fall

Fixed Costs

Costs which do not vary as the level of production increases or decreases

Game Theory

The analysis of situations in which players are interdependent

Heterogeneous Products

Branded goods which are similar but not identical - made by different firms

Homogenous Products

Products made by different firms but which are identical

Horizontal merger/integration

A merger between two firms in the same industry at the same stage of production

Increasing returns to scale

A doubling of input leads to a more than doubling of output

Interdependence

Businesses in an oligopoly will each take decisions in the light of the behaviour, or the expected reactions, of the other firms in the industry

Internal markets

Where parts of an organisation, such as the NHS or the BBC, compete against each other to provide services

Law of diminishing returns

In the short run, as output is increased by adding more of the variable input factors to a fixed amount of a fixed factor, productive efficiency will at first rise then fall

Limit Pricing

When a firm, rather than profit maximising, sets a low enough price to deter new entrants from coming into its market

Long Run

In the long run, all factor inputs are variable

Marginal Costs

The cost of producing one extra unit of output MC = ΔTC/ΔQ

Marginal Revenue

The income from selling an extra unit of output the difference between total revenue at different levels of output MR = ΔTR/ΔQ

Market Concentration

The degree to which the output of an industry is dominated by its largest producers

Market Share

The proportion of sales in a market taken by a firm or a group of firms

Market Structure

The characteristics of a market which determine the behaviour of firms within the market

Merger, amalgamation, integration or takeover

The joining together of two or more firms under common ownership

Minimum efficient scale of production

The lowest level of output at which long run average cost is minimised

Monopolistic competition

A market structure similar to Perfect Competition but with heterogeneous products

Monopoly

A market structure where there is one dominant seller and barriers to entry prevent new firms from entering the market

Monopsony

A monopsony exist when there is only one buyer in the market

Natural Monopoly

Where economies of scale are so large relative to market demand than the dominant producer in the industry will always enjoy lowers costs of production than any other potential competitor

Normal Profit (zero profit)

The profit the firm could make by using its resources in their next best use (implied by AR=AC)

Oligopoly

A market structure where there is a high market concentration, interdependence and barriers to entry

Optimum level of production

The range out output over which long run average cost is lowest

Pareto Efficiency

Pareto efficiency occurs when the only way to make one person better off is to make another worse off

Perfect Competition

A market structure where there are many buyers and sellers, where there is freedom of entry and exit to the market, where there is perfect knowledge and product homogeneity

Perfect knowledge/information

Perfect knowledge or information exists if all buyers in a market are fully informed of prices, whilst producers have equal access to information about production techniques

Predatory Pricing

A firm driving its prices down to force a competitor out of a market and then putting them back up again once its objective has been achieved

Price Discrimination

When firms charge different prices to different groups of consumers for the same good or service

Price-Maker

A firm is a price-maker if it has the power to set its price

Price-Taker

A firm which has no control over the market price and has to accept the market price if it wants to sell its product

Prisoner’s Dilemma

A game where, given that neither player knows the strategy of the other player, the optimum strategy for each player leads to a worse situation than if they had known the strategy of the other player and been able to cooperate and coordinate their strategies

Privatisation

The transfer or organisations or assets from state ownership to private sector ownership

Profit

Profit is the difference between revenue and costs

Productive efficiency

Productive efficiency is achieved when production is achieved at lowest cost (AC is minimised)

Profit Maximisaiton

MC = MR

Public Private Partnership (PPP)

A partnership between the public sector and the private sector where the public sector and private sector companies collaborate to deliver services. An example of a PPP is the Public Finance Initiative where the private sector builds and maintains infrastructure like a hospital and leases it to the government

 

Regulatory capture

When regulators are influenced by the firms they are supposed to regulate to favour the interests of the industry rather than those of the consumer

Resale price maintenance

Fixing a price at which a customer may sell on a good or service

Restrictive trade practices

Tactics used by producers to restrict competition in the market

Revenue

Revenue is money earned by a firm for selling its output

Revenue Maximisaiton

MR = 0

Sales Maximisaiton

AR = AC

Satisficing

Profit satisficing is making sufficient profits to satisfy the demands of shareholders

Separation of markets

Price discriminators are able to separate groups of consumers in a number of way including age, sex and time

Shut-down Point

A firm should shut down if its total (or average) revenue is less than its variable (or average variable) costs

Short run

In the short run, at least one factor input is fixed in supply

Sunk Costs

Costs of production which are not recoverable if a firm leaves the industry

Supernormal Profit (abnormal profit)

Profit which is in excess of the amount needed to keep the resources in the industry (implied by AR>AC)

Synergy

When two or more activities or firms put together can lead to greater outcomes than the sum of the individual parts

 

Tacit Collusion

When firms collude without any formal agreement having been reached or even without any explicit communication between the firms having taken place

 

Total Costs

TC = TFC + TVC

Total Fixed Costs

TFC = All FC added together

Total Variable Costs

TVC = All VC added together

Total Revenue

TR = P x Q

Variable Costs

Costs which vary directly in proportion to the level of output of a firm

Vertical merger/integration

A merger between two firms at different production stages in the same industry

X-Inefficiency (Organisational Slack)

Organisational slack or X-inefficiency is inefficiency arising because of a firm fails to minimise its costs of production

Zero Sum Game

A game in which the gain of one player is exactly offset by the loss by other players