Key economic terms

Unit 1, Introduction to economics

Microeconomics

The study of the behaviour of individual consumers, firms, and markets and the

determination of market prices and quantities of goods, services, and factors of

production.

Scarcity

A key concept in economics. The limited availability of economic resources

relative to society’s unlimited needs and wants of goods and services. This

tension results in economic choices which create opportunity costs.

Rational consumer choice

Occurs when consumers make choices based on the following assumptions: they have

consistent tastes and preferences, they have perfect information and they arrange their

purchases so as to make their utility as great as possible (maximise it). It is assumed in

standard microeconomic theory.

Rational producer behaviour

Occurs when firms try to maximise profit. This is an assumption in standard microeconomic

theory.

Rational behaviour

An assumption in standard (micro)economic theories in which more is done of an action for

which the benefits outweigh the costs.

Opportunity cost

The value of the next best alternative foregone (not chosen) when an economic decision is

made.

Factors of production

Resources used in the production of goods and services; include land (natural resources),

labour, capital and entrepreneurship.

Entrepreneurship

One of the factors of production. Refers to the ability of certain individuals to organise the

other factors of production (land, labour, capital) in doing so being willing to take a risk in

return for a profit.

Firm

An entity such as a business that uses factors of production in order to produce and sell goods

and services and earn profits. It is an important decision maker in a market economy.

Labour

One of the factors of production that refers to the physical and mental contribution of workers

to the production process.

Human capital

The education, training, skills, experience and good health embodied in the labour force of a country.

Land / natural resources

One of the factors of production that refers to the natural resources with which an economy is

endowed.

Infrastructure

Physical capital typically financed by governments that is essential for economic

activity to take place, including roads, power, telecommunications and sanitation, generating

significant positive externalities.

Capital (goods)

One of the factors of production. Physical capital refers to the means of production that include

machines, tools, equipment and factories; the term may also refer to the infrastructure of a

country. Human capital refers to the education, training, skills and experience embodied in the

labour force of a country.

Investment (I)

Spending by firms on capital goods such as machines, tools, equipment and factories.

Manufactured goods

Goods that have been produced by workers often working with capital goods.

Needs

Those goods and services which are necessary for survival such as food, clothing, and shelter/housing.

Wants

Those goods and services which are not necessary for survival, but make life more enjoyable.

Rationing

A method used to divide or apportion goods and services or resources among the various

interested parties.

Production

The process to transform inputs (factors of production) into output (goods and services)

Free market economy

An economic system where the factors of production are privately owned and where the

market forces of demand and supply determine the answers to the fundamental economic

questions (what/how much, how and for whom).

Planned economy

An economic system where the factors of production are owned by the state. The government

determines what/how much to produce, how to produce, and for whom to produce.

Mixed economy

An economy that has elements of a planned economy and elements of a free market economy.

This economy has a public and private sector. In reality, all economies are mixed. What is

different is the degree of the mix from country to country.

Resource allocation

Distributing / rationing available resources or factors of production to particular uses for

production by answering the questions: what, how and from whom to produce. Resource

allocation decisions depend on the economic system in place.

Primary sector

That part of the economy in which output is derived from natural resources (land), including

agricultural output and primary commodities such as metals and minerals.

Wage

Reward / Payment received by the factor of production labour, which is a certain amount per

unit of time (hour / day / month). Is part of total income earned.

Interest

The reward earned by the factor of production capital, which is usually expressed as a

percentage per period of time. Is part of total income earned.

Profit

The reward earned by the factor of production entrepreneurship. Is part of total income earned.

In a different context also defined as the difference between the total revenues and total costs

over a certain period of time for a firm.

Rent

The reward earned by natural resources. Is part of total income earned.

National income

The income earned by the factors of production of an economy, equal to wages plus interest,

plus rents, plus profits.

Income

a flow of earnings from using factors of production to produce goods and services. Wages and

salaries are the factor reward to labour and interest is the flow of income for the ownership of

capital.

Free goods

Goods such as air or sea water that are not considered scarce and thus do not have an opportunity cost.