Edexcel Economics A Level Definitions: Theme 3

Firm

a production unit, which converts resources into goods and services

Industry

a collection of firms operating in the same production process

Stakeholder

any individual or organisation who has an interest in the decision making of a business

Shareholder

any individual or organisation who owns the business

Dividends

percentage of profits that shareholders receive

Public sector organisations

are owned and controlled by the state (government), goal of control rather than profit maximisation

Private sector organisations

are owned and controlled by private investors, goal of profit maximisation

Public limited company

a firm owned by shareholders and shares are list on the stock exchange market for public purchase

Private limited company

a firm owned by private shareholders with limited liability. Its shares are not available to the public and are typically held by a small group of investors.

Not-for-profit firms

are organizations that operate without the intention of generating profit for owners or shareholders. Instead, they reinvest any surplus revenue into their mission or community services.

Organic growth

the internal growth of business, driven by internal expansion using reinvested profits or loans

Horizontal integration

a merger/takeover of a firm at the same stage of the production process in the same industry/sector

Backwards vertical integration

A merger/takeover with another firm further backward in the supply chain or production process, closer to the raw materials

Forwards vertical integration

A merger/takeover with another firm further forward in the supply chain or production process, closer to the final consumers

Conglomerate integration

a merger/takeover of firms in a completely different industry

Merger

when two firms combine to create a new firm

Takeover

the purchase of a controlling interest in one firm by another i.e. accquistion of one firm by another

Demerger

when a firm decides to split into separate firms or sell of at least one business it owns

Profit maximisation

Firms maximise profits or minimise losses. Occurs at MC = MR.

Revenue maximisation

when a firm maximises total revenue, occurs at MR = 0

Sales maximisation

when a firm maximises sales of its output while still achieving normal profit, occurs at AC = AR

Satisficing

when a firm aims to make a minimum accepted level of profit and then pursues other aims

Total revenue

Total value of sales a firm incurs. TR = P x Q

Average revenue

Overall revenue per unit. AR = TR/Q

Marginal revenue

the extra revenue received from the sale of an additional unit of output. MR = change in TR/ change in Q

Price taker

a firm that cannot influence price in the market

Price maker

A firm that has market power and can manipulate prices to change demand

Fixed cost

A cost that is independent of output and so does not change when the level of output changes.

Variable cost

A cost that varies directly with output

Marginal cost

the cost of producing an additional unit of output, MC = change in TC/change in Q

Total cost

TC = TFC + TVC

Total fixed cost

TFC = FC x Q or TC - TVC

Total variable cost

TVC = VC x Q or TC - TFC

Average cost

AC = TC/Q or AFC + AVC

Average fixed costs

AFC = FC/Q or AC - AVD

Average variable cost

AVC = VC/Q or AC - AFC

Marginal product of labour (MP)

The change in output that results from adding an additional unit of labour, MP = change in TP/ change in Q

Constant returns to scale

A firm grows and output increases proportionate to input

Increasing returns to scale

A firm grows and output increases proportionately more than the increase in inputs

Decreasing returns to scale

A firm grows and output increases proportionately less than the increase in input

Economies of scale

Fall in LRAC as a firm grows

Diseconomies of scale

LRAC rise as a firm grows

Minimum efficient scale (MES)

The lowest point on a LRAC curve, correlates to the lowest possible cost per unit that a firm can achieve in the long run

Internal economies of scale

Economies of scale resulting from growth in production within the firm

External economies of scale

Economies of scale that occur when there is a growth in a sector or location in which the firm operates that causes falling LRAC for the firm

Explicit costs

costs that must be paid

Implicit costs

opportunity costs of production

Normal profit

amount of profit needed for a firm to stay open, TR = TC

Supernormal profit

Any amount of profit over and above what is necessary for a firm to stay open, TR > TC

Loss

TR < TC

Short run shutdown point

AR = AVC

Long run shutdown point

AR < AC

Productive efficiency

when firms produce maximum output using minimum input, MC = AC

Allocative efficiency

Firms use resources in a way that maximises social welfare, MC = AR

X-inefficiency

when firms produce at any given level of output at a higher cost than necessary, AC is higher than the lowest possible AC

Dynamic efficiency

Efficiency gained over time

Perfect competition

A market where a large number of small firms co-exist, selling homogenous goods. Normal profits are achieved in the long run.

Monopolistic competition

A market with many small firms that supply slightly differentiated goods, allowing some price-setting power.

Oligopoly

A market dominated by a few firms.

Interdependence

The actions of one firm in the industry will impact other firms in the industry

Concentration ratio

The market share controlled by the ‘n’ largest firms

Collusion

an agreement between two or more firms to limit competition and divide the market, set prices or output

Non-collusive behaviour

when firms actively compete to maintain or increase their market share

Overt collusion

when firms openly fix prices, output, marketing or the sharing out of customers

Price fixing

when firms come together to ensure that prices remain stable, thus avoiding price competition

Cartel

a group of firms providing the same products join together to limit output and raise prices, effectively acting as a monopoly

Tacit collusion

Implicit cooperation with no spoken agreement. Firms signal their intentions through pricing behaviour, output levels etc.

Price leadership

One, normally the largest, firm sets a price and other firms follow this, without explicit agreement

Game theory

A mathematical framework which is used by firms to ensure optimal decisions are made in a setting where there is a high level of interdependence

Dominant strategy

That which is best regardless of the other firm’s choice, carries the least risk

Nash equilibrium

Any situation where all firms are pursuing their best possible strategy, given the strategies of all other firms

Price wars

Firms repeatedly cut prices below that of its competitors

Predatory pricing

Pricing below costs of production to drive out other firms

Limit pricing

Pricing at a level near AC to discourage entry of new firms

Non-price competition

competition that is not based on price but on other factors e.g. branding, marketing

Barrier to entry

An obstacle or conditions that prevents new firms entering an industry by making it difficult or expensive to compete profitably with existing suppliers

Monopoly

the sole supplier of a good or service

Cross-subsidisation

when firms use profit generated by one product to lower the price of another, loss-making, product

Price discrimination

when a firm charges different prices to different consumers for an identical good or service with no difference in the costs of production

Natural monopoly

when one large business can supply a market at a lower price than smaller ones, it is most efficient for only one firm to operate

Sunk costs

costs that have already been incurred and cannot be recovered

Monopsony

sole buyer of a good in the market

Contestable market

A market with low sunk costs and therefore low barriers to entry

Contestability

the threat of competition or new entrants into the market

Barriers to exit

costs associated with a firm’s decision to leave the industry

Derived demand

demand is based on the demand for goods or services being produced

Marginal revenue product of labour (MRPL)

The extra revenue generated when a firm employs an additional worker, MRPL = MP x MR

Elasticity of demand for labour

the responsiveness of demand to changes in the wage rate

Labour supply

the number of hours people are willing and able to work at a given wage rate

Elasticity of supply of labour

the responsiveness of workers, or potential workers, to changes in the wage rate

Immobility of labour

the inability of workers to change between jobs

Geographical immobility

barriers that mean people cannot move from one area to another to find work

Occupational immobility

workers are unable to change jobs or take up new opportunities due to a lack of skills or training

Monopsony power of employers

A company is the only, or dominant, employer in a geographical area; they have buying power of labour

Perfectly competitive labour market

when the interaction between demand and supply creates a price for labour, the equilibrium wage rate

Trade union

an organised association of workers in a trade or profession, formed to protect workers’ rights

Minimum wage

the minimum pay per hour workers are legally entitled to

Real wage unemployment

Unemployment caused by a minimum wage that is set above the equilibrium wage rate, leading to a surplus of labour.

Competition policy

the means by which governments of countries seek to restore and maintain competition in markets, to ensure efficient working of markets and improved consumer welfare

Regulation

direct government control of firms, used when market forces are judged to be inadequate as a means of protecting consumer interests