UVI microeconomics

Rational behaviour (the traditional view)

acting in pursuit of self-interest, which for a consumer means attempting to maximise the welfare, satisfaction or utility gained from the goods and services consumed.

Behavioural economics

a method of economic analysis that applies psychological insights into human behaviour to explain how individuals make choices and decisions.

Asymmetric information

when one party to a market transaction possesses less information relevant to the exchange than the other.

Moral hazard

the tendency of individuals and firms, once insured against some contingency, to behave so as to make that contingency more likely.

Adverse selection

a situation in which people who buy insurance often have a better idea of the risks they face than do the sellers of insurance. People who know they face large risks are more likely to buy insurance than people who face small risks.

Bounded rationality

limited rationality; when making decisions, an individual's rationality is limited by the information they have, the limitations of their minds, and the finite amount of time available.

Bounded self-control

limited self-control, individuals lack the self-control to act in what they see as their self-interest.

Cognitive bias

a mistake in reasoning or in some other mental thought process occurring as a result of, for example, using rules-of-thumb or holding onto one's preferences and beliefs, regardless of contrary information.

Rule-of-thumb (heuristic)

a rough and practical method or procedure that can be easily applied when making decisions.

Anchoring

a cognitive bias describing the human tendency when making decisions to rely too heavily on the first piece of information offered (the so-called 'anchor'). Individuals use an initial piece of information when making subsequent judgements.

Availability bias

occurs when individuals make judgements about the likelihood of future events according to how easy it is to recall examples of similar events.

Social norms

forms or patterns of behaviour considered acceptable by a society or social group.

Altruism

concern for the welfare of others.

Choice architecture

a framework setting out different ways in which choices can be presented to consumers, and the impact of that presentation on consumer decision making.

Framing

how something is presented (the 'frame') influences the choices people make.

Default choice

an option that is selected automatically unless an alternative is specified.

Mandated choice

people are required by law to make a decision.

Restricted choice

offering people a limited number of options so that they are not overwhelmed by the complexity of the situation. If there are too many choices, people may make a poorly thought-out decision or not make any decision.

Nudges

factors which encourage people to think and act in particular ways. Nudges try to shift group and individual behaviour in ways which comply with desirable social norms.

Fixed costs

costs of production that do not vary as output changes

Variable costs

costs of production that vary with output.

Average cost =

Total cost ÷ Output

Marginal cost

the addition to total cost of producing one addition unit of a good.

Short run

the period during which at least one factor of production is fixed (usually capital is fixed, and labour is allowed to vary).

Long run

period of time during which all factors become variable.

Law of diminishing returns

in the short term, as a variable factor of production is added to a fixed factor of production, both the marginal and average returns to the variable factor will begin to fall.

Minimum efficient scale

the lowest output at which a firm can produce at the lowest point on the LRAC curve.

Economies of scale

an increase in output leads to lower average cost (diseconomies- higher AC)

Price-maker

when a firm faces a downward-sloping demand curve for its product, it possesses the market power to set the price at which it sells the product.

Price-taker

a firm which is so small that it has to accept the ruling market price. If the firm raises its price, it loses all its sales; if it cuts its price, it gains no advantage.

Profit =

Revenue - Cost

Normal profit

the minimum amount of profit required to keep a firm in business.

Supernormal / abnormal profit

the amount received in excess of normal profit.

Profit maximisation

where a firm produces up to the point where MC=MR.

Satisficing

achieving a satisfactory outcome rather than the best possible outcome.

Divorce of ownership from control

the owners and those who manage the firm are different groups with different objectives.

Productive efficiency

the level of output at which goods are produced at the lowest possible average cost (lowest point on the AC curve)g

Allocative efficiency

occurs when it is impossible to improve overall economic welfare by reallocating resources between markets. Price must equal marginal cost (P = MC)

Static efficiency

efficiency at a point in time (if it is both productively and allocatively efficient)

Dynamic efficiency

efficiency over time (due to new products, new production techniques and processes which increase economic growth)

X-inefficient

when companies do not reduce costs to their lowest level (due to a lack of competitive pressure)

Consumer surplus

a measure of the economic welfare enjoyed by consumers: the difference between what a consumer is willing and able to buy a good for and what they actually pay.

Producer surplus

a measure of the economic welfare enjoyed by firms or producers: the difference between the price a firm receives and the minimum price it would be prepared to accept.

Creative destruction

capitalism evolving and renewing itself over time through new technologies and innovations replacing older technologies and innovations.

Innovation

improves on or makes a significant contribution to something that has already been invented, thereby turning the results of invention into a product.

Invention

making something entirely new; something that did not exist before at all.

Technological change

a term that is used to describe the overall effect of invention, innovation and the spread of technology in the economy.

Perfect competition

market structure where there are many buyers and sellers, so no individual can buy or sell at any price other than the going price. Characteristics:

No barriers to entry or exit,

Infinitely many buyers and sellers, who are infinitely small

Homogeneous products, and all buyers and sellers have perfect information & knowledge

Therefore firms are price takers

Monopolistic competition

a market structure with the following characteristics:

fairly low barriers to entry

many small firms

products are differentiated to an extent, there is imperfect information

firms have some price making power

Oligopoly

a market structure dominated by a few firms; there is a high concentration ratio. It can be defined either by structure (below) or conduct (firms may either compete or collude, so they are interdependent and the outcome is uncertain). Characteristics:

quite high barriers to entry

dominated by a few large firms

products may either be differentiated or homogeneous, there is imperfect information

firms have price making power

firms are interdependent(where the actions of one firm have an effect on the sales and revenue of other firms in the market)

n-firm Concentration ratio

the market share of the n largest firms in an industry.

Collusion

where firms agree not to compete on price

Tacit collusion

where firms have reached an 'agreement' as to how they will behave, based on how they have acted over time

Price leader

a firm that establishes the market price that all other firms in the agreement follow.

price war

occurs when rival firms continuously lower prices to undercut each other.

Cartel

a collusive agreement by firms to fix prices, restrict output and/or deter entry of new firms.

Monopoly

a single seller in the market or industry. Characteristics:

there are high barriers to entry, so other firms cannot enter the market

the firm is the industry- there is only one firm

there is only one product, there is imperfect information

the firm is a price maker

Price discrimination

where a firm sells identical products at different prices to different buyers.

Natural monopoly

a market where it is impossible to fully exploit economies of scale, so it is uneconomic for more than one firm to supply the market.

Deadweight loss/ welfare loss

the reduction in consumer surplus and producer surplus when output is less than the optimum level.

Contestable market

an industry where there are no barriers to entry or exit (no sunk costs)

Sunk costs

a cost which cannot be recovered on exiting the industry.

Hit-and-run competition

occurs when a new entrant can 'hit' the market, make profits and then 'run', given that there are no or low barriers to exit.

Derived demand

labour is demanded because of the output it can produce, not because firms want workers in their own right.

Marginal Revenue Product (MRP)

the addition to total revenue from employing an extra worker.

Marginal Physical Product (MPP)

the addition to total output from employing an extra worker.

Wage elasticity of demand (supply) for labour

the responsiveness of quantity demanded (supplied) for labour to a change in the wage rate.

Economically inactive

the percentage of the population who are neither in work nor seeking it.

Participation rate / activity rate

the percentage of the population of working age currently in work or actively seeking work.

Unemployment

the number of people of working age who do not have a job but are actively seeking work.

Net advantage

the sum of the monetary and non-monetary benefits of working.

Monopsony

single buyer in a market.

Trade Union

an organisation of workers which aims to further the interests of its members (e.g. to improve wages and working conditions)

National Minimum Wage (NMW)

a floor below which wages cannot legally fall.

National living wage

an adult wage rate, set by the UK government, which all employers must pay from 2016 onward, and which has replaced the adult national minimum wage rate.

Discrimination

where groups of workers are treated differently to other workers in the same job regarding pay and employment.

Occupational immobility of labour

when workers are unwilling or unable to move from one type of job to another, e.g. because different skills are needed. (Geographical - unwilling or unable to move from one geographic area to another)

Equality

means that everyone is treated exactly the same. A completely equal distribution of income means that everybody has the same income.

Equity

means that everybody is treated fairly (a normative concept).

Horizontal equity

the fair / equal treatment of people in the same circumstances

Vertical equity

the 'fair' treatment of people in different circumstances (very subjective). This notion is often used to justify taxing richer people more to bring about greater 'fairness'

Poverty

the state of not having enough money or income to meet basic needs.

Absolute poverty

a state where a person is unable to purchase the basic necessities to sustain a civilised life. (e.g. income of less than $1 per day)

Relative poverty

a state where a person is significantly poorer than the average for the rest of society (e.g. less than 50% of median income)

Income

money earned over a period of time (a 'flow' concept)

Wealth

the value of an individual's assets at a point in time. (a 'stock' concept)

Universal benefits

benefits which are paid to all, not dependent on a person's income.

Means Tested Benefits

benefits which are only paid to households who can prove they are poor.

Gini coefficient

a statistical measure of inequality (0 = perfect equality, 1 = maximum inequality)

Poverty trap

the disincentive to work when someone on benefits faces a very high effective marginal rate of tax if they start work. (Replacement ratio - the ratio of unemployment benefits to average earnings.)

Market failure

when the price mechanism leads to a misallocation of resources.

Missing market (complete market failure)

the absence of a market for a good or service, most commonly in the case of public goods and externalities.

Partial market failure

a market does function, but it delivers the 'wrong' quantity of a good or service, which results in resource misallocation.

Public good

a good which has the characteristics of non-excludability and non-rivalry.

Quasi-public good

a good which has characteristics of both a public and private good, e.g. it might be non-excludable but rival, or excludable but non-rival.

Property rights

the exclusive authority to determine how a resource is used. In the case of a private property right, the owner of private property (such as land) has the right to prevent other people from consuming it unless they are prepared to pay a price to the owner.

(De) Merit good

a good which is (overconsumed) underconsumed if left to the free market. (due to both externalities and consumers underestimating the long term (harm) benefits to themselves).

Negative (positive) externality

a negative (positive) third-party effect of a market activity for which no compensation is paid.

Tradable permit

a legal right to pollute a fixed amount which can be bought or sold between firms.

Government Failure

where government intervention causes inefficiency in resource allocation.