Microeconomics Key Terms, Formulaes and Concepts

Ability to pay

Where taxes should be set according to how well a person can afford to pay.

Ad valorem tax

An indirect tax based on a percentage of the sales price of a good or service.

Adam Smith

One of the founding fathers of modern economics. His most famous work was the Wealth of Nations (1776) - a study of the progress of nations where people act according to their own self-interest - which improves the public good. Smith's discussion of the advantages of division of labour remains a potent idea.

Adverse selection

Where the expected value of a transaction is known more accurately by the buyer or the seller due to an asymmetry of information; e.g. health insurance.

Air passenger duty

APD is a charge on air travel from UK airports. The level of APD depends on the country to which an airline passenger is flying.

Alcohol duties

Excise duties on alcohol are a form of indirect tax and are chargeable on beer, wine and spirits according to their volume and/or alcoholic content.

Alienation

A sociological term to describe the estrangement many workers feel from their work, which may reduce their motivation and productivity. It is sometimes argued that alienation is a result of the division of labour because workers are not involved with the satisfaction of producing a finished product, and do not feel part of a team.

Allocative efficiency

Allocative efficiency occurs when the value that consumers place on a good or service (reflected in the price they are willing and able to pay) equals the cost of the resources used up in production (technical definition: price equals marginal cost). Scarce resources are allocated optimally.

Asking price

The price at which a security, commodity or currency is offered for sale on the market - generally the lowest price the seller will accept.

Asymmetric information

When somebody knows more than somebody else in the market. Such asymmetric information can make it difficult for the two people to do business together.

Automation

Production technique that uses capital machinery/technology to replace or enhance human labour and bring about a rise in productivity.

Average cost

Total cost divided by the number of units of the commodity produced.

Average fixed cost

Average fixed costs are total fixed costs divided by the number of units of output, that is, fixed cost per unit of output.

Barriers to entry

Factors making it expensive for new firms to enter a market.

Barter

The practice of exchanging one good or service for another, without using money.

Basic problem

There are infinite wants but finite (scarce) resources with which to satisfy them.

Behavioural economics

Branch of economics that studies the impact of psychological and social factors on economic decision making.

Black market

An illegal market in which the market price is higher than a legally imposed price ceiling. Black markets can develop where there is excess demand for a commodity.

Bottlenecks

Any factor that causes production to be delayed or stopped - this may reduce the price elasticity of supply of a product.

Buffer stock

Buffer stock schemes seek to stabilize the market price of agricultural products by buying up supplies of the product when harvests are plentiful and selling stocks of the product onto the market when supplies are low.

Bulk-buying

The purchase by one organisation of large quantities of a product or raw material, which often results in a lower price because of their market power and because it is cheaper to deal with one customer and the deliveries can be on a larger scale.

Buyer's market

A market that favours buyers because supply is plentiful relative to demand and therefore prices are relatively low. The opposite of a seller's market.

By-product

Something produced as a consequence of producing another good or service.

Capacity utilisation

The extent to which a business is making full use of existing factor resources e.g. 80% capacity utilisation means that 20% of capacity is not being used (spare).

Capital goods

Producer or capital goods such as plant (factories) and machinery and equipment are useful not in themselves but for the goods and services they can help produce in the future.

Capital-intensive

A production technique which uses a high proportion of capital to labour.

Capitalist economy

Economic system organised along capitalist lines uses market prices to guide our choices about the production and distribution of goods. One key role for the state is to maintain the rule of law and protect private property.

Carbon capture and storage

The process of trapping and storing carbon dioxide produced by burning fossil fuels.

Carbon credits

An allowance to a business to generate a specific level of emissions - may be traded in a carbon market.

Cartel

A cartel is a formal agreement among firms. Cartel members may agree on prices, total industry output, market shares, allocation of customers, allocation of territories, bid rigging, establishment of common sales agencies, and the division of profits or combination of these.

Cartels

are illegal under UK and European competition laws

Ceteris paribus

To simplify analysis, economists isolate the relationship between two variables by assuming ceteris paribus - all other influencing factors are held constant

Cigarette duties

UK taxes on cigarettes = 16.5% retail price + £154.95 per thousand cigarettes.

Collusion

Collusion is any agreement between suppliers in a market to avoid competition. The main aim is to reduce market uncertainty and achieve a level of joint profits similar to that which might be achieved by a pure monopolist

Command and control

Laws and regulation backed up by inspection and penalties for non-compliance e.g. regulations on carbon emissions

Command economy

Economic system where resources are allocated by the government

Common resources

Goods or services that have characteristics of rivalry in consumption and non-excludability - grazing land or fish stocks are examples. The over-exploitation of common resources can lead to the 'tragedy of the commons'

Competition policy

Government policy directed at encouraging competition in the private sector: e.g. the investigation of takeovers or restrictive practices

Competitive market

A market where no single firm has a dominant position and where the consumer has plenty of choice. There are few barriers to the entry of new firms

Competitive supply

Alternative products a firm could make with its resources. E.g. a farmer can plant potatoes or carrots. An electronics factory can produce VCRs or DVDs

Complements

Two complements are said to be in joint demand

Composite demand

Where goods or services have more than one use so that an increase in the demand for one product leads to a fall in supply of the other. E.g. milk which can be used for cheese, yoghurts, cream, butter. If more milk is used for manufacturing cheese, ceteris paribus there is less available for butter

Congestion charging

A direct charge for use of roads in a defined zone e.g. central London

Conspicuous consumption

Conspicuous consumption is consumption designed to impress others rather than something that is wanted for its own sake

Constraints

Limits to what we can afford to consume - we have to operate within budgets, and make choices from those sets that are feasible/affordable

Consumer durable

A good such as a washing machine or a digital camera that lasts a period of time, during which the consumer can continue getting utility from it

Consumer sovereignty

Consumer sovereignty exists when the economic system allows scarce resources to be allocated to producing goods and services that reflect the wishes of consumers.

Sovereignty

Can be distorted by the effects of persuasive advertising.

Consumer surplus

Consumer surplus is the difference between the total amount that consumers are willing and able to pay for a good or service (indicated by the demand curve) and the total amount that they actually pay (the market price).

Consumption

The act of buying and using goods and services to satisfy wants.

Contestable market

Market with no entry barriers - firms can enter or leave without significant cost.

Cost Benefit Analysis

CBA is a decision making tool which compares the social costs and social benefits of a project, over time, to establish a net present value.

Costs

Costs faced by a business when producing a good or service for a market.

Cross price elasticity of demand

Responsiveness of demand for good X following a change in the price of good Y (a related good). With cross price elasticity we make a distinction between substitute products and complementary goods and services.

Cyclical demand

Demand that change in a regular way over time depending on the part of the economic (business) cycle that a country is in or the time of year.

Deadweight loss

The loss in producer and consumer surplus due to an inefficient level of production perhaps resulting from market failure or government failure.

Demand

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

Demand curve

A demand curve shows the relationship between the price of an item and the quantity demanded over a period of time. For normal goods, more of a product will be demanded as the price falls.

De-merit goods

The consumption of de-merit goods can lead to negative externalities which causes a fall in social welfare. The government normally seeks to reduce consumption of de-merit goods.

Consumers

Consumers may be unaware of the negative externalities that these goods create - they have imperfect information.

Deregulation

The removal of legally enforced rules that restrict or ban specified activities.

Derived demand

Derived demand occurs when the demand for a particular product depends on the demand for another product or activity.

Diminishing returns

As more of a variable factor (e.g. labour) is added to a fixed factor (e.g. capital) a firm will reach a point where it has a disproportionate quantity of labour to capital and so the marginal product of labour will fall, thus raising marginal costs.

Diseconomies of scale

Disadvantages to the firm, in the form of higher long-run unit costs, from increasing their size of operation.

Disequilibrium

A situation where there is a state of imbalance and so a tendency for change.

Diversification

The reduction of risk achieved by replacing a single risk with a larger number of smaller unrelated risks.

Division of labour

The specialization of labour in specific tasks, intended to increase productivity.

Dominant monopoly

A firm with 40% or higher market share.

Economic agents

Decision makers e.g. consumers and producers.

Economic efficiency

Economic efficiency is about making the best or optimum use of scarce resources among competing ends so that economic and social welfare is maximised over time.

Economic growth

An increase in the productive potential of the country - shown by an outward shift of the production possibility frontier.

Economy of scale

Benefits, in the form of lower unit costs, from increasing the size of operation.

Economy of scope

Economies of scope occur where it is cheaper to produce a range of products.

Effective demand

Demand in economics must be effective. Only when a consumers' desire to buy a product is backed up by an ability to pay for it do we speak of demand.

Elastic demand

Demand for which price elasticity is greater than 1.

Elastic supply

Where the price elasticity of supply is greater than +1.

Elasticity of supply

Price elasticity of supply measures the relationship between change in quantity supplied and a change in price.

Emission tax

A charge made to firms that pollute the environment based on the quantity of pollution they emit i.e. the volume of CO2 emissions.

Entrepreneur

An individual who seeks to supply products to a market for a rate of return (i.e. a profit). Entrepreneurs will usually invest their own financial capital in a business and take on the risks associated with a business investment.

Equilibrium

Equilibrium means 'at rest' or 'a state of balance' - i.e. a situation where there is no tendency for change.

Equity

Fairness; a view on the 'rightness' of an issue based on opinion rather than fact - requires a value judgement.

Excess demand

The difference between the quantity supplied and the higher quantity demanded when price is set below the equilibrium price. This will result in queuing and an upward pressure on price.

Excess supply

When supply is greater than demand and there are unsold goods in the market. Surpluses put downward pressure on the market price.

Excise duties

Excise duties are indirect taxes levied on our spending on goods and services such as cigarettes, fuel and alcohol. There are also duties on air travel, car insurance.

Excludability

The property of a good whereby a person can be prevented from using it.

External cost

External costs are those costs faced by a third party for which no appropriate compensation is forthcoming.

Externalities

Externalities are third party effects arising from production and consumption of goods and services for which no appropriate compensation is paid.

Extreme poverty

A severe and persistent deprivation of basic human needs.

Factor incomes

Factor incomes are the rewards to factors of production. Labour receives wages and salaries, land earns rent, capital earns interest and enterprise earns profit.

Finite resources

There are only a finite number of workers, machines, acres of land and reserves of oil and other natural resources. By producing more for an ever-increasing population, we may destroy the natural resources of the planet.

Firm

An organisation that hires and organises resources to make products.

First mover advantage

The first company to introduce a new product to market, has the opportunity to extract the greatest long term benefit from the product introduction.

Fixed costs

Costs that do not vary directly with the level of output. Examples of fixed costs include: rent and business rates, the depreciation in the value of capital equipment (plant and machinery) due to age and marketing and advertising costs.

Flexible pricing

A firm varies price by customer to maximise revenue.

Flexible working

A workforce that is multi-skilled and able to work variable hours in response to changing demand.

Free market

In a free market, the forces of supply and demand alone determine price and output without any government intervention.

Free markets

Markets that are totally unregulated.

Freemium

A business model, especially on the Internet, whereby basic services are provided free of charge while more advanced (premium) features must be paid for.

Geographical immobility

Barriers that prevent people from moving from one area to another to find work.

Gini Coefficient

Measures the extent to which the distribution of income (or consumption expenditures) among individuals or households within an economy deviates from a perfectly equal distribution, ranging from 0 (perfect equality) to 1 (complete inequality).