Economics Flashcards

Key vocabulary terms and definitions from economics lecture notes.

Total Utility

The total satisfaction obtained from the consumption of a given number of units of a particular product.

Marginal Utility

The increase in utility that a consumer gains from consuming an additional unit of a product.

Diminishing Marginal Utility

The principle that the consumption of successive units of a product will eventually lead to a fall in marginal utility.

Equi-marginal principle

A consumer will maximise total satisfaction by equating the utility or satisfaction per unit of money spent on the marginal unit of each product consumed

Paradox of Value

The fact that certain products that are essential to survival (e.g. water) are cheaper than products that are less important to survival (e.g. diamonds).

Behavioral Economics

An approach to decision making which argues that the behaviour of individuals is often based on ideas that do not correspond to the traditional view of rational economic behaviour.

Indifference Curve

A curve showing all the possible combinations of two products between which an individual consumer is indifferent.

Budget Line

A line showing all the possible combinations of two products that a consumer would be able to purchase with fixed prices and a given income.

Price Effect

The effect on the consumption of a product that occurs as a result of a price change.

Income Effect

The effect on consumption of a change in real income that occurs as a result of a price change.

Substitution Effect

The effect of a rise or fall in the price of a product on the utility or satisfaction obtained from each unit of money spent on that product.

Giffen Good

A good where a higher price causes an increase in demand, reversing the usual law of demand.

Efficient Resource Allocation

The optimal use of scarce inputs to produce the largest possible output.

Productive Efficiency

Where a firm operates at the minimum of its average cost curve; or where a whole economy is operating on its production possibility curve.

Average Cost

The total cost of employing all the factor inputs divided by the number of units produced.

Technical Efficiency

Where a firm produces the maximum output possible from given inputs, shown by the lowest point on the lowest possible average cost curve.

Cost Efficiency

Where a firm uses the most appropriate combination of inputs of factors of production, given the relative costs of those factors.

Allocative Efficiency

A situation that describes the extent to which the allocation of resources in an economy matches consumer preferences and P = MC.

Optimum Resource Allocation

The best allocation of resources possible in the situation of scarcity.

Pareto Optimality

A particular use of the term ‘optimality’ associated with the Italian economist Vilfredo Pareto, who stated that this situation existed when it was not possible to reallocate resources to make someone better off without making someone else worse off.

Dynamic Efficiency

The greater efficiency that can result from improvements in technical or productive efficiency over a period of time.

Market Failure

A market imperfection which gives rise to an allocation of scarce resources that is not as efficient as it might have otherwise been.

Social Costs

The sum of private costs and external costs (i.e. the total cost to society of an economic decision or activity).

Social Benefits

The sum of private benefits and external benefits (i.e. the total benefit to society of an economic decision or activity).

Externality

A cost or benefit of either consumption or production that is paid for or enjoyed not by the consumer or the producer, but by a third party.

Positive Externality

The external benefit that may occur as a result of an action, bringing some benefit to a third party.

Negative Externality

The external cost that may occur as a result of an action, bringing some disadvantage to a third party

Positive Consumption Externality

A third party effect that influences the consumption side of a market in a positive or beneficial way.

Welfare Gain

A welfare gain situation that arises when the marginal social benefit exceeds the marginal social cost, leading to a socially efficient allocation of resources.

Positive Production Externality

A third party effect that influences the production side of a market in a positive or beneficial way.

Negative Consumption Externality

A third-party effect that influences the consumption side of a market in a negative or disadvantageous way.

Welfare Loss

A welfare loss situation that arises when the marginal social cost exceeds the marginal social benefit, leading to a socially inefficient allocation of resources.

Negative Production Externality

An externality that affects the production side of a market in a negative or disadvantageous way.

Deadweight Loss

The loss of economic efficiency that occurs when the socially optimal quantity of a product is not produced.

Asymmetric Information

A situation in which there is unequal knowledge between the parties of a transaction, resulting in an advantage to the party with additional knowledge.

Moral Hazard

A situation in which a person takes a decision about how much risk to take in the knowledge that someone else bears the cost of that risk.

Cost-Benefit Analysis

An analysis of a project which includes a valuation of the total costs and total benefits involved, including private and external costs and private and external benefits.

Fixed Factors of Production

Resource inputs that exist in the short run when the quantity of the factors used cannot be changed (e.g. capital equipment).

Variable Factors of Production

Resource inputs that can be varied in the short run (e.g. raw materials), when at least one factor of production is fixed.

Production Function

The ratio of inputs to output over a given time period; it shows the resources needed to produce a maximum level of output, assuming that the inputs are used efficiently.

Total Product

The total output produced by the factors of production.

Average Product

The output per unit of the variable factor (e.g. output per worker per period of time); also referred to as ‘productivity’.

Marginal Product

The additional output that is produced from employing another unit of a variable factor (e.g. the extra output from employing an additional worker).

Law of Diminishing Returns

As additional units of a variable factor (e.g. labour) are added to a fixed factor (e.g. capital), the additional output (or marginal product) of the variable factor will eventually diminish; also known as the ‘law of variable proportions.

Fixed Costs

The costs of production that remain constant at all levels of output, including zero production (e.g. rent and interest payments).

Variable Costs

The costs of production that vary with changes in output; the cost is zero if nothing is produced (e.g. the cost of raw materials and component parts).

Total Cost

The sum of all costs incurred by a firm in producing a particular level of output.

Average Cost

The total cost of employing all the factor inputs divided by the number of units produced; also known as ‘average total cost’.

Marginal Cost

The additional cost of producing an extra unit of a product.

Average Fixed Cost

The total fixed cost of production divided by the number of units produced.

Average Variable Cost

The total variable cost of production divided by the number of units produced.

Economies of Scale

The benefits gained from a fall in long-run average costs of production as the scale of operations grows and the output of a firm increases.

Returns to Scale

The relationship between the level of output produced by a firm and the quantity of inputs required to produce that output.

Minimum Efficient Scale (MES)

The lowest level of output where average cost is at the minimum.

Internal Economies of Scale

The advantages of a firm growing in size in the form of a reduction in the average cost of production.

Financial Economies

A reduction in average cost as a result of a larger firm being able, for example, to negotiate more favourable borrowing terms on a loan.

Technical Economies

A reduction in average cost as a result of the application of advanced technology in a firm, which brings about a greater degree of efficiency.

Economies of Large Dimensions

A reduction in average cost as a result of using larger factors of production (e.g. larger containers in the transportation process).

Risk-bearing Economies

By diversifying into different markets, the overall pattern of demand is more predictable, so a firm can save on costs (e.g. by reducing the amount of stocks held in reserve).

Diversification

Where a firm decides to operate in a number of markets to spread risk.

External Economies of Scale

When costs of production fall because of developments outside a particular firm.

Constant Returns to Scale

Where average costs remain the same as the level of output increases.

Increasing Returns to Scale

Where an increase in factors of production leads to a more than proportionate increase in output.

Decreasing Returns to Scale

Where an increase in factors of production leads to a less than proportionate increase in output.

Diseconomies of Scale

Where the same proportional increase in productive factors gives rise to decreasing additions to total output.

Internal Diseconomies of Scale

The disadvantages of a firm growing in size, resulting in an increase in the average cost of production.

External Diseconomies of Scale

When average costs of production rise because of the growth of an industry.

Total Revenue (TR)

The total amount of income received from sales of a product, calculated as the number of units sold multiplied by the price of each unit.

Average Revenue (AR)

The total revenue obtained by a firm from sales divided by the number of units sold.

Marginal Revenue (MR)

The extra revenue obtained by a firm from the sale of an additional unit of a product.

Profit Maximization

The situation where marginal cost is equal to marginal revenue.

Profit

The reward to enterprise, defined as the difference between total revenue and total costs.

Break-even Point

The level of output at which a firm is making neither a loss nor a profit.

Normal Profit

The level of profit that a firm requires to keep operating in the industry.

Subnormal Profit

Any profit less than normal profit.

Supernormal Profit

The level of profit over and above normal profit; also known as ‘abnormal profit’.

Perfect Competition

A market or industry consisting of many virtually identical firms which all accept the market price in the industry.

Barriers to Entry or Exit

Various obstacles that make it very difficult, or impossible, for new firms to enter or exit an industry (e.g. technical economies of scale, patents or heavy capital investments).

Imperfect Competition

A market that lacks some, or all, of the features of perfect competition.

Monopolistic Competition

A market or industry where there is competition between a large number of firms that produce products that are similar but differentiated, usually through the use of brand images.

Oligopoly

A market or industry in which there are a few large firms competing with each other.

Monopoly

A market or industry where there is a single firm which controls the supply of the product.

Natural Monopoly

A situation where average cost will be lower with just one provider, avoiding the wasteful duplication of resources.

X-inefficiency

A situation where average cost is not at its lowest point because monopoly power has given rise to inefficiency.

Contestable Market

A situation where it may be relatively easy for new entrants to enter a market or industry; the effect of this is that existing firms in an industry face the threat of new firms coming into the industry and increasing the degree of competition.

Sunk Costs

Costs which were paid when a firm entered a market and are non-recoverable when it leaves, e.g. for research and development.

Price Competition

A process of setting competitive prices to achieve particular objectives in a market.

Non-price Competition

A process of using a variety of ways to increase sales other than price.

Price Agreement

Where firms in an oligopolistic market agree to fix prices between themselves.

Cartel

Where a number of firms agree to collude, such as by limiting output to keep prices higher than would be the case if there were competition between them.

Prisoner's Dilemma

In an oligopolistic market, a firm to decides to either confess or not without knowing the other's action.

Concentration Ratio

The percentage of a market controlled by a given number of firms (e.g. the five largest firms in an industry might control 80% of the output of the industry).

Firm

A particular and distinct organisation that is owned separately from any other organisation.

Industry

A collection of firms producing similar products.

Merger

Where two or more firms combine together as a result of mutual agreement.

Takeover

Where two or more firms combine together as a result of some form of hostile bid by one firm for another; also known as an ‘acquisition’.

Integration

The process whereby two or more firms come together through a takeover or merger.

Horizontal Integration

Where firms at the same stage of production merge.

Vertical Integration

Where a firm joins with another firm at an earlier stage of the production process (backward vertical integration) or a later stage of the production process (forward vertical integration).

Conglomerate Integration

A merger between firms that are operating in completely different markets rather than in different stages of the same market.