A-level AQA Economics Key Terms and Definitions

Allocative efficiency

This occurs when the available economic resources are used to produce the combination of goods and services that best matches peoples' tastes and preferences.

Division of labour

The specialisation of individuals through the separation of tasks in the production process and their allocation to different groups of workers.

Factors of production

Inputs into the production process namely land, labour, capital and enterprise.

Normative statement

A statement that includes a value judgement, is subjective and therefore cannot be refuted just by looking at the evidence.

Opportunity cost

The next best alternative foregone whenever an economic decision is made. It is also the gradient of the PPF.

Positive statement

A statement which is value free, objective and can be empirically tested to see whether or not it is correct.

Productive efficiency

This occurs when it is impossible for an economy to produce more of one good without producing less of another. The economy would be operating somewhere on its PPF.

Production

A process, or set of processes, that converts inputs (factors of production) into outputs (goods or services).

Production possibility frontier (PPF) or Production possibility boundary (PPB)

A curve showing the alternative combinations of two goods (or types of good) than an economy can produce when all the available resources are fully and efficiently employed.

Productivity

Output per unit of input per time period.

Scarcity

Linked to the fundamental economic problem scarcity is the result of finite resources in the economy being unable to produce enough goods and services to fulfil society's infinite wants.

Specialisation

This occurs when an economic agent chooses to concentrate on producing a particular good or service and then trades with others in order to survive.

Capital good

A good which is used in the production of other goods or services. Also known as a producer good.

Complementary good

A good which is in joint demand or is demanded at the same time as the other good e.g. hot dog and bun.

Competing supply

Raw materials that are used to produce one good cannot be used to produce another good e.g. wheat for flour or for biofuel.

Composite demand

Demand for a good which has more than one use e.g. land for housing or a factory.

Condition of demand

A determinant of demand, other than price, that shifts the demand curve.

Condition of supply

A determinant of supply, other than price, that shifts the supply curve.

Consumer good

A good which is consumed by individuals and households to satisfy their wants and needs.

Consumer surplus

The difference between the maximum price which a consumer is willing and able to pay for a good and the actual price they have to pay in the market. It is the area below the demand curve and above the equilibrium price line.

Contraction of demand or supply

A movement along the demand or supply curve.

Cross elasticity of demand

The percentage change in the quantity demanded of Good A divided by the percentage change in the price of Good B.

Derived demand

An indirect demand for a good or service (e.g. labour) which is an input into the production of another good (e.g. cars).

Demand (effective demand)

The quantity of a good or service that consumers are willing and able to buy at given prices in a given time period.

Elasticity

The proportionate responsiveness of one variable (e.g. quantity demanded) with respect to a proportionate change in another variable (e.g. price).

Equilibrium price

The price at which planned demand for a good or service exactly equals planned supply for that good or service.

Expansion of demand or supply

A movement along the demand or supply curve.

Income elasticity of demand

The percentage change in quantity demanded divided by the percentage change in income.

Inferior good

A good for which demand rises as income falls and demand falls as income rises.

Joint supply

When one good is produced another good is also produced from the same raw materials e.g. beef and leather.

Law of Demand

The inverse relationship between price and quantity demanded.

Law of Supply

The positive correlation between price and quantity supplied.

Market

A voluntary meeting of buyers and sellers where both parties are willing to participate in an exchange.

Normal good

A good for which demand increases when income rises and demand falls when income falls.

Price elasticity of demand

The percentage change in quantity demanded divided by the percentage change in its price.

Price (market) mechanism

This is the means by which millions of decisions taken by consumers and businesses interact to determine the allocation of scarce resources between competing uses.

Privatisation

The transfer of assets, including firms and industries, from the public sector to the private sector.

Producer surplus

The difference between the minimum price for which a firm is willing and able to sell a good or service and the actual price which they receive in the market. It is the area above the supply curve and below the equilibrium price line.

Substitute good

A good in competing demand i.e. which can be purchased instead of another good e.g. butter and margarine.

Supply

The quantity of a good or service that firms are willing to sell at given prices in a given time period.

Sustainable development

A pattern of resource use that aims to meet human needs now and in the future whilst preserving the environment.

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.

Asymmetric information

When one party to a transaction possesses more information than the other.

Demerit good

A good, such as tobacco, for which the social benefit of consumption is less than the private benefit of consumption.

Externality

A third party spill-over effect felt outside the market mechanism. Externalities can be positive or negative. They are the difference between marginal private costs and benefits and marginal social costs and benefits.

Government failure

This occurs when government intervention reduces economic welfare leading to an allocation of resources that is worse than the free-market outcome.

Imperfect information

This occurs when consumers misunderstand the true costs and benefits of consumption.

Market failure

When the market mechanism fails to provide the correct signals and incentives which leads to a misallocation of resources, either completely failing to provide a good or service or providing the wrong quantity, so that social welfare is not maximised.

Merit good

A good, such as healthcare, for which the social benefit of consumption is greater than the private benefit of consumption.

Missing market

A situation in which there is no market because the functions of prices have broken down e.g. public goods. This is an example of complete market failure.

Moral hazard

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

Partial market failure

When the market produces a quantity of output which fails to maximise social welfare e.g. too few merit goods or too many demerit goods.

Property rights

The exclusive authority to determine how a resource is used.

Public good

A good that is non-excludable and non-rival. It is not provided by the free market and is an example of a missing market.

Regulation

Rules and legal constraints that restrict the freedom of economic agents by setting standards for the consumption or production of goods or their externalities.

Subsidy

A payment made by the government to a firm to reduce the variable cost of production hence to increase supply and lower the price to consumers to increase market quantity.

Tax

A compulsory levy imposed by the government to pay for its activities. Direct tax is levied on individuals and firms and targets income, wealth and profits. Indirect tax is levied on the producer and targets expenditure.

Tragedy of the commons

The overuse and subsequent destruction of common property attributed to the lack of private property rights e.g. ozone layer and overfishing.

Absolute poverty

Insufficient income to buy the basic necessities of life i.e. food, shelter, heating and clothing. It depends both upon income and access to facilities.

Equality

Sameness of outcome. For example equality of income would mean that everyone receives the same income.

Equity

Fairness or justice e.g. equity of income would mean that those who worked more received a higher income.

Fiscal drag

This occurs when the government fails to raise tax thresholds in line with inflation such that as wages rise a higher proportion of income is paid in tax.

Gini coefficient

Measures the extent to which an economy's distribution of income differs from a perfectly equal distribution.

Income

The flow of money a person or household receives in a particular time period.

Lorenz curve

A graph on which the cumulative percentage of total national income or wealth is plotted against the cumulative percentage of population.

Relative poverty

This occurs when income is below 60% of the median income.

Wealth

The stock of everything which has a value that a person or household owns at a particular point in time.

Abnormal profit

Also known as supernormal or economic profit this is producer surplus i.e. the profit above normal profit.

Allocative efficiency

For a firm this means producing where AR (P) = MC because price represents utility of consumption and MC represents the cost of producing the last unit.

Average (total) cost

Total cost of output divided by quantity of output. ATC = TC ÷ Q ATC = AFC + AVC

Average fixed cost

Total fixed cost divided by the quantity of output. AFC = TFC ÷ Q

Average revenue

Total revenue divided by quantity of output. Total revenue per unit of output. AR = TR ÷ Q

Average variable cost

Total variable cost divided by the quantity of output. AVC = TVC ÷ Q

Barriers to entry

Factors which prevent the free access of firms to an industry.

Creative destruction

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

Dynamic efficiency

This occurs in the long run and leads to the development of new products and more efficient processes that improve productive efficiency and lowers production costs.

Economies of scale

Falling LRATCs as output rises.

Fixed cost

A short run cost of production which is unrelated to the quantity of output produced.

Innovation

This converts the results of invention into marketable products or services.

Invention

This creates new ideas for products or processes.

Long-run

The time period in which the quantity of all factors of production are variable.

Marginal cost (MC)

The change in total cost when output increases by one unit. MC = TC ÷ Q The gradient of the TVC and TC curves.

Marginal revenue (MR)

The change in total revenue when output increase by one unit. MR = TR ÷ Q The gradient of the TR curve.

Minimum efficient scale (MES)

The lowest level of output at which the firm is able to exploit all economies of scale such that it begins to operate at its minimum LRATC.

Normal profit

The minimum profit a firm must make to stay in business which is, however, insufficient to attract new firms into the industry. This occurs when ATC = AR.

Productive efficiency

For a firm this occurs at the minimum point of the ATC curve i.e. when MC = ATC

Profit maximization

Producing where MC = MR to give the greatest difference between total revenue and total cost. If MR>MC then that unit of output improves the firm's profit position because it adds more to revenue than it does to costs.

Revenue maximization

Producing where MR = 0 to maximise total revenue. When MR is positive a firm increase its revenue as output increases.

Satisficing

Achieving a satisfactory outcome rather than the best possible outcome.

Short-run

The time period in which the quantity of at least one factor of production is fixed.

Sunk costs

Costs which have already occurred and cannot be recovered.

Total cost

The total cost of production i.e. the sum of fixed costs and variable costs. Positively related to output. TC = TFC + TVC

Total revenue

The total value of sales received by the firm. TR = AR (P) × Q

Variable cost

A cost of production directly related to the quantity of output produced.

X-inefficiency

The difference between the efficient behaviour of firms and their observed efficiency. Caused by a lack of competitive pressure it is often found in monopolies.

Cartel

A collusive agreement by firms or countries to restrict output, fix prices or prevent new entrants.

Collusion

Co-operation between firms for example to fix prices.

Concentrated market

A market containing very few firms.

Concentration ratio

Measures the combined market share (percentage) of the biggest firms in the industry.

Contestable market

A market in which the potential exists for new firms to enter.