Economics Definitions Full

Allocative Efficiency

Allocative Efficiency

This occurs when the available economic resources are used to produce the combination of goods and services that best matches peoples 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 which 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 desicion is made.

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 the PPF.

Production

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

Production possibility frontier (PPF)

A curve showing the alternative combinations of two goods (or types of good) that an economy can produce when all 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 demanded at the same time as the other good e.g. hot dog and bun.

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 needs and wants.

Consumer surplus

The difference between the maximum price which a consumer is willing 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 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

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) 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 incomes rise.

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 as income falls.

Price elasticity of demand

The percentage change in quantity demanded divided by the percentage change in 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 the human needs now and in the future while preserving the environment.

Asymetric information

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

Externality

A third party spillover 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.

Missing Market

A situation in which there is no market because the functions of the prices have broken down e.g. public goods. This is an example of a 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 maximize 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 legal freedom of economic agents by setting standards for the consumption or production of goods or their externalities.

Subsidy

Payments by the government to a firm to reduce the variable costs 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 a lack of private ownership 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 the 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 would receive more income.

Gini coefficient

Measures the extent to which an economy’s distribution of wealth differs from a perfectly equal distrubution.

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 income.

Relative poverty

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

Wealth

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

Supernormal profit

Also known as abnormal 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=AFC+AVC

Average fixed cost

Total fixed cost divided by quantity of output.

Average revenue

Total revenue divided by quantity of output. Total revenue per unit of output.

Average variable cost

Total variable cost divided by quantity of output.

Barriers to entry

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

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.

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=change in TC divided by change in quantity.

Marginal revenue (MR)

The change in total revenue when output increases by one unit. MR=chnage in TR divided by change in quantity.

Minimum efficient scale (MES)

The lowest 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 bussiness 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 maximisation

Producing when MC=MR to give the greatest difference between total revenue and total cost. If MR is greater than MC then that unit of output improves the firms profit position because it adds more to revenue than it does to costs.

Revenue maximisation

Producing where MR=0 to maximise total revenue. When MR is positive a firm increases 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 and variable costs. Positively related to output.

Total revenue

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

Imperfect competition

Any market structure that is not perfectly competitive i.e. monopolistic, oligopoly, duopoly or monopoly.

Interdependence

When firms must take into account the behaviour and reactions of other firms when making price and output desicions.

Monopoly (pure)

There is only one seller in the market i.e. the firm is the industry.

Monopoly power

The ability for a firm to set quantity of output or prices.

Monopolistic competition

A structure in which many firms sell slightly differentiated products.

Monopsony (pure)

The ability of a firm to dictate labour contracts to the workforce.

Natural monopoly

When there is only room in the market of one firm benefitting from full economies of scale.

Oligopoly

A market dominated by a few large firms.

Product differentiation

The process of creating real differences in a product e.g. functionality or design or imaginary differences in a product through changes in factors like packaging and branding.

Price differentitation

When a firm sells an identical good or service at different prices where there is no difference in the cost of production.