Econ 2.8-2.12
2.7 Role of government in microeconomics
Maximum price A price set by a government or other authority that is below the market equilibrium price of a good or service, also known as a price ceiling.
Minimum price A price set by a government or other authority above the market equilibrium price of a good or service, also known as a price floor.
Price ceiling (maximum price) A price imposed by an authority and set below the equilibrium price. Prices cannot rise above this price.
Price controls Prices imposed by an authority, set above or below the equilibrium market price.
Price floor (minimum price) A price imposed by an authority and set above the market price. Prices cannot fall below this price.
Stakeholder An individual or group of individuals who have an interest, or stake, in an economic activity or outcome.
2.8 Market failure—externalities and common pool or common access resources
Allocative inefficiency When either more or less than the socially optimal amount is produced and consumed so that misallocation of resources results. MSB ≠ MSC.
Carbon (emissions) taxes Taxes levied on the carbon content of fuel. They are a type of Pigouvian tax.
Collective self-governance In the case of a common pool resource, such as a fishery, users solve the problem of overuse by devising rules concerning the obligations of the users, the monitoring of the use of the resource, penalties of abuse, and conflict resolution.
Common pool resources A diverse group of natural resources that are non-excludable, but their use is rivalrous, for example, fisheries.
Demerit goods Goods or services that not only harm the individuals who consume these but also society at large, and that tend to be overconsumed. Usually they are due to negative consumption externalities.
Excludable A characteristic that most goods have that refers to the ability of producers to charge a price and thus exclude whoever is not willing or able to pay for it from enjoying it.
Externalities External costs or benefits to third parties when a good or service is produced or consumed. An externality arises when an economic activity imposes costs or creates benefits on third parties for which they are not compensated or do not pay for respectively.
Marginal social benefit (MSB) The extra or additional benefit/utility to society of consuming an additional unit of output, including both the private benefit and the external benefit.
Marginal social cost (MSC) The extra or additional cost to society of producing an additional unit of output, including both the private cost and the external costs.
Market failure The failure of markets to achieve allocative efficiency. Markets fail to produce the output at which marginal social benefits are equal to marginal social costs; social or community surplus (consumer surplus + producer surplus) is not maximized.
Merit goods Goods or services considered to be beneficial for people that are under-provided by the market and so under-consumed, mainly due to positive consumption externalities.
Negative externalities of consumption Negative effects suffered by a third party whose interests are not considered when a good or service is consumed, so the third party are therefore not compensated.
Negative externalities of production Negative effects suffered by a third party whose interests are not considered when a good or service is produced, so the third party are therefore not compensated.
Pigouvian taxes An indirect tax that is imposed to eliminate the external costs of production or consumption.
Positive externalities of consumption The beneficial effects that are enjoyed by third parties whose interests are not accounted for when a good or service is consumed, therefore they do not pay for the benefits they receive.
Positive externalities of production The beneficial effects that are enjoyed by third parties whose interests are not accounted for when a good or service is produced, therefore they do not pay for the benefits they receive.
Rivalrous Goods and services are considered to be rivalrous when the consumption by one person, or group of people, reduces the amount available for others.
Socially optimum output This occurs where there is allocative efficiency, or where the marginal social cost of producing a good is equal to the marginal social benefit of the good to society. Alternatively, it occurs where the marginal cost of producing a good (including any external costs) is equal to the price that is charged to consumers (P = MC for the last unit produced).
Tradable permits Permits to pollute, issued by a governing body, that sets a maximum amount of pollution allowable. These permits may be traded (bought or sold) in a market for such permits.
Tragedy of commons A situation with common pool resources, where individual users acting independently, according to their own self-interest, go against the common good of all users by depleting or spoiling that resource through their collective action.
Welfare loss A loss of a part of social surplus (consumer plus producer surplus) that occurs when there is market failure so that marginal social benefits are not equal to marginal private benefits.
2.9 Market failure—public goods
Free rider problem Arises when individuals consume a good or service without paying for it because they cannot be excluded from enjoying it.
Non-excludable A characteristic of a good, service or resource where it is impossible to prevent a person, or persons, from using it.
Non-rivalrous A characteristic of some goods such that their consumption by one individual does not reduce the ability of others to consume them. It is a characteristic of public goods.
Public goods Goods or services that have the characteristics of non-rivalry and non-excludability, for example, flood barriers.
2.10 Market failure—asymmetric information (HL only)
Asymmetric information A type of market failure where one party in an economic transaction has access to more or better information than the other party.
Moral hazard A type of market failure involving asymmetric information where a party takes risks but does not face their full costs by changing behaviour after a transaction has taken place. It is very common in insurance markets.
Screening In asymmetric information, the use of a screening process by the participant with less information to gain more information regarding a transaction, and so reduce adverse selection
Signalling In asymmetric information, the participant with more information sending a signal revealing relevant information about a transaction to the participant with less information, to reduce adverse selection.
2.11 Market failure—market power (HL only)
Abnormal profit This arises when average revenue is greater than average cost (greater than the minimum return required by a firm to remain in a line of business).
Abuse of market power When a firm acts with the intention to eliminate competitors or to prevent entry of new firms in a market.
Adverse selection A type of market failure involving asymmetric information, where the party with the incomplete information is induced to withdraw from the market. The buyer, for example, of a used car, may hesitate to buy without knowing about the quality of the vehicle. The seller, for example of health insurance, may hesitate to sell a policy without knowing the health of the buyer.
Average costs Total costs per unit of output produced.
Average revenue Revenue earned per unit sold; average revenue is thus equal to the price of the good.
Barriers to entry Anything that deters entry of new firms into a market, for example, licenses or patents.
Collusive oligopoly A market where firms agree to fix price and/or to
engage in other anticompetitive behaviour.
Competitive market A market with many firms acting independently where no firm has the ability to control the price.
Concentration ratios The proportion of industry sales accounted for by the largest firms; the greater this proportion, the greater the degree of market power of the firms in the industry.
Corporate social responsibility A corporate goal adopted by many firms that aims to create and maintain an ethical and environmentally responsible image.
Default choice When a choice is made by default, meaning that when given a choice it is the option that is selected when one does not do anything.
Economies of scale Falling average costs that a firm experiences when it increases its scale of operations.
(HL only in microeconomics but SL/HL in global economy)
Game theory A branch of mathematics that studies the strategic interaction of decision-makers that may be individuals, firms, countries, and so on.
Homogeneous product Goods that are considered identical across firms in the eyes of consumers; examples include mostly primary sector goods like corn, wheat or copper.
Imperfect competition A market structure where firms have a degree of market power as they face a negatively sloped demand curve and can thus set price.
Investment (I) Spending by firms on capital goods such as machines, tools, equipment and factories.
(HL only in micro but then SL/HL in macro)
Long run in microeconomics The period of time when all factors of production are variable.
Loss (economic) Occurs when total costs of a firm are greater than total revenues. It is equal to total cost minus total revenue.
Marginal revenue The extra or additional revenue that arises for a firm when it sells one more unit of output.
Market concentration The extent to which the total sales in a market are accounted for by the largest firms, providing an indication of the degree of market power in the industry. It is measured by the concentration ratio.
Market power The ability of a firm (or group of firms) to raise and maintain price above the level that would prevail under perfect competition (or P > MC).
Monopolistic competition A market structure where there are many sellers, producing differentiated products, with no barriers to entry.
Monopoly A market structure where there is only one firm in the industry, so the firm is the industry. There are high barriers to entry.
Natural monopoly A monopoly that can produce enough output to cover the entire needs of a market while still experiencing economies of scale. Its average costs will therefore be lower than those of two or more firms in the market.
Non-collusive oligopoly Firms in an oligopoly do not resort to agreements to fix prices or output. Competition tends to be non-price. Prices tend to be stable.
Non-price competition Competition between firms that is based on factors other than price, usually taking the form of product differentiation.
Normal profit The minimum return that must be received by a firm in order to stay in business. A firm earns normal profit when total revenue is equal to total cost, or when average revenue or price is equal to average cost.
Oligopoly A market structure where there are a few large firms that dominate the market, with high barriers to entry.
Payoff matrix A table showing all possible outcomes of decisions taken by decision-makers in game theory.
Perfect competition A market structure where there is a very large number of small firms, producing identical products, with no barriers to entry or exit, and perfect information. All the firms are thus price takers.
Perfect information Where all stakeholders in an economic transaction have access to the same information.
Price maker A firm that is able to influence the price at which it sells its product. Includes firms in all market structures except perfect competition.
Price competition Competition between firms that is based on price, for example, a firm that wants to increase its sales at the expense of other firms will lower its price.
Price taker A firm that is unable to influence the price at which it sells its product, being forced to accept the price determined in the market. It includes firm in perfect competition.
Price war Occurs when firms successively cut their prices in an effort to match the price cuts of other firms, resulting in lower profits, possibly losses.
Product differentiation The process by which firms try to make their products different from the products of other firms in an effort to increase their sales. Differences involve product quality, appearance, services offered and many others.
Rational producer behaviour Occurs when firms try to maximize profit. This is an assumption in standard microeconomic theory.
Rules of thumb Rules of thumb are mental shortcuts (heuristics) for decision-making to help people make a quick, satisfactory, but often not perfect, decision to a complex choice.
Short run in microeconomics The period of time when at least one factor of production is fixed.
Total costsAll the costs of a firm incurred for the use of resources to produce something.