Micro key terms

abnormal profit (also known as supernormal profit and abovenormal profit ) profit over and above normal profit. absolute poverty a condition characterised by severe deprivation of basic human needs, including food, safe drinking water, sanitation facilities, health, shelter, education and information. It depends not only on income but also on access to services. availability bias occurs when individuals make judgements about the likelihood of future events according to how easy it is to recall examples of similar events. average cost of labour total wage costs divided by the number of workers employed. cartel a collusive agreement by firms, usually to fix prices. Sometimes there is also an agreement to restrict output and to deter the entry of new firms. choice choosing between alternatives when making a decision on how to use scarce resources. allocative efficiency occurs when it is impossible to improve overall economic welfare by reallocating resources between markets. In the whole economy, price must equal marginal cost ( P = MC ) in every market. average fixed cost total cost of employing the fixed factors of production to produce a particular level of output, divided by the size of output: AFC = TFC ÷ Q . choice architecture a framework setting out different ways in which choices can be presented to consumers, and the impact of that presentation on consumer decision making. allocative function of prices changing relative prices allocate scarce resources away from markets exhibiting excess supply and into markets in which there is excess demand. average returns of labour total output divided by the total number of workers employed. average revenue total revenue divided by output. average total cost (also known as average cost ) total cost of producing a particular level of output, divided by the size of output: ATC = AFC + AVC . cognitive bias a systematic error in thinking that affects the decisions and judgements that people make. allocative inefficiency occurs when P > MC , in which case too little of a good is produced and consumed, and when P < MC , in which case too much of a good is produced and consumed. average variable cost total variable cost divided by the size of output. collective bargaining a process by which wage rates and other conditions of work are negotiated and agreed upon by a union or unions with an employer or employers. altruism concern for the welfare of others. behavioural economics a method of economic analysis that applies psychological insights into human behaviour to explain how individuals make choices and decisions. command economy (also known as a planned economy ) an economy in which government officials or planners allocate economic resources to firms and other productive enterprises. anchoring a cognitive bias describing the human tendency when making decisions to rely too heavily on the first piece of information offered (the so-called ‘anchor’). Individuals use an initial piece of information when making subsequent judgements. bounded rationality when making decisions, individuals’ rationality is limited by the information they have, the limitations of their minds, and the finite amount of time available in which to make decisions. Competition and Markets Authority (CMA) government agency responsible for advising on and implementing UK competition policy. artificial barriers ‘man-made’ barriers to market entry (e.g. patent protection). competition policy the part of the government’s microeconomic policy and industrial policy which aims to make goods markets more competitive. It comprises policy towards monopoly, mergers and restrictive trading practices. asymmetric information when one party to a market transaction possesses less information relevant to the exchange than the other. bounded self-control where individuals have limited selfcontrol to act rationally in their own interests. capital good (also known as a producer good ) a good which is used in the production of other goods or services. capital productivity output per unit of capital. competitive demand when a good is viewed by consumers as an alternative for another good, i.e. the two goods are substitutes.

competitive markets markets in which the large number of buyers and sellers possess good market information and can easily enter or leave the market. complementary goods when two goods are complements, they experience joint demand. complete market failure a market fails to function at all and a ‘missing market’ results. composite demand demand for a good which has more than one use, which means that an increase in demand for one use of the good reduces the supply of the good for an alternative use. It is related to the concept of competing supply. concentration ratio measures the market share (percentage of the total market) of the biggest firms in the market. For example, a fivefirm concentration ratio measures the aggregate market share of the largest five firms. condition of demand a determinant of demand, other than the good’s own price, that fixes the position of the demand curve. condition of supply a determinant of supply, other than the good’s own price, that fixes the position of the supply curve. constant returns to scale when the scale of all the factors of production employed increases, output increases at the same rate. consumer good a good which is consumed by individuals or households to satisfy their needs or wants. consumer surplus a measure of the economic welfare enjoyed by consumers: surplus utility received over and above the price paid for a good. consumption externality an externality (which may be positive or negative) generated in the course of consuming a good or service. contestable market a market in which the potential exists for new firms to enter the market. A perfectly contestable market has no entry or exit barriers and no sunk costs, and both incumbent firms and new entrants have access to the same level of technology. creative destruction capitalism evolving and renewing itself over time through new technologies and innovations replacing older technologies and innovations. cross elasticity of demand measures the extent to which the demand for a good changes in response to a change in the price of another good; it is calculated by dividing the percentage change in quantity demanded by the percentage change in the price of another good. deadweight loss the loss of economic welfare when the maximum attainable level of total welfare fails to be achieved. decrease in demand a leftward shift of the demand curve. decrease in supply a leftward shift of the supply curve. decreasing returns to scale when the scale of all the factors of production employed increases, output increases at a slower rate. default choice an option that is selected automatically unless an alternative is specified. demand the quantity of a good or service that consumers are willing and able to buy at given prices in a given period of time. demerit goods goods, such as tobacco, for which the social costs of consumption exceed the private costs. Value judgements are involved in deciding that a good is a demerit good. deregulation the removal of previously imposed regulations. derived demand demand for a good or factor of production, wanted not for its own sake, but as a consequence of the demand for something else. diseconomies of scale as output increases, long-run average cost rises. disequilibrium a situation in which opposing forces are out of balance. distribution of income how income is divided between rich and poor, or between different groups in society, e.g. on a regional, age or gender basis. distribution of wealth how wealth is divided between rich and poor, or between different groups in society, e.g. on a regional, age or gender basis. division of labour different workers performing different tasks in the course of producing a good or service. divorce of ownership from control the owners and those who control the firm (managers) are different groups with different objectives. duopoly two firms only in a market. dynamic efficiency measures improvements in productive efficiency that occur in the long run over time. economic growth the increase in the potential level of real output the economy can produce over a period of time. economic system the set of institutions within which a community decides what, how and for whom to produce. economic welfare the economic well-being of an individual, a group within society, or an economy. economies of scale as output increases, long-run average cost falls.
effective demand the desire for a good or service backed by an ability to pay. elasticity the proportionate responsiveness of a second variable to an initial change in the first variable. elasticity of demand for labour proportionate change in demand for labour following a change in the wage rate. The elasticity can be calculated by using the following formula: percentage change in quantity of labour demanded / percentage change in the wage rate elasticity of supply of labour proportionate change in the supply of labour following a change in the wage rate. The elasticity can be calculated by using the following formula: percentage change in quantity of labour supplied / percentage change in the wage rate entry barriers obstacles that make it difficult for a new firm to enter a market. equality when everyone is treated exactly the same. A completely equal distribution of income means that everybody has the same income. equilibrium a state of rest or balance between opposing forces. equity when everyone is treated fairly. excess demand when consumers wish to buy more than firms wish to sell, with the price below the equilibrium price. excess supply when firms wish to sell more than consumers wish to buy, with the price above the equilibrium price. exchange to give something in return for something else received. Money is a medium of exchange. excludable good people who do not want to pay can be excluded from benefiting from the good. exit barriers obstacles that make it difficult for an established firm to leave a market. external diseconomy of scale an increase in long-run average costs of production resulting from the growth of the market or industry of which the firm is a part. external economy of scale a fall in long-run average costs of production resulting from the growth of the market or industry of which the firm is a part. externality a public good, in the case of an external benefit, or a public bad, in the case of an external cost, that is ‘dumped’ on third parties outside the market. factors of production inputs into the production process (e.g. land, labour, capital and enterprise). fairness the quality of being impartial, just, or free of favouritism. It can mean treating people equally, sharing with others, giving others respect and time, and not taking advantage of them. firm a productive organisation which sells its output of goods and/or services commercially. fixed cost a cost of production which, in the short run, does not change with output. framing how something is presented (the ‘frame’) influences the choices people make. free-rider problem a freerider is someone who benefits without paying as a result of non-excludability. Customers may choose not to pay for a good, preferring instead to free-ride, with the result that the incentive to provide the good through the market disappears. full employment when all who are able and willing to work are employed. fundamental economic problem how best to make decisions about the allocation of scarce resources among competing uses, so as to improve and maximise human happiness and welfare. geographical immobility of labour when workers are unwilling or unable to move from one area to another in search of work. Gini coefficient measures the extent to which the distribution of income or wealth among individuals or households within an economy deviates from a perfectly equal distribution. government failure occurs when government intervention reduces economic welfare, leading to an allocation of resources that is worse than the free-market outcome. hypothesis of diminishing marginal utility for a single consumer, the marginal utility derived from a good or service diminishes for each additional unit consumed. hit-and-run competition occurs when a new entrant can ‘hit’ the market, make profits and then ‘run’, given that there are no or low barriers to exit. immobility of labour the inability of labour to move from one job to another, either for occupational reasons (e.g. the need for training) or for geographical reasons (e.g. the cost of moving to another part of the country). incentive function of prices prices create incentives for people to alter their economic behaviour, e.g. a higher price creates an incentive for firms to supply more of a good or service. income personal or household income is the flow of money a person or household receives in a particular time period. income elasticity of demand measures the extent to which the demand for a good changes in response to a change in income; it is calculated by dividing the percentage change in quantity demanded by the percentage change in income. increase in demand a rightward shift of the demand curve. increase in supply a rightward shift of the supply curve.
increasing returns to scale when the scale of all the factors of production employed increases, output increases at a faster rate. incumbent firm a business with an established position in the market which often benefits from consumer loyalty and economies of scale. individual demand the quantity of a good or service that a particular consumer or individual is willing and able to buy at different market prices. inferior good a good for which demand decreases as income rises and demand increases as income falls. information failure occurs when people make wrong decisions because they do not possess or they ignore relevant information. Very often they think just of the present rather than the future consequences of their actions. innovation improves on or makes a significant contribution to something that has already been invented, thereby turning the results of invention into a product. internal economies and diseconomies of scale changes in long-run average costs of production resulting from changes in the size or scale of a firm or plant. invention making something entirely new; something that did not exist before at all. joint supply when one good is produced, another good is also produced from the same raw materials, perhaps as a by-product. labour productivity output per worker. law of diminishing marginal returns (also known as law of diminishing marginal productivity ) a short-term law which states that, as a variable factor of production is added to a fixed factor of production, both the marginal and eventually the average returns to the variable factor will begin to fall. long run the time period in which no factors of production are fixed and all the factors of production can be varied. Lorenz curve a graph on which the cumulative percentage of total national income or wealth is plotted against the cumulative percentage of population (ranked in increasing size of share). The extent to which the curve dips below a straight 45-degree diagonal line indicates the degree of inequality of distribution. mandated choice people are required, often by law, to make a decision. marginal cost addition to total cost resulting from producing one additional unit of output. marginal cost of labour the addition to a firm’s total cost of production resulting from employing one more worker. marginal physical product of labour the addition to a firm’s total output brought about by employing one more worker. marginal returns of labour the change in the quantity of total output resulting from the employment of one more worker, holding all the other factors of production fixed. marginal revenue addition to total revenue resulting from the sale of one more unit of the product. marginal revenue product of labour the money value of the addition to a firm’s total output brought about by employing one more worker. marginal tax rate the tax rate levied on the last pound of income received. The term can be applied solely to income taxes or to all the taxes that a person or business pays. marginal utility the additional welfare, satisfaction or pleasure gained from consuming one extra unit of a good or service. market a voluntary meeting of buyers and sellers with exchange taking place. market conduct the pricing and marketing policies pursued by firms. This is also known as market behaviour, but is not to be confused with market performance, which refers to the end results of these policies. market demand the quantity of a good or service that all the consumers in a market are willing and able to buy at different market prices. market disequilibrium exists at any price other than the equilibrium price, when either planned demand < planned supply or planned demand > planned supply. market economy an economy in which goods and services are purchased through the price mechanism in a system of markets. market equilibrium a market is in equilibrium when planned demand equals planned supply, where the demand curve crosses the supply curve. market failure when the market mechanism leads to a misallocation of resources in the economy, either completely failing to provide a good or service or providing the wrong quantity. market structure the organisational and other characteristics of a market. market supply the quantity of a good or service that all the firms in a market plan to sell at given prices in a given period of time. merit good a good, such as healthcare, for which the social benefits of consumption exceed the private benefits. Value judgements are involved in deciding that a good is a merit good. missing market a situation in which there is no market because the functions of prices have broken down.
mixed economy an economy that contains both a large market sector and a large non-market sector in which the planning mechanism operates. monopolistic competition a market structure in which firms have many competitors, but each one sells a slightly different product. monopoly one firm only in a market. monopoly power (also known as market power ) the ability of a monopoly to raise and maintain price above the level that would prevail under perfect competition. Market power can also be exercised, usually to a lesser degree, by firms in oligopoly and monopolistic competition. monopsony there is only one buyer in a market. monopsony power the market power exercised in a market by the buyer of a good or the services of a factor of production such as labour, even though the firm is not a pure monopsonist. moral hazard the tendency of individuals and firms, once insured against some contingency, to behave so as to make that contingency more likely. mortgage a long-term loan usually used to buy a house. The loan is secured against the value of the house. national minimum wage a minimum wage or wage rate that must by law be paid to employees, though in many labour markets the wage rate paid by employers is above the national minimum wage. natural barriers (also known as innocent barriers ) barriers to market entry which are not caused by deliberate actions of firms in the industry. need something that is necessary for human survival, such as food, clothing, warmth or shelter. negative externality an external cost that occurs when the consumption or production of a good causes costs to a third party, where the social cost is greater than the private cost. non-renewable resource (also known as a finite resource ) a resource (e.g. oil) that is scarce and runs out as it is used. normal good a good for which demand increases as income rises and demand decreases as income falls. normal profit the minimum profit a firm must make to stay in business, which is, however, insufficient to attract new firms into the market. normative statement a statement that includes a value judgement and cannot be refuted just by looking at the evidence. nudges factors which encourage people to think and act in particular ways. Nudges try to shift group and individual behaviour in ways which comply with desirable social norms. occupational immobility of labour when workers are unwilling or unable to move from one type of job to another, e.g. because different skills are needed. opportunity cost the cost of giving up the next best alternative. partial market failure a market does function, but it delivers the ‘wrong’ quantity of a good or service, which results in resource misallocation. perfect competition a market that displays the six conditions of: a large number of buyers and sellers; perfect market information; the ability to buy or sell as much is desired at the ruling market price; the inability of an individual buyer or seller to influence the market price; a uniform or homogeneous product; and no barriers to entry or exit in the long run. plant an establishment, such as a factory, a workshop or a retail outlet, owned and operated by a firm. positive externality an external benefit that occurs when the consumption or production of a good causes a benefit to a third party, where the social benefit is greater than the private benefit. positive statement a statement of fact that can be scientifically tested to see if it is correct or incorrect. poverty the state of being extremely poor and not having enough money or income to meet basic needs. price agreement an agreement between a firm, similar firms, suppliers or customers regarding the pricing of a good or service. price ceiling a price above which it is illegal to trade. Price ceilings, or maximum legal prices, can distort markets by creating excess demand. price discrimination charging different prices to different customers for the same product or service, with the prices based on different willingness to pay. price elasticity of demand measures the extent to which the demand for a good changes in response to a change in the price of that good. price elasticity of supply measures the extent to which the supply of a good changes in response to a change in the price of that good. price floor a price below which it is illegal to trade. Price floors, or minimum legal prices, can distort markets by creating excess supply. price leadership the setting of prices in a market, usually by a dominant firm, which is then followed by other firms in the same market.
price war occurs when rival firms continuously lower prices to undercut each other. price-maker when a firm faces a downward-sloping demand curve for its product, it possesses the market power to set the price at which it sells the product. price-taker a firm which is so small that it has to accept the ruling market price. If the firm raises its price, it loses all its sales; if it cuts its price, it gains no advantage. private good a good, such as an orange, that is excludable and rival. privatisation the transfer of assets from the public sector to the private sector. producer surplus a measure of the economic welfare enjoyed by firms or producers: the difference between the price a firm succeeds in charging and the minimum price it would be prepared to accept. product differentiation the marketing of generally similar products with minor variations or the marketing of a range of different products. production converts inputs or factor services into outputs of goods and services. production externality an externality (which may be positive or negative) generated in the course of producing a good or service. production possibility frontier a curve depicting the various combinations of two products (or types of product) that can be produced when all the available resources are fully and efficiently employed. productive efficiency for the economy as a whole occurs when it is impossible to produce more of one good without producing less of another. For a firm it occurs when the average total cost of production is minimised. productivity output per unit of input. productivity gap the difference in labour productivity between, for example, the UK and other developed economies. profit the difference between total sales revenue and total cost of production. profit maximisation occurs at the level of output at which total profit is greatest. progressive taxation a tax is progressive when, as income rises, a greater proportion of income is paid in taxation. The term can be applied to a particular tax such as income tax or to taxation in general. property right the exclusive authority to determine how a resource is used. public good a good, such as a radio programme, that is nonexcludable and non-rival. public ownership ownership of industries, firms and other assets such as social housing by central government or local government. The state’s acquisition of such assets is called nationalisation. quantity-setter when a firm faces a downward-sloping demand curve for its product, it possesses the market power to set the quantity of the good it wishes to sell. quasi-public good a good which is not fully non-rival and/or where it is possible to exclude people from consuming the product. rational behaviour acting in pursuit of self-interest, which for a consumer means attempting to maximise the welfare, satisfaction or utility gained from the goods and services consumed. rationing function of prices rising prices ration demand for a product. regulation the imposition of rules and other constraints which restrict freedom of economic action. regulatory capture occurs when regulatory agencies act in the interest of regulated firms rather on behalf of the consumers they are supposed to protect. relative poverty occurs when income is below a specified proportion of average income, e.g. below 60% of median income. renewable resource a resource (e.g. timber) that with careful management can be renewed as it is used. resource allocation the process through which the available factors of production are assigned to produce different goods and services (e.g. how many of society’s economic resources are devoted to supplying different products such as food, cars, healthcare and defence). restricted choice offering people a limited number of options so that they are not overwhelmed by the complexity of the situation. If there are too many choices, people may make a poorly thought-out decision or not make any decision. returns to scale the rate by which output changes if the scale of all the factors of production is changed. rival good when one person consumes a private good, the quantity available to others diminishes. rules of thumb thinking shortcuts, or informed guesses, that individuals use to make decisions in order to save time and effort. ruling market price (also known as equilibrium price ) the price at which planned demand equals planned supply. satisficing achieving a satisfactory outcome rather than the best possible outcome.
scarcity results from the fact that people have unlimited wants but resources to meet these wants are limited. In essence, people would like to consume more goods and services than the economy is able to produce with its limited resources. short run the time period in which at least one factor of production is fixed and cannot be varied. signalling function of prices prices provide information to buyers and sellers. social benefit the total benefit of an activity, including the external benefit as well as the private benefit. Expressed as an equation: social benefit = private benefit + external benefit. social cost the total cost of an activity, comprising the external cost as well as the private cost. Expressed as an equation: social cost = private cost + external cost. social norms forms or patterns of behaviour considered acceptable by a society or group within that society. specialisation a worker only performing one task or a narrow range of tasks. Also, different firms specialising in producing different goods or services. static efficiency efficiency (e.g. productive and allocative efficiency) at a particular point in time. subsidy a payment made by government or other authority, usually to producers, for each unit of the subsidised good that they produce. Consumers can also be subsidised: for example, bus passes given to children to enable them to travel on buses free or at a reduced price. substitute goods alternative goods that could be used for the same purpose. sunk costs costs that have already been incurred and cannot be recovered. supply the quantity of a good or service that producers are willing and able to sell at given prices in a given period of time. tax a compulsory levy imposed by the government to pay for its activities. Taxes can also be used to achieve other objectives, such as reduced consumption of demerit goods. technical progress new and better ways of making goods and new techniques for producing more output from scarce resources. technological change a term used to describe the overall effect of invention, innovation and the diffusion or spread of technology in the economy. total cost all the cost incurred when producing a particular size of output. total returns the whole output produced by all the factors of production, including labour, employed by a firm. total revenue all the money received by a firm from selling its total output. trade the buying and selling of goods and/or services. trade union a group of workers who join together to maintain and improve their conditions of employment, including their pay. unemployment when not all of those who are able and willing to work are employed. utility the satisfaction or economic welfare an individual gains from consuming a good or service. variable cost a cost of production which changes with the amount that is produced, even in the short run. wage discrimination paying different workers different wage rates for doing the same job. want something that is desirable, such as a mobile phone, but is not necessary for human survival. wealth personal wealth is the stock of everything that a person or household owns at a particular point in time which has value.