Abnormal profit |
Abnormal profit is any profit in excess of normal profit - also
known as supernormal profit |
Anti competitive behaviour |
Anti-competitive practices are business strategies designed
deliberately to limit the degree of competition inside a
market |
Asymmetric information |
Information relating to a transaction in a market where there is
imbalance in the information available to either the buyer or the
seller. Asymmetric information can distort the working of the market
mechanism and lead to market failure |
Barriers to entry |
Barriers to entry are designed to block potential entrants from
entering a market profitably |
Behavioural economics |
A branch of economics which focuses on understanding the nature
of human decision making and which explores how decisions are taken
when economic agents do not have access to full and free information
and when their behaviour is not automatically assumed to be
rational |
Bilateral monopoly |
A market in which a single seller faces a single buyer. The final
determination of price and output is such a situation is uncertain -
much depends on the relative bargaining strength between the two
parties concerned |
Break even |
The break even output is the volume of goods or services that
have to be sold in order for the business to make neither a loss nor
a profit. The break even price is when price = average total
cost |
Break even output |
The break-even output occurs when AR=ATC (at this output, normal
profit only is made) |
Business ethics |
Business ethics is concerned with the social responsibility of
management towards the firm’s major stakeholders, the environment
and society in general |
Collective bargaining |
Unions might seek to exercise their collective bargaining power
with employers to achieve a mark-up on wages compared to those on
offer to non-union members |
Collusive oligopoly |
When several large firms in an industry act to restrict price or
output |
Compensating wage differentials |
Wage differentials in part act as a compensation for people who
have to work unsocial hours or who are exposed to different degrees
of risk at work, both in the short term and long run |
Competition policy |
Government policy which seeks to promote competition and
efficiency in different markets and industries |
Complex monopoly |
A complex monopoly exists if at least one quarter (25%) of the
market is in the hands of one or a group of suppliers who,
deliberately or not, act in a way designed to reduce competitive
pressures within a market |
Concentration ratio |
Measure the proportion of an industry's output or employment
accounted for by, say, the three, five or seven largest
firms |
Constrained revenue maximisation |
Shareholders of a business may introduce a constraint on the
price and output decisions of managers – this is known as
constrained sales revenue maximisation |
Consumer surplus |
Consumer surplus is the difference between the total amount that
consumers are willing and able to pay for a good or service
(indicated by the demand curve) and the total amount that they
actually pay (the market price) |
Contestable market |
Baumol defined contestable markets as existing where “an entrant
has access to all production techniques available to the incumbents,
is not prohibited from wooing the incumbent’s customers, and entry
decisions can be reversed without cost.” |
Cost benefit analysis |
Cost benefit analysis (COBA) is a technique for assessing the
monetary social costs and benefits of a capital investment project
over a given time period |
Cost reducing innovation |
Cost reducing innovations have the effect of causing an outward
shift in market supply and they also provide the scope for
businesses to enjoy higher profit margins with a given level of
demand |
Cross subsidy |
A firm operates a cross subsidy when it uses profits from one
line of business to finance losses in another line of business.
There are many reasons for maintaining a cross subsidy, either to
promote a product new to the market which is making losses, or as a
form of predatory pricing designed to eliminate an existing
competitor, the latter is illegal under UK and European competition
law |
Deadweight loss |
A loss of social welfare deriving from a policy or action that
has no corresponding gain. Deadweight losses of welfare are often
associated with the economic costs of monopoly power in a market or
the effects of negative and positive externalities that remain
ignored by the free market mechanism |
Dependency ratio |
The ratio of dependent population (the young and the elderly) to
the working age population |
Deregulation of markets |
Also known as market liberalisation, de-regulation involves the
opening up of markets to competition by reducing some of the
statutory barriers to entry that exist |
Derived demand |
The demand for all factors of production (inputs), including
labour, is a derived demand i.e. the demand for factors of
production depends on the demand for the products they
produce |
Diminishing returns |
The law of diminishing returns states that as we add more units
of a variable input (i.e. labour or raw materials) to fixed amounts
of land and capital, the change in total output will at first rise
and then fall. Diminishing returns to labour occurs when marginal
product starts to fall |
Diseconomies of scale |
A business may expand in the long run may expand beyond the
optimal size in the long run and experience diseconomies of scale.
This leads to rising LRAC. |
Disposable income |
Disposable income equals gross income net of direct tax payments
and state welfare benefits. |
Divorce between ownership and control |
The owners of a company normally elect a board of directors to
control the business’s resources for them. However, when the owner
of a company sells shares, or takes out a loan to raise finance,
they sacrifice some of their control |
Dominant market position |
A firm holds a dominant position if it can operate within the
market without taking account of the reaction of its competitors or
of intermediate or final consumers. |
Duopoly |
Any market that is dominated by two organisations |
Duopsony |
Two major buyers of a good or service in a market |
Dynamic efficiency |
Dynamic efficiency occurs over time. It focuses on changes in the
consumer choice available in a market together with the
quality/performance of goods and services that we buy |
Economic efficiency |
Economic efficiency is achieved when an output of goods and
services is produced making the most efficient use of our scarce
resources and when that output best meets the needs and wants and
consumers and is priced at a price that fairly reflects the value of
resources used up in production |
Economies of scope |
Economies of scope occur where it is cheaper to produce a range
of products |
Elasticity of labour demand |
Elasticity of labour demand measures the responsiveness of demand
for labour when there is a change in the ruling market wage
rate |
Elasticity of labour supply |
The elasticity of labour supply to an occupation measures the
extent to which labour supply responds to a change in the wage rate
in a given time period |
Emissions trading |
Emission trading is another form of pollution control that uses
the market mechanism to change relative prices and the incentives of
producers and consumers. |
Equal Pay Act |
The Equal Pay Act introduced in 1970 sought to provide legal
protection for female workers and encouraged employers to bring the
pay for males and females into line. |
Equilibrium wage |
The equilibrium price of labour (market wage rate) in a given
market is determined by the interaction of the supply and demand for
labour |
Excess capacity |
The difference between the current output of a business and the
total amount it could produce in the current time period. Often in a
recession or slowdown, there is a rise in excess capacity (= to a
fall in capacity utilisation) due to a fall in demand. The effect
can be to increase the average fixed costs of production |
Excess demand |
When demand for a good or service exceeds the production capacity
of a business in a given time period. When a firm cannot raise
output in the short term the elasticity of supply will be zero (i.e.
perfectly inelastic) |
Explicit collusion |
The aim collusion between firms is to maximise joint profits and
act as if the market was a pure monopoly |
External benefits |
Positive externalities lead to social benefits exceeding private
benefits |
External costs |
Negative spillover effects of production or consumption for which
no compensation is paid. Externalities occur where the actions of
firms and individuals have an effect on people other than
themselves. With negative externalities, the social cost of
production exceeds the private cost |
External economies of scale |
External economies of scale exist when the long-term expansion of
an industry leads to the development of ancillary services which
benefit all or the majority of suppliers in the industry. |
First mover advantage |
The idea that a business that creates a new product and which is
first into the market can develop a competitive advantage in that
market perhaps through learning by doing, because it has the
advantage of being there first - making it more difficult and costly
for new firms to come in |
Fixed costs |
Fixed costs relate to the fixed factors of production. Fixed
costs are business expenses that do not vary directly with the level
of output i.e. they are treated as exogenous or independent of
production |
Free rider problem |
If a public good is supplied, it will be available to them just
as it would be to anyone else because pure public goods are
non-excludable. This is the essence of the “free rider problem”: the
incentive which consumers have to avoid contributing to financing
public goods in proportion to their valuation of such good.
|
Game theory |
A game occurs when there are two or more interacting
decision-takers (players) and each decision or combination of
decisions involves a particular outcome (pay-off.) |
Gini coefficient |
The gini coefficient is a measure of income or wealth inequality.
It is the ratio between the area between a Lorenz curve and the 45
degree line and the area below the 45 degree line. If the Lorenz
Curve was the 45 degree line - then the value of the Gini
Coefficient would be zero, but as the level of inequality grows so
does the Gini Coefficient. In the most extreme possible scenario the
Gini Coefficient would be 1 |
Government failure |
Even with good intentions governments seldom get their policy
application correct. They can tax, control and regulate but the
eventual outcome may be a deepening of the market failure or even
worse a new failure may arise. |
Horizontal integration |
Horizontal integration occurs when two businesses in the same
industry at the same stage of production become one |
Imperfect competition |
Covers market structures between perfect competition and pure
monopoly, i.e. an industry with barriers to entry and differentiated
products - examples include oligopoly and duopoly |
Inequality |
The extent to which income and wealth between the inhabitants of
a country is dispersed |
Innovation |
The Oxford English Dictionary defines innovation as "making
changes to something established". Invention, by contrast, is the
act of "coming upon or finding: discovery" |
Interdependence |
Interdependence exists when the actions of one firm has an effect
on its competitors in the market. Interdependence is a common
feature of an oligopoly |
Internal growth |
Internal growth occurs when a business gets larger by increasing
the scale of its own operations rather than relying on integration
with other businesses |
Kinked demand curve |
The kinked demand curve model assumes that a business might face
a dual demand curve for its product based on the likely reactions of
other firms in the market to a change in its price or another
variable |
Labour demand |
There is normally an inverse relationship between the demand for
labour and the wage rate that a business needs to pay for each
additional worker employed |
Labour force |
The labour force is defined as the number of people either in
work or actively seeking paid employment and available to start
work. |
Labour market |
This is made up of firms willing to employ workers and labour
seeking employment. The demand for labour by firms is downward
sloping with respect to wage (price of labour), while the supply of
labour by households is upward sloping with respect to wage. The
labour market is in equilibrium where the demand for labour equals
the supply of labour. |
Labour market discrimination |
Discrimination is a cause of labour market failure and a source
of inequity in the distribution of income and wealth and it is
usually subject to government intervention e.g. through regulation
and legislation. |
Law of unintended consequences |
The law of unintended consequences is that actions of consumer
and producers — and especially of government—always have effects
that are unanticipated or "unintended." Particularly when economic
agents do not always act in the way that the economics textbooks
would predict |
Limit pricing |
When a firm sets price just low enough to discourage possible new
entrants |
Marginal cost |
Marginal cost is the change in total costs from increasing output
by one extra unit |
Marginal revenue |
Marginal Revenue (MR) = The change in revenue from selling one
extra unit of output |
Marginal revenue product |
Marginal Revenue Product (MRPL) measures the change in total
revenue for a firm from selling the output produced by additional
workers employed |
Market failure |
Market failure occurs when freely-functioning markets, fail to
deliver an efficient allocation of resources. The result is a loss
of economic and social welfare |
Market failure under monopoly |
The standard case against monopoly is that the monopoly price is
higher than both marginal and average costs leading to a loss of
allocative efficiency and a failure of the market
mechanism |
Means tested benefits |
The process of means-testing looks at the levels of income and
wealth of an individual or household to assess if they are entitled
to something |
Merit good |
A merit good is a product that the government believes consumers
undervalue and under-consume because of imperfect
information |
Minimum efficient scale |
The minimum efficient scale (MES) is the scale of production
where the internal economies of scale have been fully exploited. It
corresponds to the lowest point on the long run average cost
curve |
Minimum wage |
The National Minimum Wage was introduced in the UK with effect
from 1st April 1999. It is a legally guaranteed wage rate for
workers aged 18 years or older |
Monopsony |
As a firm grows in size it can purchase its factor inputs in bulk
at negotiated discounted prices. This is particularly the case when
a firm has monopsony (buying) power in the market |
Monopsony employer |
A monopsony producer has significant buying power in the labour
market when seeking to employ extra workers. A monopsony employer
may use their buying-power to drive down wage rates |
Nash equilibrium |
An idea important to game theory which describes any situation
where all of the participants in a game are pursuing their best
possible strategy given the strategies of all of the other
participants |
Natural monopoly |
For a natural monopoly the long-run average cost curve falls
continuously over a large range of output. |
Negative externality |
A negative externality occurs where a transaction imposes
external costs on a third party (not the buyer or seller) who is not
compensated by the market. The result is a loss of allocative
efficiency and shown by a reduction in economic welfare |
Non price competition |
Non-price competition assumes increased importance in
oligopolistic markets. Non-price competition involves advertising
and marketing strategies to increase demand and develop brand
loyalty among consumers. |
Normal profit |
Normal profit is the minimum level of profit required to keep the
factors of production in their current use in the long run |
Oligopoly |
An oligopoly is a market dominated by a few producers, each of
which has control over the market. However, oligopoly is best
defined by the conduct (or behaviour) of firms within a market
rather than its market structure |
Operating costs |
Another term for variable costs |
Original income |
Original income comes from wages and salaries in work,
self-employment income, investment incomes |
Overheads |
Another term for fixed costs |
Participation rate |
The percentage of the population of working age in the labour
force. |
Peak pricing |
When a business raises its prices at a time when demand has
reached a peak - higher prices might be justified on the grounds of
the higher marginal costs of supply at peak times |
Penetration pricing |
A pricing policy used to enter a new market, usually by setting a
very low price |
Perfect price discrimination |
With perfect price discrimination, the firm separates the whole
market into each individual consumer and charges them the price they
are willing and able to pay |
Polluter pays principle |
The principle that firms which cause pollution should bear the
cost of eradicating it, ameliorating it, or compensating those who
have been affected by it |
Pollution permit |
A marketable pollution permit gives a business the right to emit
a given volume of waste or pollution into the environment |
Poverty trap |
A situation in which a rise in income results in the recipient
being worse off once tax has been paid and benefits withdrawn. The
poverty trap acts as a disincentive for people on low incomes to
earn some extra income from working extra hours or taking another
job |
Predatory pricing |
When a business deliberately reduces price in the short run so as
to force competitors out of the industry. Predatory pricing is
illegal under current UK and EU competition law |
Price discrimination |
Price discrimination occurs when a firm charges a different price
to different groups of consumers for an identical good or service,
for reasons not associated with costs |
Price fixing |
Price fixing represents an attempt by suppliers to control supply
and fix price at a level close to the level we would expect from a
monopoly |
Price leadership |
Price leadership occurs when one firm has a clear dominant
position in the market and the firms with lower market shares follow
the pricing changes prompted by the dominant firm |
Privatisation |
Privatisation means the transfer of assets from the public
(government) sector to the private sector. In the UK the process has
led to a sizeable reduction in the size of the public sector of the
economy |
Producer surplus |
Producer surplus is the difference between what producers are
willing and able to supply a good for and the price they actually
receive. The level of producer surplus is shown by the area above
the supply curve and below the market price |
Product differentiation |
Product differentiation occurs when a business seeks to
distinguish what are essentially the same products from one another
by real or illusory means. This means that the assumption of
homogeneous products made under conditions of perfect competition no
longer applies |
Product line pricing |
It is frequently observed that a producer may manufacture many
related products. They may choose to charge one low price for the
core product (accepting a lower mark-up or profit on cost) as a
means of attracting customers to the components / accessories that
have a much higher mark-up or profit margin. |
Product markets |
Product markets are where businesses and consumers meet to buy
and sell the output of goods and services produced by an
economy |
Production function |
A mathematical relationship between the output of a business in a
given time period and the inputs (factors of production) used to
produce that output. We normally make a distinction between short
run and long run production although this is often blurred in many
industries |
Profit maximisation |
Profit maximisation occurs when marginal cost = marginal revenue
(MC=MR) |
Profit per unit |
Profit per unit (or the profit margin) = AR - ATC |
Profit related pay |
Where part of the earnings of people working for a business are
linked directly to the profits made by that business. Profit related
pay is often used as an incentive to raise productivity |
Regulatory capture |
This is when the industries under the control of a regulatory
body (i.e. a government agency) appear to operate in favour of the
vested interest of producers rather than consumers |
Rent seeking behaviour |
Behaviour by producers in a market that improves the welfare of
one but at the expense of another |
Returns to scale |
In the long run, all factors of production are variable. How
output responds to a change in factor inputs is called returns to
scale |
Revenue |
Revenue (or turnover) is the income generated from the sale of
output in goods markets |
Revenue maximisation |
Revenue maximization is when MR = zero (i.e. when price
elasticity of demand = 1) |
Satisficing behaviour |
Maximising behaviour may be replaced by satisficing which in
essence involves the owners setting minimum acceptable levels of
achievement in terms of revenue and profit. |
Second degree price discrimination |
This type of price discrimination involves businesses selling off
packages of a product deemed to be surplus capacity at lower prices
than the previously published/advertised price |
Sex Discrimination Act |
The Sex Discrimination Act of 1975 outlawed unequal opportunities
for employment and promotion in the workplace because of gender and
it set up the Equal Opportunities Commission |
Short run |
The short run is defined as a period of time where at least one
factor of production is assumed to be in fixed supply |
Shut down price |
In the short run the firm will continue to produce as long as
total revenue covers total variable costs or put another way, so
long as price per unit > or equal to average variable cost (AR =
AVC). |
Social benefit |
Social benefits refer to the total benefit to society from a good
i.e. the benefit to individuals and any beneficial unintended
spill-over effects on third parties |
Spare capacity |
When a firm or economy is able to produce more with existing
resources |
Static efficiency |
Static efficiency occurs at a point in time and focuses on how
much output can be produced now from a given stock of resources, and
whether producers are charging a price to consumers that reflects
fairly the cost of the factors used to produce a product. |
Strategic entry deterrence |
Strategic entry deterrence involves any move by existing firms to
reinforce their position against other firms or potential
rivals |
Sub-normal profit |
Sub-normal profit - is any profit less than normal profit (where
price < average total cost) |
Sunk costs |
Sunk costs cannot be recovered if a business decides to leave an
industry |
Tacit collusion |
Tacit collusion occurs where firms undertake actions that are
likely to minimise a competitive response, e.g. avoiding price
cutting or not attacking each other’s market |
Total cost |
Total cost = total fixed cost + total variable cost |
Total revenue |
Total revenue (TR) refers to the amount of money received by a
firm from selling a given level of output and is found by
multiplying price (P) by output i.e. number of units sold |
Trade unions |
Trade unions are organisations of workers that seek through
collective bargaining with employers to protect and improve the real
incomes of their members, provide job security, protect workers
against unfair dismissal and provide a range of other work-related
services including support for people claiming compensation for
injuries sustained in a job. |
Two part pricing tariffs |
A fixed fee is charged (often with the justification of it
contributing to the fixed costs of supply) and then a supplementary
“variable” charge based on the number of units consumed |
Variable cost |
Variable costs are business costs that vary directly with output
since more variable inputs are required to increase output |
Vertical integration |
Vertical Integration involves acquiring a business in the same
industry but at different stages of the supply chain |
Work leisure trade off |
The choice labour makes between working more hours and taking
more leisure when the rate of income tax changes. |
X inefficiency |
The lack of real competition may give a monopolist less of an
incentive to invest in new ideas or consider consumer
welfare |