Economics Unit 3 – Key Terms

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Firm
Firm
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A business organisation such as a corporation, limited liability company, or partnership
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Public limited companies / PLCs
Public limited companies / PLCs
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Large firms owned by thousands of shareholders, who employ managers or executives to run the business
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Marginal returns
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The increase in output that results from adding an extra input to the firm
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Specialisation
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A method of production where specific products or tasks are assigned to certain workers, so that they become every skilled at the specific task
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Short run
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The period of time in which at least one factor of production is fixed
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Long run
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The period of time in which are factors of production are variable
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The law of diminishing returns / the law of diminishing marginal productivity
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Sets in when the marginal product of labour, or another variable factor, starts to fall. This happens when one more unit of input adds less to total output than the previous unit of input.
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Technological change
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A change in the ability of a firm to produce at a different level of output with a given quantity of inputs
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Invention
Invention
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The creation or original design of something that has not existed before
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Innovation
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The act of making changes in, or developing, something already established, especially by introducing new ideas, methods and products
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Equilibrium
Equilibrium
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A state of balance or rest, in which there is no reason for anything to change unless it is disturbed. In microeconomics, we usually see equilibrium as the point at which planned demand is equal to planned supply in a market
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Normal profit
Normal profit
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The minimum level of profit needed to keep existing firms in production, while being insufficient to attract new firms into the market. It is included in the firm’s ATC curve, because a firm must make normal profit to stay in business
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Supernormal profit
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Any extra profit above normal profit. In the long-run, and in the absence of barriers to entry, supernormal profit performs the function of attracting new firms in the market
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Monopoly
Monopoly
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A situation in which a single firm owns all, or nearly all, of the market for a given product or service. A pure monopoly owns 100%, whereas a monopoly can own 25% or more.
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Cartel
Cartel
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A group of colluding firms that fix prices, forming a price ring, and often also divide up the market by allocating maximum levels of output for each firm. Usually seen in an oligopolistic market.
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Game theory
Game theory
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An analysis of strategic situations or games, in which the success of an individual, a firm, or a government, when making choices, depends on the choices of others
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Price discrimination
Price discrimination
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Occurs when firms charge different prices to different consumers for the same product, based on differences in their ability and willingness to pay
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Contestable market
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A market in which the potential exists for firms to enter and leave the market, without incurring entry or exit costs. There are no sunk costs.
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Sunk costs
Sunk costs
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Costs that are incurred when a firm enters a market, which it cannot recover if it decides to leave the market. An example is spending on advertising
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Hit-and-run entrants
Hit-and-run entrants
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Firms that enter the market, make a quick profit, and leave. The ease of entry and exit in contestable markets allows this to happen
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Marginal revenue product / MRP
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The monetary value of the addition to a firm’s total output brought about by employing one more worker
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Marginal physical product / MPP
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Also known as the marginal returns of labour, this is the increase in output that results from adding an extra input to the labour force
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Average cost of labour
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The total wage costs, divided by the number of workers employed
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Marginal cost of labour
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The addition to a firm’s total cost of production resulting from employing one more worker
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Monopsony
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A single buyer in a market, just as a monopoly is a single seller
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Income
Income
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A flow of money going to a factor of production, such as wages paid to workers, profits to businesses or benefits given to those who require them. It is measured per period of time, such as weekly, monthly or annually
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Wealth
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The stock of physical assets, such as land, houses and art, and financial assets, such as stocks and shares, which accumulates over time
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Market failure
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Occurs whenever the market mechanism or price mechanism performs unsatisfactorily, resulting in a misallocation of resources
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Partial market failure
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When the market still functions, but either produces the wrong quantity, or sets the wrong price
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Complete market failure
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The market does not supply any products. There is a ‘missing market’
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Public good
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A good which exhibits the characteristics of non-excludability and non-rivalry
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Non-excludability
Non-excludability
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People cannot be prevented from using the good or consuming its benefits
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Non-rivalry
Non-rivalry
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Consumption of the good by one person does not limit the benefits for other people
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Pure public good
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A public good for which it is impossible to exclude free-riders, such as national defence and police
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Quasi-public good
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A near public good, which is semi-non-rival and semi-non-excludable
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Negative externality
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An external cost for a third party, as a result of an economic activity
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Positive externality
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An external benefit for a third party, as a result of an economic activity
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Information failure / imperfect information
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When people have inaccurate, incomplete, uncertain or misunderstood data, so make potentially ‘wrong’ choices
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Asymmetric information
Asymmetric information
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When somebody (the consumer or the producer) knows more about a product than someone else in the market, making it difficult for them to do business
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Property rights
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Rights provided by law, to determine how a resource is used and whether that resource is owned by the government or by individuals
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The Tragedy of the Commons
The Tragedy of the Commons
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An economic theory by Garrett Harding, which states that individuals acting independently and rationally, according to their own self-interest, behave against the best interests of the whole group by depleting some common resource
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Tax
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A compulsory contribution to state revenue, levied by the government, either indirect such as VAT, or direct such as income tax
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Subsidy
Subsidy
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A grant given by the government which lowers the price of a good, and is usually designed to encourage production or consumption
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Direct provision
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When the government intervenes in the market to provide merit goods or public goods
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Pollution permit
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A licence given to a firm allowing them a legal right to pollute a certain amount per year
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Public ownership
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A state in which a firm is owned by the government
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Nationalisation
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When a firm is taken into public ownership
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Privatisation
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When state-owned assets are sold to the private sector
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Regulation
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The imposition of laws or rules regarding private-sector enterprise
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Regulatory capture
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Allegedly occurs when a regulator, such as the government, acts in the interest of the powerful firms it is supposed to be constraining, rather than in the interest of the consumers it is supposed to protect
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De-regulation
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The removal of government legislations and laws in a particular market, often involving removing barriers to competition
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Competitive tendering
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An auction process in which large investors or firms bid for the right to run a certain service or gain a certain contract
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Internal market
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Also known as a quasi-market, it is a public sector structure, designed to reap the efficiency gains of free markets, without losing the equity benefits of traditional public systems
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Public private partnership / PPP
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A situation in which the public sector and the private sector work in conjunction on a project, usually an infrastructure project such as a road
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Equality
Equality
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‘Sameness’ – all people are treated the same and provided with the same things. It is a positive concept as it can be measured
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Equity
Equity
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‘Fairness’ – a normative concept as it cannot be measured
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Horizontal equity
Horizontal equity
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Treating people in the same circumstances equally, for example, households with the same income and personal circumstances must pay the same income tax, and are eligible for the same welfare benefits
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Vertical equity
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Taking income from the rich, and redistributing it to the poor. This is controversial
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Relative poverty
Relative poverty
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The government defines the relative poverty level as those earning below 60% of average earnings for an area
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Absolute poverty
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When a person cannot provide for his/her basic needs, including food, water and shelter
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Progressive taxation
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A tax that takes a larger percentage from the income of high-income earners, than it does from low-income earners. An example is income tax in the UK
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Regressive taxation
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A tax that takes a larger percentage from the income of low-income earners, than it does from high-income earners. An example is VAT in the UK
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Transfer payment
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A payment made to individuals by the government in order to redistribute income, such as welfare benefits
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Government failure
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When government intervention to resolve a market failure creates inefficiency and causes the problem to worsen
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Cost-benefit analysis / CBA
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A technique for evaluating all the costs and benefits of any economic action or decision, including all the social costs and benefits to the community and not just the private costs and benefits that happen to the economic agent undertaking the action
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Shadow pricing
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Placing a monetary value on a good which does not already have a monetary value, because it is not traded in a market

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