Theme 1

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Economic models

Back 1

A simplified definition of reality. Designed to produce hypothesis about economic behaviour that can be tested.

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Social science

Back 2

Studies society and the relationships among individuals within society using scientific methods.

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Ceteris paribus

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All other things being equal

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Positive statements

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Positive statements are value-free, objective and testable

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Normative statements

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Normative statements are subjective, non-testable and value judgements

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Scarcity

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Scarcity results from finite resources being unable to produce enough to fulfil infinite wants

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Opportunity costs

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This is the next best alternative which is forgone when ever an economic decision is made

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Renewable resources

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Resources that are replenished by natural processes at a rate comparable or faster than it's rate of consumption

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Land

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Natural resources: that is any free gift of nature such as fossil fuels

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Labour

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The mental or physical effort of humans in the production processes for which they are paid for.

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Capital goods

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Producer goods that indirectly satisfy wants such as machinery.

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Consumer goods

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Goods that directly satisfy consumer wants.

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Enterprise

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Organises and controls the other factors of production.

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Production Possibility Frontier (PPF)

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A curve showing the maximum possible alternative combinations of two goods that an economy can produce. E.G. capital and consumer goods. Using all available factors of production efficiently. Moving from one point to another indicates opportunity cost of increasing one items production in terms of units of the other one forgone.

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Productive efficiency

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Producing the greatest value output out of the least value inputs. For a firming means producing at the lowest average total cost (ATC)

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Allocative efficiency

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Producing the correct bundle of goods to maximise welfare. For a firm it means producing where price = marginal cost

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Division of labour

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The separation of tasks in the production process and their allocation to different groups of workers.

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Diminishing Marginal Returns

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The idea that as successive units of a variable factor are added to a fixed factor that each extra unit of the variable factor adds less output than the one before it.

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Short run

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The time period in which at least one factor of production is fixed

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Long run

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The time period in which all factor of production are variable.

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Market economy

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An economy based on competition, the private ownership of factors, little government intervention and where the price mechanism determines the allocation of scarce resources through the market forces of supply and demand.

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Control economy

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A type of economic system where the resources are state-owned and their allocation and use is determined by the centralized decisions of a planning authority (North Korea)

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Mixed economy

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An economic system which is a combination of market and command economic systems. Where market forces control the allocation of some resources, but also government's intervene in the allocation to try to correct market failures.

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Transition economy

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This is an economy which is changing from a planned economy to a free market. This economic change (letting market forces set prices, lowering trade barriers, and moving from public to private ownership of resources) often leads to initial high inflation and may lead to increased inequality of incomes and wealth.

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Competitive markets

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Characterised by large number of buyers and sellers, freedom to enter and exit the market and a homogenous product.

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Rational economic behaviour

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A decision making process by individuals and firms by which they act to maximise their welfare. Individuals might maximise utility whilst firms may maximise profit.

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Effective demand

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The quantity of the good that people are willing and able to buy at any given price over a period of time.

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Supply

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The quantity of the good that firms are willing and able to offer for sale at any given price over a period of time.

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DMU

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Diminishing Marginal utility. The idea that the satisfaction received from each extra unit consumed falls.

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Price elasticity of demand (PED)

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A measure of the responsiveness of the quantity demanded of a product to a change in it's price, in percentage terms.

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Income elasticity of demand (YED)

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A measure of the responsiveness of the quantity demanded of a product to a change in income in percentage terms.

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Cross elasticity of demand (XED)

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A measure of the responsiveness of the quantity demanded of a product to a change in the price of another product, in percentage terms.

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Price elasticity of supply (PES)

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A measure of the responsiveness of the quantity supplied of a product to a change in it's prices in percentage terms.

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Normal goods

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These are any goods for which demand increases when income increases. This means YED is positive.

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Inferior goods

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These are goods for which demand decreases when income rises. This mean YED is negative.

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Complementary goods

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Goods that are consumed in conjunction with others they have a negative XED. Car and petrol.

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Substitute goods

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Goods that compete for the same market and can be used in place of each other. They have a positive XED. Rice and pasta

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Price mechanism

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The price mechanism is the method through which the market allocates scarce resources by responding to changes in the conditions of supply and demand. Prices create signals and incentives to determine what is produced, how it's produced and ration who receives the product

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Consumer surplus

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Is the difference between what a person would be willing to pay and what they actually pay to buy a certain quantity of a good. This represents the extra utility that a consumer gains .

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Producer surplus

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The difference between what a producer is paid for a quantity of a good and the lowest price the producer requires in order to supply that quantity demanded.

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Direct tax

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Tax that is collected directly by government from the individuals on whom it is levied. Income tax

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Indirect tax

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A tax on the production or sale of a good or service. Indirect taxes are included in the price paid for the good or service by it's final purchaser

VAT

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Specific tax

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A tax based on the volume of the product sold.

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Ad valorem tax

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Means according to value. This is a method of taxation using the value of the product taxed to determine the amount of tax. VAT 20%

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Incidence of tax

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The way in which the burden of tax eventually falls on the consumer and producer.

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Subsidy

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a grant given by the government that lower the price of a good destined to encourage production or consumption causes a positive **** of demand

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Behavioural economics

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A method of economic analysis that applies psychological insights into human behaviour to explain someone's decision making.

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Commodity

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Any product of fishing farming mining that is produced to be traded or sold.

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Market failure

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When unrestricted markets fail to provide the correct signals and incentives and so resources fail to be allocated effiecently resulting in social welfare not being maximised.

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Externalities

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3rd party effects that are the consequences felt outside of the market by those other than the decision maker.

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Private costs

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Felt only by decision maker social costs - negative externalities

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Social costs

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These are felt by the whole of society private costs + external costs

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Public goods

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Goods/services that are usually not provided by the free market. Non excludeable and non rivalry

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Free riding

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The ability to consume a good without having to pay for it.

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Asymmetric information

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Agents in one side of the market have much better information than those on the other side . Car sellers

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Adverse selection

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Occurs when buyers have better information than sellers can distort the market process

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Regulation

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These are illegal constraints that set standards for the consumption or the production of goods.

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Maximum prices

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A price ceiling set by law. To have an effect it must be set below the market clearing price. For example in the US a number of areas have sent control.

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Minimum prices

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A price floor set by law. To have an effect it must be set above the market clearing price. Minimum prices on alcohol Scotland

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Tradeable permits

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Tradeable permits are legal authorizations for firms to pollute a certain amount of pollution per year.

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Government failure

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When government intervention in a failing market leads to an allocation of resources that are less efficient than before . Results in a fall in social welfare.