Unit 3 Economics

Front 1

Allocative efficiency

Back 1

Occurs when resources cannot be reallocated to produce a different combination of goods that will increase economic welfare; i.e. economic welfare is maximised and the sum of consumer and producer surplus is maximised (P=MC).

Front 2

Average cost

Back 2

The cost per unit – total costs divided by quantity of output.

Front 3

Average revenue

Back 3

The average selling price – total revenue divided by the number of units of output sold.

Front 4

Backward vertical integration

Back 4

Where a firm merges or takes over a business that is one stage further away from the consumer in the production process.

Front 5

Barriers to entry

Back 5

Anything that prevents new firms entering a market such as brand loyalty, economies of scale, technical know-how and patents.

Front 6

Cartel

Back 6

A group of firms that agree to act together as though they were a monopoly in order to raise profits.

Front 7

Competition Commission

Back 7

The government body responsible for investigating markets that may have experienced a diminution of competition and cases referred to them by OFT. Also charged with the investigation of mergers that may result in reduced competition in a market.

Front 8

Competition policy

Back 8

Policies designed to restrict the acquisition and exercise of monopoly power by firms, and to prohibit anti-competitive practices.

Front 9

Competitive tendering

Back 9

When several firms bid for a contract, providing the buyer (often the government) with lower cost and higher quality choices.

Front 10

Concentration ratio

Back 10

The combined market share of the largest x firms in the industry (3, 5 and 7 firm ratios commonly used).

Front 11

Conglomerate merger

Back 11

When firms producing unrelated products merge.

Front 12

Contestable markets

Back 12

A perfectly contestable market is one where the sunk costs of entry are zero and there is perfect information.

Front 13

Corporate objectives

Back 13

The range of targets a firm may have: it is often assumed in economics that a firm aims to maximise profits.

Front 14

De-merger

Back 14

Where a firm is divided up into separate businesses.

Front 15

Diminishing marginal returns

Back 15

An economic law stating that if increasing quantities of a variable factor are applied to a given quantity of a fixed factor, the marginal product of the variable factor will eventually decrease.

Front 16

Diseconomies of scale

Back 16

A situation where increasing the scale of production further leads to an increase in the long run average costs of production.

Front 17

Economic efficiency

Back 17

Occurs when output is produced at the lowest cost in terms of resources used (productive) and in the quantity that reflects the best possible use of those resources given the relative value consumers place on the output (allocative).

Front 18

European Commission

Back 18

Oversees EU competition rules in order to make EU markets work better. It acts against anti-competitive agreements and the abuse of dominance, controls mergers, monitors liberalised markets and the impact of state aid.

Front 19

Explicit collusion

Back 19

When firms agree to co-operate rather than compete in order to raise profits.

Front 20

External economies of scale

Back 20

Cost savings that arise from sources outside the firm due to the growth of the industry as a whole.

Front 21

First-mover advantage

Back 21

The advantages that accrue to a firm by being the first to enter a market such as market power or supernormal profit.

Front 22

Fixed costs

Back 22

Costs that do not vary with output and exist only in the short run.

Front 23

Forward vertical integration

Back 23

Where a firm merges or takes over a business that is one stage closer to the consumer in the production process.

Front 24

Game theory

Back 24

Game theory is used to predict a firm’s decision when faced with a set of choices whose payoffs are influenced by the choices of other firms in the market.

Front 25

Homogeneous products

Back 25

A product is homogeneous when consumers perceive each unit to be identical.

Front 26

Horizontal integration

Back 26

The joining of two firms together which produce similar products at the same stage of production in the same industry.

Front 27

Imperfect competition

Back 27

Where firms have some price setting market power and thus face a downward sloping demand curve; e.g. duopoly, oligopoly and monopolistic competition.

Front 28

Incumbent firms

Back 28

Firms that are established in a market and therefore do not face sunk costs.

Front 29

Indivisibility

Back 29

Where a firm would not use a resource to its full capacity and therefore will not achieve the lowest unit costs of production – expanding the scale of production allows firms to utilise more efficient, larger machines and therefore reduce average costs.

Front 30

Interdependence

Back 30

Where the outcome from a decision is dependent upon the decisions of other rival firms.

Front 31

Internal economies of scale

Back 31

A situation where increasing the scale of production leads to a decrease in the long run average costs of production.

Front 32

Limit pricing

Back 32

Where a firm sets its price below the average cost of potential entrants in order to discourage entry.

Front 33

Long run

Back 33

The period of time required for all input costs to be variable.

Front 34

Marginal cost

Back 34

The additional cost of producing one more unit of output.

Front 35

Marginal revenue

Back 35

The additional revenue from selling one more unit of output.

Front 36

Market share

Back 36

A firm’s percentage share of the total market, normally measured using sales.

Front 37

Merger

Back 37

When two formerly independent firms unite.

Front 38

Monopolistic competition

Back 38

A market structure in which there are many buyers and sellers, free entry and exit but heterogeneous products giving each individual firm some price setting power.

Front 39

Monopoly

Back 39

A pure monopoly is one where the market has only one supplier. In the UK, the legal definition of a monopoly is when a firm has 25% or more market share.

Front 40

Monopoly power

Back 40

Monopoly power exists when a single seller in a market has the ability to set prices.

Front 41

Monopsony

Back 41

A market with only one purchaser of a product or factor of production.

Front 42

Multinational

Back 42

A firm that has operations in more than one country (MNC).

Front 43

New entrants

Back 43

New firms in a market normally attracted by the existence of supernormal profits.

Front 44

Non-price competition

Back 44

Competitive activity that doesn’t involve reducing prices such as brand promotion, product differentiation, innovation and customer service.

Front 45

Normal profit

Back 45

The level of profit that represents the opportunity cost of the resources used to achieve it. If normal profits are not attained, resources will leave the market to be used more productively in an alternative market.

Front 46

OFT

Back 46

The Office of Fair Trading oversees competition policy in the UK, often referring suspected reductions in competition to the Competition Commission for investigation. It can bring criminal charges on business leaders and fine firms who are found to breach competition law e.g. formation of a cartel.

Front 47

Oligopoly

Back 47

An oligopoly is a market where there are a few interdependent firms dominating the market.

Front 48

Patent

Back 48

The legal right to be the sole user of a particular process or producer of a unique product.

Front 49

Perfect competition

Back 49

A market structure in which there are many buyers and sellers, free entry and exit, perfect information and homogeneous products thus making all firms price takers.

Front 50

Predatory pricing

Back 50

Predatory pricing (P<AVC) occurs when a firm incurs short-term losses with the intention of removing a rival and/or deterring other potential competitors. It is considered anti-competitive by the OFT.

Front 51

Price discrimination

Back 51

The sale of the same good or service to different consumer groups at different prices. Three conditions are necessary: effective separation of markets to prevent resale, different PEDs for the separated markets and a degree of monopoly power.

Front 52

Price elasticity of demand

Back 52

The responsiveness of quantity demanded to a change in price.

Front 53

Price leader

Back 53

A firm with sufficient market power to decide on a price change which its competitors will tend to follow.

Front 54

Price taker

Back 54

A firm that can alter its output without having any effect on the price of the product it sells.

Front 55

Prisoner’s dilemma

Back 55

A model used to help show how two interdependent firms may rationally produce where both firms are worse off if collusion does not take place.

Front 56

Privatisation

Back 56

The transferring of economic activity out of the public sector and into the private sector in order to improve the productive efficiency of provision, improve innovation and increase investment.

Front 57

Product differentiation

Back 57

The existence of close substitutes within a market as firms try and establish a degree of price setting power.

Front 58

Productive efficiency

Back 58

Where a firm produces at the lowest point on its average cost curve and thus minimises the use of resources per unit produced.

Front 59

Profit maximisation

Back 59

Profit maximisation is achieved at the level of output where MR=MC. It is often assumed that this is the primary objective of firms.

Front 60

Public-private partnerships (PPPs)

Back 60

The use of private firms by the government to improve the provision of public services through higher and more efficient investment. Private Finance Initiatives (PFIs) uses private capital and private sector companies to finance and operate infrastructure that was previously publicly funded and managed.

Front 61

Revenue maximisation

Back 61

An alternative objective in order to increase market share – it is the level of output where MR=0.

Front 62

Sales maximisation

Back 62

An alternative objective in order to achieve the highest level of sales whilst only making normal profit – it is the level of output where P(AR)=AC.

Front 63

Satisficing

Back 63

A business that pursues other objectives once a satisfactory level of profit has been attained.

Front 64

Second mover advantage

Back 64

The advantages that a follower firm has of being able to use pioneers’ experiences to learn about consumer tastes, new designs and manufacturing techniques, and the potential size of a market. They can also learn from their mistakes.

Front 65

Short run

Back 65

The period of time over which the inputs of some factors cannot be varied and thus the quantity of firms in a market is constant.

Front 66

Shutdown point

Back 66

The level of output where total revenue is equal to total variable costs – below this point a firm would choose zero output to minimise the loss made.

Front 67

Shutdown price

Back 67

The price that is equal to average variable cost, below which a firm would choose zero output to minimise the loss made.

Front 68

Sunk costs

Back 68

A sunk cost of entry is a cost that a firm must incur to enter a market and that cannot be recovered if the firm subsequently exits.

Front 69

Supernormal profit

Back 69

A level of profit that is higher than the required level of profit to keep the firm in the market. The existence of such excess profits will attract the entry of firms in the long run.

Front 70

Tacit collusion

Back 70

When firms behave in each other’s mutual interest and restrict their competitive actions without any agreement in place.

Front 71

Takeover bid

Back 71

The offer made by the potential buyer for the shares of another firm in order to achieve control of the business.

Front 72

Variable costs

Back 72

Costs that vary directly with output.

Front 73

X-inefficiency

Back 73

The failure of a firm to minimise costs at a given level of output and thus produce above its own average cost curve.