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Definitions Economics Unit 3 A Level
Definitions Economics Unit 3 A Level
Allocative
efficiency
Average cost
Average revenue
Backward vertical
integration
Barriers to entry
Cartel
Competition
Commission
When several firms bid for a contract, providing the buyer with
lower cost and higher quality choices.
Concentration
ratio
Conglomerate
merger
Contestable
markets
Corporate
objectives
De-merger
Diminishing
marginal returns
Diseconomies of
scale
Economic
efficiency
Explicit collusion
External
economies of scale
Cost savings that arise from sources outside the firm due to the
growth of the industry as a whole.
First-mover
advantage
Fixed costs
Costs that do not vary with output and exist only in the short run.
Forward vertical
integration
Game theory
Homogeneous
products
Horizontal
integration
Imperfect
competition
Where firms have some price setting market power and thus face a
downward sloping demand curve; e.g. duopoly, oligopoly and
monopolistic competition.
Incumbent firms
Indivisibility
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.
Interdependence
Internal
economies of scale
Limit pricing
Where a firm sets its price below the average cost of potential
entrants in order to discourage entry.
Long run
Marginal cost
Marginal revenue
Market share
Merger
Monopolistic
competition
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.
Monopoly
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.
Monopoly power
Monopsony
Multinational
New entrants
Non-price
competition
Normal profit
OFT
Oligopoly
Patent
Perfect
competition
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.
Predatory pricing
Price
discrimination
Price elasticity of
demand
Price leader
Price taker
A firm that can alter its output without having any effect on the
price of the product it sells.
Prisoners
dilemma
Privatisation
Product
differentiation
Productive
efficiency
Profit
maximisation
Public-private
partnerships
(PPPs)
Revenue
maximisation
Sales
maximisation
Satisficing
Short run
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.
Shutdown point
Shutdown price
The price that is equal to average variable cost, below which a firm
would choose zero output to minimise the loss made.
Sunk costs
Supernormal
profit
Tacit collusion
Takeover bid
The offer made by the potential buyer for the shares of another
firm in order to achieve control of the business.
Variable costs
X-inefficiency
Variable cost
A cost which varies with output in both the short and long-run (e.g. raw materials, direct labour,
etc).
Sunk cost
A cost which is irrecoverable upon exiting the industry (e.g. advertising, R&D, etc).
Total cost
TC = TFC + TVC
Average cost
Cost per unit of output.
AC =
TC
Q
Marginal cost
The addition to TC from producing one more unit of output.
MC =
TC
Q
Total Revenue
The total income gained from selling the firms output.
TR = P Q
Average revenue
Revenue per unit of output.
AR =
TR
Q
Marginal revenue
The addition to TR from selling one more unit of output.
MR =
TR
Q
Economies of scale
A fall in long-run average costs as output increases.
Diseconomies of scale
A rise in long-run average costs as output increases.
Allocative efficiency
Where society gets the optimum mix of goods and services in the highest possible quantities, at
which point P = MC.
Productive efficiency
Any level of output at which LRAC is minimised; occurs where LRAC = LRMC.
Normal profit
The minimum (accounting) profit which the entrepreneur needs to remain in long-term production
(i.e. the opportunity cost of capital and enterprise). Occurs at the level of output where AR = AC.
Supernormal profit
Any profits in excess of normal profits. Occurs at any level of output where AR > AC
Market Structures
Monopoly
A market dominated by a single seller (alternatively, the legal definition: where a single firm has
>25% market share).
Assumptions: single seller, many buyers; profit-maximisation; no substitutes for the good; existence of entry
barriers; hence the firm is a price maker earning supernormal profits in both the short and long-run.
Natural monopoly
Where the economies of scale are so great that there is only room for one firm in the market.
Assumptions: very high FC, usually sunk costs, and AC falling continuously with output. Negligible MC, which
also falls continuously with output.
Perfect competition
A market with many buyers, many sellers and a homogenous good, such that each firm is a price
taker.
Assumptions: many buyers and many sellers; profit-maximisation; homogenous good; perfect information; no
entry barriers; hence the firm is a price taker earning normal profits in the long-run.
Oligopoly
A market dominated by a few firms (hence a high concentration ratio).
Monopolistic competition
A market with a large number of firms selling slightly differentiated products.
Assumptions: many sellers and many buyers; product differentiation; no entry barriers.
Concentration ratio
A measure of the combined market share held by the largest n firms in an industry.
Contestability
A market with no entry / exit barriers due to an absence of sunk costs. This leads to hit and run
competition whenever there are supernormal profits to be made.
Revenue maximisation
The level of output where the TR curve is flat. Occurs where MR = 0.
Sales maximisation
The highest level of output that can be attained without incurring a loss. Occurs where TR = TC, or
AR = AC.
Cost-plus pricing
Where price is set at average cost plus a certain percentage mark-up.
Predatory pricing
Where P < AVC, in order to eliminate existing competition in the market.
Limit pricing
Where price is set below the AC of potential rivals, in order to prevent new firms entering the
market.
Non-price competition
Where the firm aims to attract new customers through branding, quality and innovation.
Cartel
A formal agreement between two or more firms to fix prices and / or output, thereby avoiding a
price war.
Collusion
A secret and informal agreement between two or more firms to fix prices and / or output, thereby
avoiding a price war.
Tacit collusion
Where firms refrain from price competition, but without any communication or formal agreement.
External growth
Where the firm grows through mergers and acquisitions.
Horizontal integration
The merging of two firms in the same industry and at the same stage of production.
Vertical integration
The merging of two firms operating at different stages of production.
Backward / upstream vertical integration (taking over a firm in a preceding stage of production)
Forward / downstream vertical integration (taking over a firm in the next stage of production)
Conglomerate integration
The merging of two firms from completely unrelated markets.
Government Intervention
OFT / Competition Commission / Competition policy
Aim: to promote competition, thereby protecting consumer interests in the form of lower prices
and greater quality, variety and choice.
RPI X
A method of price-capping where the firm is only permitted to raise price by the level of inflation
(RPI) minus the expected efficiency gain (the X value).
RPI + K
A method of price-capping where the firm is permitted to raise price by the level of inflation (RPI)
plus an allowance made for capital investment purposes (the K value).
Regulatory capture
Where the regulator begins to sympathise with the regulated firm, leading to lenient price caps and
performance targets.
Deregulation
Where the government removes or simplifies restrictions on entering an industry, with the aim of
stimulating new competition.