definitions for unit 1.pdf
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7/23/2019 definitions for unit 1.pdf http://slidepdf.com/reader/full/definitions-for-unit-1pdf 1/6 Produced by Marwan Mikdadi St Paul's School 6EC01 – key definitions Term Definition Normative statement It is a statement that contains a value judgement and cannot be tested; i.e. what ought to be . Positive statement It is a statement that is testable; i.e. what is, was or will be . PPF A production possibility frontier is a graphical representation of the maximum output an economy can produce given a finite combination of resources. Movement along the frontier implies an opportunity cost in terms of the output of one good foregone to gain the output of another. Opportunity cost The value of the next best alternative foregone. Division of labour The breaking of a production process into separate, sequential tasks leading to workers specialising. Specialisation A system of organisation where individuals specialise in the production of particular goods or services and then trade the surplus to satisfy their wants, as opposed to self-sufficiency. Price mechanism An economic system which allocates resources using prices to transmit information, provide incentives and distribute rewards. Rationing function of the price mechanism The price mechanism allocates scarce resources to those buyers who are prepared to pay a high enough price. Signalling function of the price mechanism. Prices help to determine where and how resources should be allocated e.g. if prices increase, this suggests more resources should be allocated to the market. Incentive function of the price mechanism Prices act as an incentive to both buyers and sellers e.g. a rising price may encourage sellers to supply more of the product and buyers to purchase less. Market equilibrium A position where the market price has no tendency to change, assuming ceteris paribus, because demand equals supply. Ceteris paribus An assumption that all other factors are held constant. Quantity of Good X Quantity of Good Y
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6EC01 – key definitionsTerm Definition
Normative statement It is a statement that contains a value judgement and cannot be tested; i.e. what
ought to be .
Positive statement It is a statement that is testable; i.e. what is,was or will be .
PPF A production possibility frontier is a graphicalrepresentation of the maximum output aneconomy can produce given a finite combinationof resources. Movement along the frontierimplies an opportunity cost in terms of theoutput of one good foregone to gain the output
of another.Opportunity cost The value of the next best alternative foregone.
Division of labour The breaking of a production process intoseparate, sequential tasks leading to workersspecialising.
Specialisation A system of organisation where individualsspecialise in the production of particular goodsor services and then trade the surplus to satisfytheir wants, as opposed to self-sufficiency.
Price mechanism An economic system which allocates resourcesusing prices to transmit information, provideincentives and distribute rewards.
Rationing function of the
price mechanism
The price mechanism allocates scarce resourcesto those buyers who are prepared to pay a highenough price.
Signalling function of the
price mechanism.
Prices help to determine where and howresources should be allocated e.g. if pricesincrease, this suggests more resources should be
allocated to the market.Incentive function of the
price mechanism
Prices act as an incentive to both buyers andsellers e.g. a rising price may encourage sellersto supply more of the product and buyers topurchase less.
Market equilibrium A position where the market price has notendency to change, assuming ceteris paribus,because demand equals supply.
Ceteris paribus An assumption that all other factors are heldconstant.
Quantity of Good X
Quantity of
Good Y
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Free-market economy An economy which tackles the basic economicproblem, the co-existence of infinite wants andfinite resources, predominately through the pricemechanism.
Command economy An economy which allocates its resourcespredominately through the direction of a centralplanning authority.
Mixed economy An economy where both the price mechanismand the planning authority have a significant rolein allocating resources.
Consumer surplus The difference between the amount a consumeris willing to pay for a product and the amountthey actually pay. (Represented by the areabelow the demand curve and above the price
line)
Producer surplus The difference between the price a firm is willingto sell a good or service for and the actual pricethey sell the good or service for. (Representedby the area above the supply curve and belowthe price line)
Indirect tax A tax on expenditure collected by the produceron behalf of the government.
Note: the tax shifts the supply curve up verticallyby the tax per unit. Multiply this by the numberof units, Q1, gives the total tax revenue (areashaded).
Subsidies A payment made by the government to
producers which they will receive in addition tothe market price.
Note: the subsidy shifts the supply curve downvertically by the subsidy per unit. Multiply this bythe number of units, QN, gives total expenditure(area shaded).
Quantity
Price
Demand
P1
Price
Quantity
Supply
P1
Quantity
PriceSTAX
S
D
P1
Q1
Quantity
Price S
SSUBSIDY
D
POLD
P NEW
QO Q N
Tax per
unit
Subsidy
per unit
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Incidence of tax The distribution of the burden of an indirect taxbetween buyers and sellers.
The stripped area (above the original price) ispaid for by the consumers.
The dark area (below the original price) is paidfor by the producers.
Price elasticity of
demand
Measures the responsiveness of quantitydemand to a change in price. %∆ QD
%∆ P
Income elasticity of
demand
Measures the responsiveness of quantitydemand to a change in income. %∆ QD
%∆ Y
Cross-price elasticity of
demand
Measures the responsiveness of quantitydemand of good A to a change in the price ofgood B. %∆ QD of Good A
%∆ P of Good B
Substitutes A pair of goods which are considered to bealternatives to each other by consumers; i.e. apositive cross-price elasticity of demand.
Complements A pair of goods that are consumed together; i.e.a negative cross-price elasticity of demand.
Normal good A good whose demand increases when incomeincreases; i.e. a positive income elasticity ofdemand.
Inferior good A good whose demand falls when incomeincreases i.e. a negative income elasticity ofdemand. This relationship may arise asconsumers buy more desirable alternatives astheir income rises.
Derived demand The demand for a factor of production that
results from the demand for the product that itis used to make.
Price elasticity of supply Measures the responsiveness of supply to achange in price. %∆ QS
%∆ P
Short run The period of time over which the quantity ofsome factor of production is fixed.
Long run The period of time over which the quantity of allfactors of production can be changed.
Allocative efficiency Occurs when resources cannot be reallocated to
Quantity
Price
S
STAX
D
P NEW
POLD
Q NEW QOLD
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produce a different combination of goods thatwill increase economic welfare; i.e. economicwelfare is maximised and the sum of consumerand producer surplus is maximised (P=MC).
Market failure Occurs when a free market produces amisallocation of scarce resources.
Government failure Occurs when government intervention leads toan even greater misallocation of resources and amovement away from the socially optimal pointof production than if there was no intervention.
Public-choice theory The failure of government to act in the interestsof the population because public servants pursue
their own private interests ahead of the widerpublic interest; i.e. salary, public reputation,power, etc .
Asymmetric information Where one party in an economic relationship hasmore information than another; e.g. doctors andpatients.
Moral hazard When people take actions that increase socialcosts because they are insured against privateloss: sometimes it is called hidden action due tothe agent’s actions being hidden from theprincipal.
Buffer stock scheme A scheme that buys surplus produce in periodsof abundance and sells stock in periods ofshortage, in order to stabilise the market price.
Price ceiling A maximum price set by a regulator above whichsuppliers cannot sell; i.e. rent controls for low-cost housing.
S
D
Price
Quantity
P*
Q*
S
D
Price
QQPOOR QGOOD
Sell stock Buy stock
Q*
PTARGET
Quantity
S
D
PMAX
Price
Q1 Q2
Excess demand
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Price floor A minimum price set by a regulator below whichbuyers cannot purchase; i.e. the nationalminimum wage.
Public goods Goods and services that, once produced, can beconsumed by everyone in society: they exhibitnon-rivalry and non-excludability.
Free riders People who use public goods but don’t pay forthem.
Externalities The costs or benefit received by a third party toan economic transaction outside of the marketmechanism; i.e. the spillover effects of aneconomic activity.
External costs The costs received by a third party to aneconomic transaction outside of the marketmechanism
External benefits The benefit received by a third party to aneconomic transaction outside of the marketmechanism
Pigouvian tax A tax placed on a good with negativeexternalities so that the external cost isinternalised: the polluter pays principle .
The tax is set equal to the marginal negativeexternality.
Tradeable permits A market-oriented solution to regulating thequantity of pollution, where the rights to pollutea given amount are traded so that a pre-
determined level of pollution abatement isachieved for the least cost.
Property rights A legal right to the ownership of a resource. Ifthis remains undefined, the resource may beoverexploited; i.e. fishing.
Command-and-control
(CAC)
The use of law and regulation backed up byinspection and penalties for non-compliance.
Competition policy Government policy directed at encouragingcompetition in the private sector: e.g. the
investigation of takeovers or restrictive practices .
PriceS
D
PMIN
QuantityQ1 Q2
Excess supply
Costs and
benefits
MSC
MPC
MSB=MPB
Quantity
External costs
Q* Q1
Deadweight
loss
MSCCosts and
benefits
MPC
MSB=MPB
QuantityQTAX Q1
PTAX
P1
Tax
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Trade Union An organisation of workers with the primarypurpose of collectively bargaining for improvedpay and conditions for its members.
Geographical immobility The inability of workers to move location to
attain work due to the cost of commuting orrelocating and non-pecuniary factors.
Occupational immobility The inability of workers to move occupation orfind work due to a shortage of the requiredskills.
Cost benefit analysis
(CBA)
An investment appraisal tool used to weigh upthe social benefits of a project against the socialcosts.
