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Unit 3 Micro: Business Economics Key Term Glossary

Sunday, June 02, 2013
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Mainly designed for A2 micro students taking exams in business economics


Concept

Glossary Entry

Abnormal profit

Profit in excess of normal profit - also known as supernormal profit or monopoly profit. Abnormal profits may be maintained in a monopolistic market in the long run because of barriers to entry

Agency problem

Possible conflicts of interest that may result between the shareholders (principal) and the management (agent) of a firm

Anti-competitive behaviour

Strategies designed to limit the degree of competition inside a market

Asymmetric information

Where different parties have unequal access to information in a market

Average cost

Total cost per unit of output = Total cost / output = TC/Q

Average cost pricing

Setting prices close to average cost. It is a way to maximise sales, whilst maintaining normal profits. It is sometimes known as sales maximization

Average fixed cost

Total fixed cost per unit of output = TFC/Q

Average revenue

Total revenue per unit of output

Average variable cost

Total variable cost per unit of output = TVC/Q

Backward vertical integration

Acquiring a business operating earlier in the supply chain – e.g. a retailer buys a wholesaler, a brewer buys a hop farm

Barriers to entry

Ways to prevent the profitable entry of new competitors – they may relate to differences in costs between existing and new firms. Or the result of strategic behaviour by firms including expensive marketing and advertising spending

Batch production

When a factory makes a quantity of one form of a product or part, followed by a quantity of another different form

Behavioural economics

Branch of economic research that adds elements of psychology to traditional models in an attempt to better understand decision-making by investors, consumers and other economic participants

Bi-lateral monopoly

Where a monopsony buyer faces a monopsony seller in a market

Brand extension

Adding a new product to an existing branded group of products

Brand loyalty

The degree to which people regularly buy a particular brand and refuse to or are reluctant to change to other brands

Break-even output

The break-even price is when price = average total cost (P=AC)

Business ethics

Business ethics is concerned with the social responsibility of management towards the firm’s major stakeholders, the environment and society in general

Capacity

The amount that can be produced by a plant, company, or economy (industrial capacity) over a given period of time.

Capital intensive

When an industry or production process requires a relatively large amount of capital (fixed assets) or proportionately more capital than labour

Cartel

An association of businesses or countries that collude to influence production levels and thus the market price of a particular product

Collusion

Collusion takes place when rival companies cooperate for their mutual benefit. When two or more parties act together to influence production and/or price levels, thus preventing fair competition. Common in an oligopoly / duopoly

Competition Commission

Body that conducts in-depth inquiries into mergers, markets and the regulation of the major regulated industries such as water, electricity and gas

Competition Policy

Government policy which seeks to promote competition and efficiency in different markets and industries

Competitive advantage

When a company has an advantage over another in the provision of a particular product or service

Complex monopoly

A complex monopoly exists if at least one quarter (25%) of the market is in the hands of one or a group of suppliers who, deliberately or not, act in a way designed to reduce competitive pressures within a market

Concentration ratio

Measures the proportion of an industry's output or employment accounted for by the largest firms. When the concentration ratio is high, an industry has moved towards a monopoly, duopoly or oligopoly. Share can be by sales, employment or any other relevant indicator.

Conglomerate merger

Joining together of two companies that are different in the type of work they do - the acquisition has no clear connection to the business buying it

Consolidation

Consolidation refers to the reduction in the number of competitors in a market and an increase in the total market share held by the remaining firms.

Constant returns

When long run average cost remains constant as output increases because output is rising in proportion to the inputs used in the production process

Consumer surplus

The difference between the total amount that consumers are willing and able to pay for a good or service (indicated by the demand curve) and the total amount that they actually pay (the market price).

Consumption tax

A tax imposed on the consumer of a good or service. This can be levied at the final sale level (sales tax), or at each stage in the production

Contestable market

Where an entrant has access to all production techniques available to the incumbents is not prohibited from wooing the incumbent’s customers, and entry decisions can be reversed without cost. The crucial assumption for a contestable market is that businesses are free to enter and leave the market

Cooperative outcome

An equilibrium in a game where the players agree to cooperate

Corporate governance

Practices, principles and values that guide a firm and its activities

Corporate strategy

A company's aims in general, and the way it hopes to achieve them - strategic objective which supports the achievement of corporative aims

Cost synergies

Cost synergies are the cost savings that a buyer aims to achieve as a result of taking over or merging with another business

Cost-plus pricing

Where a firm fixes the price for its product by adding a fixed percentage profit margin to the average cost of production. The size of the profit margin may depend on factors including competition and the strength of demand

Cost-reducing innovations

Cost reducing innovations have the effect of causing an outward shift in market supply. They provide the scope for businesses to enjoy higher profit margins with a given level of demand

Countervailing power

When the market power of a monopolistic/oligopolistic seller is offset by powerful buyers who can prevent the price from being pushed up

Creative destruction

First introduced by the Austrian School economist Joseph Schumpeter. It refers to the dynamic effects of innovation in markets - for example where new products or business models lead to a reallocation of resources. Some jobs are lost but others are created. Established businesses come under threat

Credit Union

Financial co-operatives owned and controlled by their members offering banking products

Cross-subsidy

A cross subsidy uses profits from one line of business to finance losses in another line of business e.g. Royal Mail and 2nd class letters

Deadweight loss

Loss in producer & consumer surplus due to an inefficient level of production

De-layering

De-layering involves removing one or more levels of hierarchy from the organizational structure. For example, many high-street banks no longer have a manager in each of their branches

De-merger

The hiving off of one or more business units from a group so that they can operate as independently managed concerns

Deregulation

The opening up of markets to competition by reducing statutory barriers to entry. The aim is to increase market supply, stimulate competition and innovation and drive prices down for final consumers

Diseconomies of scale (internal)

A business may expand beyond the optimal size in the long run and experience diseconomies of scale. This leads to rising LRAC. For example, a firm increases all inputs by 300 %, its output increases by 200%.

Dis-synergies

Dis-synergies are negative or adverse effects of a takeover or merger.  These are the disruptions that arise from the deal which result additional costs or lower than expected revenues

Diversification

Increasing the range of products or markets served by a business. The extent of diversification depends on the extent to which those products or markets are different from the existing products and markets served by the business.

Divorce between ownership and control

The owners of a company normally elect a board of directors to control the business’s resources for them. However, when the owner of a company sells shares, or takes out a loan to raise finance, they sacrifice some of their control

Dominant market position

A firm holds a dominant position if it can operate within the market without taking full account of the reaction of its competitors or final consumers

Dominant strategy

A dominant strategy in game theory is one where a single strategy is best for a player regardless of what strategy the other players in the game decide to use

Due Diligence

Due diligence is the process undertaken by a prospective buyer of a business to confirm the details (e.g. financial performance, assets & liabilities, legal ownership & issues, operations, market position) of what they expect to buy

Duopoly

Any market that is dominated by two suppliers. Proctor & Gamble and Unilever took 84 per cent of the UK market liquidi detergent sales in 2005

Duopsony

Two major buyers of a good or service in a market each of whom is likely to have some buying power with suppliers in their market.

Dynamic efficiency

Dynamic efficiency focuses on changes in the choice available in a market together with the quality/performance of products that we buy. Economists often link dynamic efficiency with the pace of innovation in a market

Economic risk

The risk that a company may be disadvantaged by exchange rate movements or regulatory changes in the country in which it is operating

Economies of scale

Falling long run average cost as output increases in the long run

Economies of scope

Where it is cheaper to produce a range of products

Enlightened self interest

Acting in a way that is costly or inconvenient at present, but which is believed to be in one’s best interest in the long term. E.g. firms accepting some short term costs (lower profits) in return for long-term gains

Equilibrium output

A monopolist is assumed to profit maximise, in other words, aims to achieve an output equal to the point where MC=MR

Excess capacity

The difference between the current output of a business and the total amount it could produce in the current time period.

Experience curve

Pattern of falling costs as production of a product or service increases, because the company learns more about it, workers become more skilful

External diseconomies of scale

When the growth of an industry leads to higher costs for businesses that are part of that industry – for example, increased traffic congestion

External economies of scale

When the expansion of an industry leads to the development of ancillary services which benefit suppliers in the industry – causing a downward sloping industry supply curve. A business might benefit from external economies by locating in an area in which the industry is already established

First mover advantage

The idea that a business that creates a new product and which is first into the market can develop a competitive advantage perhaps through learning by doing - making it more difficult and costly for new firms to come in

Fixed cost

Business expenses that do not vary directly with the level of output

Forward vertical integration

Acquiring a business further up in the supply chain – e.g. a vehicle manufacturer buys a car parts distributor

Franchised monopoly

When the government grants a company the exclusive right to sell or manufacture a product or service in a particular area

Freemium

Business model in which some basic services are provided for free, with the aim of enticing users to pay for additional, premium features or content

Game Theory

A “game” happens when there are two or more interacting decision-takers (players) and each decision or combination of decisions involves a particular outcome (known as a pay-off.)

Herfindahl Index

A measure of market concentration. The index is calculated by squaring the % market share of each firm in the market and summing these numbers.

Hit-and-run competition

When a business enters an industry to take advantage of temporarily high (supernormal) market profits. Common in highly contestable markets.

Horizontal collusion

Where there is agreement between firms at the same stage of the production process to charge prices above the competitive level.

Horizontal integration

When companies from the same industry amalgamate to form a larger company - firms are at the same stage of the production process

Hostile takeover

A takeover that is not supported by the management of the company being acquired - as opposed to a friendly takeover

Innovation

Making changes to something established. Invention, by contrast, is the act of coming upon or finding. Innovation is the creation of new intellectual assets

Innovation-diffusion

The extent and pace at which a market adopts new products, or improved versions of existing products

Interdependence

When the actions of one firm has an effect on its competitors in the market. Interdependence is a feature of an oligopoly. In simple terms - when two or more things depend on each other (i.e. business and society)

Internal growth

Internal growth occurs when a business gets larger by increasing the scale of its own operations rather than relying on integration with other businesses

Inventories

Inventory is a list for goods and materials, or those goods and materials themselves, held available in stock by a business

Joint-venture

Agreement between two or more companies to cooperate on a particular project or a business that serves their mutual interests.

Kinked demand curve

The kinked demand curve model assumes that a business might face a dual demand curve for its product based on the likely reactions of other firms in the market to a change in its price or another variable

Laissez-faire

“Leave alone” – a doctrine that a Government should not interfere with actions of business and markets

Last mover advantage

The advantage a company gains by being one of the last to sell a product or provide a service, when technology has improved and costs are very low

Light-touch regulation

An approach of government to managing business behaviour - prefers to “influence” rather than “legislate/regulate” Carrot or stick?

Limit pricing

When a firm sets price low enough to discourage new entrants into the market

Marginal cost

The change in total costs from increasing output by one extra unit – the formula for MC is  ‘change in total cost divided by change in quantity

Marginal profit

The increase in profit when one more unit is sold or the difference between MR and MC. If MR = £20 and MC = £14 then marginal profit = £6

Marginal revenue

The change in total revenue from selling one extra unit of output

Merger

A merger is a combination of two previously separate organisations.

Merger integration

The process of bringing two firms together once they have come under common ownership. Often regarded as the most difficult part of any takeover or merger. The integration process needs to cover “hard” areas such as IT systems and marketing strategy as well as “soft” issues such as different business cultures

Metcalfe’s Law

Coined by Robert Metcalfe, Metcalfe's law says that the usefulness of a network equals the square of the number of users. This is linked to the concept of network economies of scale

Minimum efficient scale

Scale of production where internal economies of scale have been fully exploited. Corresponds to the lowest point on the long run average cost curve

Monopolistic competition

Competition between companies whose products are similar but sufficiently differentiated to allow each to benefit from monopoly pricing. A market structure characterized by many buyers and sellers of slightly different products and easy entry to, and exit from, the industry. Firms have differentiated products and therefore the demand is not perfectly elastic

Monopoly profit

A firm is said to reap monopoly profits when a lack of viable market competition allows it to set its prices above the equilibrium price for a good or service without losing profits to competitors

Monopsony

When a single buyer controls the market for a particular good or service, in essence setting price and quality levels, normally because without that buyer there would not sufficient demand for the product to survive

Moral Hazard

When someone pays for your accidents and problems, you may be inclined to take less effort to avoid accidents and problems

Multinational

A company with subsidiaries or manufacturing bases in several countries

Mutual interdependence

The relationship between oligopolists, in which the actions of each business affect the other businesses

Nash Equilibrium

An idea in game theory - any situation where all of the participants in a game are pursuing their best possible strategy given the strategies of all of the other participants. In a Nash Equilibrium, the outcome of a game that occurs is when player A takes the best possible action given the action of player B, and player B takes the best possible action given the action of player A

Nationalization

When a government takes over a private sector company

Natural monopoly

For a natural monopoly the long-run average cost curve falls continuously over a large range of output. The result may be that there is only room in a market for one firm to fully exploit the economies of scale that are available

NGO

Non-governmental organization (e.g. WWF, Greenpeace)

Non-price competition

Non-price competition assumes increased importance in oligopolistic markets. Competing not on the basis of price but by other means, such as the quality of the product, packaging, customer service, etc.

Normal profit

Normal profit is the transfer earnings of the entrepreneur i.e. the minimum reward necessary to keep her in her present industry. The activities of the entrepreneur are independent of the level of output. Normal profit is therefore a fixed cost, included in the average, not the marginal, cost curve

Oligopoly

An oligopoly is a market dominated by a few producers, each of which has control over the market. However, oligopoly is best defined by the conduct (or behaviour) of firms within a market rather than its market structure

Optimal plant size

Optimal plant is the size where costs are minimized, i.e. when all economies of scale have been obtained, but diseconomies have not set in. Sometimes the size of a firm or plant is also limited by the size of the market

Pareto efficiency

Where it is not possible for individuals, households, or firms to bargain or trade in such a way that everyone is at least as well off as they were before and at least one person is better off. Also known as an efficient outcome

Patent

Right under law to produce and market a good for a specified period of time

Paywall

Blocking access to a website which is only available to paying subscribers

Peak pricing

When a business raises its prices at a time when demand has reached a peak might be justified due to the higher marginal costs of supply at peak times

Penetration pricing

A pricing policy used to enter a new market, usually by setting a very low price

Perfect competition

Theoretical condition of a market where prices reflect complete mobility of resources and freedom of entry and exit, full access to information by all participants, relatively homogeneous products, and the fact that no one buyer or seller, or group of buyers or sellers, has any advantage over another.

Perfect price discrimination

When a firm separates the whole market into each individual consumer and charges them the price they are willing and able to pay

Predatory pricing

Setting an artificially low price for a product in order to drive away competition - deemed to be illegal by the UK and European competition authorities. When predatory pricing is happening it is likely than Price <Average Cost in the short run, but in the long run there will be a rise in prices as competition is reduced.

Price capping

A government-imposed limit on the price charged for a product - otherwise known as price capping. Often introduced as a way of controlling the monopoly pricing power of businesses with a large amount of market power

Price ceiling

Law that sets or limits the price to be charged for a particular good

Price discrimination

When a firm charges a different price to different groups of consumers for an identical good or service, for reasons not associated with costs

Price fixing

Price fixing represents an attempt by suppliers to control supply and fix price at a level close to the level we would expect from a monopoly

Price leadership

When one firm has a clear dominant position in the market and the firms with lower market shares follow the pricing changes prompted by the dominant firm

Price regulation

Government control of prices, normally for utilities and other essential services

Prisoners’ dilemma

A problem in game theory that demonstrates why two people might not cooperate even if it is in both their best interests to do so. In the classic game, cooperating is strictly dominated by defecting, so that the only possible equilibrium for the game is for all players to defect. No matter what the other player does, one player will always gain a greater payoff by playing defect.

Private equity

Injection of funds by specialized investors into private companies with the aim of achieving high rates of return

Private Finance Initiative

The PFI is a means of obtaining private funds for public sector projects

Privatization

The sale of state-owned companies to the private sector, normally through a stock market listing. The opposite of nationalization

Procurement collusion

Where companies illegally bid for large contracts by rigging bids to decide which one of them gets the contract in advance.

Producer surplus

The difference between what producers are willing and able to supply a good for and the price they actually receive. The level of producer surplus is shown by the area above the supply curve and below the market price

Product differentiation

When a business seeks to distinguish what are essentially the same products from one another by real or illusory means. The assumption of homogeneous products under conditions of perfect competition no longer applies.

Production function

The relationship between a firm’s output and the quantities of factor inputs (labour, capital, land) that it employs

Productivity

How much is produced per unit of input. Labour productivity, for instance, can be calculated per worker, per hour worked, etc. Capital productivity is similar to calculating a return from an investment

Profit

The excess of revenue over expenses; or a positive return on an investment.

Profit margin

The ratio of profit over revenue, expressed as a percentage. Mainly an indication of the ability of a company to control costs

Profit maximization

Profit maximization occurs when marginal cost = marginal revenue

Profit per unit

Profit per unit (or the profit margin) = AR – ATC. In markets where demand is price inelastic, a business may be able to raise price well above average cost earning a higher profit margin on each unit sold. In more competitive markets, profit margins will be lower because demand is price elastic

Public utility

A company that provides public services, such as power, water and telecommunications. Regulated by government, not necessarily state-owned

Regulated industry

An industry that is closely controlled by the government

Regulatory capture

When industries under the control of a regulatory body appear to operate in favour of the vested interest of monopoly producers rather than consumers

Rent seeking behaviour

Behaviour by producers in a market that improves the welfare of one but at the expense of another. A feature of monopoly and oligopoly

Retained profit

Profit retained by a business for its own use and which is not paid back to the company’s shareholders or paid in taxation to the government

Revenue maximization

Revenue maximization is an output when marginal revenue = zero (MR=0)

Revenue synergies

The ability to sell more products and services or raise prices after a business merger e.g. marketing and selling complementary products; cross-selling into a new customer base and sharing distribution channels.

RPI-X Pricing Formula

This formula encourages efficiency within regulated businesses by taking the retail price index (i.e. the rate of inflation) as its benchmark for the allowed changes in prices and then subtracting X – an efficiency factor – from it.

Satisficing

Satisficing involves the owners setting minimum acceptable levels of achievement in terms of revenue and profit.

Saturation

To offer so much for sale that there is more than people want to buy

Second degree price discrimination

Businesses selling off packages of a product deemed to be surplus capacity at lower prices than the previously published/advertised price – also volume discounts

Shareholder return

Total return (dividends + increases in business value) for shareholders

Short run

A time period where at least one factor of production is in fixed supply. We normally assume that the quantity of plant and machinery is fixed and that production can be altered through changing labour, raw materials and energy

Short-termism

When a business pursues the goal of maximizing short-term profits because of a fear of being taken-over or having the stock market mark down the value of the company. Short-termism may make it difficult for a business to follow longer-term objectives

Shut down price

In the short run the firm will continue to produce as long as total revenue covers total variable costs or put another way, so long as price per unit > or equal to average variable cost (P>AVC)

Social enterprises

Businesses run on commercial lines with profits reinvested for social aims – often said to be built on three pillars – profit, people and planet

Social reporting

Accounting for, and formally reporting the social & environmental impacts of a firms actions to all relevant stakeholders

Socially responsible investing

Also known as ethical investing; shareholders pursuing investment strategies which seeks to maximize both financial return and social good

Spare capacity

Spare, surplus or excess capacity is the difference between current output (utilized capacity) and what can be produced at full capacity

Stakeholder

Any party that is committed, financially or otherwise, to a company and is therefore affected by its performance. This would normally include shareholders, employees, management, customers and suppliers. Their interests do not always coincide

Stakeholder conflict

Stakeholder conflict occurs when different stakeholders have different objectives. Firms have to choose between maximizing one objective and satisfactorily meeting several stakeholder objectives, so called satisficing

Static efficiency

Static efficiency focuses on how much output can be produced now from a given stock of resources, and whether producers are charging a price to consumers that reflects fairly the cost of the factors used to produce a product

Strategic behaviour

Decisions that take into account the market power and reactions of other firms

Sub-normal profit

Any profit less than normal profit

Sunk costs

Sunk costs cannot be recovered if a business decides to leave an industry. The existence of sunk costs makes a market less contestable.

Supernormal profit

A firm earns supernormal profit when its profit is above that required to keep its resources in their present use in the long run i.e. when price > average cost

Synergy

When the whole is greater than the sum of the individual parts

Tacit collusion

Where firms undertake actions that are likely to minimize a competitive response, e.g. avoiding price cutting or not attacking each other’s market. Tacit collusions is when firms co-operate but not formally, e.g. price leadership, or quiet or implied co-operation, secret, unspoken cooperation

Takeover

Where one business acquires a controlling interest in another business. Takeovers are much more common than mergers.

Technical efficiency

How well and quickly a machine produces high quality goods. When measuring the technical efficiency of a machine, the production costs are not considered important

Total cost

Total cost = total fixed cost + total variable cost

Total revenue

Total revenue (TR) is found by multiplying price (P) by output i.e. number of units sold. Total revenue is maximized when marginal revenue = zero

Variable cost

Variable costs are business costs that vary directly with output since more variable inputs are required to increase output. Also known as prime costs

Vertical integration

Vertical Integration involves acquiring a business in the same industry but at different stages of the supply chain

Welfare economics

The study of how an economy can best allocate scarce resources to maximise the welfare of its citizens

Whistle blowing

When one or more agents in a collusive agreement report it to the authorities

X-inefficiency

A lack of real competition may give a monopolist less of an incentive to invest in new ideas or consider consumer welfare

Zero-sum game

An economic transaction in which whatever is gained by one party must be lost by the other. In a zero sum game, the gain of one player is exactly offset by the loss of the other players. If one business gains market share, it must be at the expense of the other firms in the market





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