AS Economics - Key terms in Microeconomics

Absolute poverty measures the number of people living below a certain income threshold or the number of households unable to afford certain basic goods and services.

An indirect tax based on a percentage of the sales price of a good or service. The best known example in the UK is Value Added Tax

One of the founding fathers of modern economics. His most famous work was the Wealth of Nations (1776) - a study of the progress of nations where people act according to their own self-interest - which improves the public good. Smith's discussion of the advantages of division of labour remains a potent idea in the economic literature.

Developing consumer loyalty by establishing branded products can make successful entry into the market by new firms much more expensive. Advertising can cause an outward shift of the demand curve and also make demand less sensitive to changes in price

An increase in the average age of the population arising from an increase in life expectancy and a fall in the birth rate. In the long run, an ageing population has important implications for both the level and pattern of demand in the economy. There are also widespread consequences for government welfare spending (e.g. on state pensions) and the demand for health and other need services

Allocative efficiency occurs when the value that consumers place on a good or service (reflected in the price they are willing and able to pay) equals the cost of the resources used up in production. The technical condition required for allocative efficiency is that price = marginal cost. When this happens, total economic welfare is maximised.

Anti-competitive practices are strategies operated by firms that are deliberately designed to limit the degree of competition in a market. Such actions can be taken by one firm in isolation or a number of firms engaged in some form of explicit or implicit collusion. Where firms are found to be colluding it would be seen to be against the public interest)

Asymmetric information occurs when somebody knows more than somebody else in the market. Such asymmetric information can make it difficult for the two people to do business together

Total output divided by the total units of labour employed

A black market (or shadow market) is an illegal market in which the normal market price is higher than a legally imposed price ceiling (or maximum price). Black markets develop where there is excess demand (or a shortage) for a commodity. Some consumers are prepared to pay higher prices in black markets in order to get the goods or services they want. When there is a shortage, higher prices act as a rationing device. Good examples of black markets include tickets for major sporting events, rock concerts and black markets for children's toys and designer products that are in scarce supply.

A distinctive product offering which is created by the use of a logo, symbol, name, design, packaging or combination thereof. The key in designing and building a brand is to differentiate it from competitors

Brand loyalty exists when consumers regard one particular brand of a product differently from competing products. Persuasive advertising seeks to reinforce and strengthen brand loyalty and thereby make the demand for the product more inelastic. Brand loyalty can be seen as a potential entry barrier in a market. It makes it more difficult and costly for a new product to break into the market when there are established suppliers enjoying a substantial degree of brand loyalty

One way to smooth out the fluctuations in prices is for the government to operate price support schemes through the use of buffer stocks. Buffer stock schemes seek to stabilize the market price of agricultural products by buying up supplies of the product when harvests are plentiful and selling stocks of the product onto the market when supplies are low.

The term capital means investment in goods that are used to produce other goods in the future. Fixed capital includes machinery, plant and equipment, new technology, factories and buildings - all of which are capital goods designed to increase the productive potential of the economy in future years.

Producer or capital goods such as plant (factories) and machinery are useful not in themselves but for the goods and services they can help produce in the future.

An economic system organised along capitalist lines uses market-determined prices to guide our choices about the production and distribution of goods; these economies generally have productive resources which are privately owned and managed. State intervention is kept to a minimum. One key role for the state is to maintain the rule of law and protect private property.

A producer cartel seeks to maximise joint profits in a market by engaging in price fixing. This can be achieved by controlling market output

Ceteris paribus means all other things being equal. Economists recognise that many factors affect an economic variable. E.g. demand is influenced by the price of the good, income, taste, etc. To simplify and enable analysis, economists isolate the relationship between two variables by assuming ceteris paribus - i.e. that all other influencing factors are held constant

Because of scarcity, choices have to be made on a daily basis by individual consumers, firms and governments. Making a choice made normally involves a trade-off - in simple terms, choosing more of one thing means giving up something else in exchange. Because wants are unlimited but resources are finite, choice is an unavoidable issue in economics.

Collusion is any explicit or implicit agreement between suppliers in a market to avoid competition. Producers may decide to control market supply by entering into a collusive agreement and opt to fix prices rather than engage in competition. The main aim of this is to reduce market uncertainty and achieve a level of joint profits similar to that which might be achieved by a pure monopolist.

The Common Agricultural Policy has been in place now for over forty five years and is one of the most controversial aspects of the European Union. To many economists, the CAP is a grossly inefficient form of farm support and is in need of fundamental reform. To others, the CAP has done much to increase the efficiency of the European farm system and has met many of its original objectives.

The Competition Commission carries out inquiries into matters referred to it by the other UK competition authorities concerning monopolies, mergers and the economic regulation of utility companies. The Appeal Tribunals hear appeals against decisions of the Director General of Fair Trading and the regulators of utilities in respect of infringements concerning anti-competitive agreements and abuse of a dominant position.

A competitive market is one where no one firm has a dominant position and where the consumer has plenty of choice when buying goods or services. Firms in a competitive market each have a small market share. There are few barriers to the entry of new firms which allows new businesses to enter the market if they believe they can make sufficient profits

Goods in competitive supply are alternative products a firm could make with its resources. E.g. a farmer can plant potatoes or carrots. An electronics factory can produce VCRs or DVDs.

Two complements are said to be in joint demand. Examples include: fish and chips, DVD players and DVDs, iron ore and steel, success and hard work. A rise in the price of a complement to Good X should cause a fall in demand for X. For example an increase in the cost of flights from London Heathrow to New York would cause a decrease in the demand for hotel rooms in New York and also a fall in the demand for taxi services both in London and New York. A fall in the price of a complement to Good Y should cause an increase in demand for Good Y. For example a reduction in the market price of computers should lead to an increase in the demand for computer peripherals such as printers, scanners and software applications.

Composite demand exists where goods or services have more than one use so that an increase in the demand for one product leads to a fall in supply of the other. The most commonly quoted example is that of milk which can be used for cheese, yoghurts, cream, butter and other products. If more milk is used for manufacturing cheese, ceteris paribus there is less available for butter.

Consumer surplus is a measure of the welfare that people gain from the consumption of goods and services, or a measure of the benefits they derive from the exchange of goods. Consumer surplus is 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 is the use of a good or a service by consumers (households) to satisfy a want or a need

A contestable market has no entry barriers - firms can enter or leave an industry costlessly. The threat of potential entry encourages imperfectly competitive to set price and output at or close to the competitive price and output

There is growing interest in the concept of ethical businesses and corporate social responsibility where the traditional assumption of businesses driven solely by the profit motive is challenged and where businesses are encouraged to take account of their economic, social and environmental impacts.

Governments face choices: do we build new hospitals or new or new schools, etc. Given limited resources how can government decide which projects to prioritize and build and which to reject? Cost Benefit Analysis (CBA) offers a systematic framework for measuring and evaluating the likely impact of public sector project, takes into account both private and external costs and benefits over the entire life of the project.

Costs are those expenses faced by a business when producing a good or service for a market. Every business faces costs - these must be recouped if a business is to make a profit from its activities. In the short run a firm will have fixed and variable costs of production

Cross price elasticity (CPed) measures the responsiveness of demand for good X following a change in the price of good Y (a related good). With cross price elasticity we make an important distinction between substitute products and complementary goods and services

Demand is defined as the quantity of a good or service that consumers are willing and able to buy at a given price in a given time period. Each of us has an individual demand for particular goods and services.

A demand curve shows the relationship between the price of an item and the quantity demanded over a period of time. For normal goods, more of a product will be demanded as the price falls. This is because at lower prices, consumers can afford to purchase more with their income. A fall in prices causes an increase in a consumers' real income. Secondly, a fall in price makes one good relatively cheaper than a substitute encouraging consumers to switch their demand in favour of the lower priced product.

Merit goods are 'good' for you. In contrast, de-merit goods are thought to be 'bad' for you. Examples include alcohol, cigarettes and various drugs. The consumption of de-merit goods can lead to negative externalities which causes a fall in social welfare. The government normally seeks to reduce consumption of de-merit goods. Consumers may be unaware of the negative externalities that these goods create - they have imperfect information.

The demand for a product X might be strongly linked to the demand for a related product Y - giving rise to the idea of a derived demand. For example, the demand for coal is derived in part on the demand for fossil fuels to burn in the process of generating energy. Likewise the demand for steel is strongly linked to the demand for new vehicles and many other manufactured products, so that when an economy goes into a downturn or recession, so we would expect the demand for steel to decline likewise.

The Law of Diminishing Returns occurs because factors of production are not perfect substitutes for each other. Resources used in producing one type of product are not necessarily as efficient when switched to the production of another good or service. The law of diminishing returns lies at the heart of conventional production and cost theory.

There are nearly always limits to the potential to achieve economies of scale. Indeed when a business expands beyond a certain size, average costs per unit may start to increase. This is known as diseconomies of scale. Diseconomies of scale arise mainly through problems of management. As a firm grows, management finds it more difficult to organize production efficiently. It is much easier to lose control of costs in a large organization than in a small business.

Division of labour means the specialization of the functions and roles involved in making the separate parts of a product. It is closely tied to the standardization of production, the introduction and perfection of machinery, and the development of large-scale industry. As a result of mass-production techniques, total production is many times what it would be had each worker made the complete product. Problems created by the division of labour include job monotony, technological unemployment, and eventually chronic unemployment if the economy does not expand quickly enough to reabsorb the displaced labour.

Economies of scale are of huge importance to many businesses - not least those that have to compete in international markets where cost competitiveness is vital. Both producers and consumers stand to gain from economies of scale. Businesses can bring down their average costs by producing on a larger scale. This opens up the possibility of them making bigger profit margins and also building a competitive advantage in their chosen markets. For consumers, lower costs per unit can be translated into a reduction in market prices which leads to a rise in their real purchasing power and a potential improvement in economic welfare (e.g. measured by the level of consumer surplus).

Demand in economics must be effective. Only when a consumers' desire to buy a product is backed up by an ability to pay for it do we speak of demand. For example, many people would be willing to buy a luxury sports car, but their demand would not be effective if they did not have the financial means to do so. They must have sufficient real purchasing power.

An entrepreneur is an individual who seeks to supply products to a market for a rate of return (i.e. a profit). Entrepreneurs will usually invest their own financial capital in a business and take on the risks associated with a business investment. The reward to this risk-taking is the profit made from running the business. Many economists agree that entrepreneurs should be classed as specialised part of the factor input 'labour'.

For a high level of profits to be maintained in the long run, a monopolist must successfully prevent the entry of new suppliers into a market. Barriers to entry are the mechanisms by which potential competitors are blocked. Monopolies can then enjoy higher profits in the long run as rivals have not diluted market share.

Equilibrium means ‘at rest’ or ‘a state of balance’ - i.e. a situation where there is no tendency for change

External costs are those costs faced by a third party for which no appropriate compensation is forthcoming. Identifying and then estimating a monetary value for air pollution is a difficult exercise - but one that is increasingly important for economists concerned with the impact of economic activity on our environment.

External economies arise from the growing size of an industry. As the industry grows in size and there are more firms in the industry, these companies may enjoy lower average total costs for several reasons: Firms will be able to draw on a pool of skilled labour, trained by firms and government, thus reducing their own training and living costs.

Externalities are third party effects arising from production and consumption of goods and services for which no appropriate compensation is paid. Externalities occur in nearly every market and industry and can cause market failure if the price mechanism does not take into account the full social costs and benefits of production and consumption. Externalities occur outside of the market i.e. they affect economic agents not directly involved in the production and/or consumption of a particular good or service

Factor immobility occurs when a factor is unable to switch easily between different sectors of the economy

Small firms often have to pay higher interest rates on loans since they are perceived by financial organizations to carry a higher level of risk. Firms therefore have to pay a risk premium on their loans. The smaller firm may find it more difficult to raise money through selling new shares than a larger firm.

There are only a finite number of workers, machines, acres of land and reserves of oil and other natural resources on the earth. Because resources are finite, we cannot produce an infinite number of goods and services. By producing more for an ever-increasing population, we are in danger of destroying the natural resources of the planet. This will have serious consequences for the long-term sustainability of economies throughout the world and potentially enormous implications for our living standards and the quality of life.

A firm is an organisation that uses factors of production (resources) to create goods and services e.g. public limited companies plcs

These costs relate to the fixed factors of production and do not vary directly with the level of output. Examples of fixed costs include: rent and business rates, the depreciation in the value of capital equipment (plant and machinery) due to age and marketing and advertising costs

Franchises and licences give a firm the right to operate in a market - and are usually open to renewal every few years. Examples include: Commercial television and radio licences, local taxi route licences and the franchise holders to run regional rail services

Not all goods have an opportunity cost. Free goods are not scarce and no cost is involved when consuming them

In a free market economic system, governments take the view that markets work, assume a laissez faire (let alone) approach, step back, and allow the forces of supply and demand to set prices and allocate resources. Government intervention is required mainly to prevent or correct market failure through for example enforcing anti-monopoly legislation (i.e. preventing abuses of market power), enforcing private property rights, and redistributing income through the tax and benefit system etc

Public goods are non-excludable. Once the product is provided, other consumers cannot be excluded from benefiting from the good. This means some consumers may avoid payment and become free riders i.e. benefit without contributing to the cost of provision. If sufficient consumers decide to take a free-ride then the product will not be provided through the market. Consider the case of the provision of an army of traffic wardens and safety signs on roads. One person's benefit from these services is not unique - other motorists benefit from the service as well - but they cannot be stopped and asked to pay for the benefits they derive.

A futures market is a commodity exchange where contracts for the future delivery of grain, livestock, and precious metals are bought and sold. Speculation in futures serves to protect both the producers and the users of the commodities from unpredictable price fluctuations.

People may also experience geographical immobility – meaning that there are barriers to them moving from one area to another to find work

The Gini coefficient is a statistical measure of income distribution. A Gini coefficient of 0 means perfect equality; 1 total inequality

Globalisation is the increased worldwide integration and interdependence of those economies that trade. For example, transnational firms locate the production and assembly of goods in different locations across the world.

Even with good intentions governments seldom get their policy application correct. They can tax, control and regulate but the eventual outcome may be a deepening of the market failure or even worse a new failure may arise. Government failure may range from the trivial, when intervention is merely ineffective, but where harm is restricted to the cost of resources used up and wasted by the intervention, to cases where intervention produces new and more serious problems that did not exist before. The consequences of this can take many years to reverse.

Some economists argue that the “nanny state” is when the government imposes its own preferences on consumers. For example, when the government subsidies university tuition fees and taxes cigarettes it is saying ‘we know better than you what is good for you’.

Health rationing occurs when the demand for health care services outstrips the available resources leading to waiting lists and delays for health treatment. Rationing may take place in various ways - for example health service practitioners may ration the resources to patients on the basis of clinical need. In private sector markets, health care will be available on the basis of willingness and ability to pay

Where two firms join at the same stage of production in one industry. For example two car manufacturers may decide to merge, or a leading bank successfully takes-over another bank. The world's biggest contested takeover took place in 2000 when British business Vodafone mounted a successful bid for German telecoms firm Mannesmann

Human capital is the stock of skills, experience and qualifications held by the labour force that can be brought into the production function. New Growth theorists believe there is a strong link between investment in human capital and long-term growth.

HRM describes improvements to procedures involving recruitment, training, promotion, retention and support of faculty and staff. This becomes critical to a business when the skilled workers it needs are in short supply. Recruitment and retention of the most productive and effective employees makes a sizeable difference to corporate performance in the long run (as does the flexibility to fire those at the opposite extreme!)

Consumers and producers require complete information if they are to make efficient choices. In perfectly competitive markets we assume that all agents in the market have perfect information about the availability of goods and services and also the prices charged by suppliers. Consumers can make purchasing decisions on the basis of full and free information on the products that they are buying. In reality, all of us experience information deficits which can lead to a misallocation of resources. Information failure occurs when people have inaccurate, incomplete, uncertain or misunderstood data and so make potentially ‘wrong’ choices. Consumers can never be expected to have a full-informed view about the products they are faced with in each and every market. Searching for information is time consuming and carries an obvious opportunity cost. Likewise, producers do not have full information about the products and prices being charged by their competitors.

Incentives matter enormously in our study of microeconomics, markets and market failure. For competitive markets to work efficiently economic agents (i.e. consumers and producers) must respond to appropriate price signals in the market. Government intervention in markets can often change the incentives that both producers and consumers face - for example a change in relative prices brought about by the introduction of government subsidies and taxation.

Income represents a flow of earnings from using factors of production to generate an output of goods and services

Income effects refer to changes in the real purchasing power of consumers. For example when the average price level falls, a given amount of money income can now buy more goods and services. Consumer demand for normal goods will increase, but decrease for inferior goods. Changes in real price levels affect the real incomes of households and firms.

Income elasticity of demand measures the relationship between a change in quantity demanded and a change in real income. The formula for income elasticity is: percentage change in quantity demanded divided by the percentage change in income

An indirect tax is imposed on producers (suppliers) by the government. Examples include excise duties on cigarettes, alcohol and fuel and also value added tax. Taxes are levied by the government for a number of reasons - among them as part of a strategy to curb pollution and improve the environment. A tax increases the costs of a business causing an inward shift in the supply curve. The vertical distance between the pre-tax and the post-tax supply curve shows the tax per unit. With an indirect tax, the supplier may be able to pass on some or all of this tax onto the consumer through a higher price. This is known as shifting the burden of the tax and the ability of businesses to do this depends on the price elasticity of demand and supply.

For normal products, more is demanded as income rises, and less as income falls. Most products are like this but there are exceptions called inferior products. They are often cheaper poorer quality substitutes for some other good. Examples include black-and-white television sets, cigarettes, white bread and several other basic foods. With a higher income a consumer can switch from the cheaper substitute to the more expensive, but preferred alternative. As a result, less of the inferior product is demanded at higher levels of income. Inferior goods have a negative income elasticity of demand.

Human beings want better food; housing; transport, education and health services. They demand the latest digital technology, more meals out at restaurants, more frequent overseas travel, better cars, cheaper food and a wider range of cosmetic health care treatments. Whilst our economic resources are limited, human needs and wants are infinite. Indeed the development of society can be described as the uncovering of new wants and needs - which producers attempt to supply by using the available factors of production.

The change in demand for a good or service brought about by a change in interest rates. The demand for many products is sensitive to interest rate changes - notably sectors of consumer demand linked to the strength of the housing market. Goods and services bought on credit might also be expected to have a relatively high interest elasticity of demand.

Firms can generate higher sales and increased market share by expanding their operations and exploiting possible economies of scale. The alternative is to grow externally through mergers and takeovers. See also integration of firms

The 18th Century economist Adam Smith - one of the founding fathers of modern economics, described how the invisible or hidden hand of the market operated in a competitive market through the pursuit of self-interest to allocate resources in society's best interest. This remains the central view of all free-market economists, i.e. those who believe in the virtues of a free-market economy with minimal government intervention.

Joint supply describes a situation where an increase or decrease in the supply of one good leads to an increase or decrease in supply of another. For example an expansion in the volume of beef production will lead to a rising market supply of beef hides. A contraction in supply of lamb will reduce the supply of wool

Knowledge based industries are essentially service industries. Examples include communication, finance, and personal services. However hi-tech manufacturing also comes under this umbrella term. This would include pharmaceuticals, computer hardware and software industries and TV and other communication equipment.

Land is the natural resources available for production. Some nations are endowed with natural resources and specialise in the extraction and production of these resources – for example – the development of the North Sea Oil and Gas in Britain and Norway.

Latent demand exists when there is willingness to purchase a good or service, but where the consumer lacks the real purchasing power to be able to afford the product. Latent demand is affected by persuasive advertising - where the producer is seeking to influence consumer tastes and preferences.

The law of demand is that there is an inverse relationship between the price of a good and demand. As prices fall we see an expansion of demand. If price rises there should be a contraction of demand.

The long run in economics is defined as a period of time in which all factor inputs can be changed. The firm can therefore alter the scale of production. If as a result of such an expansion, the firm experiences a fall in long run average total cost, it is experiencing economies of scale. Conversely, if average total cost rises as the firm expands, diseconomies of scale are happening.

Macroeconomics is more concerned with the economy as a whole. For example, how the levels of output, inflation, employment, growth, imports and exports are determined.

A large manufacturer can employ specialist staff to supervise production, thus cutting managerial costs per unit. Greater control of the workforce should raise labour productivity. Specialist administrative equipment, like networked systems of computers, can be used profitably in large firms. The cost of transmitting business information is reduced and employees can communicate more effectively.

Marginal cost is defined as the change in total costs resulting from increasing output by one unit. Marginal costs relate to variable costs only. Changes in fixed costs in the short run affect total costs, but not marginal costs

Marginal product (MP) = the change in total output from adding one extra unit of labour

Marginal Utility is the change in total utility or satisfaction resulting from the consumption of one more unit of a good. The hypothesis of diminishing marginal utility states that as the quantity of a good consumed increases, the marginal utility falls

Market demand is the sum of the individual demand for a product from each consumer in the market. If more people enter the market, then demand at each price level will rise. For example, market demand for mobile phones has expanded rapidly over the last few years as call costs have fallen. Eventually though the market demand for mobile phones will reach saturation point - every product has a life-cycle.

Market dominance occurs when a firm acquire monopoly power

Equilibrium means a state of equality between demand and supply. Without a shift in demand and/or supply there will be no change in market price. Prices where demand and supply are out of balance are termed points of disequilibrium. Changes in the conditions of demand or supply will shift the demand or supply curves. This will cause changes in the equilibrium price and quantity in the market.

Market failure occurs when freely functioning markets, operating without government intervention, fail to deliver an efficient or optimal allocation of resources - Therefore - economic and social welfare may not be maximised - leading to a loss of allocative and productive efficiency. When this happens there is market failure - In reality - all markets fail at some time or other. Market failure exists when the competitive outcome of markets is not efficient from the point of view of the economy as a whole. This is usually because the benefits that the market confers on individuals or firms carrying out a particular activity diverge from the benefits to society as a whole

Market power refers to the ability of a firm to influence or control the terms and condition on which goods are bought and sold. Monopolies can influence price by varying their output because consumers have limited choice of rival products

Markets can be characterised according to how many suppliers are seeking the demand of consumers. The spectrum of competition ranges from competitive markets where there are many sellers, each of whom has little or no control over the market price - to a pure monopoly where a market or an industry is dominated by one single supplier. In many sectors of the economy we see an oligopoly - where a just a few producers dominate the majority of the market. In a duopoly two firms dominate the market.

Market supply is the total amount of an item producers are willing and able to sell at different prices, over a given period of time e.g. one month. industry, a market supply curve is the horizontal summation of all each individual firm’s supply curves

A marketable pollution permit gives a firm the right to emit a given quantity of waste / pollution in a given time period. The quantity of pollution permits issued is determined by the regulators / government as they aim curb pollution to a socially optimum level. These permits can be bought and sold.

A large-scale manufacturer can buy raw materials and other inputs (components) in bulk and thereby negotiate lower prices than the small manufacturer. When a major buyer in a market has substantial buying power, this is termed a monopsony. For example, the major hotel chains can buy the consumables used in hotel rooms at much lower cost than individual consumers. The motor industry can use its monopsony power when negotiating the supply of tyres, in-car entertainment systems and other component parts. The average cost of selling each unit produced can also be lower, because advertising and marketing costs can be spread over a large output sold and specialist salesmen/buyers are employed to maximise sales.

The Government can set a legally imposed maximum price in a market that suppliers cannot exceed - in an attempt to prevent the market price from rising above a certain level. To be effective a maximum price has to be set below the free market price. One example of a maximum price might be for foodstuffs when a shortage of essential foodstuffs threatens a very large rise in the free market price. Other examples include rent controls on properties - for example the complex system of rent controls still in place in Manhattan in the United States.

Means testing allows government welfare benefits to go to those in greatest need - i.e. to those families / households with the lowest incomes. This would help the welfare system to target help for those households on the lowest incomes. However means tested benefits are often unpopular with the recipients. And if benefits are withdrawn at a high rate as earned income increases, there is a risk that households on low incomes will be stuck in the poverty trap and will opt to remain out of work and in receipt of welfare payments.

Mergers take place when two businesses agree to merge their operations and become one single company. There are different types of integration between firms - see also horizontal and vertical integration

Merit Goods are those goods and services that the government feels that people will under-consume, and which ought to be subsidised or provided free at the point of use. Both the public and private sector provide merit goods & services. Consumption of merit goods is widely believed to generate positive externality effects - where the social benefit from consumption exceeds the private benefit. A merit good is a product that society values and judges that everyone should have regardless of whether an individual wants them. In this sense, the government (or state) is acting paternally in providing merit goods and services. They believe that individuals may not act in their own best interests in part because of imperfect information about the benefits that can be derived.

Microeconomics concerns itself with the study of economics and decisions taken at the level of the individual firm, industry or consumer / household. Microeconomics is also concerned with how prices are determined in markets; how much people get paid in different occupations; how we decide what to buy; the effects of government intervention on the prices and quantities of individual goods and services and the efficiency with which our scarce resources are used.

A minimum price is a legally imposed price floor below which the normal market price cannot fall. To be effective the minimum price has to be set above the normal equilibrium price. A good example of this is minimum wage legislation currently in force in the UK. The National Minimum Wage was introduced by the Labour Government in April 1999. The main adult rate for the minimum wage in the UK is £4.80 per hour.

The price mechanism is the only allocative mechanism solving the economic problem in a free market economy. However, most modern economies are mixed economies, comprising not only a market sector, but also a non-market sector, where the government uses the planning mechanism to provide goods and services such as police, roads and health.

A pure monopolist is a single seller of a product in a given market or industry. In simple terms this means the firm has a market share of 100%. The working definition of a monopolistic market relates to any firm with greater than 25% of the industries' total sales. Monopolies can develop in a variety of ways:

A natural monopoly exists when there is great scope for economies of scale to be exploited over a very large range of output. Indeed the scale of production that achieves productive efficiency may be a high percentage of the total market demand for the product. Natural monopolies are associated with industries where there is a high ratio of fixed to variable costs. For example, the fixed costs of establishing a national distribution network for a product might be enormous, but the marginal (variable) cost of supplying extra units of output may be very small. In this case, the average total cost will continue to decline as the scale of production increase, because fixed (or overhead) costs are being spread over higher and higher levels of output.

Humans have many different types of wants and needs e.g.: economic, social and psychological. In economics the focus is on studying how material wants and needs are satisfied: A need is something essential for survival e.g. food satisfies hungry people. A want is something desirable but not essential to survival e.g. cola quenches thirst. Household (consumer) wants and needs are satisfied (met) by consuming (using) products i.e. goods or services

Negative externalities occur when production and/or consumption impose external costs on third parties outside of the market for which no appropriate compensation is paid

A branch of economics that stresses the importance of competitive markets as a way of improving economic welfare. New classical economists believe that markets clear rapidly - i.e. excess demand in a market will cause higher prices; excess supply causes a fall in prices. They believe that government economic policy should allow the free operation of markets and that intervention should be limited to allowing private sector markets to work efficiently

Normal goods have a positive income elasticity of demand so as consumers' income rises, so more is demanded at each price level. Normal necessities have an income elasticity of demand of between 0 and +1. Normal luxuries have an income elasticity of demand > +1 i.e. the demand rises more than proportionate to a change in income

Normative statements express an opinion about what ought to be. They are subjective statements rather than objective statements - i.e. they carry value judgments. For example, the level of duty on petrol is too unfair and unfairly penalizes motorists. Or the government should increase the national minimum wage to £6 per hour in order to reduce relative poverty. A third example - the UK government should join the Single European Currency as soon as possible.

Occupational immobility occurs when there are barriers to the mobility of factors of production between different sectors of the economy which leads to these factors remaining unemployed, or being used in ways that are not economically efficient. Some capital inputs are occupationally mobile – a computer can be put to use in many different industries. Commercial buildings can be altered to provide a base for many businesses. However some units of capital are specific to the industry they have been designed for. Labour often experiences occupational immobility. For example, workers made redundant in the sheet metal industry or in heavy engineering may find it difficult to gain re-employment in the near term. They may have job-specific skills that are not necessarily needed in growing industries. This implies that there is a mismatch between the skills on offer from the unemployed and those required by employers looking for extra workers. This is also called structural unemployment and explains why there is a core of workers in the UK who find it difficult to find paid work. Clearly this leads to a waste of scarce resources and represents market failure.

The Office of Fair Trading plays a key role in protecting the economic welfare of consumers, and in helping to enforce UK competition policy. Its main roles are to identify and put right trading practices which are against the consumer's interests and to investigate anti-competitive practices and abuses of market power and bringing about market structures, which encourage competitive behaviour. The Office of Fair Trading reports on allegations of anti-competitive practices including claims of collusive behaviour where firms are thought to be engaging in price-fixing.

An oligopoly is a market dominated by a few large suppliers. The degree of market concentration is high with typically the leading five firms taking over sixty per cent of total market sales.

There is a well known saying in economics that "there is no such thing as a free lunch". Even if we are not asked to pay a price for consuming a good or a service, economic resources are used up in the production of it and there must be an opportunity cost involved - i.e. the next best alternative that might have been produced using those resources. Opportunity cost measures the cost of any choice in terms of the next best alternative foregone.

Firms can generate higher sales and increased market share by expanding their operations and exploiting possible economies of scale. This is internal rather than external growth (i.e. organic growth) and therefore tends to be a slower means of expansion contrasted to mergers and acquisitions

Some goods are luxurious items where satisfaction comes from knowing both the price of the good and being able to flaunt consumption of it to other people! A higher market price may also be regarded as a reflection of product quality and some consumers on high incomes are prepared to pay this for the "snob value effect". Examples might include perfumes, designer clothes, and top of the range cars. Goods of ostentatious consumption have a high-income elasticity of demand. That is, demand rises more than proportionately to an increase in consumers' income. With products of ostentatious consumption, the demand curve may slope upwards from left to right - more is bought at higher prices.

Sometimes producers may deliberately limit supply through output quotas. This is designed to reduce market supply and force the price upwards. An example of this is the fishing quota introduced by the EU Commission as part of the Common Fisheries Policy. In part the quota is designed to protect fish stocks from permanent depletion.

A Pareto efficient allocation of resources occurs when resources cannot be readjusted to make one consumer better off without making another worse off

Patents are government enforced property rights to prevent the entry of rivals. They are generally valid for 17-20 years and give the owner an exclusive right to prevent others from using patented products, inventions, or processes

The government may choose to intervene in the market to ensure that the firms and consumers who create negative externalities include them when making their decisions e.g. first parties are forced to internalise external costs & benefits through indirect taxes

Some countries have moved toward market-based incentives to achieve pollution reduction. This new approach involves the creation of a limited volume of pollution rights, distributed among firms that pollute, and allows them to be traded in a secondary market. The intent is to encourage lowest-cost pollution reduction measures to be utilized, in exchange for revenues from selling surplus pollution rights. Companies that are efficient at cutting pollution will have spare permits that they can then sell to other businesses. As long as the total bank (or stock) of permits is reduced year by year by the government or an agency, cuts in total pollution can be achieved most efficiently.

One common approach to adjust for externalities is to tax those who create negative externalities. This is sometimes known as “making the polluter pay”. Introducing a tax increases the private cost of consumption or production and ought to reduce demand and output for the good that is creating the externality. Taxes send a signal to polluters that our environment is valuable and is worth protecting.

Positive externalities exist when third parties benefit from the spill-over effects of production/consumption e.g. the social returns from investment in education & training or the positive benefits from health care and medical research

Positive statements are objective statements that can be tested or rejected by referring to the available evidence. Positive economics deals with objective explanation. For example: A rise in consumer incomes will lead to a rise in the demand for new cars. Or, a fall in the exchange rate will lead to an increase in exports overseas. Or if the government decides to raise the tax (duty) on beer, this will lead to a fall in profits of the major brewers.

The poverty trap affects people on low incomes. It creates a disincentive to look for work or work longer hours because of the effects of the tax and benefits system. For example, a worker might be given the opportunity to earn an extra £50 a week by working ten additional hours. This boost to his/her gross income is reduced by an increase in income tax and national insurance contributions. The individual may also lose some income-related state benefits. The combined effects of this might be to take away over 70% of a rise in income, leaving little in the way of extra net or disposable income.

Firms may adopt predatory pricing policies by lowering prices to a level that would force any new entrants to operate at a loss. A high profile case came to a head in 1999 when the Office of Fair Trading found News International guilty of adopting predatory pricing policies in a bid to reduce competition in the market for broadsheet newspapers.

Price elasticity of demand measures the responsiveness of demand for a product following a change in its own price. The formula for calculating the co-efficient of elasticity of demand is: Percentage change in quantity demanded divided by percentage change in price. If the demand increased by 10% due to a fall in a good's own price of 5%, the price elasticity of demand for a product would be 2. Since changes in price and quantity nearly always move in opposite directions, economists usually do not bother to put in the minus sign. We are more concerned with the co-efficient of price elasticity of demand.

Price elasticity of supply (Pes) measures the relationship between change in quantity supplied and a change in price. When supply is elastic, producers can increase production without a rise in cost or a time delay. When supply is inelastic, firms find it hard to change their production levels in a given time period. The formula for price elasticity of supply is: Percentage change in quantity supplied divided by the Percentage change in price

The price mechanism is the means by which decisions of consumers and businesses interact to determine the allocation of resources between different goods and services.

This involves extraction of natural resources e.g. agriculture, forestry, fishing, quarrying, and mining

The need for extra finance of merit goods has brought to the top of the political agenda the debate about public versus private sector funding. The current Labour government is committed to using public private partnerships (PPPs) to inject extra finance for capital spending in education, health and transport. The private finance initiative gives the private sector responsibility for building and managing projects like roads and hospitals in return for a yearly fee. PPPs have been used by Labour to build large numbers of schools, hospitals and roads. More controversially, it is also the chosen route for part-privatising the London Underground and the air traffic control system

Subsidies represent payments by the government to suppliers that have the effect of reducing their costs and encouraging them to increase output. The effect of a subsidy is to increase supply and therefore reduce the market equilibrium price. The subsidy causes the firm's supply curve to shift to the right. The total amount spent on the subsidy is equal to the subsidy per unit multiplied by total output.

Producer surplus is a measure of producer welfare. It is measured as 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 markets refer to markets in which all kinds of commodities are traded, for example the market for airline travel; for new cars; for pharmaceutical products and the market for financial services such as banking and occupational pensions.

Production involves in nearly all cases, using up scarce resources. Production can take place at various levels - ranging from primary industries in which basic resources are extracted through manufacturing and construction (secondary industries) to tertiary and quaternary industries (the service sector).

Production refers to the output of goods and services produced within a market in a given time period

A production possibility frontier (PPF) or boundary shows the combinations of two or more goods and services that can be produced using all available factor resources efficiently. A PPF is normally drawn on a diagram as concave to the origin because the extra output resulting from allocating more resources to one particular good may fall. I.e. as we move down the PPF, as more resources are allocated towards Good Y, the extra output gets smaller - and more of Good X has to be given up in order to produce the extra output of Good Y. This is known as the principle of diminishing returns.

The output of productive efficiency occurs when a business in a given market or industry reaches the lowest point of its average cost curve. Output is being produced at minimum cost per unit implying an efficient use of scarce resources and a high level of factor productivity

Profits are made when total revenue exceeds total cost. Total profit = total revenue - total cost. Profit per unit supplied = price = average total cost. The standard assumption is that private sector businesses seek to make the highest profit possible from operating in a market. There are times when this assumption can be dropped - but the profit seeking firm or business remains a powerful component of standard economic analysis.

Property rights confer legal control or ownership of a good. For markets to operate efficiently, property rights must be clearly defined and protected - perhaps through government legislation and regulation. If an asset is un-owned no one has an economic incentive to protect it from abuse. This can lead to what is known as the Tragedy of the Commons i.e. the over use of common land, fish stocks etc which leads to long term permanent damage to the stock of natural resources.

Public bads would include environmental damage and global warming which affects everyone – no one is excluded from the dis-benefits of others polluting economic activity

The characteristics of pure public goods are the opposite of private goods: Non-excludability: The benefits of public goods cannot be confined to only those who have paid for it. In this sense, non-payers can enjoy the benefits of consumption for no financial cost. Non-rivalry in consumption: Consumption of a public good by one person does not reduce the availability of a good to others - we all consume the same amount of public goods even though our tastes for these goods (and therefore our valuation of the benefit we derive from them) might differ

A quasi-public good is a near-public good i.e. it has many but not all the characteristics of a public good. Quasi public goods are: (i) Semi-non-rival: up to a point extra consumers using a park, beach or road do not reduce the amount of the product available to other consumers. Eventually additional consumers reduce the benefits to other users. (ii) Semi-non-excludable: it is possible but often difficult or expensive to exclude non-paying consumers. E.g. fencing a park or beach and charging an entrance fee; building toll booths to charge for road usage on congested routes

The quaternary sector is involved with information processing e.g. education, research and development, administration, and financial services such as accountancy

Our working assumption is that consumers make choices about what to consume based on the objective of maximising their own welfare. They have a limited income (i.e. a limited budget) and they seek to allocate their funds in a way that improves their own standard of living. Of course in reality consumers rarely operate in a perfectly informed and rational way. Very often, decisions about which products to purchase and consume are actually based on imperfect information which can lead to a loss of welfare not only for consumers themselves but society as a whole. As consumers we have all made poor choices about which products to buy

Prices serve to ration scarce resources when demand in a market outstrips supply. When there is a shortage of a product, the price is bid up - leaving only those with a willingness and ability to buy with the effective demand necessary to purchase the product. Be it the demand for cup final tickets or the demand for a rare antique the market price acts a rationing device to equate demand with supply. Rationing by other means might be regarded as inefficient. Consumers with the highest income stand to have most influence on what is eventually produced. This can cause difficulties when there is a high degree of inequality in the distribution of income and wealth.

Relative poverty measures the extent to which a household's financial resources falls below an average income threshold for the economy. Although living standards and real incomes have grown because of higher employment and sustained economic growth over recent years, the gains in income and wealth have been unevenly distributed across the population.

Research and development spending is heaviest in those industries that require a leading edge in the development of new projects and processes. And in industries and markets where there are high level gains from acquiring patents.

Resource allocation refers to a given use of land, labour, capital and entrepreneurs those results in particular amounts of goods and services being produced. A reallocation of resources means some factors of production are switched from one use to another i.e. into different industries and occupations resulting in different amounts of goods and services produced.

Revenue means the income firms receive from the sale of output

A large firm sells in more markets and has a wider product range than a smaller company. The rapid expansion of multi product businesses is part of a process of diversification. This helps spread business risks so that if one market does badly the company has other markets to sell into.

Scarce means limited. Our resources of land labour capital and enterprise are finite. There is only a limited amount of resources available to produce the unlimited amount of goods and services we desire

This involves the production of goods in the economy, i.e. transforming materials produced by the primary sector e.g. energy manufacturing and the construction industry

Self-sufficiency is where people try to meet their own wants and needs without producing a surplus to trade.

The short run is a period of time when there is at least one fixed factor of production. This is usually the capital input such as plant and machinery and the stock of building and technology. In the short run, output expands when more variable factors (labour, raw materials and components) are employed.

Prices have a signaling function - if prices are rising because of stronger demand from consumers, this is a signal to suppliers to expand output to meet the higher demand. In this sense consumer preferences send information to producers about the changing nature of our needs and wants. When demand is strong, higher market prices act as an incentive to raise output (production) because the supplier stands to make a higher profit.

The socially efficient level of output and or consumption occurs when social marginal benefit = social marginal cost. At this point we maximise social economic welfare. The existence of negative and positive externalities means that the private optimum level of consumption or production often differs from the social optimum leading to some form of market failure and a loss of social welfare.

Self-sufficiency is where people try to meet their own wants and needs without producing a surplus to trade. Specialisation is when individuals, regions or countries concentrates on making one product to create a surplus to be traded

The demand for a product can also be affected by speculative demand in the marketplace. Here, potential buyers are interested not just in the satisfaction they may get from consuming the product, but also the potential rise in market price leading to a capital gain or profit. When prices are rising, speculative demand may grow, adding to the upward pressure on prices. The speculative demand for housing and for shares (also known as equities) might come into this category.

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

Stakeholders are groups who have an interest in the activity of a business e.g. shareholders, managers, employees, suppliers, customers, government and local communities. Different stakeholders have different objectives e.g. owners want maximum profits, customers low prices and workers high wages. Stakeholder conflict ensues. In plcs ownership and control are separate. Owners seek profits; managers may seek sales maximisation as these increase bonuses.

Substitutes are goods in competitive demand and act as replacements for another product. For example, a rise in the price of Esso petrol (other factors held constant) should cause a substitution effect away from Esso towards competing brands. A fall in the monthly rental charges of cable companies or Vodafone mobile phones might cause a decrease in the demand for British Telecom services. Consumers will tend over time to switch to the cheaper brand or service provider. When it is easy to switch, consumer demand will be sensitive to price changes (see the section on price elasticity of demand)

A substitute in production is a product that could have been produced using the same resources. Take the example of barley. An increase in the price of wheat makes wheat growing more attractive. The pursuit of the profit motive may cause farmers to use land to grow wheat rather than barley.

Supply is the quantity of a good or service that a producer is willing and able to supply onto the market at a given price in a given time period. The basic law of supply is that as the market price of a commodity rises, so producers expand their supply onto the market.

A supply curve shows a relationship between price and quantity a firm is willing and able to sell. If the price of the good varies, we move along a supply curve. A price rise will usually cause an expansion of supply. If the market price falls there would be a contraction of supply in the market. Producers are responding to price signals when making their output decisions.

A tariff is a tax on the value of imports and remains the most common form of trade protection in the world economy today despite numerous attempts by the World Trade Organization (WTO) to encourage a reduction in average tariff levels between countries.

Technical Efficiency = production of goods and services using the minimum amount of resources

The tertiary sector provided services such as banking, finance, insurance, retail, education and travel and tourism

Total Revenue (TR) refers to the amount of money received by a firm from selling a given level of output and is found by multiplying price (P) by output i.e. number of units sold (TR)

Trade is the exchange of goods or services. Trade improves consumer choice and total welfare. Individual have different skills. Regions or countries have different factor endowments e.g. climate, skilled labour force, and natural resources vary between nations. Therefore individuals, regions and countries are better placed in the production of certain goods than others

Economic choices almost always involve deciding between more of one product for less of another. A trade off involves a sacrifice, an exchange, a giving up X for Y

Value added is the difference between inputs and outputs e.g. if a firm spends £500 making a good (inputs) and sells its product (output) for £750, then value added is £250

Variable costs vary directly with output. I.e. as production rises, a firm will face higher total variable costs because it needs to purchase extra resources to achieve an expansion of supply. Common examples of variable costs for a business include the costs of raw materials, labour costs and consumables.

Where a firm develops market dominance by integrating with different stages of production in the industry e.g. by buying its suppliers or controlling the main retail outlets. A good example is the oil industry where many of the leading companies are both producers and refiners of crude oil. Forward vertical integration occurs when a business merges with another business further forward in the supply chain. Backward vertical integration occurs when a firm merges with another business at a previous stage of the supply chain

Wealth is a stock of assets that generates a flow of income and can be held in a variety of forms by individuals, firms and also the nation as a whole:

Willingness to pay is the maximum price a consumer is prepared pay to obtain a product rather than forego consumption and is shown by the demand curve.

Working capital refers to stocks of finished and semi-finished goods (or components) that will be either consumed in the near or will be made into finished consumer goods. Another term for stocks is inventories.