It is a statement that contains a value judgement and cannot be tested; i.e. what ought to be.
It is a statement that is testable; i.e. what is, was or will be.
A production possibility frontier is a graphical representation of the maximum output an economy can produce given a finite combination of resources. Movement along the frontier implies an opportunity cost in terms of the output of one good foregone to gain the output of another.
The value of the next best alternative foregone.
Division of labour
The breaking of a production process into separate, sequential tasks leading to workers specialising.
A system of organisation where individuals specialise in the production of particular goods or services and then trade the surplus to satisfy their wants, as opposed to self-sufficiency.
An economic system which allocates resources using prices to transmit information, provide incentives and distribute rewards.
Rationing function of the price mechanism
The price mechanism allocates scarce resources to those buyers who are prepared to pay a high enough price.
Signalling function of the price mechanism
Prices help to determine where and how resources should be allocated e.g. if prices increase, this suggests more resources should be allocated to the market.
Incentive function of the price mechanism
Prices act as an incentive to both buyers and sellers e.g. a rising price may encourage sellers to supply more of the product and buyers to purchase less.
A position where the market price has no tendency to change, assuming ceteris paribus, because demand equals supply.
An assumption that all other factors are held constant.
An economy which tackles the basic economic problem, the co-existence of infinite wants and finite resources, predominately through the price mechanism.
An economy which allocates its resources predominately through the direction of a central planning authority.
An economy where both the price mechanism and the planning authority have a significant role in allocating resources.
The difference between the amount a consumer is willing to pay for a product and the amount they actually pay. (Represented by the area below the demand curve and above the price line)
to sell a good or service for and the actual price they sell the good or service for. (Represented by the area above the supply curve and below the price line)
A tax on expenditure collected by the producer on behalf of the government. Note: the tax shifts the supply curve up vertically by the tax per unit. Multiply this by the number of units, Q1, gives the total tax revenue (area shaded).
A payment made by the government to producers which they will receive in addition to the market price. Note: the subsidy shifts the supply curve down vertically by the subsidy per unit. Multiply this by the number of units, QN, gives total expenditure (area shaded)
Incidence of tax
The distribution of the burden of an indirect tax between buyers and sellers. The stripped area (above the original price) is paid for by the consumers. The dark area (below the original price) is paid for by the producers.
Price elasticity of demand
Measures the responsiveness of quantity demand to a change in price.
%Δ QD %Δ P
Income elasticity of demand
Measures the responsiveness of quantity demand to a change in income.
%Δ QD %Δ Y
Cross-price elasticity of demand
Measures the responsiveness of quantity demand of good A to a change in the price of good B.
%Δ QD of Good A %Δ P of Good B
A pair of goods which are considered to be alternatives to each other by consumers; i.e. a positive cross-price elasticity of demand.
A pair of goods that are consumed together; i.e. a negative cross-price elasticity of demand.
A good whose demand increases when income increases; i.e. a positive income elasticity of demand
A good whose demand falls when income increases i.e. a negative income elasticity of demand. This relationship may arise as consumers buy more desirable alternatives as their income rises.
The demand for a factor of production that results from the demand for the product that it is used to make.
Price elasticity of supply
Measures the responsiveness of supply to a change in price.
%Δ QS / %Δ P
The period of time over which the quantity of some factor of production is fixed.
The period of time over which the quantity of all factors of production can be changed.
Occurs when resources cannot be reallocated to
produce a different combination of goods that will increase economic welfare; i.e. economic welfare is maximised and the sum of consumer and producer surplus is maximised (P=MC).
Occurs when a free market produces a misallocation of scarce resources.
Occurs when government intervention leads to an even greater misallocation of resources and a movement away from the socially optimal point of production than if there was no intervention.
The failure of government to act in the interests of the population because public servants pursue their own private interests ahead of the wider public interest; i.e. salary, public reputation, power, etc.
Where one party in an economic relationship has more information than another; e.g. doctors and patients.
When people take actions that increase social costs because they are insured against private loss: sometimes it is called hidden action due to the agent’s actions being hidden from the principal.
Buffer stock scheme
A scheme that buys surplus produce in periods of abundance and sells stock in periods of shortage, in order to stabilise the market price.
A maximum price set by a regulator above which suppliers cannot sell; i.e. rent controls for low-cost housing.
A minimum price set by a regulator below which buyers cannot purchase; i.e. the national minimum wage.
Goods and services that, once produced, can be consumed by everyone in society: they exhibit non-rivalry and non-excludability.
People who use public goods but don’t pay for them.
The costs or benefit received by a third party to an economic transaction outside of the market mechanism; i.e. the spillover effects of an economic activity.
The costs received by a third party to an economic transaction outside of the market mechanism
The benefit received by a third party to an economic transaction outside of the market mechanism
A tax placed on a good with negative externalities so that the external cost is internalised: the polluter pays principle. The tax is set equal to the marginal negative externality.
A market-oriented solution to regulating the quantity of pollution, where the rights to pollute a given amount are traded so that a pre-determined level of pollution abatement is achieved for the least cost.
A legal right to the ownership of a resource. If this remains undefined, the resource may be overexploited; i.e. fishing.
The use of law and regulation backed up by inspection and penalties for non-compliance.
Government policy directed at encouraging competition in the private sector: e.g. the investigation of takeovers or restrictive practices.
An organisation of workers with the primary purpose of collectively bargaining for improved pay and conditions for its members.
The inability of workers to move location to attain work due to the cost of commuting or relocating and non-pecuniary factors.
The inability of workers to move occupation or find work due to a shortage of the required skills.
Cost benefit analysis (CBA)
An investment appraisal tool used to weigh up the social benefits of a project against the social costs.