Theme 1 Economic Definitions

THEME 1 – A LEVEL – DEFINITIONS

Scarcity & The economic problem

Scarcity occurs due to there being a finite amount of resources and unlimited wants.

Opportunity Cost

This is the next best alternative forgone (given up).

Ceteris Paribus

All other factors remaining the same

PPF Curves

A PPF curve shows the maximum combination of two goods and services an economy can produce when all its resources are fully and efficiently employed.

Direct Taxes

A direct tax is a tax levied directly on a individual or firm. They do not have choice to pay it or not. E.g Income Tax and Corporation Tax. 

Indirect Taxes

A tax imposed on expenditure, it is indirect in that the tax is only paid when the product on which the tax is levied is purchased.

Specific Tax

An indirect tax that is a fixed amount per unit of good. 

Ad Valorem Tax

This a percentage tax. The higher the price the greater the percentage of the tax will be. 

Subsidy 

A grant provided by the government to reduce the cost of production, increase output and lower price.

Free Market

A free market occurs when the forces of supply and demand determine prices. There is no government intervention. 

Market Failure

Market failure occurs when the price mechanism of supply & demand fails to efficiently allocate resources. This normally happens in the free market. 

PED

Price elasticity of demand (PED) measures the responsiveness of the demand for a good due to a change in its price.

PES

Price elasticity of demand (PES) measures the responsiveness of the supply for a good due to a change in its price.

XED

Cross elasticity of demand measures the responsiveness of the quantity demanded for a good to a change in the price of another good.

YED

Income elasticity of demand (YED) measures the responsiveness of the quantity demanded for a good or service to a change in income.

Normal Goods (+YED)

Normal goods tend to have a positive YED. This is because as incomes increase consumers tend to purchase what they deem to be better products (Normal Goods)

Inferior Goods (-YED)

Inferior goods tend to have a negative YED. This is because as incomes decrease consumers tend to switch demand from normal goods to inferior goods.

Substitute goods (XED is positive)

These are goods which provide a viable alternative to each other. They are similar goods that compete with each other.

E.g. Butter and Margarine

A rise in the price of butter (Good A) would cause an increase in demand for margarine.

Complementary goods (XED is negative)

These are goods which work in conjunction with each other.

E.g. Tennis racket and tennis balls

Complementary goods work together. A fall in the price of a tennis racket would cause an increase in demand for tennis balls.

Demand

Demand is the quantity of a good or service that consumers are prepared to buy at a given time period.

Supply

Supply is the quantity of a good or service that producers are willing to supply at a given price.

A Mixed Economy

This is an economy where some resources are allocated by the free market (Supply & Demand) and some by the government.

Most of the world’s economies are mixed such as U.S.A, U.K, China, France, Sweden etc.

Command/ Controlled Economies

A command or planned economy occurs when the government controls all major aspects of the economy and economic production. In a command economy, it is the government that decides what to produce, how to produce goods and how to distribute goods and services within the economy.

There is only one major planned economy in the world (North Korea).

Asymmetric Information

There is a mismatch of information as the buyer or seller possesses more information than the other

Symmetric Information

The same information exists between the buyer and seller

Capital

This refers to goods which can be used in the production process of goods and is therefore one of the four factors of production

Capital Goods

Goods which are used in the production process for the development of consumer goods

Consumer Goods

Goods which are bought by households and individuals

Consumer Surplus

The difference between the price a consumer is paying for the good and the highest price he / she is willing to pay

Producer Surplus

The difference between the price a producer receives for a good and the lowest price he / she is willing to accept

Diminishing Marginal Utility

The idea that any additional benefit gained from the consumption of a good usually declines as extra units are consumed and supports the theory of the demand curve being downward sloping

Division of Labour

Tasks are split amongst the workers during the production process so that each worker performs specific roles in which they are specialised in

Enterprise

This is one of the four factors of production and refers to the ability of entrepreneurs to use their knowledge / skills to produce new goods / services

It combines the other three factors of production

Equilibrium

This is occurs when the quantity demanded equals the quantity supplied and is used to determine the price / quantity in the market

Excess Demand

Demand is greater than supply as the price is set too low

Excess Supply

Supply is greater than demand as the price is set too high

Externalities

An economic transaction outside of the market mechanism which results in a third party being faced with an external benefit or cost

External Cost / External Benefit

The difference between social cost / benefit and private cost / benefit

It is the cost / benefit a third party not involved in the economic transaction is faced with

Free Rider Problem

The private sector under provide goods which people do not pay for but are still able to receive the benefits from

Government Intervention

Regulatory action taken by the government to help resolve any form of market failure

Government Failure

The government intervenes to correct market failure but insteads ends up creating a worser outcome

Land

One of the factors of production and refers to resources such as oil, coal, and physical space

Labour

One of the factors of production and refers to human capital

Luxury Goods

When YED is above 1 and an increase in incomes causes a bigger increase in demand

Merit Goods

These provide a benefit to individuals and society through its positive consumption externalities

Demerit Goods

These are damaging to individuals and society as they provide negative consumption / production externalities

Maximum Prices

A price ceiling – occurs when a government sets a legal limit on the price of a good / service

Minimum Prices

A price floor – these are legally enforced by the government to protect producers as they will receive a guaranteed amount of income

Public Goods

Essential goods and services provided by the government, as they are under-provided by the free market due to the free rider problem

They possess two main characteristics: non-excludability and non-rivalry / non-diminshability

Private Goods

These are opposite to public goods as they are rivalry and excludable 

Rationality

Decision-making which allows economic agents to maximise their utility

Utility

The satisfaction from consuming a good

Weakness at computation

Consumers are bad at making calculations, estimating probabilities and working out future benefits / costs due to irrational behaviour

Social Science

The study of human behaviour and societies

Social Optimum Position

The amount at which should be produced / consumed in order to maximise welfare

This is where social cost = social benefit

Normative Statement

This is concerned with value judgements and opinions as they are subjective

They often use sentences which include should, could, better / worse

Positive Statements

This is concerned with factual information and can be tested to be true or false. They usually use a scientific approach towards economics