Microeconomic Definitions


    Collusion. Collusion occurs when large firms in an oligopoly form a cartel to act as a monopoly to restrict output and raise prices.

    Competition Policy. Competition policy aims to make markets more competitive to benefit consumers with lower prices, increased consumer surplus and more choice.

    Competitive Tendering. Competitive tendering occurs when the government invites private firms to bid for the contract to produce a good or service. The firm bidding the lowest cost, subject to quality, wins the contract.

    Concentration Ratio. Measures the combined market share of the largest ‘N’ firms in an industry.

    Conglomerate Merger. A conglomerate merger occurs when two firms who have no common production interests merge.

    Constant Returns to Scale. A doubling of inputs leads to a doubling of output.

    Consumer Surplus. Consumer surplus is the difference between what consumers are willing (and able) to pay and what they actually pay. Consumer surplus is the area between the demand curve and the market price.

    Contestable Market. A contestable market is one in which there are little (or no) barriers to entry or exit, entry/exit costs are low (or zero) so the threat of potential competition is high.

    Contracting Out. Contracting out is when the government employ private firms to produce a good or service. For example roads, tanks and waste disposal.

    Cost. Cost is the cost to a firm for using the factors of production.

    Credible Threat. A credible threat is one that is in the best interest of a punisher to act out, so players believe it will happen.

    Decreasing Returns to Scale. A doubling of inputs leads to a less than doubling of output.

    Deregulation. Deregulation is the removal of government controls (red tape, laws and regulations) over markets.

    Diseconomies of Scale. A firm experiences DEoS when long-run average costs rise as output rises.

    Dominant Strategy. A dominant strategy is the best option a player has no matter what the other player chooses.

    Duopoly. Two large firms dominate the market.

    Dynamic Efficiency. A firm is dynamically efficient if it invests in Research and Development (R&D) to innovate and produce new and better products/technologies for consumers.

    Economies of Scale. A firm experiences EoS when long-run average costs fall as output rises.

    Entry Barrier. A barrier to entry is a factor blocking or disincentivizing a new firm from entering a market. Exit Barrier. A barrier to exit is a factor blocking an existing firm from leaving a market quickly and at a low cost.

    External Economies of Scale. External EoS occurs when an industry grows and its long-run average costs fall.

    First-Degree Price Discrimination. 1st degree price discrimination occurs when each good is sold to the consumer with the highest reservation price for it.

    Fixed Costs. FC are costs that do not vary with output.

    Heterogeneous (Differentiated) Output. Goods are slightly different from each other either due to physical differences or advertising/branding.

    Homogenous Output. All goods are perfect substitutes.

    Horizontal Merger. A horizontal merger is a merger between two firms in the same industry at the same stage of production.

    Increasing Returns to Scale. A doubling of inputs leads to a more than doubling of output.

    Internal Market. An internal market is where public sector providers compete amongst themselves for contracts and jobs. Providers must become more efficient to get new contracts.

    Limit Pricing. Limit pricing occurs when an incumbent firm sets a price so low that they earn normal profit (or low super-normal profit) to make rivals make a loss (because they are not as efficient).

    Loss. A firm makes a loss if AC > AR.

    Marginal Cost. MC is the change in total costs from producing an additional unit of output.

    Minimum Efficient Scale. MES is the minimum scale to fully benefit from economies of scale.

    Market Share. A firm’s share of the market’s sales or revenue.

    Merger. A merger/amalgamation occurs when two or more firms join together under common ownership.

    Monopolistic Competition. A monopolistically competitive market has many buyers and sellers, perfect information, heterogeneous output, price-making firms, profit maximizers and low entry/exit barriers.

    Monopoly. A monopoly is a single seller (or the most dominant firm with at least 25% market share), is a price-maker, a profit maximizer and has significant entry/exit barriers.

    Monopoly Power. The power to restrict output to raise price.

    Monopsony. A monopsony is the only buyer in a market.

    Nash Equilibrium. A Nash equilibrium occurs when player A’s choice is optimal given player B’s choice and vice versa.

    Natural Monopoly. A natural monopoly exists if an industry can only support one firm.

    Normal Profit (Zero Profit). Normal profit is the profit that could have been made had the resources been employed in their next best use. Normal profit is the minimum level of profit required to keep a firm’s resources in their current use in the long-run.

    Oligopoly. An oligopoly occurs when there are a few large dominant firms, large firms are interdependent and there are significant entry/exit barriers.

    Overt Collusion. A formal agreement (written or verbal) amongst firms to control the market.

    Pareto Efficiency. Pareto efficiency occurs when the only way to make one person better off is to make another worse off.

    Perfect Competition. A perfectly competitive market has many buyers and sellers, perfect information, homogenous output, price-taking firms, profit maximizers and no entry/exit barriers.

    Predatory Pricing. An incumbent firm may use predatory pricing to price below their own AC curve so that both they and rivals make a loss.

    Price Capping. . RPI is the rate of inflation measured by the Retail Price Index and x is costsavings that the regulator believes the industry can make by becoming more efficient. Each year the industry’s price is allowed to rise by only .

    Price Discrimination. Price discrimination occurs when a firm charges different consumers different prices for identical goods.

    Price-Maker. A firm is a price-maker if it has the power to set its price.

    Price-Taker. A firm is a price-taker if it must accept the market price and cannot affect prices.

    Privatization. Privatization is the sale of state-owned assets/enterprises/industries to the private sector.

    Producer Surplus. Producer surplus is the difference between the price producers are willing (and able) to supply at and what they actually receive. Producer surplus is the area between the market price and the supply curve.

    Productive Efficiency. Productive efficiency occurs when a firm is on the minimum point of its AC curve. An economy is productively efficient if it is producing on the edge of its PPF, that is, if output is maximized in any mix with resources fully employed.

    Profit. Profit is the difference between revenue and costs.

    Profit Maximization. Profit maximization occurs at .

    Public Private Partnership. A Public Private Partnership is an arrangement by which a government service or private business project is funded and operated through a partnership between the government and private sector.

    Revenue. Revenue is money earned by a firm for selling its output.

    Revenue Maximization. Revenue maximization occurs at

    Sales Maximization. Sales maximization occurs at .

    Sunk Costs. Costs that cannot be recovered upon exiting a market.

    Super-Normal Profit (Abnormal Profit). Super-normal profit is profit greater than normal profit, .

    Third-Degree Price Discrimination. 3rd degree price discrimination occurs when different groups of consumers are charged different prices for the same good.

    Tacit Collusion. An informal or implicit agreement amongst firms to control the market. For example, price leadership, where the price leader sets a high price and then rivals follow suit.

    Total Costs. TC are TFC and TVC added together.

    Total Fixed Costs. TFC equals all FC added together.

    Total Variable Cost. TVC equals all VC added together.

    Total Revenue. Total revenue (TR) is the total money earned by a firm for selling its output.

    Variable Costs. VC are costs that vary directly with output.

    Vertical Merger. A vertical merger is a merger between two firms in the same industry at different stages of production. Backward integration occurs when a buyer buys a supplier. Forward integration occurs when a supplier buys a buyer.

    Welfare Loss. A loss to society due to market failure.

    X-Inefficiency. A firm is X-inefficient if there is no competition so its workers become slack and its costs are not minimized.


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