Economics Concepts and Definitions

A Free Market Economy

A free market economy is a rationing system by which societies allocate resources to the production of goods and services using the price mechanism, with no government intervention. All economic decisions are based on the market forces of demand and supply. (Adam Smith)

A Command Economy

A command economy, also called centrally planned economy, is a rationing system where the means of production are owned by the state. There is no private property and all economic decisions are made by the government. (Karl Marx)

Positive Economics

Positive economics are statements based on facts or evidence; free from subjectivity. They can be tested scientifically and proved.

Normative Economics

Normative economics are economic statements based on norms, and thus they are based on subjective evaluation. They cannot be proved or disproved scientifically.

Scarcity

Scarcity is when the available resources or factors of production are finite, while human wants and needs are infinite. There are not enough resources to produce everything that is necessary to satisfy human beings' needs and wants.

Opportunity Cost

Opportunity cost is the next best alternative foregone when an economic decision is made.

Production Possibility Frontier

The production possibility frontier is the curve that shows the maximum combination of goods and services a country can produce in a specific period of time, using all of its resources in the most efficient way, at the actual state of technology.

Economic Efficiency

Economic efficiency is the situation in which a country is producing at a point where it cannot increase the production of one good, without decreasing the amount produced of the other.

Efficiency

Efficiency is when scarce resources are not wasted, and also when just the right amount of each good or service is produced from society’s point of view.

Demand

Demand is defined as the quantity of a good or service that consumers are willing and able to purchase at a given price, and at a specific time period, ceteris paribus.

Substitute Goods

Substitute goods are goods which are similar in characteristics and uses for consumers, such that when the price of one increases, the demand for the other one increases, as people switch their consumption to the one that has become relatively cheaper. E.g. Apple iPhone and Samsung iPhone

Complementary Goods

Complementary goods are goods which are consumed together, such that when the price of one increases, the demand for the other one decreases, as people tend to consume less of both as one has become more expensive. E.g. DVDs and DVD players

Supply

Supply is defined as the quantity of a good or service that producers are willing and able to offer at a given price, at a specific time period, ceteris paribus.

Equilibrium Price

Equilibrium price is the price at which the quantity demanded of a good equals the quantity supplied, so that there are no surpluses nor shortages at that price. It is the market-clearing price, as everything that is offered at that price, is sold.

Excess Supply

Excess supply is the situation where, at a specific price, above the equilibrium price, the quantity demanded of a good is smaller than the quantity supplied producing a surplus in the market.

Excess Demand

Excess demand is the situation where, at a specific price, below the equilibrium price, the quantity demanded of a good is greater than the quantity supplied producing a shortage in the market.

Linear

Linear is a straight line.

Productive Efficiency

Productive efficiency refers to producing goods by using the fewest possible resources, which implies producing at the lowest possible cost. If firms are producing at the productively efficient level of output, then we can assume they are combining their resources as efficiently as possible and resources are not being wasted by inefficient use.

Allocative Efficiency

Allocative efficiency refers to producing the combination of goods, which is the optimal mix from the society's point of view. Allocative efficiency is achieved when the economy is allocating resources in a way such that no one can be better off without making somebody else worse off. In other words, the benefits from consuming these goods are maximized for the whole society. This situation is called Pareto optimality.

Consumer Surplus

Consumer surplus is the difference between the highest price consumers were willing and able to pay for a good, and the actual price they end up paying.

Producer Surplus

Producer surplus, on the other hand, is the difference between the lowest price producers were willing and able to offer the good at, and the actual price that they end up receiving for it.

Price Elasticity of Demand

Price elasticity of demand is a measure of the responsiveness of the quantity demanded of a good or service, to changes in its own price. QD/P

Total Revenue

Total revenue (TR) is the amount of money received by firms for selling a good or service. It is the price of the good (P) times the quantity sold (Q): TR = P × Q

Income Elasticity of Demand

Income elasticity of demand is a measure of the responsiveness of the quantity demanded of a good or service, to changes in people's income. Qdx/income

Price Elasticity of Supply

Price elasticity of supply is a measure of the responsiveness of the quantity supplied of a good or service, to changes in its own price.

An Indirect Tax

An indirect tax is one imposed upon expenditure. It is placed upon the selling price of the product, raising the firms' costs of production and therefore shifting the supply curve upwards by the amount of the tax.

A Specific Tax

A specific tax is a fixed amount of tax imposed upon a good or service per unit sold; for example, a tax of €2 per can of beer.

A Percentage Tax or Ad Valorem Tax

A percentage tax or ad valorem tax is a fixed percentage charged on the selling price of the good; for example, a 20% tax on the price of cigarettes. In this case, the amount of the tax increases as the price of the good or service increases.

Welfare Loss

Welfare loss is the deadweight loss in terms of welfare benefits for society because resources are not allocated efficiently.

A Subsidy

A subsidy is an amount granted by the government to a certain firm or industry. It is usually given per unit of output, decreasing the firm's costs of production and therefore shifting the supply curve downwards by the amount of the subsidy.

A Price Control

A price control is a form of government intervention in the market of a good or service, where the price is set above or below the equilibrium price, preventing the market to clear, creating surpluses or shortages.

Price Ceiling

Price ceiling is to protect consumers, it is usually for merit goods and to increase consumption and allow poor people to access the good or service (Low price, below equilibrium, maximum price)

Price Floor

Price floor is to protect the producers and reduce demerit good.(minimum price, protect producers, increase income of producers, protect workers by setting high wage, above equilibrium price)

Market Failure

Market failure refers to the failure of the market to allocate resources efficiently as too much or too little of a good or service is produced or consumed from the society's point of view. This happens when by the existence of an external effect or circumstance, the condition 'MPB = MSB = MPC = MSC' is not met.

Public Goods

Public goods are goods and services that are at the same time non-rivalrous and non-excludable. They would not be provided by private firms in a free market as no private individual would pay for them because of the free rider problem.

Merit Goods

Merit goods are goods that are beneficial for the individual and for society as a whole, and therefore would be under-provided in a free market.

Demerit Goods

Demerit goods are considered harmful for the individual and for society as a whole, and would therefore be over-provided in a free market.

An Externality

An externality occurs when the production or consumption of a good or service has an effect on a third party.

A Negative Externality of Production

A negative externality of production is a situation in which the production of a good or service generates a negative effect on a third party or society, which has not been part of the decision-making process of producing such good.

A Positive Externality of Production

A positive externality of production is a situation in which the production of a good or service generates a positive effect on a third party or society, which has not been part of the decision-making process of producing such good.

A Negative Externality of Consumption

A negative externality of consumption is a situation in which the consumption of a good or service generates a negative effect on a third party or society, which has not been part of the decision-making of consuming such good.

A Positive Externality of Consumption

A positive externality of consumption is a situation in which the consumption of a good or service generates a positive effect on a third party or society, which has not taken part in the decision making.

Common Access Resources

Common access resources are resources that are not owned by anyone, do not have a price, and are available to use without payment. They are rivalrous and non-excludable.

Sustainability

Sustainability refers to the ability of something to be maintained or preserved. It exists when the consumption needs of the present generation are met without compromising the ability of future generations to meet theirs.

Sustainable Development

Sustainable development is defined as development that meets the needs of the present without compromising the ability of the future generations to meet their own.

Cap and Trade Schemes

Cap and trade schemes impose a cap (a maximum amount) on the total amount of carbon dioxide that producers can release into the atmosphere. Permits to release carbon dioxide are distributed to producers and permits can be bought and sold in the market.