Tutor2u A2 Business Economics Glossary

Concept Glossary Entry

Abnormal profit Profit in excess of normal profit - also known as supernormal profit or monopoly profit. Abnormal
profits may be maintained in a monopolistic market in the long run because of barriers to entry

Agency problem Possible conflicts of interest that may result between the shareholders (principal) and the
management (agent) of a firm

Allocative efficiency Producing an output demanded by consumers at a price that reflects the marginal cost of supply

Anti-competitive Strategies designed to limit the degree of competition inside a market and reinforce the
behaviour monopoly power of established businesses

Asymmetric Where different parties have unequal access to information in a market

information

Average cost Total cost per unit of output = Total cost / output = TC/Q

Average cost pricing Setting prices close to average cost. It is a way to maximise sales, whilst maintaining normal
profits. It is sometimes known as sales maximization

Average fixed cost Total fixed cost per unit of output = TFC/Q
(AFC)

Average revenue Total revenue per unit of output = Price/Output

(AR)

Average variable cost Total variable cost per unit of output = TVC/Q

Backward vertical Acquiring a business operating earlier in the supply chain – e.g. a retailer buys a wholesaler, a
integration brewer buys a hop farm

Barriers to entry Ways to prevent the profitable entry of new competitors – they may relate to differences in costs
between existing and new firms. Or the result of strategic behaviour by firms including
expensive marketing and advertising spending

Behavioural Branch of research that adds elements of psychology to traditional models in an attempt to
economics better understand decision-making by investors, consumers and other economic participants

Bi-lateral monopoly Where a monopsony buyer faces a monopsony seller in a market

Brand extension Adding a new product to an existing branded group of products

Brand loyalty The degree to which people regularly buy a particular brand and refuse to or are reluctant to
change to other brands

Break-even output The break-even price is when price = average total cost (P=AC)

Business ethics Business ethics is concerned with the social responsibility of management towards the firm’s
major stakeholders, the environment and society in general

Capacity The amount that can be produced by a plant or business over a given period of time.

Capital intensive When an industry or production process requires a relatively large amount of capital (fixed
assets) or proportionately more capital than labour
Cartel An association of businesses or countries that collude to influence production levels and thus
the market price of a particular product

Collusion Collusion takes place when rival companies cooperate for their mutual benefit. When two or
more parties act together to influence production and/or price levels, thus preventing fair
competition. Common in an oligopoly / duopoly

Competition and The CMA has been created by unifying the Competition Commission with most functions of the
Markets Authority Office of Fair Trading – tackling price fixing, monopolies and unfair mergers
(CMA)

Competition Policy Policy which seeks to promote competition and efficiency in different markets and industries

Complex monopoly A complex monopoly exists if at least one quarter (25%) of the market is in the hands of one or
a group of suppliers who, deliberately or not, act in a way designed to reduce competitive
pressures within a market

Concentration ratio Measures the proportion of an industry's output or employment accounted for by the largest
firms. When the concentration ratio is high, an industry has moved towards a monopoly,
duopoly or oligopoly. Share can be by sales, employment or any other relevant indicator.

Conglomerate merger Joining together of two companies that are different in the type of work they do - the acquisition
has no clear connection to the business buying it

Consolidation Consolidation refers to the reduction in the number of competitors in a market and an increase
in the total market share held by the remaining firms.

Constant returns When long run average cost remains constant as output increases because output is rising in
proportion to the inputs used in the production process

Consumer surplus 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 tax A tax imposed on the consumer of a good or service. This can be levied at the final sale level
(sales tax), or at each stage in the production

Contestable market Where an entrant has access to all production techniques available to the incumbents is not
prohibited from wooing the incumbent’s customers, and entry decisions can be reversed without
cost. In a contestable market is that businesses are free to enter and leave the market

Cooperative outcome An equilibrium in a game where the players agree to cooperate

Corporate strategy A company's aims in general, and the way it hopes to achieve them - strategic objective which
supports the achievement of corporative aims

Cost synergies Cost synergies are the cost savings that a buyer aims to achieve as a result of taking over or
merging with another business

Cost-plus pricing Where a firm fixes the price for its product by adding a fixed percentage profit margin to the
average cost of production. The size of the profit margin may depend on factors including
competition and the strength of demand

Cost-reducing Cost reducing innovations causing an outward shift in supply. They provide the scope for
innovations businesses to enjoy higher profit margins with a given level of demand

Countervailing power When the market power of a monopolistic/oligopolistic seller is offset by powerful buyers who
can prevent the price from being pushed up
Creative destruction First introduced by Joseph Schumpeter. It refers to the dynamic effects of innovation in markets
- for example where new products or business models lead to a reallocation of resources. Some
jobs are lost but others are created. Established businesses come under threat

Credit Union Financial co-operatives owned & controlled by members offering banking products

Cross-subsidy A cross subsidy uses profits from one line of business to finance losses in another line of
nd
business e.g. Royal Mail and 2 class letters

Deadweight loss Loss in producer & consumer surplus due to an inefficient level of production

De-layering De-layering involves removing one or more levels of hierarchy from the organizational structure.
For example, many high-street banks no longer have a manager in each of their branches

De-merger The hiving off of one or more business units from a group so that they can operate as
independently managed concerns

Deregulation Opening up of markets by reducing barriers to entry. The aim is to increase supply, competition
and innovation and bring lower prices for consumers

Diminishing returns Addition of a variable factor to a fixed factor results in a fall in marginal product

Diseconomies of A business may expand beyond the optimal size in the long run and experience diseconomies
scale (internal) of scale. This leads to rising Long Run Average Cost (LRAC)

Dis-synergies Negative or adverse effects of a takeover or merger. E.g. disruptions that arise from the deal
which result additional costs or lower than expected revenues

Diversification Increasing the range of products or markets served by a business

Divorce between The owners of a company normally elect a board of directors to control the business’s
ownership and resources for them. However, when the owner of a company sells shares, or takes out a loan to
control raise finance, they sacrifice some of their control

Dominant market A firm holds a dominant position if it can operate within the market without taking full account of
position the reaction of its competitors or final consumers

Dominant strategy A dominant strategy in game theory is one where a single strategy is best for a player
regardless of what strategy the other players in the game decide to use

Due Diligence Due diligence is the process undertaken by a prospective buyer of a business to confirm the
details (e.g. financial performance, assets & liabilities, legal ownership & issues, operations,
market position) of what they expect to buy

Duopoly Any market that is dominated by two suppliers

Duopsony Two major buyers of a good or service in a market each of whom is likely to have some buying
power with suppliers in their market.

Dynamic efficiency Dynamic efficiency focuses on changes in the choice available in a market together with the
quality/performance of products that we buy. Economists often link dynamic efficiency with the
pace of innovation in a market

Economic risk The risk that a company may be disadvantaged by exchange rate movements or regulatory
changes in the country in which it is operating

Economies of scale Falling long run average cost as output increases in the long run
Economies of scope Where it is cheaper to produce a range of products

Enlightened self Acting in a way that is costly or inconvenient at present, but which is believed to be in one’s best
interest interest in the long term. E.g. firms accepting some short term costs (lower profits) in return for
long-term gains. Relevant to game theory

Equilibrium output A monopolist is assumed to profit maximise i.e. an output equal to the point where MC=MR

Excess capacity The difference between the current output of a business and the total amount it could produce
in the current time period.

Experience curve Pattern of falling costs as production of a product or service increases, because the company
learns more about it, workers become more skilful

External When the growth of an industry leads to higher costs for businesses that are part of that
diseconomies of industry – for example, increased traffic congestion
scale

External economies When the expansion of an industry leads to the development of services which benefit suppliers
of scale in the industry – causing a downward sloping industry supply curve. A business might benefit
from external economies by locating in an area in which the industry is already established

Exit cost A barrier to exit – the costs associated with a business halting production and leaving a market
- linked to the concept of sunk costs

First mover A business first into the market can develop a competitive advantage through learning by doing
advantage - making it more difficult and costly for new firms to enter

Fixed cost Business expense that does not vary directly with the level of output

Forward vertical Acquiring a business higher in the supply chain – e.g. a vehicle manufacturer buys a car parts
integration distributor

Franchised monopoly When the government grants a company the exclusive right to sell or manufacture a product or
service in a particular area

Freemium Business model in which some basic services are provided for free, with the aim of enticing
users to pay for additional, premium features or content

Game Theory A “game” happens when there are two or more interacting decision-takers (players) and each
decision or combination of decisions involves a particular outcome (known as a pay-off.)

Herfindahl Index A measure of market concentration. The index is calculated by squaring the % market share of
each firm in the market and summing these numbers

Hit-and-run When a business enters an industry to take advantage of temporarily high (supernormal) market
competition profits. Common in highly contestable markets

Horizontal collusion Where there is agreement between firms at the same stage of the production process to charge
prices above the competitive level

Horizontal integration When companies from the same industry amalgamate to form a larger company - firms are at
the same stage of the production process

Hostile takeover A takeover that is not supported by the management of the company being acquired - as
opposed to a friendly takeover

Innovation Making changes to something established. Invention, by contrast, is the act of coming upon or
finding. Innovation is the creation of new intellectual assets
Innovation-diffusion The extent and pace at which a market adopts new products

Interdependence When the actions of one firm has an effect on its competitors in the market. Interdependence is
a feature of an oligopoly. In simple terms - when two or more things depend on each other (i.e.
business and society)

Internal growth Internal growth occurs when a business gets larger by increasing the scale of its own operations
rather than relying on integration with other businesses

Inventories Inventory is a list for goods and materials, or those goods and materials themselves, held
available in stock by a business

Joint-venture Agreement between two or more companies to cooperate on a particular project or a business
that serves their mutual interests.

Kinked demand curve The kinked demand curve model assumes that a business might face a dual demand curve for
its product based on the likely reactions of other firms in the market to a change in its price or
another variable

Last mover The advantage a company gains by being one of the last to sell a product or provide a service,
advantage when technology has improved and costs are very low

Light-touch An approach of government to managing business behaviour - prefers to “influence” rather than
regulation “legislate/regulate” Carrot or stick?

Limit pricing When a firm sets price low enough to discourage new entrants into the market

Marginal cost The change in total costs from increasing output by one extra unit – the formula for MC is
‘change in total cost divided by change in quantity

Marginal profit The increase in profit when one more unit is sold or the difference between MR and MC. If MR
= £20 and MC = £14 then marginal profit = £6

Marginal revenue The change in total revenue from selling one extra unit of output

Merger A merger is a combination of two previously separate organisations.

Merger integration The process of bringing two firms together once they have come under common ownership.
Often regarded as the most difficult part of any takeover or merger. The integration process
needs to cover “hard” areas such as IT systems and marketing strategy as well as “soft” issues
such as different business cultures

Metcalfe’s Law Coined by Robert Metcalfe, Metcalfe's law says that the usefulness of a network equals the
square of the number of users. This is linked to the concept of network economies of scale

Minimum efficient Scale of production where internal economies of scale have been fully exploited. Corresponds
scale to the lowest point on the long run average cost curve.

Monopolistic A market structure characterized by many buyers and sellers of slightly different products and
competition easy entry to, and exit from, the industry. Good examples include fast food outlets in towns and
cities

Monopoly profit A firm is said to reap monopoly profits when a lack of viable market competition allows it to set
its prices above the equilibrium price for a good or service without losing profits to competitors

Monopsony When a single buyer controls the market for a particular good or service, in essence setting
price and quality levels, normally because without that buyer there would not sufficient demand
for the product to survive
Moral Hazard When someone pays for your accidents and problems, you may be inclined to take less effort to
avoid accidents and problems

Multinational A company with subsidiaries or manufacturing bases in several countries

Mutual The relationship between oligopolists, in which the actions of each business affect the other
interdependence businesses

Nash Equilibrium In a Nash Equilibrium, the outcome of a game that occurs is when player A takes the best
possible action given the action of player B, and player B takes the best possible action given
the action of player A

Nationalization When a government takes over a private sector company

Natural monopoly For a natural monopoly the long-run average cost curve falls continuously over a large range of
output. The result may be that there is only room in a market for one firm to fully exploit the
economies of scale that are available

NGO Non-governmental organization (e.g. WWF, Greenpeace)

Non-price Non-price competition assumes increased importance in oligopolistic markets. Competing not
competition on the basis of price but by other means, such as the quality of the product, packaging,
customer service, etc.

Normal profit Normal profit is the transfer earnings of the entrepreneur i.e. the minimum reward necessary to
keep her in her present industry. Normal profit is therefore a fixed cost, included in the average,
not the marginal, cost curve

Oligopoly An oligopoly is a market dominated by a few producers, each of which has control over the
market. However, oligopoly is best defined by the conduct (or behaviour) of firms within a
market rather than its market structure

Optimal plant size Optimal plant is the size where costs are minimized, i.e. when all economies of scale have been
obtained, but diseconomies have not set in. Sometimes the size of a firm or plant is also limited
by the size of the market

Pareto efficiency Where it is not possible for individuals, households, or firms to bargain or trade in such a way
that everyone is at least as well off as they were before and at least one person is better off.
Also known as an efficient outcome

Patent Right under law to produce and market a good for a specified period of time

Paywall Blocking access to a website which is only available to paying subscribers

Peak pricing When a business raises its prices at a time when demand has reached a peak might be justified
due to the higher marginal costs of supply at peak times

Penetration pricing A pricing policy used to enter a new market, usually by setting a very low price

Perfect competition Theoretical condition of a market where prices reflect complete mobility of resources and
freedom of entry and exit, full access to information by all participants, relatively homogeneous
products, and the fact that no one buyer or seller, or group of buyers or sellers, has any
advantage over another.

Perfect price When a firm separates the whole market into each individual consumer and charges them the
discrimination price they are willing and able to pay

Predatory pricing Setting an artificially low price for a product in order to drive away competition - deemed to be
illegal by the UK and European competition authorities
Price capping A government-imposed limit on the price charged for a product - otherwise known as price
capping. Often introduced as a way of controlling the monopoly pricing power of businesses
with a large amount of market power

Price ceiling Law that sets or limits the price to be charged for a particular good

Price discrimination When a firm charges a different price to different groups of consumers for an identical good or
service, for reasons not associated with costs

Price fixing Price fixing represents an attempt by suppliers to control supply and fix price at a level close to
the level we would expect from a monopoly

Price leadership When one firm has a clear dominant position in the market and the firms with lower market
shares follow the pricing changes prompted by the dominant firm

Price regulation Government control of prices, normally for utilities and other essential services

Prisoners’ dilemma A problem in game theory that demonstrates why two people might not cooperate even if it is in
both their best interests to do so. In the classic game, cooperating is dominated by defecting, so
that the only possible equilibrium for the game is for all players to defect. No matter what the
other player does, one player will always gain a greater payoff by playing defect.

Private equity Injection of funds by specialized investors into private companies with the aim of achieving high
rates of return

Private Finance The PFI is a means of obtaining private funds for public sector projects. PFI is when major
Initiative infrastructure/buildings/project/large scale contracts are issued by governments to private firms

Privatization The sale of state-owned companies to the private sector, normally through a stock market
listing. The opposite of nationalization

Procurement Where companies illegally bid for large contracts by rigging bids to decide which one of them
collusion gets the contract in advance.

Producer surplus 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 When a business seeks to distinguish what are essentially the same products from one another
differentiation by real or illusory means. The assumption of homogeneous products under conditions of perfect
competition no longer applies.

Production function The relationship between a firm’s output and the quantities of factor inputs (labour, capital, land)
that it employs

Productivity How much is produced per unit of input. Labour productivity can be calculated per worker, per
hour worked, etc. Capital productivity is similar to calculating a return from an investment

Profit The excess of revenue over expenses; or a positive return on an investment.

Profit margin The ratio of profit over revenue, expressed as a percentage. Mainly an indication of the ability of
a company to control costs

Profit maximization Profit maximization occurs when marginal cost = marginal revenue

Profit per unit Profit per unit (or the profit margin) = AR – ATC. In markets where demand is price inelastic, a
business may be able to raise price well above average cost earning a higher profit margin on
each unit sold. In more competitive markets, profit margins will be lower because demand is
price elastic
Public utility A company that provides public services, such as power, water and telecommunications.
Regulated by government, not necessarily state-owned

Regulated industry An industry that is closely controlled by the government

Regulatory capture When industries under the control of a regulatory body appear to operate in favour of the vested
interest of monopoly producers rather than consumers

Rent seeking Behaviour by producers in a market that improves the welfare of one but at the expense of
behaviour another. A feature of monopoly and oligopoly

Revenue Revenue maximization is an output when marginal revenue = zero (MR=0)

maximization

Revenue synergies The ability to sell more products and services or raise prices after a business merger e.g.
marketing and selling complementary products; cross-selling into a new customer base and
sharing distribution channels.

RPI-X Pricing This formula encourages efficiency within regulated businesses by taking the retail price index
Formula (i.e. the rate of inflation) as its benchmark for the allowed changes in prices and then
subtracting X – an efficiency factor – from it.

Satisficing Satisficing involves the owners setting minimum acceptable levels of achievement in terms of
revenue and profit.

Saturation To offer so much for sale that there is more than people want to buy

Second degree price Businesses selling off packages of a product deemed to be surplus capacity at lower prices
discrimination than the previously advertised price – also volume discounts

Shareholder return Total return (dividends + increases in business value) for shareholders

Short run A time period where at least one factor of production is in fixed supply. We normally assume
that the quantity of plant and machinery is fixed and that production can be altered through
changing labour, raw materials and energy

Short-termism When a business pursues the goal of maximizing short-term profits because of a fear of being
taken-over or suffer a fall in their share price

Shut down price In the short run the firm will continue to produce as long as total revenue covers total variable
costs or put another way, so long as price per unit > or equal to average variable cost (P>AVC)

Social enterprises Businesses run on commercial lines with profits reinvested for social aims – often said to be
built on three pillars – profit, people and planet

Socially responsible Also known as ethical investing; shareholders pursuing investment strategies which seeks to
investing maximize both financial return and social good

Spare capacity Spare, surplus or excess capacity is the difference between current output (utilized capacity)
and what can be produced at full capacity

Stakeholder Any party that is committed, financially or otherwise, to a company and is therefore affected by
its performance e.g. shareholders, employees, management, customers and suppliers. Their
interests do not always coincide

Stakeholder conflict Stakeholder conflict occurs when different stakeholders have different objectives. Firms have to
choose between maximizing one objective and satisfactorily meeting several stakeholder
objectives, so called satisficing
Static efficiency Static efficiency focuses on how much output can be produced now from a given stock of
resources, and whether producers are charging a price to consumers that reflects fairly the cost
of the factors used to produce a product

Strategic behaviour Decisions that take into account the market power and reactions of other firms

Sub-normal profit Any profit less than normal profit – where price < average cost

Sunk costs Sunk costs cannot be recovered if a business decides to leave an industry. The existence of
sunk costs makes a market less contestable.

Supernormal profit A firm earns supernormal profit when its profit is above that required to keep its resources in
their present use in the long run i.e. when price > average cost

Synergy When the whole is greater than the sum of the individual parts

Tacit collusion Where firms undertake actions that are likely to minimize a competitive response, e.g. avoiding
price cutting or not attacking each other’s market. Tacit collusions is when firms co-operate but
not formally, e.g. price leadership, or quiet or implied co-operation, secret, unspoken
cooperation

Takeover Where one business acquires a controlling interest in another business. Takeovers are much
more common than mergers.

Technical efficiency How well and quickly a machine produces goods. When measuring the technical efficiency of a
machine, the production costs are not considered important

Total cost Total cost = total fixed cost + total variable cost

Total revenue Total revenue (TR) is found by multiplying price (P) by output i.e. number of units sold. Total
revenue is maximized when marginal revenue = zero

Variable cost Variable costs are business costs that vary directly with output since more variable inputs are
required to increase output. Also known as prime costs

Vertical integration Vertical Integration involves acquiring a business in the same industry but at different stages of
the supply chain

Welfare economics The study of how an economy can best allocate scarce resources to maximise the welfare of its
citizens

Whistle blowing When one or more agents in a collusive agreement report it to the authorities

X-inefficiency A lack of real competition may give a monopolist less of an incentive to invest in new ideas or
consider consumer welfare

Zero-sum game An economic transaction in which whatever is gained by one party must be lost by the other. In
a zero sum game, the gain of one player is exactly offset by the loss of the other players. If one
business gains market share, it must be at the expense of the other firms in the market