Microeconomics
Key Words
Word
Microeconomics
Basic Economic Problem
Choice
Economic goods
Free Goods
Margin
Needs
Opportunity Cost
Production Possibility Frontier (PPF)
Scarce Resources
Wants
Capital Productivity
Division Of Labour
Factors Of Production
Fixed Capital
Human Capital
Labour Productivity
Definition
The study of the behaviour of individuals or
groups within an economy, typically within a
market context
Resources have to be allocated between
competing uses because wants are infinite
whilst resources are scarce
Economic choices involve the alternative
uses of scarce resources
Goods which are scarce because their use
has an opportunity cost
Goods which are unlimited in supply and
which therefore have no opportunity cost
A point of possible change
The minimum which is necessary for a
person to survive as a human being
The benefits foregone of the next best
alternative
A curve which shows the maximum potential
level of output of one good given a level of
output for all other goods in the economy
Resources which are limited in supply so that
choices have to be made about their use
Desires for the consumption of goods and
services
Output per unit of capital employed
Specialisation by workers
The inputs to the production process: land,
which is all natural resources; labour, which
is the workforce; capital, which is the stock
of manufactured resources used in the
production of goods and services;
enterprise, individuals seeking out profitable
opportunities for production and taking risks
in attempting to exploit these
Economic resources such as factories and
hospitals which are used to transform
working capital into goods and services
The value of the productive potential of an
individual or group of workers. It is made up
of the skills, talents, education and training
of an individual or group and represents the
value of future earnings and production
Output per worker
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Microeconomics
Market
Non-renewable Resources
Non-sustainable Resources
Primary Sector
Productivity
Profits
Renewable Resources
Secondary Sector
Specialisation
Stakeholders
Sustainable Resource
Tertiary Sector
Utility
Welfare
Working/Circulating Capital
Base Period
Index Number
Any convenient set of arrangements by
which buyers and sellers communicate to
exchange goods and services
Raw materials, such as coal or oil, which
once exploited cannot be replaced
Resources which are being economically
exploited in such a way that it is being
reduced over time
Extractive and agricultural industries
Output per unit of input employed
The reward to the owners of a business. It is
the difference between a firm’s revenues
and its costs
Raw materials, such as fish stocks or forests,
which can be exploited over and over again
because they have the potential to be
reproduced
Production of goods, mainly manufactured
A system of organisation where economic
units such as households or nations are not
self-sufficient but concentrate on producing
certain goods and services and trading the
surplus with others
Groups of people which have an interest in a
firm, such as shareholders, customers,
suppliers, workers, the local community and
government
Renewable resources which are being
economically exploited in such a way that
they will not diminish or run out
Production of services
The satisfaction derived from consuming a
good
The well-being of an economic agent or
group of economic agents
Resources which are in the production
system waiting to be transformed into goods
or other materials before being finally sold
to the consumer
The period, such as a year or a month, with
which all other values in a series are
compared
An indicator showing the relative value of
one number to another from a base of 100.
It is often used to present an average of a
number of statistics
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Nominal Values
Real Values
Ceteris Paribus
Equilibrium
Law
Normative Economics
Normative Statement
Partial And General Models
Positive Economics
Positive Statement
Static And Dynamic Models
The Scientific Method
Theory Or Model
Command Or Planned Economy
Economic System
Free-market Economy
Mixed Economy
Consumer Surplus
Values unadjusted for the effects of inflation
(i.e. values at current prices)
Values adjusted for the effects of inflation
(i.e. values at constant prices)
The assumption that all other variables
within the model remain constant whilst one
change is being considered
The point where what is expected or
planned is equal to what is realised or
actually happens
A theory or model which has been verified
by empirical evidence
The study and presentation of policy
prescriptions involving value judgements
about the way in which scarce resources are
allocated
A statement which cannot be supported or
refuted because it is a value judgement
A partial model is one with few variables
whilst a general model has many
The scientific or objective study of the
allocation of resources
A statement which can be supported or
refuted by evidence
A static model is one where time is not a
variable. In a dynamic model, time is a
variable explicit in the model
A method which subjects theories or
hypotheses to falsification by empirical
evidence
A hypothesis which is capable of refutation
by empirical evidence
An economic system where government,
through a planning process, allocates
resources in society
A complex network of individuals,
organisations and institutions and their
social and legal interrelationships
An economic system which resolves the
basic economic problem through the market
mechanism
An economy where both the free-market
mechanism and the government planning
process allocate significant proportions of
total resources
The difference between how much buyers
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Microeconomics
Demand Curve
Demand Or Effective Demand
Individual Demand Curve
Market Demand Curve
Shift In The Demand Curve
Individual Supply Curve
Market Supply Curve
Producer Surplus
Supply
Equilibrium Price
Excess Demand
Excess Supply
Market Clearing Price
Competitive Demand
Complement
Composite Demand
Derived Demand
Joint Demand
Joint Supply
are prepared to pay for a good and what
they actually pay
The line on a price-quantity diagram which
shows the level of effective demand at any
given price
The quantity purchased of a good at any
given price, given that other determinants of
demand remain unchanged
The demand curve for a single consumer,
firm or other economic unit
The sum of all individual demand curves
A movement of the whole demand curve to
the right or left of the original caused by a
change in any variable affecting demand
except price
The supply curve of a single producer
The supply curve of all producers within the
market. In a perfectly competitive market it
can be calculated by summing the supply
curves of individual producers
The difference between the market price
which firms receive and the price at which
they are prepared to supply
The quantity of goods that suppliers are
willing to sell at any given price over a period
of time
The price at which there is no tendency to
change because planned purchases (i.e.
demand) are equal to planned sales (i.e.
supply)
Where demand is greater than supply
Where supply is greater than demand
The price at which there is neither excess
demand nor excess supply but where
everything offered for sale is purchased
When two or more goods are substitutes for
each other
A good which is purchased with other goods
to satisfy a want
When a good is demanded for two or more
distinct uses
When the demand for one good is the result
of the demand for another good
When two or more complements are bought
together
When two or more goods are produced
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Microeconomics
Substitute
Elastic Demand
Inelastic Demand
Price Elasticity Of Demand
Unitary Inelasticity
Cross-price Elasticity Of Demand
Income Elasticity Of Demand
Price Elasticity Of Supply
Giffen Good
Income Effect
Inferior Good
together, so that a change in supply of one
good will necessarily change the supply of
the other good(s)
A good which can replace another to satisfy
a want
Where the price elasticity of demand is
greater than 1. The responsiveness of
demand is proportionally greater than the
change in price. Demand is infinitely elastic if
price elasticity of demand is infinity
Where the price elasticity of demand is less
than 1. The responsiveness of demand is
proportionally less than the change in price.
Demand is infinitely inelastic if price
elasticity of demand is zero
The proportionate response of changes in
quantity demanded to a proportionate
change in price
Where the value of price elasticity of
demand is 1. The responsiveness of demand
is proportionally equal to the change in price
A measure of the responsiveness of quantity
demanded of one good to a change in price
of another good. It is measured by dividing
the percentage change in quantity
demanded of one good by the percentage
change in price of the other good
A measure of the responsiveness of quantity
demanded to a change in income. It is
measured by dividing the percentage change
in quantity demanded by the percentage
change in income
A measure of the responsiveness of quantity
supplied to a change in price. It is measured
by dividing the percentage change in
quantity supplied by the percentage change
in price
A special type of inferior good where
demand increases when price increases
The impact on quantity demanded of a
change in price due to a change in
consumers’ real income which results from
this change in price
A good where demand falls when income
increases (i.e. it has a negative income
elasticity of demand)
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Microeconomics
Normal Good
Substitution Effect
Direct Tax
Indirect Tax
Specific Tax
Ad Valorem Tax
Subsidy
Allocative Or Economic Efficiency
Dynamic Efficiency
Market Failure
Externalities
Productive Efficiency
Static Efficiency
Technical Efficiency
External Costs
Private Costs
A good where demand increases when
income increases (i.e. it has a positive
income elasticity of demand)
The impact on quantity demanded due to a
change in price, assuming that consumers’
real incomes stay the same (i.e. the impact
of a change in price excluding the income
effect)
Levied directly to an individual or
organisation. Generally paid on incomes
Usually levied on the purchase of goods and
services. It represents a tax on expenditure
A type of indirect tax. It is charged as a fixed
amount per unit of a good. (Example: Excise
Tax)
Charged as a percentage of the price of a
good. (Example: VAT)
A grant provided by the government, to
encourage suppliers to increase production
of a good or service, leading to a fall in its
price
Occurs when resources are distributed in
such a way that no consumers could be
made better off without other consumers
becoming worse off
Occurs when resources are allocated
efficiently over time
Occurs when the price mechanism causes an
inefficient allocation of resources; the forces
of demand and supply lead to a net welfare
loss in society
Those costs or benefits which are external to
an exchange. They are third part effects
ignored by the price mechanism
Is achieved when production is achieved at
lowest cost
Occurs when resources are allocated
efficiently at a point in time
Is achieved when a given quantity of output
is produced with the minimum number of
inputs
May occur in the production and the
consumption of a good or service. (i.e.
pollution)
Costs internal to the firm, which it directly
pays for
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Microeconomics
Social Costs
By adding private costs to external costs we
obtain social costs
External Benefits
May occur in the production and
consumption of a good or service. (i.e.
recycling)
Private Benefits
The revenue that a firm obtains from selling
a good or service
Social Benefits
By adding private benefits to external
benefits
we obtain social benefits
Free Rider
A person or organisation which receives
benefits that others have paid for without
making any contribution themselves
Merit Good
A good which is underprovided by the
market mechanism. A demerit good is one
which is overprovided by the market
mechanism
Private Good
A good where consumption by one person
results in the good not being available for
consumption by another
Public Good Or Pure Public Good
A good where consumption by one person
does not reduce the amount available for
consumption by another person and where
once provided, all individuals benefit or
suffer whether they wish to or not
Quasi-public Good Or Non-pure Public Good A good which may not possess perfectly the
characteristics of being non-excludable but
which is non-rival
Commodities
Raw materials used in the production of
goods
Principal-agent Problem
Occurs when the goals of principals, those
standing to gain or lose from a decision, are
different from agents, those making
decisions on behalf of the principal
Symmetric Information
Where buyers and sellers have access to the
same information
Asymmetric Information
Where buyers and sellers have different
amounts of information
Buffer Stock Schemes
A scheme whereby an organisation buys and
sells in the open market so as to maintain a
minimum price in the market for a product
Government Failure
This occurs if government intervention leads
to a net welfare loss.
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Microeconomics
Notes
 Nearly all resources are scarce.
 Human wants are infinite.
 Scarce resources and infinite wants give rise to the basic economic problem –
resources have to be allocated between competing uses.
 Allocation involves choice and each choice has an opportunity cost.
 The production possibility frontier (PPF) shows the maximum potential output of an
economy.
 Production at a point inside the PPF indicates an inefficient use of resources.
 Growth in the economy will shift the PPF outwards.
 An economy is a social organisation through which decisions about what, how and
for whom to produce are made.
 The factors of production – land, labour, capital and enterprise – are combined
together to create goods and services for consumption.
 Specialisation and the division of labour give rise to large gains in productivity.
 The economy is divided into three sectors, primary, secondary and tertiary.
 Markets exist for buyers and sellers to exchange goods and services using barter or
money.
 The main actors in the economy, consumers, firms and government, have different
objectives. Consumers, for instance, wish to maximise their welfare whilst firms
might wish to maximise profit.
 Economic data are collected not only to verify or refute economic models but to
provide a basis for economic decision making.
 Data may be expressed at nominal (or current) prices or at real (or constant) prices.
Data expressed in real terms take into account the effects of inflation.
 Indices are used to simplify statistics and to express averages.
 Data can be presented in a variety of forms such as tables or graphs.
 All data should be interpreted with care given that data can be selected and
presented in a wide variety of ways.
 Positive economics deals with statements of ‘fact’ which can either be refuted or
supported. Normative economics deals with value judgements, often in the context
of policy recommendations.
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 Economics is the study of how groups of individuals make decisions about the
allocation of scarce resources.
 Economists build models and theories to explain economic interactions.
 Models and theories are simplifications of reality.
 Models can be distinguished according to whether they are static or dynamic,
equilibrium or disequilibrium, or partial or general.
 The function of any economic system is to resolve the basic economic problem.
 In a free market economy, resources are allocated through the spending decisions of
millions of different consumers and producers.
 Resource allocation occurs through the market mechanism. The market determines
what is to be produced, how it is to be produced and for whom production is to take
place.
 Government must exist to supply public goods, maintain a sound currency, provide a
legal framework within which markets can operate, and prevent the creation of
monopolies in markets.
 Free markets necessarily involve inequalities in society because incentives are
needed to make markets work.
 Free markets provide choice and there are incentives to innovate and for economies
to grow.
 In a mixed economy, a significant amount of resources are allocated both by
government through the planning mechanism, and by the private sector through the
market mechanism.
 The degree of mixing is a controversial issue. Some economists believe that too
much government spending reduces incentives and lowers economic growth, whilst
others argue that governments must prevent large inequalities arising in society and
that high taxation does not necessarily lead to low growth.
 Demand for a good is the quantity of goods or services that will be bought over a
period of time at any given price.
 Demand for a good will rise or fall if there are changes in factors such as incomes,
the price of other goods, tastes, and the size of the population.
 A change in price is shown by a movement along the demand curve.
 A change in any other variable affecting demand, such as income, is shown by a shift
in the demand curve.
 The market demand curve can be derived by horizontally summing all the individual
demand curves in the market.
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Microeconomics
 A rise in price leads to a rise in quantity supplied, shown by a movement along the
supply curve.
 A change in supply can be caused by factors such as a change in costs of production,
technology and the price of other goods. This results in a shift in the supply curve.
 The market supply curve in a perfectly competitive market is the sum of each firm’s
individual supply curves.
 The equilibrium or market clearing price is set where demand equals supply.
 Changes in demand and supply will lead to new equilibrium prices being set.
 A change in demand will lead to a shift in the demand curve, a movement along the
supply curve and a new equilibrium price.
 A change in supply will lead to a shift in the supply curve, a movement along the
demand curve and a new equilibrium price.
 Markets do not necessarily tend towards the equilibrium price.
 The equilibrium price is not necessarily the price which will lead to the greatest
economic efficiency or the greatest equity.
 Some goods are complements, in joint demand.
 Other goods are substitutes for each other, in competitive demand.
 Derived demand occurs when one good is demanded because it is needed for the
production of other goods or services.
 Composite demand and joint supply are two other ways in which markets are linked.
 Elasticity is a measure of the extent to which quantity responds to a change in a
variable which affects it, such as price or income.
 Price elasticity of demand measures the proportionate response of quantity
demanded to a proportionate change in price.
 Price elasticity of demand derives from zero, or infinitely elastic, to infinitely elastic.
 The value of price elasticity of demand is mainly determined by the availability of
substitutes and by time.
 Income elasticity of demand measures the proportionate response of quantity
demanded to a proportionate change in income.
 Cross elasticity of demand measures the proportionate response of quantity
demanded of one good to a proportionate change in price of another good.
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Microeconomics
 Price elasticity of supply measures the proportionate response of quantity supplied
to a proportionate change in price.
 The value of elasticity of supply is determined by the availability of substitutes and
by time factors.
 The price elasticity of demand for a good will determine whether a change in the
price of a good results in a change in expenditure on the good.
 An increase in income will lead to an increase in demand for normal goods but a fall
in demand for inferior goods.
 Normal goods have positive income elasticity whilst inferior goods have a negative
elasticity.
 A Giffen good is one where a rise in price leads to a rise in quantity demanded. This
occurs because the positive substitution effect of the price change is outweighed by
the negative income effect.
 Upward sloping demand curves may occur if the good is a Giffen good, if it has snob
or speculative appeal or if consumers judge quality by the price of a product.
 Indirect taxes can be either ad valorem taxes or specific taxes.
 The imposition of an indirect tax is likely to lead to a rise in the unit price of a good
which is less than the unit value of the tax.
 The incidence of indirect taxation is likely to fall on both consumer and producer.
 The incidence of tax will fall wholly on the consumer if demand is perfectly inelastic
or supply is perfectly elastic.
 The incidence of tax will fall wholly on the producer if demand is perfectly elastic or
supply is perfectly inelastic.
 The labour market is a factor market where the price of labour is the wage rate and
the quantity is the level of employment.
 Labour is a derived demand.
 One of the determinants of the demand for and supply of labour is the wage rate
paid.
 Other determinants of the demand for labour include the price of other factors of
production and demand for the good being made.
 Other determinants of the supply of labour include population migration, income tax
and benefits, trade unions and government regulations such as the national
minimum wage.
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Microeconomics
 Economic theory suggests that trade unions, high levels of the minimum wage and
high marginal rates of income tax will reduce employment levels, but economists
disagree about how much impact these will have on employment.
 The market is a mechanism for the allocation of resources.
 In a free market, consumers, producers and owners of the factors of production
interact, each seeking to maximise their returns.
 Prices have three main functions in allocating resources. These are the rationing,
signalling and incentive functions.
 If firms cannot make enough profit from the production of a good, the resources
they use will be reallocated to more profitable uses.
 Static efficiency refers to efficiency at a point in time. Dynamic efficiency concerns
how resources are allocated over time so as to promote technical progress and
economic growth.
 Productive efficiency exists when production is achieved at lowest cost.
 Allocative efficiency is concerned with whether resources are used to produce the
goods and services that consumers wish to buy.
 All points on an economy’s production possibility frontier are both productively and
allocatively efficient.
 Free markets tend to lead to efficiency.
 Market failure occurs when markets do not function efficiently. Sources of market
failure include lack of competition in a market, externalities, missing markets,
information failure, factor immobility and inequality.
 Externalities are created when social costs and benefits differ from private costs and
benefits.
 The greater the externality, the greater the likelihood of market failure.
 Market failure occurs when marginal social cost and marginal social benefit are not
equal at the level of output shown by the ‘welfare triangle’ on a marginal social and
private cost and benefit diagram.
 Governments can use regulation, the extension of property rights, taxation and
permits to reduce the market failure caused by externalities.
 There will inevitably be market failure in a pure free market economy because it will
fail to provide public goods.
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 Public goods must be provided by the state because of the free rider problem
 Merit goods are goods which are underprovided by the market mechanism, for
instance because there are significant positive externalities in consumption.
 Governments can intervene to ensure provision of public and merit goods through
direct provision, subsidies or regulation.
 Two types of immobility of labour are geographical immobility and occupational
immobility.
 Structural unemployment arises because of the immobility of labour.
 Governments use a variety of policies to tackle the problems associated with
immobility including education and training, relocation subsidies and regional policy.
 Market failure may be caused by asymmetric information in a market.
 Principal-agent problems, adverse selection and moral hazard all occur because of
asymmetric information in markets such as health care, pensions, education and
tobacco and alcohol.
 The price of a good may be too high, too low or fluctuate too greatly to bring about
an efficient allocation of resources.
 Governments may impose maximum or minimum prices to regulate a market.
 Maximum prices can create shortages and black markets.
 Minimum prices can lead to excess supply and tend to be maintained only at the
expense of the taxpayer.
 Prices of commodities and agricultural products tend to fluctuate more widely than
the prices of manufactures goods and services.
 Buffer stock schemes attempt to even out fluctuations in price by buying produce
when prices are low and selling when prices are high.
 Government failure can be caused by inadequate information, conflicting objectives,
administrative costs and creation of market distortions.
 Public choice theory suggests that governments may not always act to maximise the
welfare of society because politicians may act to maximise their own welfare.
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