Business Economics GlossaryConcept Glossary EntryAbnormal 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 entryAgency problem Possible conflicts of interest that may result between the shareholders (principal) and the management (agent) of a firmAnti-competitive behaviour Strategies designed to limit the degree of competition inside a marketAsymmetric information Where different parties have unequal access to information in a marketAverage cost Total cost per unit of output = Total cost / output = TC/QAverage 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 maximizationAverage fixed cost Total fixed cost per unit of output = TFC/QAverage revenue Total revenue per unit of outputAverage variable cost Total variable cost per unit of output = TVC/QBackward vertical Acquiring a business operating earlier in the supply chain – e.g. a retailer buys a wholesaler, aintegration brewer buys a hop farmBarriers 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 firmsBehavioural economics Research that adds elements of psychology to traditional models in an attempt to better understand decision-making by investors, consumers and other economic participantsBi-lateral monopoly Where a monopsony buyer faces a monopsony seller in a marketBrand extension Adding a new product to an existing branded group of productsBrand loyalty The degree to which people regularly buy a particular brand and refuse to or are reluctant to change to other brandsBreak-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 generalCapacity The amount that can be produced by a plant, company, or economy (industrial capacity) 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 labourCartel An association of businesses or countries that collude to influence production levels and thus the market price of a particular productCollusion 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 / duopolyCompetition Commission Body that conducts in-depth inquiries into mergers, markets and the regulation of the major regulated industries such as water, electricity and gasCompetition Policy Policy which seeks to promote competition and efficiency in different markets and industriesCompetitive advantage When a company has an advantage over another in the provision of a particular product or serviceComplex 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 marketConcentration ratio Measures the proportion of an industrys 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 itConsolidation 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 processConsumer surplus The difference between the total amount that consumers are willing and able to pay for a good or service 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. The crucial assumption for contestability is that businesses are free to enter and leave the marketCooperative outcome An equilibrium in a game where the players agree to cooperateCorporate governance Practices, principles and values that guide a firm and its activitiesCorporate strategy A companys aims in general, and the way it hopes to achieve them - strategic objective which supports the achievement of corporative aimsCost synergies Cost synergies are the cost savings that a buyer aims to achieve as a result of taking over or merging with another businessCost-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 demandCost-reducing innovations Cost reducing innovations have the effect of causing an outward shift in market supply. They provide the scope for businesses to enjoy higher profit margins with a given level of demandCountervailing power When the market power of a monopolistic/oligopolistic seller is offset by powerful buyers who can prevent the price from being pushed upCreative destruction First introduced by the Austrian School economist 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 threatCredit Union Financial co-operatives owned and controlled by their members offering banking productsCross-subsidy A cross subsidy uses profits from one line of business to finance losses in another line of business nd e.g. Royal Mail and 2 class lettersDeadweight loss Loss in producer & consumer surplus due to an inefficient level of productionDe-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 branchesDe-merger The hiving off of one or more business units from a group so that they can operate as independently managed concernsDeregulation The opening up of markets to competition by reducing statutory barriers to entry. The aim is to increase market supply, stimulate competition and innovation and drive prices down for final consumersDiseconomies of scale A business may expand beyond the optimal size in the long run and experience diseconomies of(internal) scale. This leads to rising LRAC. For example, a firm increases all inputs by 300 %, its output increases by 200%.Dis-synergies Dis-synergies are negative or adverse effects of a takeover or merger. These are the disruptions that arise from the deal which result additional costs or lower than expected revenuesDiversification Increasing the range of products or markets served by a business. The extent of diversification depends on the extent to which those products or markets are different from the existing products and markets served by the business.Divorce between The owners of a company normally elect a board of directors to control the business’s resourcesownership and control for them. However, when the owner of a company sells shares, or takes out a loan to raise finance, they sacrifice some of their controlDominant market position A firm holds a dominant position if it can operate within the market without taking full account of the reaction of its competitors or final consumersDominant 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 useDue 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 buyDuopoly Any market that is dominated by two suppliers. Proctor & Gamble and Unilever took 84 per cent of the UK market liquidi detergent sales in 2005Duopsony 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 marketEconomic risk The risk that a company may be disadvantaged by exchange rate movements or regulatory changes in the country in which it is operatingEconomies 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 productsEnlightened self interest Acting in a way that is costly or inconvenient at present, but which is in one’s best interest in the long term. E.g. firms accepting some short term costs (lower profits) in return for long-term gainsEquilibrium output A monopolist is assumed to profit maximise, in other words, aims to achieve an output equal to the point where MC=MRExcess 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 skilfulExternal diseconomies of When the growth of an industry leads to higher costs for businesses that are part of that industryscale – for example, increased traffic congestionExternal economies of When the expansion of an industry leads to the development of ancillary services which benefitscale suppliers 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 establishedFirst mover advantage The idea that a business that creates a new product and which is first into the market can develop a competitive advantage perhaps through learning by doing - making it more difficult and costly for new firms to come inFixed cost Business expenses that do not vary directly with the level of outputForward vertical Acquiring a business further up the supply chain – e.g. a vehicle manufacturer buys a car partsintegration distributorFranchised monopoly When the government grants a company the exclusive right to sell or manufacture a product or service in a particular areaFreemium Business model in which some basic services are provided for free, with the aim of enticing users to pay for additional, premium features or contentGame 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 competition When a business enters an industry to take advantage of temporarily high (supernormal) market 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 processHostile takeover A takeover that is not supported by the management of the company being acquired - as opposed to a friendly takeoverInnovation Making changes to something established. Invention, by contrast, is the act of coming upon or finding. Innovation is the creation of new intellectual assetsInnovation-diffusion The extent and pace at which a market adopts new products, or improved versions of existing productsInterdependence When the actions of one firm has an effect on competitors. 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 businessesInventories Inventory is a list for goods and materials, or those goods and materials themselves, held available in stock by a businessJoint-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 variableLaissez-faire A doctrine that a Government should not interfere with actions of business and marketsLast mover advantage The advantage a company gains by being one of the last to sell a product or provide a service, when technology has improved and costs are very lowLight-touch regulation An approach of government to managing business behaviour - prefers to “influence” rather than “legislate/regulate” Carrot or stick?Limit pricing When a firm sets price low enough to discourage new entrants into the marketMarginal cost The change in total costs from increasing output by one extra unitMarginal 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 = £6Marginal revenue The change in total revenue from selling one extra unit of outputMerger 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 culturesMetcalfe’s Law Coined by Robert Metcalfe, Metcalfes 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 scaleMinimum efficient scale Scale of production where internal economies of scale have been fully exploited. Corresponds to the lowest point on the long run average cost curveMonopolistic competition Competition between companies whose products are similar but sufficiently differentiated to allow each to benefit from monopoly pricing. A market structure characterized by many buyers and sellers of slightly different products and easy entry to, and exit from, the industry. Firms have differentiated products and therefore the demand is not perfectly elasticMonopoly 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 competitorsMonopsony 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 surviveMoral Hazard When someone pays for your accidents and problems, you may be inclined to take less effort to avoid accidents and problemsMultinational A company with subsidiaries or manufacturing bases in several countriesMutual interdependence The relationship between oligopolists, in which the actions of each business affect the other businessesNash Equilibrium An idea in game theory - any situation where all of the participants in a game are pursuing their best possible strategy given the strategies of all of the other participants. 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 ANationalization When a government takes over a private sector companyNatural 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 availableNGO Non-governmental organization (e.g. WWF, Greenpeace)Non-price competition Competing not 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 curveOligopoly 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 structureOptimal 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 marketPareto 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.Patent Right under law to produce and market a good for a specified period of timePaywall Blocking access to a website which is only available to paying subscribersPeak 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 timesPenetration pricing A pricing policy used to enter a new market, usually by setting a very low pricePerfect competition 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 discrimination When a firm separates the whole market into each individual consumer and charges them the 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. When predatory pricing is happening it is likely than Price <Average Cost in the short run, but in the long run there will be a rise in prices as competition is reduced.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 powerPrice ceiling Law that sets or limits the price to be charged for a particular goodPrice discrimination When a firm charges a different price to different groups of consumers for an identical good or service, for reasons not associated with costsPrice 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 monopolyPrice 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 firmPrice regulation Government control of prices, normally for utilities and other essential servicesPrisoners’ 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 strictly 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 returnPrivate Finance Initiative The PFI is a means of obtaining private funds for public sector projectsPrivatization The sale of state-owned companies to the private sector, normally through a stock market listing. The opposite of nationalizationProcurement collusion Where companies illegally bid for large contracts by rigging bids to decide which one of them 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. Shown by the area above the supply curve and below the market priceProduct differentiation When a business seeks to distinguish what are essentially the same products from one another 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 employsProductivity How much is produced per unit of input. Labour productivity, for instance, can be calculated per worker, per hour worked, etc. Capital productivity is similar to calculating a return from an investmentProfit 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 costsProfit maximization Profit maximization occurs when marginal cost = marginal revenueProfit 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 elasticPublic utility A company that provides public services, such as power, water and telecommunications. Regulated by government, not necessarily state-ownedRegulated industry An industry that is closely controlled by the governmentRegulatory capture When industries under the control of a regulatory body appear to operate in favour of the vested interest of monopoly producers rather than consumersRent seeking behaviour Behaviour by producers in a market that improves the welfare of one but at the expense of another. A feature of monopoly and oligopolyRetained profit Profit retained by a business for its own use and which is not paid back to the company’s shareholders or paid in taxation to the governmentRevenue maximization Revenue maximization is an output when marginal revenue = zero (MR=0)Revenue synergies The ability to sell more or raise prices after a merger e.g. marketing and selling complementary products; cross-selling into a new customer base and sharing distribution channels.RPI-X Pricing Formula This encourages efficiency within regulated businesses by taking the retail price index as a benchmark for the 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 buySecond degree price Businesses selling off packages of a product deemed to be surplus capacity at lower prices thandiscrimination the previously published/advertised price – also volume discountsShareholder return Total return (dividends + increases in business value) for shareholdersShort 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 energyShort-termism When a business pursues the goal of maximizing short-term profits because of a fear of being taken-over or having the stock market mark down the value of the company. Short-termism may make it difficult for a business to follow longer-term objectivesShut 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 planetSocial reporting Accounting for, and formally reporting the social & environmental impacts of a firms actions to all relevant stakeholdersSocially responsible Also known as ethical investing; shareholders pursuing investment strategies which seeks toinvesting maximize both financial return and social goodSpare capacity Spare, surplus or excess capacity is the difference between current output (utilized capacity) and what can be produced at full capacityStakeholder Any party that is committed, financially or otherwise, to a company and is therefore affected by its performance. This would normally include shareholders, employees, management, customers and suppliers. Their interests do not always coincideStakeholder 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 satisficingStatic efficiency How much output can be produced now from given resources, and whether producers charge a price to consumers that reflects fairly the cost of the factors used to produce a productStrategic behaviour Decisions that take into account the market power and reactions of other firmsSub-normal profit Any profit less than normal profitSunk 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 costSynergy When the whole is greater than the sum of the individual partsTacit 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. When firms co-operate but not formally, e.g. price leadership, or quiet or implied co-operation, secret, unspoken cooperationTakeover 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 high quality goods. When measuring the technical efficiency of a machine, the production costs are not considered importantTotal cost Total cost = total fixed cost + total variable costTotal 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 = zeroVariable cost Variable costs are business costs that vary directly with output since more variable inputs are required to increase output. Also known as prime costsVertical integration Vertical Integration involves acquiring a business in the same industry but at different stages of the supply chainWelfare economics Study of how an economy can best allocate scarce resources to maximise welfareWhistle blowing When one or more agents in a collusive agreement report it to the authoritiesX-inefficiency A lack of real competition may give a monopolist less of an incentive to invest in new ideas or consider consumer welfareZero-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