100 ECONOMIC TERMS

100 ECONOMIC TERMS
Scarcity
the limited nature of society's resources
Economics
the study of how society manages its scarce resources
Efficiency
the property of society getting the most it can from its scarce resources
Equity
the property of distributing economic prosperity fairly among the members of society
Opportunity cost
whatever must be given up to obtain some item
Market economy
an economy that allocates resources through the decentralized decisions of many firms and
households as they interact in markets for goods and services
Externality
the impact of one person's actions on the well being of a bystander
Inflation
an increase in the overall level of prices in the economy
Phillips curve
a curve that shows the short run tradeoff between inflation and unemployment
Business cycle
fluctuations in economic activity, such as employment and production
Circular flow diagram
a visual model of the economy that shows how dollars flow through markets and firms
Production possibilities curve
a graph that show the combinations of output that the economy can possibly produce given
the available factors of production and the available production technology
Microeconomics
the study of how households and firms make decisions and how they interact in markets
Macroeconomics
the study of economy wide phenomena, including inflation, unemployment, and economic
growth
Positive statements
claims that attempt to describe the world as it is
Normative statements
claims that attempt to prescribe how the world should be
Interdependence
a reciprocal relation between interdependent entities
Specialization
to focus on a particular area
Absolute advantage
the comparison among producers of a good according to their productivity
Comparative advantage
the comparison among producers according to their opportunity cost
Imports
goods produced abroad and sold domestically
Exports
goods produced domestically and sold abroad
Law of demand
the claim that, other things equal, the quantity demanded of a good falls when the price of
the good rises
Normal good
a good for which, other things equal, an increase in income leads to an increase in demand
Inferior good
a good for which, other things equal, an increase in income leads to a decrease in demand
Substitutes
two goods for which an increase in the price of one good leads to an increase in the demand
for the other good
Complements
two goods for which an increase in the price of one good leads to a decrease in the demand
for the other good
Law of supply
the claim that, other things equal, the quantity supplied of a good rises when the price of the
good rises
Equilibrium
a situation in which the price has reached the level where quantity demanded equals
quantity supplied
Surplus
a situation in which quantity supplied is greater than quantity demanded
Shortage
a situation in which quantity demanded is greater than quantity supplied
Adam Smith
Scottish political economist and moral philosopher. His inquiry into the Nature and Causes
of the Wealth of Nations was one of the earliest attempts to study the historical
development of industry and commerce in Europe. That work helped to create the modern
academic discipline of economics and provided one of the best known intellectual
rationales for free trade and capitalism
John Maynard Keynes
an English economist, whose radical ideas had a major impact on modern economic and
political theory as well as Franklin D. Roosevelt's New Deal. He is particularly
remembered for advocating interventionist government policy, by which the government
would use fiscal and monetary measures to aim to mitigate the adverse effects of economic
recessions, depressions, and booms. He is considered to be the founder of macroeconomics
.
Elasticity
a measure of the responsiveness of quantity demanded or quantity supplied to one of its
determinants
Price elasticity of demand
a measure of how much the quantity demand of a good responds to a change in the price of
that good, computed as the percentage change in quantity demanded divided by the
percentage change in price
Income elasticity of demand
a measure of how much the quantity demanded of a good responds too a change in
consumer's income, computed as the percentage change in quantity demanded divided by
the percentage change in income
Cross price elasticity of demand
a measure of how much the quantity demanded of one goods responds to a change in price
of another good, computed as the parentage change in quantity demanded of one good
divided by the percentage change in price of the second good
Price elasticity of supply
a measure of how much the quantity supplied of a good responds to a change in the price of
that good, computed as the percentage change in quantity supplied divided by the
percentage change in price
Price ceiling
a legal maximum on the price at which a good can be sold
Price floor
a legal minimum on the price at which a good can be sold
Tax incidence
the manner in which the burden of a tax is shared among participants in a market
Welfare economics
the study of how the allocation of resources affects economic well being
Consumer surplus
a buyer's willingness to pay minus the amount the buyer actually pays
Producer surplus
the amount a seller is paid for a good minus the seller's cost
Cost
the value of everything a seller must give up to produce a good
Deadweight loss
the fall in total surplus that results from a market distortion, such as a tax
Laffer Curve
a curved graph that illustrates the theory that, if tax rates rise beyond a certain level, they
discourage economic growth, thereby reducing government revenues
Supply side economics
the branch of economics that concentrates on measures to increase output of goods and
services in the long run. The basis is that marginal tax rates should be reduced to provide
incentives to supply additional labor and capital, and thereby promote long term growth.
Tariff
a tax on goods produced abroad and sold domestically
Import quota
a limit on the quantity of a good that can be produced abroad and sold domestically
Coase theorem
the proposition that if private parties can bargain without cost over the allocation of
resources, they can solve the problem of externalities on their own
Pigovian tax
a tax enacted to correct the effects of a negative externality
Private goods
goods that are both excludable and rival
Public goods
goods that are neither excludable nor rival
Free rider
a person who receives the benefits of a good but avoids paying for it
Budget surplus
an excess of government receipts over government spending
Budget deficit
a shortfall of tax revenue from government spending
Average tax rate
total taxes paid divided by total income
Marginal tax rate
the extra taxes paid on an additional dollar of income
Lump sum tax
a tax that is the same amount for every person
Proportional tax
a tax for which higher income taxpayers and low income taxpayers pay the same fraction of
income
Regressive tax
a tax for which higher income tax payers pay a smaller fraction of their tax than do lower
income tax payers
Progressive tax
a tax for which higher income taxpayers pay a larger portion of their tax than do lower
income tax payers
Total revenue
the amount paid by buyers and received by sellers of a good, computed as the price of the
good times the quantity sold
Total cost
the value of the inputs a firm uses in production
Profit
total revenue minus total cost
Explicit costs
input costs that require an outlay of money by the firm
Implicit costs
input costs that no not require the outlay of money by the firm
Economic profit
total revenue minus total cost including explicit and implicit costs
Accounting profit
total revenue minus explicit cost
Production function
the relationship between quantities of inputs used to make a good and the quantity of output
of that good
Marginal product
the increase in output that arises from an additional unit of input
Diminishing marginal product
the property whereby the marginal product of an input declines as the quantity of the input
increases
Fixed costs
costs that do not vary with the quantity of output produced
Variable cost
costs that vary with the quantity of output produced
Average total cost
total cost divided by the quantity of output
Average fixed cost
fixed costs divided by the quantity of output
Average variable cost
variable costs divided by the quantity of output
Marginal cost
an increase in total cost that arises from an extra unit of production
Efficient scale
the quantity of input that minimizes average total cost
Economies of scale
the property whereby long run average total cost falls as the quantity of output increases
Diseconomies of scale
the property whereby long run average total cost rises as the quantity of output increases
Constant return to scale
the property whereby long run average total cost stays the same as the quantity of output
changes
Competitive market
a market with buyers and sellers trading identical products so that each buyer and seller is a
price taker
Average revenue
total revenue divided by the quantity sold
Marginal revenue
the change in total revenue from an additional unit sold
Sunk cost
a cost that has already been committed and cannot be recovered
Natural Monopoly
a firm that arises because a single firm can supply a good of service to an entire market at a
smaller cost than could two or more firms
Price discrimination
the business practice of selling the same good at different prices to different customers
Oligopoly
a market structure in which only a few sellers offer similar or identical products
Monopolistic completion
a market structure in which many firms sell products that similar but not identical
Collusion
an agreement among firms in a market about quantities to produce or prices to charge
Cartel
a group of firms acting in unison
Nash equilibrium
a situation in which economic actors interaction with one another each choose their best
strategy given the strategies that all the other actors have chosen
Game theory
the study of how people behave in strategic situations
Factors of production
the inputs used to produce goods and services
Lorenz Curve
a curve showing the distribution of income in an economy. The cumulated percentage of
families (income receivers) is measured along the horizontal axis and the cumulated
percentage of income is measured along the vertical axis
Capital
the equipment and structures used to produce goods and services
Monopoly
a firm that is the sole seller of a product without close substitutes
Marginal Product of Labor
the increase in the amount of output from an additional unit of labor
BASIC TERMS OF ECONOMICS
Significance
Something difficult is neither easy nor impossible. It requires skills,
effort, attention, but still the result is not guaranteed.
"Difficulty" is a key concept for a new economics, because mainstream
neoclassical economics distiguishes only what feasible from what
impossible, without allowing this intermediate category so relevant in
reality.
People face difficult tasks, thus have to cope with them by learning,
technology, social networking, etc. To a large extent, the fact that
acquiring information, elaborating it, delivering a proposal that matches
conflicting criteria are all difficult tasks constitutes the rationale for
bounded rationality and its simplifying routines.
In neoclassical perspective, everything can be bought. Difficulty would
be reduced to the cost of overwhelming it. But difficulty cannot be
overwhelmed by purchase: money does not make a normal person
understanding high mathematics, whatever the effort.
You need innate talent, skills, a peculiar personal history; to
acquire skills you need priceless time in non-outsourcable exercise and
there is no guarantee that you will succeed: you may spend you life in
trying to jump higher than the world champion but never achieve this.
In certain situations, certain people can have a pleasure in drilling and
learning more and more difficult things. However most of the people
most of the time prefer to take it easy, being also more sure of the
result.
Not only individuals face difficult tasks; also firms encounter difficulties in
management, they can fail to achieve their objectives and to
implement their choices.
In another vein, there is an important relation between difficulty and motivation. A slightly
more difficult task than the present skill level would guarantee is particularly motivating:
too easy or impossible tasks are less motivating that challenging tasks.
Determinants
A task is difficult because of its in-built structure. In certain cases, the
difficulty is imbedded in one key component of what has to be
performed. However a rising number of difficult components makes
the overall task more and more difficult.
Difficulty would be particularly high when the task is complex and
cannot be performed by solving successively several elementary
components.
By comparing the in-built structure with the skills of the people trying to
perform, one can say that a difficult task requires high, specific,
and rare skills.
As a general analogy, you may think at what happens in climbing
mountains. Indeed, there is a recognised system of classification of the
degreed of difficulty of a mountain path, based on many factors such as
the the kind of the rock, the degree of vertical inclination, the length,
the presence or absence of natural aids, etc.
For more intellectual tasks, take the example of memory. Words that are
easy to remember remain short and well connected to others, whereas
difficult ones have long and unusual pattern.
"A-A" is easier to remember than "assatmani", while
"afsdfindlfasdfinklkdfafpollibnlknkfadfsdffs" might be impossible if you
are not given enough time and incentives and you do not device some
method / technique / technology.
More in general, a proper technology can sometimes help in overwhelming difficulty.
The lack of it makes the task difficult or impossible. Thus innovation should be understood
as the attempt of overcoming difficulties.
In some cases, what's important is the level of skill in a vertical scale (low, medium,
high,...). In this cases, you may expect learning being important in improving the skills of
the potential user, from early childhood context to broad and narrowed-focused teaching.
Repetition of the task, imitation of good performace (maybe under rallenty) and
explanations for failures might help.
In other cases, what matters is the presence of a specialised skill: a Chinese ideogram is
difficult to remember and reproduce to almost everybody, but not to a Chinese person (an
example of horizontal differentiation of skills).
In still other cases, skills are useless. Let's imagine that in an experiment you are asked to
remember what they show you for a short while. A square is easy to remember, an irregular
shape cannot be reproduced exactly, independently from whom you are.
Impact on other variables
The degree of difficulty influences the rate of failure, the good quality of the result, the
speed of the execution. When difficulty is high, there is a high rate of failure, the result
tends to be poor and the execution lengthy.
The degree of difficulty impacts the time and the cost of learning, with long period with
highly skilled teachers being required if difficulty is high.
However you are not granted that you can overcome the difficulty by paying only: you
need to engage yourself, make use of your general and idiosyncratic skills, have some
luck. All this in larger amounts the more difficult the task.
As a consequence, the number of people / organisations / agents able to perform that task
depends on the degree of difficulty. High difficulty is associated to a low number of
successful agents.
The relevance for the consumer theory
There are four main areas of consumer theory that are influenced by the
notion of "difficulty":
1. The elaboration of information used to choose the good to buy
2. The technical difficulty to use the good as an additional constraint to
the choice
3. The non-exhaustion of budget as a prudential rule
4. The choice at prices near the reserve prices
5. Preference building processes.
Sub 1. Experiments with real consumers have shown widespread difficulties in
memorising prices, brands, and features of goods. This means that comparisons among
potential substitutes are usually limited to what is exposed in the current point of sale, with
some simple heuristics used to postpone purchase if strongly disappointed by its supply.
People tend to remember just few brands for each category of goods (e.g. biscuits or
toothpaste), with a large group of consumers trusting only those brands, so that new
entrants have a strong barrier to overcome.
The comparison of goods with respect to their features is difficult, so attention is
concentrated on one (or few) most important features (lexicographic rule) or avoided
through sequential choice (one version is tested against certain minimal thresholds in a set
of features; if it passes the test it is bought without looking for another; if it does not pass
the test a further version is tested, and so on) or coped with through other heuristics, as in
this model of ours.
When the consumer does compare different versions, then it may be faced with a truly
"difficult choice" if each version has defects and unpleasant sides.
Sub 2. If a good is technically or socially difficult to use as well as it
requires a high level of specialised expertise, many consumer would
renounce to buy it, even if they need it and would like to buy it. The
distribution of the skills of the consumer (and socially acceptable
behaviours) becomes a further constraint to the diffusion of goods,
especially of innovative ones.
This also implies important inertia and lock-in phenomena against
superior but non-standard solutions in favour of older products (as in
the famous case of Dvorak and QWERTY keyboards for writing
machines).
In other words, the utility that neoclassical theory attributes to goods is
in the real world dependent on actions taken which make use of those
goods, with the skills of the performer being an important determinant
of the final outcome. The performer is commonly the consumer himself,
but can well be a third person (be paid or not), so the too-simple
mapping of preferences over a Cartesian space of good quantities
(indifference curves) is too weak to grasp significant features of realworld decision-making.
Sub 3. Contrary to timeless neoclassical theory of consumer choice, the consumer takes
decisions over time (real days, real weeks, real months,...). He never exhausts the budget, as
the neoclassical consumer does by choosing a bundle on the budget line, because he wants
to keep room for further purchases, planned and unplanned.
If an expenditure is planned, small, corresponding to highly valued
needs, it will be easily carried out. If abruptly a large expenditure
proposal arise, which is clearly unnecessary, maybe even in contrast to
other's opinion, the consumer will have difficulties in making up his
mind. He may be tempted to postpone the choice.
Sub 4. In many cases, the consumer a priori decides a maximum price
he is willing to pay for satisfying a certain need. This price is called his
"reserve price".
This, often implicit, practice can be easily introduced in formal models of
consumer behaviour, as this. If the price of the good is near the reserve
price, the modeller might use - to forecast purchasing - a probability
distribution of purchasing instead of the deterministic rule of 100%
purchase below the reserve price and 0% of probabilty of purchase
above it that we used in the first version of this model.
Sub 5. People prefer goods and services presented at and exhibiting the
"proper" level of difficulties. Newbies prefer easy things, masters prefer
difficult things. Little babies tend their arm towards things in front of
their eyes and easy to grasp; later on, they notice new things passing
by quickly and hidden, rotating their heads and discarding what they
have in front to get what they noticed. From difficulty degree to
preference: this is a new insight in consumer theory, as we abandon the
neoclassical assumption of preferences as "given" (from where? by
whom? through which process?). It's because a good has the "right"
level of difficulty that it appeal to the consumer.
The relevance for the firm theory
Production is difficult. It requires a vast array of technical and non-technical
competences which are difficult to acquire, coordinate, maintain, improve. These
competences are embedded in organizational routines performed by real people making
use of material and immaterial assets, capital goods, territorial landscape, social networks.
These resources are not necessarily for sale; this limits the number of firms operating in a
market because entrants may not own the "know-how" to properly produce. Their money
may not be sufficient for "purchasing" skills because some skills are simply not on the
market.
It's true that they can try to imitate the incumbents, but imitation is usually difficult, i.e.
costly, long, and with no guarantee of success. Entrants can try to leverage their own
knowledge base in other sectors and make an effort in Research & Development in order to
innovate current practices, but again R&D is difficult and not available to everyone.
Imagine that you would like to enter the market of craftmade pottery; you need training but
you still have no guarantee that you will succeed. Imagine the difficulty for a new
unexperienced firm to build a dam. Who would give it the permission to experiment,
putting at risk people in the valley?
Contrary to the neoclassical approach based on isoquants, productive tasks do not neatly fit
into the dychotomous categories of "feasible" and "not-feasible": they are "difficult"!
In other words, the competence-based theory of the firm, whose importance is rising in the
battlefield of ideas, clearly assumes that production is difficult and that only firms with a
sound competence can carry out it. Accordingly, maintaining and nurturing core
competences and strategically complementary competences become keys to business
success.
Given this assumption, industries can be judged in reference to the digree of difficulty they
present. If production is comparatively easy, the competences needed might be owned by a
fairly large number of firms (or to acquire them may be relatively easy for new entrants).
Without other barriers, the industry will probably comprehend many small firms, especially
if there are not many possibilities for "best performers" to differentiate from the rest. On the
contrary, if production is highly difficult (e.g. it requires a widely differentiated body of
formal and non-formal knowledge), then just few firms could put together the necessary
skills.
Industrial concentration thus can be traced back, among other factors, to the degree of
difficulty in production, innovation, imitation.
In another vein, if several firms have different skills to produce a difficult product, their
supply will be vertically differentiated, with highly skilled firms producing better versions
of the product.
The relevance for the labour market
High difficulty is associated to a low number of successful agents. This has important
consequences for wages: jobplaces with easy tasks, requiring very broadly available skills,
are usually paid less than jobplaces with difficult tasks, where only few can succeed. The
latter have a higher bargaining power with respect to the firm. All this is true irrespective of
the profits the overall combination of tasks leads to products sold on the market.
Indeed, contrary to the neoclassical theory of wages being determined by marginal
productivity of the individual worker, it is usually impossible to discern the contribution of
each worker to the final product, because the outcome depends on team-work and
coordination, and even less so to profits (which are determined by much more than just
physical productivity).
Since difficulty is an important determinant of wages, the workers have an interest in
increasing the difficulty of the tasks (and to increase and differentiate their skills), whereas
the firms prefer innovations that homogenize tasks and labourforce. This tension impact the
technological trajectories, backed by R&D and product innnovation.
Difficulty vs. risk
"Difficulty" should not be confused with "risk", although both have to do with probabilities.
Something can be risky but not difficult: gambling is risky but require no skills (it's exactly
because non-skilled person can earn a lot of money by betting that roulette gambling is so
appealing to them). Conversely, a master can manage even difficult tasks without any risk
of failing.
How to formalise difficulty
Evolutionary economics presents many formalised agent-based models in the form of
computer simulation. Essentially, a simulation is computer code embracing several
algorithms. Each algorithm has a role, as for instance to determine whether a firm obtains
an innovation or not.
When a role requires the expression of a certain degree of difficulty, five basic elements
should be in place:
1. a level of skill;
2. a success level;
3. an "effort" component, usually costly (sometimes coupled with an "attention"
component, usually free but scarce);
4. a first random draw to determine whether success is reached or not.
5. a second random draw, contingent on success, to determine the quality of the result.
If the degree of difficulty is very low for everybody, the success level is very low and the
random draw would exhibit a large probability of success, even for low level of effort. If
the degree of difficulty is low for skilled-enough agents, then the success level is very near
to the level of their skill.
Coherently with these settings of low difficulty, the second random draw would lead to
good quality results with high probability.
On the other extreme, to express an overall high livel of difficulty, the level of success is
set very high, with probability zero to be reached from low levels of skill and with
requiring high level of effort even from more skilled agents to get a significant probability
of success. In the (unguarantee) case of success, the quality of the results again might have
a distribution of probability skewed to the left, with most random draws falling at low level
of quality.
Formalising difficulty in this way allows, however, many intermediate and mixed cases. In
particular, it allows for skills to be important or not.
In case of success, it is possible (but not necessary) a feedback on the level of skill
(learning). An independent algorithm for learning (e.g. with imitation or explicity taking
"lessons" from a teacher) might be also in place.
This algorith can be extended to cover more of our earlier discussion. In particular, a
number of horizontally differentiated skills could be introduced (e.g. the foreign languages
known by the worker).
More in general, any routine of bounded rational agents is somehow an answer to the
difficulty of the task.
Empirical scales of degree of difficulty
In practice, there exist categorial scales of difficulty based on the skill level requested to
address them. A simple scale distinguishes three levels: Beginner, Intermediate, Advanced.
Tasks characterised by these levels can be described with the following keywords:
Beginner - quick, easy, little to no experience, basic, straight, very little equipment
requested;
Intermediate - some very basic skills, very basic understanding of technical terms,
challenging to someone with no experience;
Advanced - for people with good grasp of the subject, experienced, good supply of
equipment, a fair understanding of how to use this equipment.
A more refined scale would include sub-levels, such as:
B1, B2, B3,
I1, I2, I3,
A1, A2, A3.
More complex schemes for attributing the difficulty to what has been performed can be
exemplified by this paper on synchronized skating.
Formal models
The production function of students' degrees where it is difficult ot get
good marks
A model of dynamic competition where goods are difficult to use and R&D is difficult
Data
The NASA classification of R&D activities according to the degree of
difficulty
The degree of difficulty in a sport discipline: synchronized skating