Economic Terms

An economy that does not trade with other countries. Although there are very few practical or significant examples of this, making the assumption that an economy is closed is often made to explain and analyse various macroeconomic issues.

A period of market instability that is initiated by a supply side shock but converges back to equilibrium over several cycles because demand is more elastic than supply.

Below is a diagram to show how a disequilibrium converges to an equilibrium over time in a specific agricultural market.  A poor harvest in period 1 means supply falls to Q₁ so that prices rise to P₁. If producers plan their period 2 production under the expectation that this high price will continue, then the period 2 supply will be higher, at Q₂. Therefore, prices fall to P₂ when they try to sell all their output. As this process repeats itself i.e. between periods of low supply with high prices and then high supply with low prices, the price and quantity trace out a spiral. In the figure below, the economy converges to the equilibrium where supply and demand intersect. However this process can also work in the reverse in a diverging case - but that only happens when the supply curve is more elastic than the demand curve.

A systematic limitation in a human's ability to think rationally about a situation. It is these cognitive biases which lead to irrational behaviour which ultimately is the driving force behind behavioural economics. For instance, one cognitive bias is the representative bias which causes individuals to fall for the gambler's fallacy and ultimately make incorrect decisions based on false beliefs.

 

Is an asset that secures repayment on a loan i.e. a house in a mortgage loan or car in a car loan.

When rival firms within an industry co-operate for their own mutual benefit i.e. to maximise profits. There are different types of firm collusion such as overt collusion and tacit collusion.

The flowchart below depicts the logical sequence of an example of collusion which is anti-competitive i.e. predatory pricing. This like all forms of collusion is legally prohibited but firms with superior financial resources to other firms have the ability and incentive to collude to protect their market share and position.

An economic system that operates in a different way to capitalism. The state decides what goods and services are produced and how they are distributed.

An institution licensed to receive and hold deposits, that enables monetary transactions and creates credit. Deposits are used to finance loans that earn a high enough rate of interest to earn a profit after payment of interest to depositors and covering the cost of administration and bad debts.

Below is an illustration of the main activities that a commerical bank undertakes i.e. deposit-taking and lending activites to the retail and household sectors of the economy. They are often called intermediairies because they intermediate funds between surplus units (savers) and deficit units (borrowers).

 

 

Markets that trade large quantities of raw materials e.g agricultural products such as wheat, sugar and cocoa and mined/extracted products like copper, gold, silver and petroleum.

If a country experiences a differential absolute advantage in both goods this generates a difference in the opportunity cost of production and provides incentives for both countries to specialise and trade.

The following example demonstrates how although France has an absolute advantage in the production of both goods it does not benefit from a comparative advantage in the production of both goods. France has a comparative advantage in wine but not in milk as Poland has a comparative advantage in this product. This will become clear by calculating the opportunity cost of producing each good for each of the two countries.

The opportunity cost = production gained /production lost. For example, if a country divides resources evenly between two goods and makes 3 wine and 4 milk it can make another 3 wine if it gives up 4 milk. So production gained is 3 wine / production lost is 4 milk. This means that the opportunity cost of producing 1 extra wine is 1.33 milk (i.e. 3/4). The table shows that France has the lowest wine opportunity cost and Poland has the lowest milk opportunity cost. France specialises in wine and Poland in milk.

If you find the calculations are challenging it is sometimes easier to start by drawing PPFs which are non parallel but do not intersect (see below). A Some students may find it easier to draw the graph and then analyse the relationship between PPFs to determine comparative advantages:

1. The most efficient country (PPF furthest from origin = France) has a comp advantage in the good exhibiting the LARGEST difference in production i.e. the good plotted on the axis where the difference between the 2 PPFs is LARGEST = wine.
2. The least efficient country (PPF closest to the origin = Poland) has a comp advantage in the good exhibiting the SMALLEST difference in production i.e. the good plotted on the axis where the difference between the two PPFs is SMALLEST = milk.

 

Situations where factors of production can be used to produce different goods so that an increase in the supply of one commodity requires a reduction in the supply of another commodity.

Below is a diagram to illustrate this in a supply and demand framework. In this instance farmers use their land to rear animals to produce products such as beef and lamb. However if farmers decide to use more land to rear cows to help produce more beef this causes the supply of beef to increase. However, as land is required to rear other animals such as land, if there is less land available to rear sheep then the supply of lamb will fall. This is all caused because of scarce supply of land.