Economic Terms

The measure used by Government to set the inflation target for the Bank of England. It is different to the Retail Prices Index as it does not reflect inflation associated with housing costs (e.g. mortgage interest and council tax). This price index is often shortened to CPI.

CPI is calculated as follows. Firstly a basket of goods are selected based on the spending patterns of the average household and then weights are attached to each good reflecting the importance of that good to families. Then several price surveys are carried out to work out the average prices of these goods. The CPI can then be compared year on year with subtle changes to the baskets of goods to monitor how the overall inflation rate in the economy is developing and changing.

Below is a figure that traces the annual CPI percentage change for the UK from 2005.

The production of goods and services in influenced by the preferences of consumers.

The amount of money consumers save because the equilibrium price is lower than the maximum price they are prepared to pay for the good or service.

This is always illustrated for any region above the market price and below the demand curve as the diagram below highlights.

It is important to remember that consumer surplus measures the accumulated gain that consumers receive for buying a good at a price lower than their maximum willingness to pay (given by the demand curve) and not the individual gain.

The amount by which consumer surplus is reduced by the imposition of an indirect tax. However, the elasticity of the demand curve affects how much of the tax is passed onto consumers.

Below is a diagram to illustrate how the imposition of an indirect tax implaces a burden on consumers. In this instance the demand curve is neither inelastic or elastic and therefore the tax burden is split evenly between the consumers and producers.

Below is a diagram to illustrate when the demand curve is inelastic and therefore the tax burden is split unevenly towards consumers ahead of producers.

Below is a diagram to illustrate when the demand curve is elastic and therefore the tax burden on consumers is small.

People who purchase and are the end users of a good or service.

In macroeconomics this is the amount of money that households spend on goods and services over a given period of time. In microeconomics this means purchasing and then using or experiencing goods or services.

Externalities that arise from the consumption of a good.

An equation that explains the relative influence of different factors on the consumption of households.

Below is an example of a consumption function in which the level of consumption is directly related to the level of disposable income. The following consumption function (C = xYd +c) has a slope equal to x, which represents the marginal propensity to consume for a consumer. There are different varieties of consumption functions some of a convex or concave shape. But the one below illustrates a linear consumption function with a constant level of MPC throughout all levels of disposable income i.e. consumers will always spend the same fraction of a new amount of disposable income regardless of their current level of income.

Is when the collapse of bank can create bank runs on other healthy banks depsite those banks not appearing to have any liquidity/solvency problems. This is caused due to the asymmetrical infromation which prevents depositors to be able to forensically analyse a bank's balance sheet and assess the risks that this bank has taken on. Therefore they determine the riskiness of their bank by looking at close substitute banks.

A contestable market is a type of market structure in which firms can enter and exit freely and costlessly, therefore making the incumbent firms vulnerable from hit-and-run entry. Due to the freedom of entry and exit there must be an insignificant level of sunk costs attached to competing in these types of market.

Below is a graphic to illustrate the main characteristics of a contestable market. For instance the firms that wish to engage in hit-and-run entry need to be classed as profit maximisers, otherwise the incentive to undercut the incumbent firms will not exist. Firms also need to have perfect information to be able to undertake successful hit-and-run entry. Finally the key factor is that firms need to be able to enter absolutely freely and exit absolutely costlessly.