Glossary
Allocative Efficiency
A state of the economy in which production represents consumer preferences; in particular, every good or service is produced up to the point where the last unit provides a marginal benefit to consumers equal to the marginal cost of producing it (P=MC).
Example:
A perfectly competitive market achieves allocative efficiency because firms produce at the quantity where price equals marginal cost.
Barriers to Entry
Any factor that prevents or makes it difficult for new firms to enter a market, thereby limiting competition.
Example:
Government regulations requiring extensive permits for new businesses can act as significant barriers to entry.
Brand Reputation (as a barrier to entry)
A barrier to entry where an established firm's strong brand recognition and customer loyalty make it difficult for new firms to attract customers.
Example:
It's hard for a new soft drink company to compete with Coca-Cola's established brand reputation.
Control of Resources (as a barrier to entry)
A barrier to entry where a single firm owns or controls a crucial input necessary for production, preventing others from competing.
Example:
If a company owns all the diamond mines, it has control of resources as a barrier to entry in the diamond market.
Deadweight Loss
The loss of economic efficiency that occurs when the equilibrium for a good or service is not Pareto optimal, often due to market imperfections like monopoly power.
Example:
When a monopolist restricts output to raise prices, the resulting reduction in total surplus for society is known as deadweight loss.
Demand > Marginal Revenue (MR)
A relationship in imperfectly competitive markets where the demand curve lies above the marginal revenue curve because to sell an additional unit, the firm must lower the price on all units sold.
Example:
For a firm selling designer handbags, the price of the 10th bag sold is higher than the additional revenue gained from selling it, illustrating why Demand > Marginal Revenue (MR).
Differentiated Products
Products that are similar but have unique features, branding, or perceived qualities that distinguish them from competitors' offerings.
Example:
While all coffee shops sell coffee, each offers a differentiated product through unique blends, ambiance, or customer service.
Economic Profit
The difference between total revenue and total economic costs, which include both explicit (accounting) costs and implicit (opportunity) costs.
Example:
If a firm's total revenue exceeds its explicit costs and the opportunity cost of its resources, it is earning an economic profit.
Economies of Scale (as a barrier to entry)
A barrier to entry where large firms can produce goods at a lower average cost per unit than smaller firms, making it difficult for new, smaller entrants to compete on price.
Example:
The massive production facilities needed for car manufacturing create economies of scale that deter new companies from entering the industry.
Geography (as a barrier to entry)
A barrier to entry where a firm controls a key resource or has a unique location advantage, making it difficult for competitors to serve the same market.
Example:
The only gas station for hundreds of miles in a desert region benefits from geography as a barrier to entry.
Government (as a barrier to entry)
A barrier to entry created by government actions, such as granting patents, licenses, or exclusive franchises.
Example:
The exclusive right granted to a cable company to operate in a specific city is an example of government acting as a barrier to entry.
High Barriers to Entry
Obstacles that make it difficult or impossible for new firms to enter a market, protecting existing firms from competition.
Example:
The enormous capital investment required to build a new car manufacturing plant represents high barriers to entry for aspiring automakers.
High Fixed Costs (as a barrier to entry)
A barrier to entry where the initial investment required to start a business in an industry is prohibitively large, deterring potential competitors.
Example:
Building a new power plant involves such high fixed costs that it acts as a significant barrier to entry for new energy providers.
Imperfect Competition
Market structures where individual firms have some control over the price of their product, unlike in perfect competition where firms are price takers.
Example:
When you choose between different smartphone brands, you're observing a market with imperfect competition, as each company can influence its phone's price.
Inefficient (in imperfect competition)
A characteristic of imperfectly competitive markets where firms do not produce at the lowest possible average cost (productive inefficiency) and/or do not produce the socially optimal quantity where price equals marginal cost (allocative inefficiency).
Example:
A monopolist producing less output than is socially optimal demonstrates that imperfect competition can be inefficient.
Location Advantage (as a barrier to entry)
A barrier to entry where a firm benefits from being the sole or primary provider in a specific geographic area, making it difficult for new firms to compete locally.
Example:
The only grocery store in a remote mountain town has a strong location advantage as a barrier to entry.
Long-Run Profits
Economic profits that firms can sustain over an extended period, typically due to significant barriers to entry that prevent new competitors from eroding profits.
Example:
A utility company operating as a natural monopoly might consistently earn long-run profits because of the high costs and regulations that deter new entrants.
Monopolistic Competition
A market structure with many firms selling differentiated products, allowing for some control over price but also relatively easy entry and exit.
Example:
The vast array of restaurants in a city, each offering a unique menu and ambiance, illustrates monopolistic competition.
Monopoly
A market structure characterized by a single seller of a unique product with no close substitutes, giving that firm significant market power.
Example:
A small town might have only one internet service provider, making it a local monopoly for broadband access.
Non-Price Competition
Competition among firms based on factors other than price, such as advertising, branding, product quality, or customer service.
Example:
Instead of lowering prices, soda companies engage in non-price competition by sponsoring major events and running extensive advertising campaigns.
Oligopoly
A market structure dominated by a few large firms that produce similar or differentiated products, leading to strategic interdependence among them.
Example:
The global market for commercial aircraft, dominated by Boeing and Airbus, is a classic example of an oligopoly.
Patents and Protections (as a barrier to entry)
Legal rights granted by the government to inventors, giving them exclusive control over the production and sale of their inventions for a set period.
Example:
A pharmaceutical company's patents and protections on a new drug prevent other companies from producing generic versions for years.
Price Makers
Firms that have the ability to influence the market price of their product due to their market power, rather than simply accepting the prevailing market price.
Example:
A pharmaceutical company holding a patent on a new drug acts as a price maker, setting the price for its unique medication.
Profit Maximization (MR=MC)
The process by which a firm determines the price and output level that returns the greatest profit, which occurs where marginal revenue equals marginal cost.
Example:
A firm will continue to produce additional units as long as the revenue from the next unit exceeds its cost, stopping production when MR=MC to achieve profit maximization.