Accounting costs

Glossary

Abnormal profit. The return in excess of the minimum required to prevent the owner from closing the firm down, equivalent to revenue minus accounting costs minus normal profit.

Absolute cost advantage entry barrier. An incumbent incurs a lower long-run average cost than a potential entrant at any output level.

Accounting profitability approach. An indirect method of testing for economies of scale, based on the corre­lation between firm size and accounting profitability.

Accounting rate of profit. A profit measure based on company accounts data. Normally calculated as the ratio of profit to assets (return on capital), equity (return on equity) or sales revenue (return on sales).

Adverse selection. Arises when a principal is unable to verify an agent’s claims concerning the agent’s own ability or productivity.

Advertising elasticity of demand. A measure of the sen­sitivity of quantity demanded to changes in adver­tising expenditure. Measured as the ratio of the proportionate change in quantity demanded to the proportionate change in advertising expenditure.

Advertising intensity. See advertising-to-sales ratio.

Advertising response function. Measures the respon­siveness of sales revenue to the volume of advertis­ing expenditure.

Advertising-to-sales ratio. The ratio of advertising expenditure to sales revenue.

Affiliated valuations model. In auction theory, the case where information about one bidder’s valuation of the item would influence other bidders’ valuations. Represents an intermediate case between the inde­pendent private values model and the pure common value model.

Agency theory. The study of relationships between principals and agents. For example, a manufactur­ing firm, acting as principal, contracts a supplying firm, the agent, to produce its inputs.

Aggregate concentration. The share of the largest firms in total sales, assets or employment (or other appro­priate size measure) for the economy as a whole.

Allocative efficiency. Describes an allocation of resources such that no possible reallocation could make one agent (producer or consumer) better off without making at least one other agent worse off.

Article 101. In EU competition policy Article 101 deals with restrictive practices; prohibiting agreements between firms from EU member states that prevent or restrict competition.

Article 102. In EU competition policy Article 102 regulates possible abuses of monopoly power, such as monopoly pricing, predatory pricing and price discrimination.

Ascending bid auction. See English auction.

Asset specificity. An asset that is specific to a contrac­tual relationship, and which has little or no value outside that relationship.

Asset-stripping. The practice of buying a company with the intention of transferring funds or assets to another company but leaving the liabilities behind.

Austrian school. A school of thought originally identi­fied with the University of Vienna. Views competi­tion as a dynamic process, driven by the acquisition of new information. Tends to be hostile to govern­ment intervention.

Average cost. The ratio of total cost to output.

Average fixed cost. The ratio of total fixed cost to output.

Average product of labour. The ratio of total output to the number of workers employed.

Average revenue. The ratio of total revenue to quantity demanded, equivalent to price.

Average variable cost. The ratio of total variable cost to output.

Backward vertical integration. Expansion upstream into an activity at an earlier stage of a productionprocess (further away from the final market). For example, a manufacturer starts producing its own inputs. Also known as upstream vertical integration.

Bargain-then-ripoff pricing. A pricing strategy that involves offering new customers a low price in order to attract their business, and charging existing cus­tomers a high price in order to extract increased revenue or profit.

Barometric price leadership. One firm announces a price change, which is followed by other firms in the same industry. The leader is not necessarily a dominant firm and does not necessarily have market power.

Barrier to entry. Any factor which makes the average cost of a would-be entrant higher than that of an incumbent or that impedes entry in any other way.

Barrier to exit. Any cost incurred by an incumbent wishing to exit from an industry.

Battle of the sexes. A game in which both players are better off if they both pursue the same strategy, but each prefers a different strategy to be the one they both choose.

Bertrand model. A duopoly model in which each firm sets its own price treating its rival’s price as fixed at its current level (zero conjectural variation). Each firm sells as much output as it can at its chosen price.

Best value. Has recently replaced compulsory competi­tive tendering as a method for determining the provi­sion of local government services in the UK. Local government departments are expected to demon­strate that provision is efficient.

Bounded rationality. Recognises that decision making takes place within an environment of incomplete information and uncertainty.

Bundling. The practice of selling several goods together as a single package.

Burning bridges. A game in which a player can achieve a superior outcome by demonstrating commitment to follow through with a threatened retaliatory action. Commitment is demonstrated by closing off an alternative action that may have been preferred to the threatened retaliation in the event that retali­ation was required. By demonstrating commitment, the need to execute the threat may be avoided.

Business ethics. An analysis of moral issues seen from the perspective of companies and other forms of business organization. It is a practical application of ethics in the domain of business firms.

Business unit effects. The component of profitability that derives from a particular division or line of business within a firm.

Buyer concentration. A measure of the number and size distribution of buyers, reflecting the degree of mar­ket power on the demand side.

Call option. A call option on any asset gives the holder the right, but not the obligation, to purchase the asset at a predetermined price on a specified future date.

Cartel. A group of firms that acts collectively, often in order to increase their joint profitability by exploit­ing their (collective) market power.

Certification. Retailers with reputations for selling high-quality goods provide a ‘quality certification’ for their products. Discounters enjoy the benefits of such certification without incurring any cost.

Chairman-CEO duality. Under a board structure of chairman-CEO duality, the CEO is also the chair­man of the board. In other cases, chairman of the board and CEO are separate roles.

Chapter I prohibition. Part of the UK’s 1998 Com­petition Act dealing with restrictive practices. Closely related to Article 101 of the EU’s Treaty of Amsterdam.

Chapter II prohibition. Part of the UK’s 1998 Compe­tition Act dealing with abuses of monopoly power. Closely related to Article 102 of the EU’s Treaty of Amsterdam.

Chicago school. A school of thought originally identi­fied with the University of Chicago. Tends to view high profitability as a reward for superior efficiency, rather than symptomatic of abuses of market power. Argues government intervention in the form of active competition policy tends to lead to less rather than more competition.

Cluster. A group of interdependent firms that are linked through close vertical or horizontal relation­ships, located within a well-defined geographic area.

Collusion. Firms agree, either tacitly or explicitly, to limit competition through the coordination of price, output or other decisions.

Collusion hypothesis. The view that a positive associa­tion between concentration and profitability consti­tutes evidence of the abuse of market power in an effort to enhance profitability.

Committed incumbent. A firm that signals intent to resist entry by increasing its own sunk cost expenditure.

Complements. Goods with a negative cross-price elas­ticity of demand: an increase in the price of one good leads to a decrease in the demand for the other good.

Concentration measures. Measures of the number and size distribution of the firms in an industry. Size is usually measured using data on sales, assets, employees or output.

Concentration ratio. The share of an industry’s n larg­est firms in a measure of total industry size, for some specific value of n.

Conglomerate. A firm that produces a number of unre­lated products or operates in a number of unrelated markets.

Conglomerate merger. A merger between firms that produce unrelated products or operate in unrelated markets.

Conjectural variation. The assumption one firm makes about

its rivals’ reactions to its own decisions, often with respect to decisions on price or output.

Consolidation. The bringing together of separate com­panies into a single corporate entity.

Constant returns to scale. If the use of all inputs increases by к per cent, output also increases by k per cent. Long-run average cost is constant with respect to changes in output.

Constant-sum game. In game theory, a game in which the sum of the payoffs to all players is always the same, whatever actions are chosen.

Consumer surplus. The difference between the maxi­mum price a consumer would be willing to pay and the market price.

Contestable market. A market with free entry and exit conditions. An outside firm can enter temporar­ily, and cover its costs when it subsequently exits. Consequently, the behaviour of incumbents is con­strained not only by actual competition but also by potential competition.

Contractual incompleteness. Firms are unable to conclude contracts that specify outcomes under every possible contingency, due to incomplete information.

Convenience goods. Goods that are relatively cheap and purchased frequently.

Coordination problem. Arises when both players are better off if they both pursue the same strategy, but they face difficulties in determining which strategy they should choose.

Core competences. Firm-specific skills deriving from specialised knowledge, and the manner in which this knowledge is employed by the firm.

Corporate effects. The component of profitability that derives from membership of a larger corporate group.

Corporate governance. Corporate governance refers to the systems by which companies are directed and controlled. More specifically, corporate governance describes the arrangements that ensure the com­pany operates in accordance with the objectives of its own stakeholders, and the mechanisms that deal with conflicts of interest between various stakeholder groups.

Corporate social responsibility. A formulation and implementation of explicit policies designed to satisfy stakeholder expectations and fulfil social responsibilities beyond the narrow pursuit of increasing shareholder value.

Cost plus pricing. The firm calculates or estimates its average variable cost, and sets its price by adding a percentage markup to average variable cost. The markup includes a contribution towards the firm’s fixed cost, and a profit margin.

Cournot-Nash equilibrium. A duopoly or oligopoly equilibrium in which all firms make their output decisions based on a zero conjectural variation assumption: each firm optimises assuming its rivals’ actions are given or fixed.

Crowdfunding. A process by which people (the crowd) invest in unlisted companies in the early stages of innovation in return for shares in the companies. Should the project succeed, the shareholder profits and if it fails the investor can lose some or all of the investment.

Creative destruction. Term coined by Schumpeter to describe the economic impact of technological change. The creative aspect results in new and improved goods and services being brought to market, and cost-saving technologies being used in production. The destructive aspect refers to the displacement of obsolete goods, services and technologies.

Credence goods. Goods whose qualities cannot easily be assessed before or after consumption, because a judgement about quality requires specialised knowledge.

Cross-price elasticity of demand. A measure of the sensitivity of the quantity demanded of Good A to changes in the price of Good B. Measured as the ratio of the proportionate change in quantity demanded of Good A to the proportionate change in price of Good B.

Cross-subsidization. The practice of using revenue or profit earned from one activity to support or subsi­dise another activity.

Deadweight loss. The loss of social welfare (the sum of consumer surplus and producer surplus) attributable to the fact that an industry is monopolised, or to some other source of market failure or misallocation of resources.

Deconglomeration. Cessation of production of some products by a conglomerate, in order to focus more on its core products.

Decreasing returns to scale. If the use of all inputs increases by к per cent, output increases by less than к per cent. Long-run average cost is increasing with respect to an increase in output. See also disecono­mies of scale.

Degrees of collusion. Measures of the strength and effectiveness of collusion.

Demand-side economies of scale. See network externalities.

Descending bid auction. See Dutch auction.

Diffusion. The imitation and adoption of new technol­ogies (products or processes) by firms other than the original innovating firm.

Direction of diversification. Describes whether a firm diversifies within the same (broadly defined) indus­try, or into an unrelated industry.

Diseconomies of scale. Long-run average cost is increasing with respect to an increase in output. See also decreasing returns to scale.

Distinctive capabilities. A firm’s unique or specialised competences.

Dominant price leadership. The dominant firm acts as leader by setting the market price. Firms on the competitive fringe adopt price-taking behaviour with respect to the price set by the dominant firm.

Dominant strategy. In game theory, a strategy which always produces the best outcome for one player, no matter what strategies are selected by other players.

Dominant strategy equilibrium. In game theory, the out-come that is achieved if each player has a domi­nant strategy and each player follows their own dominant strategy.

Dorfman-Steiner condition. The profit-maximizing advertising-to-sales ratio equals the ratio of adver­tising elasticity of demand to price elasticity of demand.

Double marginalization. Two stages of the same production process are both under the control of monopoly producers, and each producer adds its own monopoly markup to the price. The price of the finished product is higher than it would be if the two producers were vertically integrated.

Downstream vertical integration. See forward vertical integration.

Dumping. The practice of charging a lower price in poorer countries than in richer countries for the same product.

Duopoly. A market that is supplied by two firms. A special case of oligopoly.

Dutch auction. An auction in which the price is lowered successively until a level is reached which a bidder is prepared to pay. Also known as a descending bid auction.

Economic efficiency. A firm is economically efficient if it has selected the combination of factor inputs that enable it to produce its current output level at the lowest possible cost, given prevailing factor prices.

Economies of scale. Long-run average cost is decreas­ing with respect to an increase in output. See also increasing returns to scale.

Economies of scale entry barrier. An incumbent incurs a lower long-run average cost than an entrant by virtue of producing at a larger scale, and benefiting from economies of scale.

Economies of scope. Long-run average cost when two or more goods are produced together is lower than long-run average cost when the goods are produced separately.

Edgeworth model. A duopoly model of price compe­tition with a production capacity constraint. The model predicts there is no stable equilibrium.

Efficiency hypothesis. The view that a positive associa­tion between concentration and profitability derives from a tendency for the most efficient firms to domi­nate their own industries.

Elasticity. A measure of the responsiveness of one eco­nomic variable to a small change in another vari­able. See price elasticity of demand, price elasticity of supply, cross-price elasticity of demand, advertising elasticity of demand.

Empire-building. The pursuit of growth for its own sake, rather than growth that is targeted at increas­ing shareholder value. An example of agency prob­lems that arise from the principal-agent relationship between shareholders and managers.

Engineering cost approach. Method for estimating a production function or cost function based on hypothetical rather than actual data. Expert (engi­neering) estimates are used to quantify relationships between inputs and outputs.

English auction. An auction in which the price is raised suc­cessively until a level is reached which only one bidder is willing to pay. Also known as an ascending bid auction.

Entropy coefficient. Concentration measure based on a weighted sum of market shares: the weights are the natural logarithms of the reciprocals of market shares.

Entry-deterring strategy. Any action that is taken by an established firm to discourage potential entrants from entering the market.

Executive compensation. Executive compensation packages are a key determinant of the extent to which the incentives of top managers are either aligned or misaligned with shareholder interests. In addition to the basic salary and any employee ben­efits and perquisites, executive compensation pack­ages may include cash bonuses related to company performance, share ownership and call options.

Experience goods. Goods whose qualities can only be ascertained when they are consumed, and not by inspection prior to purchase and consumption.

Experimental economics. A branch of economics which uses laboratory experiments to test economic theories.

Explicit collusion. Collusion that is organised through a formal, explicit contract or other agreement between the colluding parties.

First-degree price discrimination. Price depends on the number of units purchased and on the identity of the buyer. Also known as perfect price discrimination.

First-mover advantage. A situation in which a firm is rewarded for being the first to take some strate­gic action, to which a competitor has to respond subsequently.

First price sealed bid auction. An auction in which each bidder independently submits a single bid, without seeing the bids submitted by other bidders. The highest bidder secures the item and pays a price equivalent to their winning bid.

Five-forces model. A model used by Porter (1980) to describe competition. The five forces are: the extent and intensity of direct competition; the threat of entrants; the threat of substitute products and services; the power of buyers; and the power of suppliers.

Fixed cost. Cost that does not vary with the quantity of output produced.

Foreclosure. The practice of refusing to supply down­stream firms or to purchase from upstream firms.

Foreign direct investment An investment a firm in one country makes in an industry of another country. As opposed to financial portfolio investments, direct investment refers to a purchase of existing corporate assets through merger or acquisition or the purchase of foreign resources.

Forms of collusion. Organizational structures, as well as custom and practice, which characterise collusive agreements.

Forward vertical integration. Expansion downstream into an activity at a later stage of a production process (closer to the final market). For example, a manufacturer starts selling its own products direct to consumers. Also known as downstream vertical integration.

Franchise agreement (franchising). The allocation of exclusive rights to supply a particular good or ser­vice. The franchisee is protected from competition for the duration of the franchise.

Game theory. A theory of decision-making under con­ditions of uncertainty and interdependence. Compo­nents of a game include players, strategies, actions, payoffs, outcomes and an equilibrium.

Geographic concentration. Measures whether a large share of an industry’s total output is produced in a small number of countries or regions, or whether the industry is widely dispersed geographically.

Geographic entry barrier. Any entry barrier affecting foreign firms attempting to enter a domestic mar­ket. Examples include tariffs, quotas, frontier con­trols, national standards, regulations and exchange controls.

Geographic market definition. Involves determining whether an increase in the price of a product in one geographic area significantly affects either demand or supply, and therefore price, in another area. If so, both areas are in the same geographic market.

Gibrat’s law. Describes the implications for indus­try concentration if the growth rate of each firm is random or, more specifically, unrelated to the current size of the firm. If firm sizes are subject to random growth, the firm size distribution becomes increasingly skewed and concentration increases over time. Also known as the Law of Proportion­ate Effect.

Gini coefficient. A measure of inequality based on the Lorenz curve, which can be applied to data on firm sizes or market shares.

Governance. Describes the manner in which an orga­nization manages its contractual relationships between shareholders, managers, employees and other relevant parties.

Hannah and Kay index. Generalization of the Herfindahl-Hirschman index, based on the sum of market shares raised to some exponent, for all mem­ber firms of an industry.

Herfindahl-Hirschman index. Concentration measure based on the sum of the squared market shares of all member firms of an industry.

Hit-and-run entry. A situation in which an entrant has sufficient time to sell its product profitably and withdraw before the incumbent has time to react.

Horizontal agreement. An agreement between firms in the same industry, which may result in reduced com­petition. Subjects of such agreements may include common pricing policies, production quotas or information sharing.

Horizontal integration. See horizontal merger.

Horizontal merger. A merger between two firms that produce the same or similar products, also known as horizontal integration.

Horizontal product differentiation. Products or brands are of the same or similar overall quality, but offer different combinations of characteristics, and may be valued differently by different consumers.

Imperfect competition. Market structures that fall between the polar cases of perfect competition and monopoly. Includes monopolistic competition and oligopoly.

Incomplete contracts. A contract for which the parties cannot identify in advance every possible contin­gency which might affect their contractual relation­ship. Most contracts are incomplete contracts.

Increasing returns to scale. If the use of all inputs increases by к per cent, output increases by more than к per cent. Long-run average cost is decreas­ing with respect to an increase in output. See also economies of scale.

Independent action. Competing firms take decisions without consulting one another or colluding in any other way.

Independent private values model. In an auction, each bidder independently forms an opinion of the value of the item to themself. These private valuations dif­fer between bidders, and there is no single, intrinsic valuation that all bidders can agree on.

Industrial district. A geographic area containing a num­ber of firms producing similar products, including firms operating at different stages of a production process.

Industry concentration. Measure of importance of the largest firms in an industry. See also seller concentration.

Industry effects. The component of profitability that derives from involvement in a particular industry.

Industry life cycle. Describes the long-run evolution of an industry and its constituent firms through the introduction, growth, maturity and decline phases of the life cycle.

Informative advertising. Advertising that provides consumers with factual information about the existence, attributes or price of a product, service or brand.

Installed base. A number of existing customers, who are locked in as a result of having entered into previ­ously signed service contracts.

Innovation. Bringing a new idea or invention to the stage of commercial application, through the applied research, development and commercial pro­duction stages.

Interdependence. A situation in which the outcome for each firm depends not only on its own actions, but also on the actions of its rivals. A defining charac­teristic of the market structure of oligopoly.

Internal capital market. An organization’s procedures for allocating investment funds internally, between departments or divisions that are competing for access to such funds.

Internal rate of return. In investment appraisal, the discount rate at which the net present value of all cash flows associated with the project under consid­eration equals zero.

Intertemporal price discrimination. Price depends on the point in time when a good is sold, but produc­tion costs do not depend on the point in time when the good is produced and sold.

Invention. The creation of an idea and its initial imple­mentation, through basic research.

Isocost. All combinations of two-factor inputs which produce an identical total cost.

Isoprofit curve. All combinations of quantities pro­duced or prices charged by two firms which produce an identical profit for one of the firms.

Isoquant. All combinations of two factor inputs which produce an identical level of output.

Joint profit maximization. Two or more firms set their combined output level and price as if they were a single monopolist. The firms share the resulting monopoly profit among themselves.

Joint venture. A form of strategic alliance, in which two or more independent firms enter into an agreement to cooperate over a specific project.

Junk bond. A bond which carries a high risk of default and thus doesn’t reach an investment ‘grade’ by bond-rating agencies. To attract buyers such bonds offer higher yields.

Kinked demand curve. An oligopoly model that explains price rigidity, arguing that a firm in a situation of interdependence may be reluctant either to raise or lower its price, because in both cases it expects its rivals to react in a way that reduces its own profit.

Law of Diminishing Returns. As the use of a variable factor input increases progressively while the use of other factor inputs is fixed, beyond some point suc­cessive increases in output become smaller.

Law of Proportionate Effect. See Gibrat’s law.

Legal entry barrier. Any entry barrier created by gov­ernment, for example through franchised state- sponsored monopolies, patents and registration, certification or licensing requirements.

Lerner index. Price minus marginal cost expressed as a proportion of price. The extent to which price exceeds marginal cost can be interpreted as a mea­sure of market power.

Limit pricing. A pricing strategy by an incumbent firm intended to prevent entry. The incumbent sacrifices some profit by setting a price sufficiently low to make it impossible for an entrant to operate profitably.

Location model. A model of product differentiation in which consumers’ tastes or preferences are expressed in terms of the characteristics embodied in goods or services. Also known as a spatial model.

Long run. A time period of sufficient duration that the quantities of all factor inputs used in production can be varied.

Lorenz curve. When plotted using firm size or market share data, shows the cumulative sizes or market shares of all firms up to firm n, for n = 1. . . N (where N is the total number of firms), when the firms are numbered in descending size or market share order.

Managerial utility. Managerial satisfaction.

Marginal cost. The additional cost of producing one extra unit of output.

Marginal product of labour. The additional output obtained by employing one extra unit of labour.

Marginal revenue. The additional revenue obtained by selling one extra unit of output.

Markup test. A test suggested by Bresnahan (1982, 1989) and Lau (1982), which involves estimat­ing a structural model incorporating demand and cost equations, and drawing inferences about the nature of competition by observing each firm’s conjectural variation under an assumption of profit maximization.

Market concentration. See seller concentration and industry concentration.

Market demand function. The relationship between market price and the number of units of a product or service consumers wish to buy at that price.

Market equilibrium. At the equilibrium or market- clearing price, quantity demanded equals quantity supplied.

Merger policy. A branch of competition policy dealing with mergers. Examines whether a merger should be permitted, or prevented on the grounds that it may lead to abuses of market power.

Merger waves. Cyclical peaks in the level of merger activity across the entire corporate sector.

Metering. The practice of charging a low price for a primary product, and a high price for a secondary product that is tied to the primary product.

Minimum efficient scale. The output level beyond which the firm can achieve no further saving in long- run average cost by means of further expansion of production.

Minimum profit constraint. In managerial theories of the firm, a minimum profit level demanded by shareholders, which limits managers’ discretion to pursue objectives such as sales revenue, growth or managerial utility.

Mixed strategy. In game theory, a player adopts a mixed strategy by choosing their actions randomly, using fixed probabilities.

Mixed Strategy Nash Equilibrium. An outcome in which both players randomise their strategies with assigned probabilities, and neither player wishes to adjust his/her probabilities assuming that the other player retains his/her current probabilities.

Monopolistic competition. A market structure with a large number of firms producing similar but not identical products, and with free entry. Falls between the polar cases of perfect competition and monopoly.

Monopoly. A market structure with a single firm, pro­ducing a unique product and protected from com­petition by insurmountable entry barriers.

Monopoly policy. A branch of competition policy deal­ing with abuses of market power when a single firm or group or firms has a large market share.

Moral hazard. Arises when an agent has the oppor­tunity to act in their own private interests but against the principal’s interests, in contravention of the terms of the contract between the two par­ties. It is difficult for the principal to detect and punish opportunistic behaviour on the part of the agent.

Multinational enterprise (MNE) is a firm which has invested in the production of goods and services in one or more countries other than their home coun­try. Also known as a multinational corporation.

Multiple-period game. In game theory, a game that is repeated a number of times. Also known as a repeated game.

Nash equilibrium. In game theory, all players maxi­mise their own actual or expected payoffs, subject to a zero conjectural variation constraint: each player takes the other players’ current strate­gies as given. No player can improve their actual or expected payoff given the strategies currently chosen by the other players. Also known as Pure Strategy Nash Equilibrium. See also Cournot-Nash equilibrium.

Natural monopoly. An industry in which long-run aver­age cost is decreasing in output over all the output levels the market is capable of absorbing. The defi­nition depends on both the cost structure and the position of the market demand function.

Natural product differentiation. The distinguishing characteristics of products or services derived from their inherent or natural attributes.

Near-neighbour brands. Brands with similar characteristics.

Network effects. See network externalities.

Network externalities. The effect that one user of a product or service has on the value of the same product or service to other users. Also known as network effects or demand-side economies of scale.

New empirical industrial organization. An approach which attempts to draw inferences about market structure and competitive conditions from direct observation of conduct at firm level.

New industrial organization. Theories of industrial organization which focus primarily on strategy and conduct at firm level, rather than on market or industry structure.

Non-constant-sum game. In game theory, the sum of the gains and losses of all players depends on the actions chosen by the players.

Non-linear pricing. See quantity-dependent pricing.

Normal profit. The minimum return a firm’s owner must earn to prevent the owner from closing the firm down, equivalent to the opportunity cost of running the firm.

Numbers equivalent. An inverse measure of concentra­tion, which compares the structure of an observed N-firm industry to a hypothetical industry compris­ing N equal-sized firms.

Oligopoly. A market structure with a small number of firms, whose products may be identical or differen­tiated, and where there are barriers to entry. The firms recognise their interdependence.

Open source technology. A technology that is freely available, on condition that improvements or refine­ments developed by users are also made freely avail­able to other users.

Opportunity cost. The cost of allocating scarce resources to some economic activity, measured as the return that could be earned by allocating the same resources to the next best available alternative activity.

Organizational slack. In the behavioural theory of the firm, resources held by the organization which per­mit side-payments in excess of the minimum required to prevent individuals or groups withdrawing from the organization.

Passive incumbent. A firm that does not signal intent to resist entry.

Patent. The award of a patent to the inventor of a new product, process, substance or design confers a property right over the knowledge that is embodied in the invention.

Payoff. In game theory, a player’s return, which is dependent on the strategies and actions chosen by all players.

Peak load pricing. Demand varies over time for a good which cannot be stored, but production capacity does not vary over time. The peak-period price charged by the producer exceeds the off-peak period price.

Pecuniary economies of scale. Economies of scale aris­ing when large firms find it easier or cheaper than small firms to obtain or purchase inputs or raise finance.

Perfect competition. A market structure with a large number of firms producing identical products and with free entry.

Perfect price discrimination. See first-degree price discrimination.

Perquisites. Perquisites refer to the diversion of resources of the firm to support on-the-job con­sumption by the managers, through means such as luxury offices, expense accounts and foreign travel.

Persistence of profit. The extent to which profits or losses above or below average levels tend to be sus­tained, either in the short run or long run.

Persuasive advertising. Advertising that aims to change consumers’ perceptions of a product, service or brand with a view to stimulating sales. May include claims that are not objectively verifiable.

Porter’s Diamond Model. A model of the determinants and dynamics of competitive advantage, based on analysis of competitive rivalry, factor and demand conditions, and the existence of related and support­ing industries.

Predatory competition. A dominant firm engages in certain aggressive forms of price or non-price com­petition, aiming to force a weaker competitor to withdraw from the market.

Predatory pricing. A dominant firm adopts price-cutting as an instrument of predatory competition.

Price-cost margin. The ratio of profit to sales revenue, or price minus average cost to price.

Price dispersion. Variation in the prices charged by competing sellers for the same product or services.

Price elasticity of demand. A measure of the sensi­tivity of quantity demanded to changes in price. Measured as the ratio of the proportionate change in quantity demanded to the proportionate change in price.

Price elasticity of supply. A measure of the sensitivity of quantity supplied to changes in price. Measured as the ratio of the proportionate change in quantity supplied to the proportionate change in price.

Price leadership. See barometric price leadership and dominant price leadership.

Price rigidity. A tendency for oligopolists to avoid fre­quent changes of price, perhaps preferring instead non-price forms of competition.

Price-taking behaviour. Each firm’s market share is suf­ficiently small that the firm believes its output decision has no bearing on the market price. Therefore, the firm treats the market price as being beyond its control.

Principal-agent problem. Agency theory emphasises the conflicts that can arise between principals and agents. The principal-agent problem refers to the difficulties that arise when a principal hires an agent, due to imperfect information.

Prisoner’s dilemma. In game theory, refers to a case in which players select their dominant strategies and achieve an equilibrium in which they are worse off than they would be if they could all agree to select an alternative (non-dominant) strategy.

Privatization. The sale and transfer of assets from the public sector to the private sector.

Process innovation. The commercial application of a new piece of cost-saving technology.

Producer surplus. The difference between the market price and the minimum price a producer would be willing to accept.

Product differentiation. The practice of making close substitutes appear different, so that customers no longer regard them as similar or identical.

Product differentiation entry barrier. Arises when a potential entrant incurs advertising or other market­ing costs in order to achieve a viable market share, because consumers are loyal to the established brands of incumbents. Both natural and strategic product dif­ferentiation may give rise to entry barriers.

Product innovation. Production of a new product on a commercial basis.

Production function. A technological relationship between the quantities of inputs and the level of output.

Productive efficiency. A firm is efficient in production if it has achieved both technical efficiency and eco­nomic efficiency.

Product market definition. Includes all products that are close substitutes for one another, both in con­sumption and in production.

Profit maximization. The output level where marginal revenue equals marginal cost.

Pure common value model. In auction theory, there is a single, intrinsic value of the item being sold that is the same for all bidders.

Pure strategy. In game theory, a strategy whereby one player always chooses a certain action, regardless of the actions chosen by other players.

Pure Strategy Nash Equilibrium. See Nash Equilibrium.

Quantity-dependent pricing. The price per unit depends on the number of units purchased. Also known as non-linear pricing.

Quantity forcing. A seller with market power forces buyers to purchase more units of a good than they would wish if they had the choice.

Quasi-rent. Rent arising from the creation of an asset that is specific to some particular relationship, but with little or no value outside that relationship.

Reaction function. Shows the profit-maximizing response of one firm to a price or output decision taken by a rival firm, treating the rival’s decision as fixed.

Real economies of scale. Economies of scale arising from technological relationships between inputs and outputs embodied in a firm’s long-run production function.

Reciprocity. An agreement whereby firm A purchases inputs from firm B, on condition that firm B also purchases inputs from firm A.

Regional concentration. See geographic concentration.

Repeated game. See multiple-period game.

Representative consumer model. A model of product differentiation in which consumers’ tastes or pref­erences are expressed in terms of goods or services (rather than characteristics), and firms compete to attract buyers by differentiating the goods or ser­vices they offer.

Resale price maintenance. A practice whereby an upstream firm sets a minimum (or possibly a maxi­mum) price to be charged in a downstream (usually retail) market.

Reserve price. In auction theory, a minimum bid that must be registered for the sale of the item to proceed.

Residual rights (to control). Rights to whatever resources are left after a firm’s contractual obliga­tions have been satisfied and all specific rights to the firm’s resources have been assigned.

Restrictive practices policy. A branch of competition policy dealing with single firms or groups or firms that engage in practices that may be detrimental to consumer welfare, such as price fixing, output quo­tas, predatory pricing and vertical restraints.

Returns to scale. See increasing returns to scale and decreasing returns to scale.

Revenue equivalence theorem. In auction theory, in the case where bidders form independent private valuations of the item that is for sale, all four basic auction types (English, Dutch, first price sealed bid and second price sealed bid) yield the same expected proceeds to the seller.

Revenue test. A test proposed by Rosse and Panzar (1977), which examines whether firm conduct is in accordance with the models of perfect competi­tion, imperfect competition or monopoly, based on observation of the impact of variations in factor prices on profit-maximizing firm-level revenues.

Rule of reason. The principle that competition policy should be concerned with the practical consequences for competition and welfare of specific abuses of market power or other restrictive practices, rather than with the structural characteristics of markets which might, in theory, create opportunities for anticompetitive practice.

Sample selection bias. Bias arising in statistical analy­sis if the data has been chosen non-randomly. For example, if five years’ data is required for each firm, and only those firms that traded continuously for five years are included, a non-random sample of sur­vivors is obtained, excluding all firms that entered and exited during the five-year period. This specific form of sample selection bias is known as survivor­ship bias.

Satisficing. In the behavioural theory of the firm, a firm aims for a satisfactory profit but does not nec­essarily maximise profit.

Schumpeterian hypothesis. Describes the view that a fast pace of innovation is more likely to be associ­ated with monopoly than with competition.

Search goods. Goods whose qualities can be ascertained by inspection prior to purchase and consumption.

Second-degree price discrimination. The price per unit of output depends on the number of units pur­chased, but not on the identity of the buyer. All buyers who purchase a given number of units pay the same price per unit.

Second-mover advantage. A situation in which a firm is rewarded for waiting for a competitor to take some strategic action, and responding subsequently after observing the competitor’s decision.

Second price sealed bid auction. An auction in which each bidder independently and privately submits a single bid. The highest bidder secures the item, but pays a price equal to the second-highest submitted bid. Also known as a Vickrey auction.

Seller concentration. A measure of the number and size distribution of sellers, reflecting the degree of market power on the supply side. May refer either to aggregate concentration (for the economy as a whole) or to industry concentration (for one particular industry).

Semi-collusion. Firms collude over certain areas of activity (for example, pricing or production), but compete in other areas in which it may be more dif­ficult to specify, conclude or enforce an agreement (for example, research and development).

Sequential game. In game theory, players choose their actions sequentially (in turn). A player who moves later knows which actions were chosen by players who moved earlier.

Shopping goods. Goods that are expensive and are pur­chased infrequently.

Short run. A time period during which only one factor input used in production can be varied, while other factor inputs are fixed.

Side-payment. In the behavioural theory of the firm, a payment in excess of the minimum required to pre­vent an individual or group from withdrawing from the organization.

Simultaneous game. In game theory, all players choose their actions simultaneously. When choosing, no player knows the actions chosen by other players.

Slotting allowances. These occur in retailing, when large buyers, such as supermarket chains, require fees or other payments from suppliers, such as food manufacturers, to place their products in prominent positions.

Spatial model. See location model.

Specialization. Refers to the extent to which a coun­try’s production is composed mainly of a small number of products or services, or is more widely dispersed.

Specific rights. Rights that are specified explicitly in the terms of a contract.

Stackelberg equilibrium. A solution to a duopoly or an oligopoly model, in which one firm anticipates its rivals’ tendencies to act in accordance with a zero conjectural variation assumption, and exploits this awareness to increase its own profit.

Stakeholder. The broadest stakeholder defini­tion includes any group that has the capability to influence or exert pressure on the company’s management.

State-sponsored collusion. Collusion that is encouraged or dictated by government. The justification might be to promote rationalization, or to assure a steady supply.

Strategic alliance. A form of cooperation between pro­ducers that stops short of a full-scale merger, such as a licensing arrangement or a joint venture.

Strategic group. A group of firms from the same industry, whose conduct is similar and that tend to view other firms from the same group as their main competitors.

Strategic product differentiation. The distinguishing characteristics of products are consciously created by suppliers, for example through advertising or other types of marketing campaign.

Strategy. In game theory, a set of rules defining which action a player should choose under each possible set of circumstances that might exist at any stage in the game.

Strict dominance. Describes a situation where a strat­egy is superior to another strategy under all possible circumstances regarding the other player’s choice of strategy.

Structure-conduct-performance paradigm. A method­ological approach for research in industrial orga­nization, in which the structural characteristics of industries are assumed to influence or dictate the conduct and performance of the industry’s member firms. More sophisticated models allow for feedback effects, whereby conduct and perfor­mance variables help shape the industry’s future structure.

Subgame Perfect Equilibrium. A Nash Equilibrium solution to a game that is also a Nash Equilibrium solution to all possible subgames. Any Nash Equi­librium that could only be achieved if a player took an action that was sub-optimal at some stage of the game is not a Subgame Perfect Equilibrium.

Substitutes. Goods with a positive cross-price elastic­ity of demand: an increase in the price of one good leads to an increase in demand for the other good

Sunk cost. Expenditure on items such as advertis­ing and research and development that is non- recoverable in the event that the firm exits from the industry.

Survivorship bias. See sample selection bias.

Switching costs. Costs associated with switching from one supplier to another.

Synergy. Synergies exist when two companies merge and the combined sum in value is greater than the sum of the individual values.

Tacit collusion. Collusion that is not organised through a formal, explicit contract or other specific agree­ment between the colluding parties.

Tangency solution. Long-run equilibrium under monopolistic competition, at which each firm’s aver­age revenue function is tangential to its average cost function. Accordingly, each firm earns only a nor­mal profit.

Technical efficiency. A firm is technically efficient if it is producing the maximum quantity of output that is technologically feasible, given the quanti­ties of the factor inputs it employs. A technically efficient firm operates on (and not within) its own production function. Also known as x-efficiency.

Third-degree price discrimination. Price depends on the identity of the buyer but not on the number of units purchased. Any buyer is offered as many or as few units as he or she wishes at a constant price.

Tie-in sale. See tying.

Tit-for-tat. In game theory, a strategy whereby one player punishes another for non-cooperation in a previous period.

Tobin’s q. The ratio of a firm’s stock market value to the replacement cost of its capital.

Total cost. Variable cost plus fixed cost.

Total revenue. Price times quantity sold.

Tournament theory. The theory suggests that high CEO remuneration is a ‘prize’. This provides incentives for junior executives on much lower salaries to com­pete against each other. The winner then becomes eligible for promotion to the rank of CEO. The larger the firm, the greater the pay disparity.

Trade association. An organization that represents the interests of the member firms of an industry. It usu­ally differs from a cartel in that it has no monopo­listic intent.

Transaction costs. Costs incurred when using the mar­ket to allocate resources, arising from the acquisi­tion of information or the negotiation, monitoring and enforcement of contracts.

Transfer pricing. The pricing of intermediate products traded internally between the divisions of a single firm.

Two-part tariff. A price structure requiring the pay­ment of a fixed fee (mandatory if any purchases are to be made) and an additional uniform price for each unit purchased.

Tying. A firm with market power in the market for Good X requires buyers also to purchase Good Y in order to obtain Good X. Also known as a tie-in sale.

Type 1 industry. An industry in which growth in the size of the market leads to fragmentation of industry structure and deconcentration (Sutton, 1991). The level of sunk cost investment expenditure is deter­mined exogenously, by product characteristics and technological conditions.

Type 2 industry. An industry in which growth in the size of the market leads to growth in the size of the largest firms, and no tendency for fragmentation of industry structure or deconcentration (Sutton, 1991). The level of sunk cost investment expendi­ture is determined endogenously, by incumbent firms’ decisions on advertising and research and development.

Upstream vertical integration. See backward vertical integration.

Valuation ratio. The ratio of the firm’s stock market value to the book value of its assets.

Value chain. A technique devised to disaggregate a firm into its strategically relevant activities, in order to appraise each activity’s contribution to the firm’s performance.

Variable cost. The component of total cost that varies with output.

Variance decomposition analysis. A statistical tech­nique involving the decomposition of the varia­tion in a firm’s profitability into components deriving from the industries in which the firm operates, and from each division or business unit within the firm.

Vertical agreement. Agreements between firms oper­ating at successive stages of a production process, such as exclusive dealing contracts and resale price maintenance.

Vertical disintegration. A corporate strategy of disen­gaging from an involvement in one or more stages of the production process.

Vertical integration. See vertical merger.

Vertical merger. A merger between two firms that pro­duce at different stages of a production process, also known as vertical integration.

Vertical product differentiation. One product, service or brand differs from another in terms of overall quality. If the prices were the same, all consumers would choose the superior product.

Vertical restraint. Conditions or restrictions on trade between firms that are linked vertically.

Vickrey auction. See second price sealed bid auction. Due to Vickrey (1961).

Weak dominance. Describes a situation where a strat­egy is no worse than another strategy under all pos­sible circumstances regarding the other player’s choice of strategy, and superior to the other strat­egy under at least one choice made by the other player.

Welfare. A measure of well-being based on alternative allocations of scarce resources.

Winner’s curse. A tendency for the winning bid to exceed the intrinsic value of the item being auc­tioned, common in sealed bid auctions.

Workable competition. An approach to competition policy which seeks to adjust aspects of structure and conduct in order to bring about a favourable performance outcome.

X-efficiency. See technical efficiency.

Zero-sum game. A constant sum game in which the sum of the gains and losses of all players is always zero.