52 Useful Economic Theories

John Spacey, updated on May 16, 2019

Economics is the science that seeks to describe the economy including production, consumption, distribution, pricing and markets. It's an extremely broad area that's not always easy to apply to real business problems. The following are a few economic theories, models and concepts that are both interesting and somewhat applicable to business strategy.

Absolute Advantage

The ability to produce more than your competitors with the same amount of resources such as capital, labor and land. Generally equates to a cost advantage.

Adverse Selection

The tendency for people at high risk to buy insurance.

Attention Economics

Attention economics is the study of human attention as a scarce resource.

Bargaining Power

Bargaining power is the ability of parties to exert influence over each other in negotiation. Typically measured by how much each side has to lose if an agreement isn't reached. In other words, you tend to have a better negotiating position when you have little to lose.

Barriers To Entry

Barriers to entry are obstacles that make it difficult for new competitors to enter a market such as capital, know-how and government regulation.

Barriers To Exit

Obstacles to closing a business or discontinuing a service.

Behavioral Economics

The examination of cognitive, emotional and social factors in economic decisions. For example, asset prices are thought to be driven by cycles of optimism and fear.

Category Killer

A product or service that dominates a market.

Club Theory

A business model based on shared infrastructure and resources such as a theme park.

Coercive Monopoly

A monopoly position that is obtained by preventing any firms from competing using extraordinary power.

Commons

Resources that are available to all members of society including cultural items, natural resources and public infrastructure.

Critical Mass

The size that a company needs to reach in order to compete efficiently in a market.

Deadweight Loss

An inefficiency in an economy that prevents markets from performing normally.

Diminishing Marginal Utility

Diminishing marginal utility is a decrease in value for more of something. For example, you may find that a single smart phone is very useful but a second, third, forth or fifth mobile device has little value to you.

Diminishing Returns

Decreasing incremental output from additional resources. For example, if you put 1000 engineers on a project instead of 100 they may not finish much faster.

Diseconomies Of Scale

Disadvantages faced by large organizations such as bureaucracy, heavy weight processes and inability to change.

Economies Of Density

The economic benefits of locating in a dense urban environment such as a city or a spot close to multiple cities.

Economies Of Scale

A product or service that drops in cost as you produce more.

Economies Of Scope

Economies of scope are efficiencies gained by offering a variety of products and services.

Equilibrium

Equilibrium is a state in which economic forces such as supply and demand are in balance. As a general rule, everything moves towards equilibrium with time.

Excess Burden

Taxation or regulation that is so intensive that it prevents markets from functioning normally.

Externalities

A cost or benefit that isn't reflected in the price paid for a good or service.

Failure Demand

Additional demand for an company's products or services due to that company's failures.

Gains From Trade

The net gain achieved by countries, organizations or individuals from trade.

Giffen Goods

A good that receives more demand at a higher price because people can no longer afford more expensive substitutes.

Gift Economy

Exchanges of value that are given unconditionally as opposed to traded or exchanged based on legal conditions.

Inferior Good

A produce or service that you consume less as your income rises.

Information Asymmetry

A condition in which some market participants have better information than others.

Invisible Hand

A metaphor for the unintended global or national impact of individual choices.

Irrational Exuberance

Asset price bubbles driven by optimism.

Managerial Economics

A general term for economic models, first principles and metrics that are useful to business.

Market Power

The ability for an individual firm to raise the market price for a product or service.

Monopsony

A market with one buyer and many sellers. Being the opposite of a monopoly, a monopsony has significant power to push sellers for low prices.

Moral Hazard

A decision maker who is in a position to take risks without any consequences if things turn out badly. In some cases, such decision makers are heavily rewarded when risks bear fruit.

Natural Monopoly

A monopoly that makes economic sense because it would be too costly to duplicate infrastructure.

Network Effect

The relationship between the value of a technology, product or service relative to the number of people who are using it.

Overexploitation

Overuse of a renewable resource to the point that it no longer renews as it once did. In other words, over production in a single year can damage an ecosystem for decades or in some cases, permanently.

Perfect Competition

A market in which no competitor has any advantage over any other. It is extremely difficult to profit in such a market as prices are driven towards cost.

Perfect Information

When all market participants have the same information all the time.

Predatory Pricing

A price strategy that attempts to put competitors out of business by offering a low price, often below cost.

Price Umbrella

A price set by a dominant competitor that acts like price gravity affecting every other competitor in the same market.

Rent Seeking

Strategies that generate no value but act as a drag on economic efficiency such as lobbying a government for subsidies and trade barriers.

Speculation

Attempting to profit from price swings in assets without investing for sustained periods of time in such assets. In efficient markets, speculation is typically unprofitable in the long run.

Sticky Prices

The tendency for prices to stay at an established range and temporarily resist changes in supply and demand.

Superior Good

An expensive item that is mostly consumed by high income individuals.

Switching Barriers

The obstacles that a customer faces to change from one product or service to another.

Time Preferences

A preference for consuming now versus saving for the future.

Tragedy Of The Commons

A tendency for shared resources such as air and water to be overused and abused.

Tyranny Of Small Decisions

A tendency for seemingly rational local choices to have negative global consequences.

Veblen Goods

Goods that receive more demand at a higher price due to perceptions of quality. Many luxury goods are veblen in the long term but not in the short term. In other words, high prices can be good for long term demand but if you have a sale, it temporarily boosts demand.

White Elephant

An asset that is expensive to maintain and difficult to retire. Often applied to underperforming projects that are continued due to sunk costs.

Zero-sum Game

An activity that produces no value but is concerned with gaining a bigger piece of existing value. Often described as dividing a pie instead of baking new pies.