EC Chapter 2. Burak Alparslan Eroğlu. October 11, Introduction Economic Model Explaining Growth Explaining Stagnation

Transcription

1 EC Chapter 2 Burak Alparslan Eroğlu October 11, 2016

2 Outline s

3 Things to cover in Unit 2 Economic models help explain the Industrial Revolution, and why it started in Britain

4 Things to cover in Unit 2 Economic models help explain the Industrial Revolution, and why it started in Britain Wages, the cost of machinery and other prices all matter when people make economic decisions

5 Things to cover in Unit 2 Economic models help explain the Industrial Revolution, and why it started in Britain Wages, the cost of machinery and other prices all matter when people make economic decisions In a capitalist economy innovation creates temporary rewards for the innovator, and this provides incentives for improvements in technology to reduce costs

6 Things to cover in Unit 2 Economic models help explain the Industrial Revolution, and why it started in Britain Wages, the cost of machinery and other prices all matter when people make economic decisions In a capitalist economy innovation creates temporary rewards for the innovator, and this provides incentives for improvements in technology to reduce costs These rewards are destroyed by competition when innovation diffuses throughout the economy

7 Things to cover in Unit 2 Economic models help explain the Industrial Revolution, and why it started in Britain Wages, the cost of machinery and other prices all matter when people make economic decisions In a capitalist economy innovation creates temporary rewards for the innovator, and this provides incentives for improvements in technology to reduce costs These rewards are destroyed by competition when innovation diffuses throughout the economy Population, the productivity of labour, and living standards may interact to produce a vicious circle of economic stagnation

8 Things to cover in Unit 2 Economic models help explain the Industrial Revolution, and why it started in Britain Wages, the cost of machinery and other prices all matter when people make economic decisions In a capitalist economy innovation creates temporary rewards for the innovator, and this provides incentives for improvements in technology to reduce costs These rewards are destroyed by competition when innovation diffuses throughout the economy Population, the productivity of labour, and living standards may interact to produce a vicious circle of economic stagnation The permanent technological revolution associated with capitalism allowed some countries to make a transition to sustained growth in living standards

9 Malthusian Trap Malthus held that a sustained increase in income per capita would be impossible (Malthus s vicious cycle) Technology improves = labour productivity increase = people become better off = they tend to have more children = population grows = living standards fall Incomes might fluctuate from year to year or even century to century, but not a upward trend. Malthus does not provide optimistic insights about the economy. Malthusian Trap Industrial revolution: an extraordinary flowering of radical invention that allowed the same output to be produced with less labour = Escape from Malthusian Trap Spinning and weaving machine Steam engine Coal usage replaces edible plant usage in energy production

10 Escape from Malthusian Trap Models: simplified representations that help us to understand what is going on by focusing attention on what is important

11 Models: simplified representations that help us to understand what is going on by focusing attention on what is important. We cannot explain every single detail in an economy Unimportant concepts can be ignored A model should not be realistic, but it should nevertheless depicts the relations we investigate. An important concept about economic models: Equilibrium: An equilibrium is a situation that is self-perpetuating: that is, a situation in which something of interest does not change unless a force for change is introduced from the outside that alters the basic data describing the situation. In Malthusian model a wage equal to subsistence is an equilibrium. Note: equilibrium means that one or more things are constant. It does not need to mean that nothing changes

12 Building a Model Construct a simplified description of the conditions under which people take actions. Economic models often use mathematical equations and graphs as well as words

13 Building a Model Construct a simplified description of the conditions under which people take actions. Describe in simple terms what determines the actions that people take. Economic models often use mathematical equations and graphs as well as words

14 Building a Model Construct a simplified description of the conditions under which people take actions. Describe in simple terms what determines the actions that people take. Determine how each of their actions affects others. Economic models often use mathematical equations and graphs as well as words

15 Building a Model Construct a simplified description of the conditions under which people take actions. Describe in simple terms what determines the actions that people take. Determine how each of their actions affects others. Determine the outcome of these actions. This is often an equilibrium (something is constant). Economic models often use mathematical equations and graphs as well as words

16 Building a Model Construct a simplified description of the conditions under which people take actions. Describe in simple terms what determines the actions that people take. Determine how each of their actions affects others. Determine the outcome of these actions. This is often an equilibrium (something is constant). Finally, try to get more insight by studying what happens when conditions change. Economic models often use mathematical equations and graphs as well as words

17 A Good Model It is clear: It helps us better understand something important It predicts accurately: Its predictions are consistent with evidence It improves communication: It helps us to understand what we agree (and disagree) about It is useful: We can use it to find ways to improve how the economy works

18 Basic Concepts in s Ceteris paribus and other simplifications help us think clearly. We see more by looking at less. Prices of all inputs are the same for all firms. All firms know the technologies in use in other firms. Attitudes towards risk are similar among firm owners. Incentives matter, because they affect the benefits and costs of taking one action as opposed to another with an important motive such as material gain, love, hate, sense of duty and desire for approval. Relative prices help us compare alternatives. we are interested in ratios of things, and not their absolute level Economic rent is the basis of how we make choices. economic rent = benefit from option taken benefit from next best option

19 Capitalist Institution and Economic Rent Private Property: Firms that find a way to lower the cost of production without reducing quality stand to make substantial economic rents. These rents are the incentives driving the innovation process. Markets: The fact that the firm must compete in markets by selling goods at low cost means that those who fall behind will fail (Survival of the Profitable) Firms: The fact that most production is done in firms, rather than in families or governments, means that those who succeed can expand by attracting more funds to purchase capital goods, hiring more employees, and thereby benefiting their consumers and raising their owners profits. Similarly, if the firm fails, it will eventually disappear.

20 Technology Technology is way of organizing production, how to produce.

21 Which Technology to Use Some technologies are inferior to others. Making a decision about technology also requires economic information about relative prices about the cost of hiring a worker, and of purchasing a tonne of coal.

22 Cost of Production Notation: w: wage paid to workers p: prices of inputs (coal) L: number of workers R: number of tonnes of input (coal) used in production cost = (wage workers) + (price of a tonne of coal number of tonnes) = (w L) + (p R) Isocost Line is a line along which all the combinations of workers and coal cost the same amount.

23 Isocost Line c = wl + pr pr = c wl R = c p w p L

24 Cost Reducing Technological Change The first adopter is called an entrepreneur. Innovation rents will not last forever = creative destruction

25 British Industrial Revolution Before the Industrial Revolution technology was labour-intensive, capital goods saving and energy-saving. After new technology, production was capital goods-intensive, energy-intensive and labour-saving. Hypothesis: There were innovation rents to be earned from a switch to the energy-intensive technology. Labour was very expensive relative to the cost of energy in England and the Netherlands.

26 British Industrial Revolution Wages relative to the cost of energy and capital goods went up in the 18th century in Britain. Wages relative to the cost of energy and capital goods were higher in Britain during the 18th century than elsewhere. New capital intensive technology became more cheaper than labour intensive production techniques.

27 Malthusian Economics Consider an agricultural economy producing one good. Inputs are Labour and Land (fixed) total output Average product of labour = total number of farmers Production Function:The amount of output that will result for one or more combinations of input. Labour combined with land is productive As more farmers work, average product of labour falls

28 Population Grows When Living Standards Increase Malthus s model The law of diminishing average product of labour Population expands if living standards increase until subsistence level is achieved In the long run, an increase in productivity will result in increased population but not increased wages: Malthus Law

29 Revising Malthus Law An economy would be stuck in the Malthusian trap if it satisfied three, not two, conditions: Diminishing average product of labour in production Rising population in response to increases in wages An absence of improvements in technology to offset the diminishing average product of labour

30 Conclusion In this unit: We introduced an economic model of how the process of competition among firms both allows the owners of firms that successfully innovate to make extraordinary profits, and also stimulates the diffusion of technological improvements throughout the economy as follower firms try to avoid being left behind. We explained how the Malthusian model of the economy created a vicious circle in which population growth devoured temporary gains in income, until the permanent technological revolution allowed an escape due to improvements in technology. We explained how the forces of supply and demand, as well as political and other influences on the bargaining power of workers and their employers, help explain this particular hockey stick of history; measuring first stagnation in living standards and then a phenomenal increase.