Micro Unit 2

Question 1

2.2 Economic decisions: Opportunity costs, economic rents, and incentive

What is net benefit and its formula?

Answer 1

net benefit of X =enjoyment-direct cost of X

Question 2

2.2 Economic decisions: Opportunity costs, economic rents, and incentive

What is the oppurtunity cost?

Answer 2

The next best alternative foregone. The lost oppurtunity is a cost of the action you are taking.

Question 3

2.2 Economic decisions: Opportunity costs, economic rents, and incentive

What is economic cost?

Answer 3

This is the overall cost. The direct cost + Oppurtunity cost. (E.g. If i go to a concert that directly costs 50 pounds, and the enjoyment i would have gotten from the park is 20 pounds so the economic or overall cost would be 50+20=70)

Question 4

2.2 Economic decisions: Opportunity costs, economic rents, and incentive

What is the economic rent?

Answer 4

• This is a method to express the decision rule
• The action should be taken if the net benefit is greater than the oppurtunity cost
• The difference between net benefit and oppurtunity cost is called the economic rent.
• Economic rent=Net benefit (Enjoyment-direct cost)-Opp Cost.

Question 5

2.2 Economic decisions: Opportunity costs, economic rents, and incentive

If the economic rent is positive, what does this mean?

Answer 5

You should do this, as this benefits you more than the other option is economic rent >0. Economic rent is something you are GAINING, not to be confused with day-to-day use of the word rent.

Question 6

2.2 Economic decisions: Opportunity costs, economic rents, and incentive

What can determine incentives?

Answer 6

Economic rent and Relative prices

Question 7

2.2 Economic decisions: Opportunity costs, economic rents, and incentive

What is innovation rent (include formula)?

Answer 7

• The extra profits earned by a firm that introduces a new technology, organizational form, or strategy before others can imitate it.
• Innovation rent = profits from using the new technology − profits if you continued using the same technology as competitors.

Question 8

2.2 Economic decisions: Opportunity costs, economic rents, and incentive

Describe how innovation rents can lead to incentive

Answer 8

Innovation rents motivate firms to adopt new technologies for higher profits.

Question 9

2.2 Economic decisions: Opportunity costs, economic rents, and incentive

What do firms typically pick choices based on?

Answer 9

Whatever yields the highest profit

Question 10

2.2 Economic decisions: Opportunity costs, economic rents, and incentive

What is a relative price?

Answer 10

Relative prices = the price of one good or service compared to another, usually expressed as a ratio.
- Decisions dont change if prices rise equally, but do change based on ratio of relative prices

Question 11

2.3 Comparative advantage, specialization, and markets

What is specialisation?

Answer 11

Focusing one’s productive effort on a narrower set of goods or tasks in order to increase efficiency and productivity.

Question 12

2.3 Comparative advantage, specialization, and markets

How does specialisation arise?

Answer 12

• Learning by doing: As you do a specific task more, we acquire the skills to produce them better
• Difference in ability: Due to natural surroundings and skills, some individuals are better at some tasks than others.
• Economies of scale: Producing a large number of goods can be more cost effective than fewer goods.

Question 13

2.3 Comparative advantage, specialization, and markets

What is comparative advantage?

Question 14

2.3 Comparative advantage, specialization, and markets

If someone is better at producing BOTH goods (in this situation there are only 2 goods to produce) they have an…

Answer 14

Absolute advantage

Question 15

2.3 Comparative advantage, specialization, and markets

What is absolute advantage?

Answer 15

Absolute advantage: when a person/country can produce more of a good using the same inputs than another.

Question 16

2.3 Comparative advantage, specialization, and markets

What is comparative advantage?

Answer 16

Comparative advantage: when a person/country has a lower opportunity cost in producing a good compared to another good, relative to someone else

Question 17

2.3 Comparative advantage, specialization, and markets

Can someone benefit from specialisation if they already have absolute advantage?

Answer 17

Yes, due to comparative advantage they will still be better off specialising in 1 good as they may have a higher oppurtunity cost in another good.

Question 18

2.3 Comparative advantage, specialization, and markets

Taking this example establish who has comparative and absolute advantage and explain.

Answer 18

Greta has absolute advantage as she is more productive in both apples and wheat.
Greta produced 2.5 times as much wheat as carlos and 1.25 times as many apples.
Carlos’ disadvantage (oppurtunity cost) in producing apples is lower than Gretas.
Carlos has comparative advantage in apples.
This is because his relative cost to produce apples is lower than Greta’s. Greta has a comparative advantage in wheat as her relative cost to produce wheat is less than Carlos’

Question 19

2.3 Comparative advantage, specialization, and markets

What is self sufficiency?

Answer 19

A scenario in which individuals cannot trade and have to produce their utility on their own.

Question 20

2.3 Comparative advantage, specialization, and markets

Why is trade usually better than being self sufficient?

Answer 20

Total production is usually higher in specialisation than under self sufficiency. Even if one producer is better at everything (absolute advantage), there are gains from trade if each specialises in what they do relatively best (comparative advantage).

Question 21

2.3 Comparative advantage, specialization, and markets

What formula involving oppurtunity cost can be used to determine comparative advantage?

Answer 21

Opportunity cost of A (in terms of B) for X/Oppurtunity cost of A for Y<1

Question 22

2.3 Comparative advantage, specialization, and markets

Draw a table that compares self sufficiency and specialisation and describe what this means.
Greta:
* Self-sufficiency: Produces 500 apples and 30 tons of wheat.
* Specialisation: Focuses fully on wheat → 50 tons.
* Trade: Sells 15 tons of wheat to Carlos and buys 600 apples.

Carlos:
* Self-sufficiency: Produces 300 apples and 14 tons of wheat.
* Specialisation: Focuses fully on apples → 1,000 apples.
* Trade: Sells 600 apples to Greta and buys 15 tons of wheat.

Answer 22

Under specialisation of the good in which they have comparative advantage both Greta and Carlos consume more goods than under self sufficiency.
By specialising and trading, both move beyond their production possibilities frontier (PPF) — consuming more than they could produce alone.

Question 23

2.3 Comparative advantage, specialization, and markets

How does capatalism aid specalisation?

Answer 23

Expands the roles of markets and firms, where markets increase productivity as more people benefit from trade by specialising in the good they have comparative advantage in. Easier to specialise in larger markets.

Question 24

2.3 Comparative advantage, specialization, and markets

How do small markets limit division of labour?

Answer 24

The extent of the market limits the division of labour: If the market is small, producers cannot specialise too much because they cannot trade the surplus

Question 25

# 2.4 Firms, technology, and production What is the relationship of workers and technology to firms? What choices do firms need to make in terms of this?

Answer 25

Firms employ workers to produce and sell goods and services. Firms own or rent technology to aid production. Firms need to choose the amount of inputs required to make a fixed number of outputs and the production technology they are using to convert inputs to outputs.

Question 26

# 2.4 Firms, technology, and production What are factors of production?

Answer 26

Inputs required to make a good or service (e.g. raw materials, labour, capital goods, and energy to operate the machines.)

Question 27

# 2.4 Firms, technology, and production What is a production function?

Answer 27

A relationship that tells us how much output it will produce, given the a set number of inputs used

Question 28

# 2.4 Firms, technology, and production In terms of agricultural output (Y) using labour (X) and land what does the production function look like?

Answer 28

Y=f(X) as land is assumed to be fixed.

Question 29

# 2.4 Firms, technology, and production If there are a number of variable factors of production (M,N,O) what is the production function in terms of product (Y)?

Answer 29

y=f(M,N,O)

Question 30

# 2.4 Firms, technology, and production What occurs if 1 of multiple factors of production is increased in fixed-technology products?

Answer 30

There is no change in the production function as all factors need to be increased in the same proportion to increase output.

Question 31

# 2.4 Firms, technology, and production Describe what constant returns to scale is

Answer 31

Technologies where if production factors increase by 2x then output increases by 2x.

Question 32

# 2.4 Firms, technology, and production In technologies with fixed proportions and constant returns what is always true about average product of labour?

Answer 32

APL is always the same.

Question 33

# 2.4 Firms, technology, and production How can measuring inputs and outputs be used to compare technologies?

Answer 33

Compare the inputs required by each technology to make a fixed set of outputs.

Question 34

# 2.4 Firms, technology, and production What does this tell us about technologies A and B

Answer 34

Technology B is more energy intensive than Technology A despite having a higher APL. The slope of each ray corresponds to the energy–labour ratio. The steeper the ray, the more energy-intensive the technology (meaning that the amount of energy—relative to the number of workers—required to produce a given level of output is greater).

Question 35

# 2.5 Modelling a dynamic economy: Technology and costs What figures are required to graph the inputs required to form a set number of outputs?

Answer 35

The number of workers and number of capital (e.g no. of workers and no. of coal to make 100 mtrs of cloth)

Question 36

# 2.5 Modelling a dynamic economy: Technology and costs What would this graph look like as a table in terms of number of workers and coal required to

Answer 36

Question 37

# 2.5 Modelling a dynamic economy: Technology and costs What does this graph tell us about which technologies are labour intensive and energy intensive?

Answer 37

Technology A is the most relatively energy intensive while E is the most relatively labour intensive

Question 38

# 2.5 Modelling a dynamic economy: Technology and costs From the graph below which of the 5 technologies can we definitely know the firm will not use and why?

Answer 38

Given that all 5 of these technologies are available, C is inferior to A and D is inferior to B so neither C or D will be employed. This is because C and D use more coal and workers to produce the same amount of cloth as A and B respectively.

Question 39

# 2.5 Modelling a dynamic economy: Technology and costs How does the firm determine which to pick from A, B, E (generally)?

Answer 39

The firm requires information about the relative prices of coal and labour for each A,B,E. GENERALLY, If coal is much more cheap relative to the cost of labour, energy intensive technology (A) is chosen and if labout is much more expensive relative to coal then labour intensive technology (E) is chosen.

Question 40

# 2.5 Modelling a dynamic economy: Technology and costs What formula can a firm use to evaluate the cost of production of different technologies?

Answer 40

cost=(wage×workers)+(price of a ton of coal×number of tons)=(𝑤×𝑁)+(𝑝×𝑅)

Question 41

# 2.5 Modelling a dynamic economy: Technology and costs What is an isocost line? How does this help us determine the cost of production?

Answer 41

A line that join all the combinations of inputs that cost the same amount. Each technology is then plotted with a fixed land and labour combination. (Each technology appears as a point). Lowest isocost line + Technology point on it =

Question 42

# 2.5 Modelling a dynamic economy: Technology and costs Why are all isocost lines parallel?

Answer 42

slope of isocost lines =−𝑤/𝑝. As w and p are the same currently (fixed but only in this one scenario), the gradient for all isocost lines of the same factors are parallel as they share the same gradient.

Question 43

# 2.5 Modelling a dynamic economy: Technology and costs Which of A,B,E should be picked?

Answer 43

Technology B allows the firm to produce cloth at the lowest cost, as B is on the isocost line for 80 pounds, while A and E are above this line. Anything above the line will cost more than 80 pounds.

Question 44

# 2.5 Modelling a dynamic economy: Technology and costs What occurs if the price of w or p change?

Answer 44

If wages increase (w rises) or energy price falls (p falls), then the ratio w/p changes → the slope of isocost changes → the technology with lowest cost may shift from one point to another.

Question 45

# 2.6 Modelling a dynamic economy: Innovation and profit How does a cost reducing innovation raise profits?

Answer 45

When relative prices change (e.g. coal becomes cheaper, line becomes steeper, A is now the most cost-saving technology. This isocost line may be cheaper meaning that by cost reducing for coal, the cost of production is lower, raising profits.

Question 46

# 2.6 Modelling a dynamic economy: Innovation and profit Formula to calculate profit

Answer 46

Profit=Revenue (money selling output) -cost

Question 47

# 2.6 Modelling a dynamic economy: Innovation and profit If the economic rent of the firm to switch from technology A to B is 10 pounds should they do it?

Answer 47

Yes, if economic rent is positive this is the most cost saving option.

Question 48

# 2.6 Modelling a dynamic economy: Innovation and profit What is an entrepreneur?

Answer 48

Someone who is the first adopter of an existing technology

Question 49

# 2.6 Modelling a dynamic economy: Innovation and profit What happens to innovation rents over time according to the concept of creative destruction?

Answer 49

Innovation rents are temporary profits earned by firms that first adopt a new, lower-cost technology. Other firms soon imitate or adopt the innovation → costs fall and profits rise for them too. As more firms adopt it, market supply increases → price of output falls. Innovation rents disappear once all firms use the new technology. Firms that fail to adapt to the new technology cannot cover costs and go bankrupt.

Question 50

# 2.7 The Industrial Revolution and incentives for new technologies What did the shift to high w and low p cause in Britain?

Answer 50

With high w & low p (wage rate over price of energy), labour was expensive relative to energy → provided a strong incentive to switch to technologies that used more energy and less labour.

Question 51

Define equilibrium

Answer 51

A state of the model (economy) that, once reached, remains unless acted on by an external change.

Question 52

Define endogenous variables

Answer 52

Variables whose values are determined within the model by the relationships specified.

Question 53

Define exogenous variables:

Answer 53

Variables set outside the model (by the modeller) and not determined by the model’s internal mechanisms.

Question 54

Define Ceteris Parabis

Answer 54

A simplifying assumption where certain variables are held constant to isolate the effect of one change.