Why do we create models in economics?
in economics we create models to represent a particular situation, and understand the impacts of different factors when playing around with the model
Innovation rent
when you have better technology than competitors but you sell at the same price - much higher rent
do innovation rents last?
Innovation rents tend not to last as industry catches up and employ same technology.
Economic rent is
payment received above what would have been received in their next best alternative
Benefit from option taken - benefit from next best option
Cost for firms =
- wage x labour + price of coal x number of tonnes
- C = WL + PR
Formula for firm Isocost lines
R (number of tonnes) = c/p- WL/p
What does the slope mean on isocost lines
wage to capital ratio, steeper means wages relatively more expensive than coal
Why did people switch to coal during IR?
occurred when coal prices dropped a lot, so factories switched to energy intensive production - incentivised by lowering of costs.
Wages increased relative to cost of tech - incentive to innovate.
- decision rule in play here - if economic rent is positive, do it
Creative destruction
as more firms adopt new tech, supply of cloth in the market will rise, price falls until no one is earning innovation rents. Firms still using old technology will be unable to couver costs = bankrupt = leave market.
- This decentralised process generates a continued improvement in productivity - can be argued as virtuous.
Malthusian economics and average product of labour
- a situation in which as more labour is used in a production process - average product of labour falls.
What is DAPL in Malthusian economics?
- DAPL is one of two foundations of Malthus’ model, can be caused by more labour devoted to a fixed quantity of land, or more inferior in land brought into cultivation
- so if - population expands if living standards increase as people are happier and can sustain raising more children financially.
- But due to DAPL, as population grows, productivity of labour and wages fall, leading to lower living standards until the subsistence level, all until another input like an improvement in farming technology occurs
So why did hockey stick growth occur?
due to Malthus not considering possibly that improvements in technology coud outpace population growth - offsetting DAPL and increasing living standards as well as population.
Employ Malthusian thinking on the potato famine in Ireland
- people died, population falls
- average product of labour rises = wage rises
- living standards rise = people have more children
- population growth becomes positive
- population increases until wages fall back to subsistence level due to DAPL.
Equilibrium is
A situation that is self perpetuating
Process of creating a model:
- construct simplified description of conditions under which people take actions
- describe what determines these actions
- determine how each action effects another
- determine outcome of these actions
- more insight by studying impact on different variables when conditions change.
Reservation option
Next best option
Impact of new technology introduction on wage + population levels
- wage for every level of population rises so left curve shifts up
- same level of pop, at higher wage
- track across, higher real wage means rising population growth as SOL increase means more kids
- limited land so DAPL so population rises and productivity falls back down until wage is same as before
- no more incentive to have kids, back at subsistence wage level with higher population
Change in preference about birth rates
Can lead to change in subsistence wage rate
- lower kids per level of real wage shifts curve up, so subsistence level of wage is higher.
