Unit 2: Technology and incentives

•Net Benefit

Direct benefit - direct cost

•Opportunity cost

What you lose when you choose one action over the next best alternative

•Reservation option=

Best next alternative option or fall back option

•Economic cost=

Direct costs incurred by taking the action + opportunity cost

•Economic Rent=

Net benefit - opportunity cost  OR direct benefit - Opportunity cost

Innovation rents=

Profits from new technology − profits from technology used by competition

•Incentives=

Economic reward or punishment, which influences the benefits and costs of alternative courses of action

•Relative prices

Ratio of 2 prices or One price compared to another price used to determine incentives

Specialization(Wealth of Nations)

We become better at producing things when we each focus on a limited range of activities by learning by doing, difference in ability and economies of scale

•Division of labour=

Specialization of producers to carry out diff. tasks in prod. process

Absolute advantage=

If given a set of available inputs they can produce more of it than another person or country( who produces more?)

Comparative advantage=

If the cost to them of producing it, relative to the cost of another good, is lower than for another person or a country (Product A/Product

•Production Function (Def)

How much output it will produce, given the amounts of inputs used

•Production Function(Characteristics)

1. Fixed-proportions technology=Technology that requires inputs in fixed proportions to each other ( if I want ↗ output → I need to ↗ inputs in the same % )

2. Constant returns scales= If I ↗ all inputs by  same % → ↗ output by same %

•Production Function(Comparison with other technologies)

• Method=Comparison  input requirements for producing a standard amount of output 

• Graph=

  • Slope=Energy–labour ratio

  • Interpretation= Steeper slope→ ++ Energy-intensive technology (aka: Amount of energy, relative to the number of workers,required to produce a given level of output is greater)

How do we find the most cost effective technology?

1. Step 1=Determination of which technologies dominate or are dominated( square method)

2. Step 2= Cost calculation and isocost line( costs=(wage×workers)+(price of a ton of coal×number of tons))

Isocost line(Definition)

• Slope= -(w/p)

• Def= Line that represents all combinations of inputs that cost a given total amount

• Method=Find endpoints or other points with the same cost and then connect the dots

• Interpretation= Anything above costs more and anything under is less

Cost formula

(wage×workers)+(price of a ton of coal×number of tons) 

Formulas for profit=

• Profits= Revenue - costs

• Profits from switching from A to B tech=change in revenue — change in costs 

Elements of Economic models

• Equilibrium= Self-perpetuating situation that will not vary  unless an external force for change is introduced 

• Endogenous variables=Variables whose values are determined by relationships built into the model

• Exogenous variables=Variables whose values are determined outside the model 

• Ceteris paribus=holding other things equal