Price, Costs and Innovation Rents

2.3 of The Economy 1.0 & The Economy #1

What are the 4 key ideas of economic modelling, and why?

Ceteris Paribus: Focus on variables of interests. See more by looking at less

Incentives because they affect benefits & costs of taking one action versus another

Relative prices compares alternatives

Economic rent is the basis of how people make choices

Define each key idea of economic modelling:

Ceteris Paribus: ‘Holds other things constant’ or ‘other things equal’

Incentives: Economics reward/punishment, which influences the benefits/costs of alternative courses of action

Relative prices: Price of one good/service compared to another, expressed as a ratio

Economic Rent: Payment / other benefit gained above & beyond what the individual would have gained in their next best alternative/ reservation option.

When looking at how changes in wages affect firm’s choice of technology, what would ceteris paribus keep constant?

-Price of all inputs is the same for all firms

-All firms know the technologies used by other firms

-Attitudes towards risk are similar amongst firm owners

What are Innovation Rents?

-The temporary above-normal profits earned by firms that introduced new technologies/methods before any competitors can imitate them.

What is the formula of Economic Rent?

Note that the ‘Benefit from next best option’ can be your reservation option

What is the reservation option?

-Usually, a person’s next best alternative amongst all options in a particular scenario.

-Called a fallback option which should help illustrate its meaning

What does Economic Rent do for decision making?

-If action A gives you an economic rent, and no one else suffers, do it

-If you are already doing action A, and it gives you an economic rent, Carry on doing it