Microeconomics

GDP

Market value of all goods and services produced in a country.

Total income earned within a country

Disposable income

Total income - taxes + govt transfers

Takehome pay

GDP per capita

GDP/population

Weaknesses of GDP

1. Not equally distributed

2. Unpaid labour, e.g. unpaid carers, domestic work

3. Omitted elements, e.g. quality of social/physical environment, amount of free time

4. Impact on climate change

Malthusian Model

• If living standards increase, population increases

• People have more money meaning better nutrition so higher birth rate, lower death rate

• Law of diminishing average product of labour means that that there are more people but less resources per person now

• Therefore income will inevitably fall with a population increase

What does malthusian model suggest/assume?

That something of interest does not change unless an external force is introduced that alters the situation

What does the production function of the malthusian model describe?

The relationship between amount of output produced and number of inputs used to produce it

Average product

Total output/total number of inputs

Law of diminishing average product of labour

If land is fixed and labour expands, the average output per worker is going to fall

What happens if APL is above and below the equilibrium?

Above: population rises so APL falls

Below: population falls so APL rises

Malthusian Trap

• Improvement in tech

• Average output per farmer rises

• Farmers’ income rise

• Living standards rise

• Population rises

• Less land per farmer

• Average output per farmer falls

• Farmers’ income falls

Capitalism

An economic system where individuals and businesses privately own resources and businesses, and operate to make a profit

What was first nation to experience sustained economic growth?

Britain, around 1650

Industrial revolution

period of cumulative innovation

Reasons for capitalism and lift-off

1. Technological change

2. Specialisation

What is the power of owners and managers limited by?

Competition with other firms

Opportunity cost

Cost of foregoing the next best alternative

Reservation option

The next best alternative

Economic rent

Net benefit from the option chosen - opportunity cost of the next best alternative

Innovation rents

The extra profits made by exploiting an invention. Provides incentives for taking an action

Relative prices

The price of one option relative to another. Often expressed as a ratio of the two prices

Production technology

The process that a firm uses to convert a set of inputs into an output that it can sell

Factors of production

The inputs into the production process. Capital, enterprise, land, labour

Profit

Total revenue - costs

Isocost lines

A line that represents all the different combination of two inputs that a firm can employ for the same total cost of production

Characteristics of isocost lines

• If isocost lines have the same slope, the the ratio of input prices must be the same

• Steeper isocost line means the wage is higher relative to the price of the product

• Shallower isocost line means the wage is lower relative to the price of the product

Wealth

Total value of assets owned by an individual or business at a particular point in time

Who is describes as the ‘father of modern economics’?

Adam Smith

Mercantilists

• Believed that wealth was measured in terms of gold reserves

• Promoted exports and restricted imports

• Wanted to restrict trade

• Provided subsidies to exporting manufacturers

Physiocrats

• Believed that the only real source of wealth was agriculture

• Thought the emerging manufacturing sector was just changing the form of objects and not creating anything new

Adam Smith’s beliefs

• Argued in favour of specialisation, trade and emergence of new manufacturing sector

• Used concept of absolute advantage to explain mutual benefits possible from specialisation and exchange

• Countries should only produce goods they have an absolute advantage in

• Saw the role of the state as to provide national defence, administer justice and undertake public work such as building roads

Absolute Advantage

The ability to produce a good or service at a lower cost per unit, using fewer resources than another country

Comparative advantage

The ability to produce a good or service at a lower opportunity cost than another country

Classical eocnomics theory of value

• Only labour can add value

• Value of good relates to amount of labour gone into the production of it

• Money is something that fluctuates so it was not considered to be a true measure of value

Ricardo

• Developed the work of Smith

• His theory: value of a commodity for which it will exchange, depends on the relative quantity of labour which is necessary for its production

• His analysis of trade was later called comparative advantage

Ricardian Model

An international trade theory explaining how countries benefit from specialising in and trading goods in which they have a comparative advantage

What is there a choice between for workers?

Working time and leisure time

Marginal product

Change in y / change in x

Diminishing marginal utility

Each additional unit of consumption results in a smaller increment to total utility than it did previously

Indifference curves

Shows different combinations of goods that give a consumer the same level of utility (satisfaction)

Indifference curves characteistics

• Slopes downwards

• As you move to the right along an indifference curve, it becomes flatter

• They are usually smooth

• The flatter the curve, the lower the MRS value

• The steeper the curve, the higher the MRS value

• Each point on the same curve gives equal utility

• Indifference curves cannot cross

Marginal rate of substitution (MRS)

The amount of one good a person is willing to give up to obtain more of another good while remaining equally satisfied

Marginal rate of transformation

The rate at which an economy must sacrifice one good to produce an additional unit of another good

Substitution effect

When a good becomes relatively cheaper, consumers switch towards buying more of it

Income effect

When a good’s price changes, consumers’ purchasing power changes, affecting how much they buy

Feasible Frontier

The boundary showing the maximum combinations of two goods that can be produced using available resources and technology

What do economists use indifference curves for?

To evaluate which of these actions is best, given some objective, i.e. preferences/utilities

Trade of between work hours and free time when there is technological progress

• Tech progress increases workers’ incomes and increases opportunity cost of free time

• If the income effect dominates, workers will choose more free time

• If the substitution effect dominates workers will choose less free time

Model of contstrained optimisation

• A model of decision making used under scarcity to analyse choices of hours of work

• Overtime increases in productivity or wages, raise the opportunity cost of free time (sub. effect) and may increase the desire for free time (inc. effect)

• The overall change in hours of work depends on which of these effects is bigger

• This depends upon preferences

Game Theory

• How individuals or businesses make decisions when the outcome depends on the choices of others

• Set of models of strategic interactions

Strategy

An action that a person may take when they are aware of the mutual dependence of the results for themselves and for others

Dominant strategy

A best response to all possible strategies of the other player

Dominant strategy equilibrium

An outcome of a game in which everyone plays their dominant strategy

Pareto efficient

Situation where you cannot make someone better off without making someone else worse off

Nash equilibrium

One at which no party would unilaterally switch strategy. They cannot improve their outcome by changing their decision, assuming everyone else keeps their decision the same

Prisoner’s dilemma

Situation where two people acting in their own self interest can end up worse off than if they had cooperated

Invisible hand games

Actions taken independently by self interested individuals that result in a socially optimal outcome

Social preferences

Preferences that place a value on what happens to other people, even if it results in lower personal monetary rewards for the individual

Altruism

When an individual’s utility is increased by benefits to others

Inequality aversion

A preference for more equal outcomes

Reciprocity

Being kind/helpful to others who are kind and helpful to you

Ways to break out of prisoner’s dilemma

• Social preferences

• Repeated games

• Social norms

• Peer punishment

Pure public good

• Non-rival = one person’s use does not reduce availability for others

• Non excludable = cannot prevent other people from benefiting

• Susceptible to free riding

Social dilemma

When actions taken independently by self interested individuals result in a socially suboptimal outcome