Unit 2

Econ 200: Technology and Incentives

Course Information

• Offered by: University of Washington

• Subject: Microeconomics

• Key Topics:

  • Rational decision making

  • Technology and the Industrial Revolution

  • Production and opportunity cost

  • Specialization and gains from trade

• Reading Material: The Economy 2.0, Microeconomics Unit 2.1–2.3

Rational Decision Making

• Definition of Rational Decision Making:

  • A model of rational decision making assumes that decision makers will choose the option that yields the most net benefit from a range of choices.

  • Net Benefit:

  • Calculated as:
    $ext{Net Benefit} = ext{Benefit} - ext{Economic Cost}$

  • Also referred to as Economic Rent.

• Trade-offs in Economic Decisions:

  • Economic decisions frequently require trade-offs to be recognized, referring to the consideration of opportunity cost, which is the value of the next best alternative that is forgone.

  • Opportunity Cost:

  • Defined as the value of the next most highly-valued alternative choice foregone when making a decision.

Model of Decision Making

• Economic Cost:

  • Total economic cost comprises:

  • Direct costs incurred from taking the action + Opportunity cost.

• Economic Rent:

  • Defined as:

  • $ext{Economic Rent} = ext{Net Benefit} - ext{Opportunity Cost}$

Example of Economic Decision Making

• Scenario: Choosing between attending the Husky football game or a concert at the Neptune.

  • Benefits of attending Husky game: $120$

  • Costs of tickets: $88$

  • Opportunity cost of not attending the concert: $40$

  • Calculating Economic Rent:

  • $ext{Economic Rent} = 120 - 88 - 40 = -8$

Technology and the Industrial Revolution

• Definition of Technology:

  • Refers to a process utilizing a combination of inputs—such as materials, machinery, and labor—to produce outputs.

• Technological Progress:

  • Describes advancements allowing reduced labor requirements to produce a similar output.

  • Historical context: Technological progress was slow for millennia; however, post-Industrial Revolution, there has been a documented “permanent technological revolution.”

Market Dynamics and Technological Development

• Technological incentives for firms:

  • Competing firms are driven to adopt and develop innovative, productive technologies.

• Specialization:

  • The expansion of markets and firms facilitated a significant division of labor, enhancing productivity.

  • Rooted in overarching ideas attributed to Adam Smith, who asserted that technology enhances living standards.

Adam Smith's Philosophy

• Background:

  • Considered the father of modern economics, Smith wrote seminal works—The Theory of Moral Sentiments and An Inquiry into the Nature and Causes of the Wealth of Nations.

  • Advocated for the idea that individual self-interest could promote societal welfare.

• Government Role:

  • While famous for promoting free markets, he also believed governments were necessary to provide for defense, justice, education, and infrastructure.

Invisible Hand Concept

• Quotation by Adam Smith (1776, Book IV, Chapter II):

  • “By directing that industry in such a manner as its produce may be of greatest value, he intends only his own gain… led by an invisible hand”

  • This illustrates how self-interest can inadvertently lead to societal benefits.

Gains from Specialization

• Productivity Enhancement Through Specialization:

  • Individuals become more productive focusing on limited activities due to:

  • Learning by Doing: Increasing proficiency in tasks over time.

  • Differences in Ability/Resources: Variability in individual capabilities and available resources.

  • Economies of Scale: Benefits gained from scaling production processes.

• Necessity for Market Transactions:

  • Specialization necessitates the ability to trade for other needed goods.

Production Function

• Defined as the relationship between inputs used and outputs produced.

• Example: Greta and Carlos' production capabilities for wheat and apples:

  • If both have the same time but differ in production abilities, the amount produced may vary based on available technology and resources.

• Numeric Production Outcomes:

  • Greta:

  • 1,250 apples & 50 tons of wheat.

  • Carlos:

  • 1,000 apples & 20 tons of wheat.

Absolute Advantage vs. Comparative Advantage

• Absolute Advantage:

  • More productive in producing specific goods leads to questions about who possesses the absolute advantage.

• Example Calculation of Opportunity Cost:

  • Greta's opportunity cost of 1 ton of wheat:

  • $rac{1250 ext{ apples}}{50 ext{ tons wheat}} = 15 ext{ apples per ton of wheat}$

  • Carlos's opportunity cost:

  • $rac{1000 ext{ apples}}{20 ext{ tons wheat}} = 50 ext{ apples per ton of wheat}$

• Comparative Advantage:

  • Defined as having a lower relative opportunity cost for producing a good compared to another producer.

Example of Opportunity Costs in Production

• Hypothetical country, Canada:

  • Production options: Lumber and Fish

  • Workers can cut 10 feet of lumber or catch 20 fish per day.

  • Opportunity cost of cutting one foot of lumber in terms of fish:

  • $ext{Opportunity Cost} = rac{20 ext{ fish}}{10 ext{ feet}} = 2 ext{ fish per foot of lumber}$

Self-Sufficiency Comparison

• Greta's Time Allocation:

  • Apples: 40%,

  • Wheat: 60%.

  • Production: Apples: $1250 imes 0.4 = 500$, Wheat: $50 imes 0.6 = 30$.

• Carlos's Time Allocation:

  • Apples: 30%,

  • Wheat: 70%.

  • Production: Apples: $1000 imes 0.3 = 300$, Wheat: $20 imes 0.7 = 14$.

Total Self-Sufficiency Production

• Combined production data:

  • Apples total: $500 + 300 = 800$

  • Wheat total: $30 + 14 = 44$

Effects of Specialization and Trade

• Upon specializing in goods of comparative advantage, productivity can be maximized.

Consumption After Specialization

• Greta:

  • Apples: 0, Wheat: 50.

• Carlos:

  • Apples: 1000, Wheat: 0.

• Specialized Total Consumption:

  • Apples: 800, Wheat: 50.

Gains from Trade

• Gains for Greta and Carlos post-specialization and trade:

  • Greta: +100 apples and +5 tons of wheat.

  • Carlos: +100 apples and +1 ton of wheat.

• Rationale Behind Trade Benefits:

  • Trade enables exchanges that yield mutual benefits without deteriorating either party's welfare.

Global Implications of Specialization and Trade

• Explains why markets provide advantages for individuals and why countries specialize in particular goods.

• Various factors, such as technology, wages, and natural resources influence a country's specialization choices.

Ignoring Caring Labor in Economics

• Discussion on how domestic and reproductive labor, frequently performed by women, is often neglected in economic metrics.

• Quote by Malcolm Harris (2016):

  • “GDP declines when an economist marries his housekeeper, explaining limitations of GDP.”

Technological Progress Over Time

• Historical timeline of technological advancements:

  • Open Fires

  • Candles

  • Whale Oil Lamps

  • Incandescent Lightbulbs

  • Fluorescent Lightbulbs

  • LED Lightbulbs

Speed of Information Dissemination

• Historical speeds at which news traveled:

  • Example: 12 MPH for news of Lincoln's assassination.

• Graphical representation of information transmission speed from 1000 to 1865.

Wealth Inequality Trends

• Chart displaying wealth share of the top 1% over decades (1740-2011) with key historic events highlighted:

  • US Independence (1776)

  • French Revolution (1789-1799)

  • World Wars

  • Golden Age of Capitalism (1945-1973)

Defining Capitalism

• Characterization of Capitalism:

  • Features include private property, markets, and firm-operated production.

• Importance of non-capitalist institutions:

  • Families and governments play crucial roles in capitalist economies.

Production and Ownership in Capitalism

• Most production occurs in firms, where inputs and outputs are privately owned, and production is conducted within market transactions.

  • Power dynamics: Concentrated among owners and managers but moderated by competition.

Capitalism in Relation to Democracy

• Characteristics of a democratic system:

  • Individual rights and fair elections.

• Distinction between Capitalism and Democracy:

  • Capitalism does not rely on democratic processes to thrive, and exists in various political frameworks worldwide.

  • Emerged historically before most democratic systems.