Microeconomics I Lecture 3: Technology & Incentives
Microeconomics I Lecture 3 Technology & Incentives
Learning Objectives
Understanding the interplay of economic models, incentives, and technical change.
Concepts Covered
Relative Prices: The price of one option compared to another, often expressed as a ratio.
Incentives: Factors that motivate individuals or firms to act in certain ways.
Reservation Option: The next best alternative that could be pursued.
Economic Rent: The net benefit from an option taken minus the opportunity cost.
Isocost Line: A graphical representation showing all combinations of inputs that yield the same total cost.
Innovation Rent: Extra profits gained from utilizing an invention to increase production or efficiency.
Endogenous Variables: Variables whose values are determined within the model.
Exogenous Variables: Variables whose values are determined outside the model.
Ceteris Paribus: A Latin phrase meaning "all other things being equal"; used in economic modeling to isolate the effects of one variable.
Outline of Lecture
A. Introduction
Discusses the significance of using models in economics.
B. Decision Making
Exploration of how economic variables affect decisions.
C. Technologies and Innovation
Analysis of how advancements influence productivity and economic outcomes.
D. Economic Models
Characteristics of effective models in economics.
What Makes a Good Economic Model?
Clarity: A model should enhance understanding of important issues.
Predictive Accuracy: Predictions should align with real-world evidence.
Improved Communication: A model should facilitate discussions about areas of consensus and disagreement.
Quote: "All models are wrong, but some are useful" – G.E.P. Box (1978).
Model I: The Malthusian Model
Developed by Thomas Malthus (1766-1834) during a period of persistently low wages and living standards.
Model II: A Model of Decision Making
Opportunity Cost: The value of the best alternative action not taken.
Reservation Option: The next most valuable alternative.
Economic Cost Formula:
ext{Economic Cost} = ext{Direct Costs} + ext{Opportunity Costs}Economic Rent Formula:
ext{Economic Rent} = ext{Net Benefit} - ext{Opportunity Cost}Example: (Attendance at a concert by Taylor Swift)
Ticket Cost: £225
Enjoyment Value: £555
Net Benefit Calculation:
ext{Net Benefit} = 555 - 225 = 330Reservation Option: Earning £50 from tutoring.
Total Economic Cost:
ext{Economic Cost} = 225 + 50 = 275Economic Rent Calculation:
ext{Economic Rent} = 555 - 275 = 280
Innovation Rent and Relative Prices
Innovation Rents: Additional profits from exploiting an invention that serve as incentives for firms to engage in productive activities.
Relative Prices: Their influence on determining economic incentives is paramount, as they dictate the choices available to firms.
Firms, Technology, and Production
Production Technology: The methods used by firms to convert inputs into outputs.
Factors of Production: Including raw materials, labor, capital goods, etc.
Production Function: Defines how much output results from various levels of input.
Fixed-Proportions Technology Example: Olive Oil Production
Inputs:
Number of machines, M
Number of workers, N
Amount of energy, E (kWh)
Output, Y (litres) Examples:
For M=3, N=1, E=80, Output Y=50 litres
For M=4, N=2, E=160, Output Y=100 litres
The Firm and Production of Cloth
Fixed Output Target: 100 meters of cloth.
Input Combinations and Production Technologies:
Technology
Number of Workers
Coal Required (tonnes)
A
1
6
B
4
2
C
3
7
D
5
5
E
10
1
Cost Function
General Cost Equation:
C = wL + pRWhere:
w = wage per day (£10/day)
p = cost of coal per tonne (£20/tonne)
Actual Technology Cost Calculation:
Technology
Number of Workers
Coal Required
Total Cost (£)
A
1
6
130
B
4
2
80
E
10
1
120
Isocost Line
Graphical representation of all combinations of inputs yielding the same total cost.
Equation of the Isocost Line: ext{Cost} o c = wL + pR
Draws implications about choice among technologies based on input prices.
Slope of Isocost Line:
ext{slope} = - rac{w}{p}
Changes in Input Prices
Analysis of how changes in wages and coal prices affect the cost of production and the choice of technology:
Initial Scenario: Low costs associated with using Technology B (£80).
Post-Price Change: Increase in technology A's relative affordability leads to a switch in production methods based on new input price ratios.
Escape from the Malthusian Trap
Historical Advances: Key developments in sanitation, medicine, and family planning have allowed for increased population and GDP per capital since the 1800s.
Malthusian Insights: Technological advancements have historically corrected the balance where population pressures stymied economic growth.
Model-Building Process in Economics
Define a specific question.
Develop a simplified description of decision-making conditions.
Clarify what influences decision-making.
Assess how individual choices affect each other.
Determine the outcomes of collective actions (often leading to equilibrium).
Evaluate the effects of changes in conditions on model variables.
Key Terms in Modeling
Equilibrium: A stable state where no change occurs unless interrupted by external forces.
Endogenous Variables: Outcomes determined by internal model dynamics.
Exogenous Variables: Factors impacting the model from outside.
Ceteris Paribus: Concept of assuming other relevant factors remain unchanged when assessing impact.
Summary of the Malthusian Model
Used models to provide insights about technological revolutions affecting living standards and economic performance.
Correctly predicts historical economic developments based on relative input costs influencing technology adoption.
Continuing Education
Next topics to study: The Economics of Adam Smith focusing on the Nature of Economic Value, Specialization, and Gains from Exchange.
Action Items: Read "Micro 1 Notes: Adam Smith" and participate in discussions via Piazza.