UNIVERSITY COLLEGE LONDON
DEPARTMENT OF ECONOMICS
Economics BSc (Econ)
First Year – Term 1
ECONOMICS
ECON0002
Rodrigo Antón García
rodrigo.garcia.20@ucl.ac.uk
London, 2020
, Contents
Topic 1 – The Capitalist Revolution. 1
Topic 2 – Technology, Population and Growth. 8
Topic 3 – Scarcity, Work and Choice. 16
Topic 4 – Social Interactions. 38
Topic 5 – Property and Power: Mutual Gains and Conflict. 53
Topic 6 – The Firm: Owners, Managers and Employees. 69
Topic 7 – The Firm and its Customers. 90
Topic 8 – Supply and Demand: Price-taking and Competitive Markets. 114
Topic 11 – Rent-seeking, Price-setting, and Market Dynamics. 130
Topic 12 – Markets, Efficiency and Public Policy. 155
,Economics – ECON0002 Rodrigo Antón García
ECON0002: ECONOMICS SUMMARY – TERM 1
Topic 1 – The Capitalist Revolution.
How capitalism revolutionized the way we live, and how economics attempts to
understand this and other economic systems.
• Since the 1700s, increases in average living standards became a permanent
feature of economic life in many countries.
• This was associated with the emergence of a new economic system called
capitalism, in which private property, markets and firms play a major role.
• Under this new way of organizing the economy, advances in technology and
specialization in products and tasks raised the amount that could be produced in a day’s
work. This process, which we call the capitalist revolution, has been accompanied by
growing threats to our natural environment, and by unprecedented global economic
inequalities.
• Economics is the study of how people interact with each other and with their
natural surroundings in providing their livelihoods, and how does this change over time.
o Topic 1.1 – Income Inequality.
The differences in income before the 18th century between the regions of the world were
much less pronounced than now. In today’s world, not only the rich have much more
than the poor, but there is a huge difference in income between countries.
o Topic 1.2 – Measuring income and living standards.
Gross Domestic Product (GDP): a measure of the market value of the output of the
economy in a given period. Dividing the GDP by the population gives the GDP per capita.
‘GDP measures everything except that which makes life worthwhile’ Robert F. Kennedy.
- GDP per capita measures average income, but it not the same as disposable
income. Disposable income is the amount of wages or salaries, profit, rent, interest and
transfer payments from the government or from others received over a given period such
as a year, minus any transfers the individual made to others (including taxes).
Disposable income: income available after paying taxes and receiving transfers from the
government.
Disposable income is a better measure of our well living than GDP per capita. But it is
still insufficient, because many aspects of our wellbeing are not related with what we can
buy. For example: the quality of our social and physical environment, amount of free time,
healthcare, education and other government provided goods and services.
- Average disposable income also fails to reflect how well off a group of people is
by comparison to some other group. People care about their relative position in the
income distribution.
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GDP includes the goods and services produced by the government, such as schooling,
national defence, and law enforcement. They contribute to wellbeing but are not included
in disposable income. In this respect, GDP per capita is a better measure of living
standards than disposable income. However, government services are difficult to value.
The only measure of their value to us is how much it cost to produce them. This is one
of the difficulties involved in the calculation of GDP.
o Topic 1.3 – History’s hockey: Growth in income.
For a very long time, living standards did not grow in any sustained way. When sustained
growth occurred, it began at different times in different countries, leading to vast
differences in living standards around the world. GDP per capita graphs follow ‘hockey-
stick curves’ as living standards have risen significantly since the capitalist revolution.
Overall, for a very long time, living standards did not grow in any sustained way. And
when sustained growth occurred, it began at different times in different countries, leading
to vast differences in living standards around the world.
Understanding how this occurred has been one of the most important questions that
economists have asked, starting with the founder of the field, Adam Smith, who gave his
most important book the title ‘An Inquiry into the Nature and Causes of the Wealth of
Nations’.
Adam Smith’s believed that a significant source of prosperity comes from division of
labour and specialization, being in turn constrained by the ‘extent of the market’.
Hence specialization was fostered by the construction of navigable canals and the
expansion of foreign trade. And the resulting prosperity itself expanded the ‘extent of the
market’, in a virtuous cycle of economic expansion.
Adam Smith claimed that the coordination between economic actors – producers,
transporters, sellers, consumers – could arise spontaneously, and more importantly as
a result of individuals pursuing their self-interest.
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o Topic 1.4 – The permanent technological revolution.
Remarkable scientific and technological advances occurred at the same time as the
upward kink in the hockey stick in Britain in the middle of the 18th century. Its cumulative
character led to it being called the Industrial Revolution.
Industrial Revolution: a wave of technological advances and organizational changes
starting in Britain in the 18th century, which transformed an agrarian and craft-based
economy into a commercial and industrial economy.
The Industrial Revolution widely includes: the emergence of capitalism, European
imperialism, efforts to mine coal, and the effects of the Agricultural Revolution.
In economics, technology is a process taking a set of materials and other inputs,
including the work of people and machines, to produce an output.
Technological progress is a change in technology that reduces the amount of resources
(labour, machines, land, energy, time) required to produce a given amount of the output.
‘Compact fluorescent bulbs introduced in 1992 are about 45,000 times more efficient, in terms of labour time
expended, than lights were 200 years ago. Today the productivity of labour in producing light is half a million
times greater than it was among our ancestors around their campfire.’ Page 16.
o Topic 1.5 – The economy and the environment.
The economy is a part of a larger social system, which is itself a part of society, the
biosphere and ultimately of our physical environment.
Much of our past, and particularly current economic progress is unsustainable, this
ranges from global climate change to local resource exhaustion. The depletion of natural
resources in production, affects the environment we live in and its capacity to support
future production.
But it is not all negative. Advances in technology today may allow greater reliance on
wind, solar and other renewable sources of energy. The problem we are facing has to
do mainly with time. The irreversible damage we are doing on our planet from the
depletion of natural rainforests to the melting of ice caps.
o Topic 1.6 – Capitalism defined: Private property, markets and firms.
The capitalist revolution emerged in the 18th century, an eventual global spread of a way
of organizing the economy that we now call capitalism.
Capitalism is an economic system characterized by a particular combination of
institutions. An economic system in which private property, markets and firms play a vital
role in the way or economy is organized.
If we want to be more precise, capitalism refers not to a specific economic system, but
to a class of systems sharing these characteristics.
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Private property means that you can enjoy your possessions in a way that you choose,
exclude others from their use if you wish and dispose them by gift or sale to someone
else who then becomes their owner.
We can differentiate between capital and consumer goods:
- Capital goods are the equipment, buildings, raw materials and other inputs used
in the production of goods and services. Goods used to produce other goods.
- Consumer goods are bought for consumption and are those that give satisfaction
to consumers.
Markets a way of connecting people who may mutually benefit by the exchange of goods
and services through a process of buying and selling. Markets are reciprocated and
voluntary. In most markets there is competition.
A firm is a for-profit organization that organizes its production with the following
characteristics:
- One or more individuals own a set of capital goods that are used in production.
- They pay wages and salaries to employees and direct the employees (through
the managers they also employ) in the production of goods and services.
- The goods and services are the property of the owners which they then sell on
markets with the intention of making a profit.
The expanded role of firms created a boom in another kind of market that had played a
limited role in earlier economic systems: the labour market.
The labour market is that in which employers offer wages to individuals who may agree
to work under the direction. The employers are the demand side of the market, while the
workers are the supply side. This is called a factor market.
o Topic 1.7 – Capitalism as an economic system.
The distinctive hallmark of the capitalist economic system is the private ownership of
capital goods that organized for use in firms. Capitalist economies differ, too, from earlier
economies in the magnitude of capital goods used in production.
Two major changes have accompanied the emergence of capitalism, both of which have
enhances the productivity of individual workers:
- Technology: firms competing with each other in markets have given strong
incentives to adopt and develop new and more productive technologies (dynamic
efficiency & creative destruction), investing in capital goods beyond the reach of small-
scale family enterprises.
- Specialization: the production of a limited range of goods and services by an
individual worker, firm, region or country. We become better at producing things when
we each focus on a limited range of activities and we repeat it.
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o Topic 1.8 – The gains from specialization.
Specialization allowed for the emergence of economies of scale. Economics of scale
occurs when increased production leads to falling average costs.
Economies of scale occur when doubling all of the inputs to a production process more
than doubles the outputs.
The shape of a firm’s long-run average cost curve depends both on returns to scale in
production and the effect of scale on the process it pays for its inputs.
Division of labour in firms was a result from this process of specialisation. This is
significant because the firm facilitates a kind of cooperation among specialized
producers that increases productivity and thus production and revenues.
Division of labour is the breaking down of the production process into small parts with
each worker allocated into a specific task. Specialisation at the level of the individual
worker.
As we mentioned before, Adam Smith’s division of labour and specialization where
constrained by the ’extent of the market’.
‘When the market is very small, no person can have any encouragement to dedicate himself entirely to one
employment, for want of the power to exchange all that surplus part of the produce of his own labour, which
is over and above his own consumption, for such parts of the produce of other men’s labour as he has
occasion for.’ Page 28.
If the market is big enough, it accomplished an extraordinary result: unintended
cooperation on a global scale. Markets allow not only people and firms, but also regions
and countries that differ in their ability to produce different goods to specialize.
Economists distinguish who is better at producing what in two ways:
- Absolute advantage: a person or country has an absolute advantage in the
production of a good or service if the inputs it uses to produce this good or service are
less than in some other person or country (it can produce at a lower cost).
- Comparative advantage: a person or country has comparative advantage in the
production of a good or service, if the cost of producing an additional unit of that good or
service relative to the cost of producing another good or service is lower than another
person on country’s cost to produce the same two goods. (it can produce at a lower
opportunity cost).
Specializing and the model of comparative advantage result in an increase of global
output. Therefore, the model of comparative advantage makes a strong case for
governments to allow free trade: efficiency on a global scale will increase if countries
specialise where they have comparative advantage and trade freely with each other.
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o Topic 1.9 – Capitalism, causation and history’s hockey stick.
In economics we want to make casual statements to understand why things happen, or
to devise ways of changing something so that the economy works better.
Causality is a direction from cause to effect, establishing that a change in one variable
produces a change in another.
While correlation is simply an assessment that two things have moved together,
causation implies a mechanism accounting for the association, and is therefore a more
restrictive concept.
A method of studying causalities is called a natural experiment. This is a situation in
which there are differences in something of interest, a change in institutions for example,
that are not associated with differences in other possible causes.
Natural experiment: an empirical study exploiting naturally occurring statistical controls
in which researchers do not have the ability to assign participants to treatment and
control groups, as is the case in conventional experiments. Instead, differences in law,
policy, weather, or other events can offer the opportunity to analyse populations as if
they had been part of an experiment.
The validity of such studies depends on the premise that the assignment of subjects to
the naturally occurring treatment and control groups can be plausibly argued to be
random.
o Topic 1.10 – Varieties of capitalism.
Developmental state: a government that takes a leading role in promoting the process
of economic development through its public investments, subsidies of particular
industries, education and other public policies. South Korea is a good example of this.
Two sets of conditions contribute to the dynamism of the capitalist economic system.
One is the economic, and the other is the political.
- From an economic point of view, where capitalism is less dynamic private
property is not secure, markets are not competitive and firms are owned and managed
by people who survive because of their connections to government or their privileged
birth (nepotism).
- The government is also important. Even in countries where their role is more
limited, governments still establish, enforce and change the laws and regulations that
influence how the economy works.
In addition to supporting the institutions of the capitalist economic system, the
government provides essential goods (merit goods) and services such as physical
infrastructure, education and national defence.
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