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Summary ECON0002 Week 2, Core: The Economy Unit 2
Summary ECONOMY P, ISBN: 0247 Economics (ECON0002)
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By the end of the week’s work on Unit 2, you will be able to:1. understand the nature of economic models, the concept of ceteris paribus
assumptions, and the general applicability of models.
2. explain what production function and diminishing average product of labour are.
3. utilize Malthusian model to explain stagnation in living standards for centuries before
the Industrial Revolution.
4. understand the concept of innovation rent and explain what motivates innovation in a
capitalist economy.
5. understand how a permanent technological revolution produces an escape from a
cycle of economic stagnation.
6. explain why the Industrial Revolution occurred in Britain in the eighteenth century.
How improvements in technology happen, and how they sustain growth in living
standards
Economic models help explain the Industrial Revolution, and why it started in Britain.
Wages, the cost of machinery, and other prices all matter when people make
economic decisions.
In a capitalist economy, innovation creates temporary rewards for the innovator,
which provide incentives for improvements in technology that reduce costs.
These rewards are destroyed by competition once the innovation diffuses throughout
the economy.
Population, the productivity of labour, and living standards may interact to produce a
vicious circle of economic stagnation.
The permanent technological revolution associated with capitalism allowed some
countries to make a transition to sustained growth in living standards.
Irish Potato Blight
1845: devastated Irish food supplies for 5 years. 1m out of an initial total of 8.5m
died.
There was worldwide relief effort but Nassau Senior consistently opposed British
government famine relief because of Mathusianism.
Malthusianism
Body of theory developed by Thomas Robert Malthus in An Essay on the Principle of
Population (1798).
Theory: a sustained increase in income per capita would be impossible.
o Even if technology improved and raised labour productivity, people would still
have more children as soon as they were somewhat better off.
o Population growth would continue until living standards fell to subsistence
level, halting population increase.
Victorian colonial administrators though that famine was nature’s response to
overbreeding – Mike Davis argues that this caused unprecedented mass extinction.
For 700 years before Malthus published his essay, incomes fluctuated but did not
trend upwards.
, The Industrial Revolution:
o The period of radical invention that allowed Britain to escape from the
Malthusian trap – the vicious circle of population growth and income
stagnation.
o Textiles – the invention of spinning (traditionally done by women) and
weaving (by men).
1733: John Kay invented the flying shuttle, greatly increasing the
amount a weaver can produce in an hour.
Increased demand for yarn above the capacity of the spinning wheel.
1764: James Hargreaves’ spinning jenny responded to this problem.
o General-purpose innovation/technology: James Watt’s steam engine (1775).
Modern day – computer.
o Coal played a central role in the Industrial Revolution – vast reserve of energy
held by Britain.
Cost: environmental impact of burning fossil fuels.
o During this time, productivity rose allowing incomes to grow even as
population was increasing.
Between 1850 and 2001, the average real wage increased by around 600%.
2.2 Economic models: How to see more by looking at less
Malthus’ model:
o Based on the relationship between income and population.
o Income at subsistence level is an equilibrium – movements away from
subsistence income are self-correcting: they automatically lead back to
subsistence income as population rises.
o Equilibrium: one or two things in the model are constant; it does not mean
that nothing changes.
How models are used in economics, e.g. Irving Fisher used a water apparatus
to show flows in an economy:
o Build a model to capture elements of the economy that matter.
o Use the model to show how interactions between these elements would lead
to a result.
o Conduct experiments with the model to discover the effects of changes in
economic conditions.
Process of building a model:
o We construct a simplified description of the conditions under which people
take actions.
o Then we describe in simple terms what determines the actions that people
take.
o We determine how each of their actions affects each other.
o We determine the outcome of these actions. This is often an equilibrium
(something is constant).
o Finally, we try to get more insight by studying what happens to certain
variables when conditions change.
A good model has four attributes:
o It is clear: It helps us better understand something important.
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