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Summary Microeconomics, Institutions and Welfare
Summary Microeconomics, Institutions and Welfare
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lOMoARcPSD|11911780Microeconomics, institutions and welfare
UNIT 2: TECHNOLOGY, POPULATION AND GROWTH
Introduction
Malthusianism = body of theory developed by Thomas Malthus: Malthus held that a sustained
increase in income per capita would be impossible. (volhoudende groei in income per capita).
His logic was that, even if technology improved and raised the productivity of labour, people
would still have more children as soon as they were somewhat better off. This population
growth would continue until living standards fell to subsistence level, halting the population
increase. Malthus’ vicious circle of poverty was widely accepted as inevitable
(=onvermijdelijk)
Malthus vision of economic progress = If people succeed in improving technology, in the
long run the vast majority would earn just enough form their jobs or their farms to keep them
alive, and no more.
The change that had sprung Britain from the Malthusian trap, and would do the same for
many countries in the 100 years that followed, is known as the industrial revolution—an
extraordinary flowering of radical invention that allowed the same output to be produced
with less labour.
Industrial revolution = a wave of technological advances and organizational changes
starting in Britain in the eighteenth century, which transformed an agrarian and craft-based
economy into a commercial and industrial economy.
General-purpose innovations/technologies = technological advances that can be applied to
many sectors, and spawn (=voortbrengen) further innovations. Information and
communications technology (ICT), and electricity are two common examples.
Energy used before the industrial revolution: edible plants
Energy used during the Industrial revolution: coal, Britain had a lot of it. The costs of this
change in using energy is the environmental impact of burning fossil fuels.
These inventions discussed before along other innovations of the industrial revolution, broke
the Malthus’ vicious circle: Advances in technology and the increased use of non-renewable
resources raised the amount that a person could produce in a given amount of time
(=productivity), allowing incomes to rise even as the population was increasing. And as long
as technology continued improving quickly enough, it could outpace the population growth
that resulted from the increased income. Living standards could then rise. Much later, people
would prefer smaller families, even when they earned enough to afford to have a lot of
children. This is what happened in Britain, and later in many parts of the world. This resulted
in the hockey stick-curve
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2.1 Economist, historians, and the industrial revolution
What we call the industrial revolutions was more than just the breaking of the Malthusian
cycle; it was a complex combination of inter-related intellectual, technological, social,
economic and moral changes. The industrial revolution did not lead to economic growth
everywhere. Because it was originated in Britain and spread only slowly to the rest of the
world, it also implied a huge increase in income inequality between countries and within
countries.
Economists and historians disagree about the relative importance of these changes before the
industrial revolution and have wrestled with explanations for the primacy of Britain, and
Europe more generally. A general view of what the structural changes of the industrial
revolution drove, was the relatively high cost of labour, coupled with the low cost of local
energy sources.
It is difficult for social scientists to explain the industrial revolution, because it only happened
once. Also, the European take-off was probably the result of a combination of scientific,
demographical, political, geographic and military factors.
Economists have much to learn from historians, but often a historian’s argument is not precise
enough to be testable using a model. On the other hand, historians may regard economists’
models as simplistic, ignoring historical facts. This creative tension is what makes economic
history so fascinating.
2.2 Economic models: How to see more by looking at less
We use models, because it is impossible to understand the economy by describing every
detail. Models helps us to stand back and look at the bigger picture.
To create an effective model of the economy we need to distinguish between the essential
features of the economy that are relevant to the question we want to answer, which should be
included in the model, and unimportant details that can be ignored.
The fact that models omit details-and in this sense is unrealistic- is a feature of the model, not
a bug.
Important concepts in economics:
1. Equilibrium (=evenwicht): A situation that is self-perpetuating (=zichzelf in stand
houdend). In this case, something of interest does not change unless an outside or
external force is introduced that alters the models’ description of the situation.
For example; intersect demand and supply, constant prices etc.
• Equilibrium means that one or more things in the model are constant. It
does not mean that nothing changes. For example; we might see an
equilibrium in which GDP or prices are increasing, but at a constant
level
2. Subsistence level: the level of living standards (measured by consumption or income)
such that the population will not grow or decline.
We will apply the concept of equilibrium to the Malthusian model: An income at subsistence
level is an equilibrium, because movements away from subsistence income are self-
correcting; they automatically lead back to subsistence income as population rises.
, lOMoARcPSD|11911780
Steps of how to build a model:
1. We construct a simplified description of the conditions under which people
take actions
2. Then we describe in simple terms what determines the actions that people take
3. We determine how each of their actions affects each other
4. We determine the outcome of these actions. This is often an equilibrium
(=something is constant)
5. Finally, we try to get more insight by studying what happens to certain variables
when conditions change.
A good model has four attributes:
1. It is clear: It helps us better understand something important
2. It predicts accurately: Its predictions are consistent with evidence
3. It improves communication: It helps us to understand what we agree (and disagree)
about
4. It is useful: We can use it to find ways to improve how the economy works.
Economic models often use mathematical equations and graphs as well as words and pictures.
Mathematics is part of the language of economics and can help us to communicate our
statements about models precisely to others. Much of the knowledge of economics, however,
cannot be expressed by using mathematics alone. It requires clear descriptions, using standard
definitions of terms.
A good model starts with some assumptions or hypotheses about how people behave, and
often gives us predictions about what we will observe in the economy. Gathering data on the
economy, and comparing it with what a model predicts, helps us to decide whether the
assumptions we made when we built the model-what to include, what to leave out-were
justified.
Governments, central banks, corporations, trade unions, and anyone else who makes policies
or forecasts use some type of simplified model. Bad models can result in disastrous policies.
To have confidence in a model, we need to see whether it is consistent with evidence.
2.3 Basic concepts: Prices, costs and innovation rent
Four key ideas of economic modelling:
1. Ceteris paribus and other simplifications help us to focus on the variables of
interest. We see more by looking at less;
2. Incentives matter, because they affect the benefits and costs of taking one action
as opposed (=vergeleken met) to another.
3. Relative prices help us to compare alternatives
4. Economic rent is the basis of how people make choices.
Ceteris paribus and simplification:
Economists often simplify an analysis by setting things aside that are thought to be of less
importance to the question of interest, by using the phrase ‘holding other things constant’ or
more often the Latin expression ceteris paribus, meaning ‘other things equal’. These ceteris
paribus assumptions, when used well, can clarify the picture without distorting the key facts.
, lOMoARcPSD|11911780
Incentives matters:
By taking one option over another, people are always attempting to do as well as they can.
People are free to select different courses of action, rather than simply being told what to do.
This is where economics incentives (economische stimulansen) affect the choices we make.
But we can’t do everything we want to do: not every channel is open to us.
Like many economic models, the one we use to explain the permanent technological
revolution is based on the idea that people or firms respond to economic incentives. People
are not only motivated by the desire for material gain, but also by sense of duty, and desire of
approval. But material comfort is an important motive, and economic incentives appeal to this
motive.
For example: when owners of managers of firms decide how many workers to hire, or when
shoppers decide what and how much to buy, prices are going to be an important factor for
determining their decision. If prices are a lot lower in the discount supermarket than in the
corner shop, and it is not too far away, then this will be a good argument for shopping in the
discount supermarket rather than in the corner shop.
Relative prices:
In economic models, we are often interested in ratios of things, rather than their absolute
level. Economics focuses attention on alternatives and choices.
Relative prices are simply the price of one option relative to another. We often express
relative price as the ratio of two prices. Example of relative prices: when we study the
Industrial Revolution, you will see that the ratio of energy prices (price of coal), to the wage
rate plays an important role. (=niet alleen een prijs, maar de prijs vergeleken met een andere
optie prijs)
Reservation positions and rent:
Innovation rents are a form of economic rent-and economic rents occur throughout the
economy. An example of innovation rent is when your firm creates a much cheaper
technology while your competitors use the old technologies. It is obvious that your profit will
exceed the competitor’s profits because of your low costs through innovation. Innovation rent
is one of the reasons why capitalism can be such a dynamic system.
Economic rent = a payment or other benefit received above and beyond what the individual
would have received in his or her next best alternative (or reservation option):
Economic rent = benefit from option taken – benefit from next best option
The alternative action with the next greatest net benefit, action B, is often called the
‘reservation option’. It is ‘in reserve’ in case you do not choose option A. or if you are
excluded from doing A, your reservation option is your plan B.
Economic rent gives us a simple decision rule:
• If action A would give you an economic rent (and nobody else would suffer): Do it!
• If you are already doing action A, and it earns you an economic rent: Carry on
doing it!
This decision rule motivates our explanation of why a firm may innovate by switching from
one technology to another.
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