Principles of Economics Unit 1 - 5

Question 1

GDP per capita

Answer 1

is a measure of the total goods and services produced in a country (GDP) which is then divided by the country’s population

Question 2

GDP

Answer 2

the market value of the output produced for final consumption in an economy in a given period

Question 3

Disposable income

Answer 3

income available after paying taxes and receiving transfers from the government

Question 4

General Guidelines when measuring changes in GDP

Answer 4

1. we need to isolate the changes in the prices of the goods and services
2. When comparing output between 2 countries at a point in time, it is necessary to take into account differences in prices between the two countries

Question 5

Recall GDP

Answer 5

the market value of output (produced for final consumption ) of an economy in a given period

Question 6

Nominal GDP

Answer 6

GDP given in current prices, without adjustment for inflation

Question 7

GDP/ DI leave out

Answer 7

1. the quality of our social and physical environment such as friendships and clean air
2. The amount of free time we have
3. Goods and services that are produced within the household, such as meals or childcare
4. Violence and crime
5. Political freedoms
6. Life satisfaction

Question 8

Income inequality and the environment

Answer 8

As the economy grows income inequality increases

As living standards have soared, so too have the use of our natural resources and the degradation of our environment. The most striking effect is climate change
- increasing emissions of CO2
- Perceptible increases in average temperatures

Likely consequences of global warming
- melting of the polar ice caps; mountain glaciers
- rising sea levels that may put large coastal areas underwater
- potential changes in climate and rain patterns that may destroy the world’s food growing areas

Question 9

The capitalist revolution unit 1 - summary

Answer 9

1. Since the 1700s, increases in living standards have become a permanent feature of economic life in many countries.
2. This was associated with the emergence of a new economic system called capitalism, in which private property, markets and firms play a major role.
3. Under this new way of organizing the economy, advances in technology raised the amount that could be produced in a day’s work.
4. This process, which we call the capitalist revolution, has been accompanied by growing threats to our natural environment, and by growing inequalities.
5. Economics is the study of how people interact with each other, and with the natural environment, in producing their livelihoods.

Question 10

How can a society become better-off without a rise in its GDP per capita?

Answer 10

1. Improving Income Distribution: A society can redistribute income more equitably, reducing poverty and improving the well-being of its poorest members without necessarily increasing GDP per capita.
2. Investing in Education and Healthcare: Investing in education and healthcare can lead to a healthier and more skilled population, which can improve the overall quality of life, even if GDP per capita remains constant.
3. Environmental Sustainability: Sustainable practices can preserve natural resources and reduce environmental degradation, contributing to a better quality of life for current and future generations without necessarily increasing GDP per capita.

Question 11

What is ceteris paribus?

Answer 11

The ceteris paribus assumption, also known as the “all else being equal” assumption

Question 12

Economic model

Answer 12

A simplification of the world that explains actions and interactions of economic agents and predicts the most likely outcome.

Question 13

building a economic model

Answer 13

1. describe the conditions under which agents take actions: firms and consumers, government, and markets - conditions that govern their actions
2. describe what determines the actions of agents: objective function
3. determines how each of their actions affects each other - this leads other economic outcomes
4. and determines the outcome of these actions. this is often an equilibrium
5. Finally, we try to address what happens to the equilibrium when conditions change

Question 14

Economic rent

Answer 14

Economic rent is 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).

Question 15

How do we explain the choice of technology? we first consider

Answer 15

1. What technology is
2. how a firm evaluates the cost of different technologies -
3. based on the fact the factor prices and available technologies, we find the optimal technology for the firm

Question 16

Isocost line

Answer 16

• A line representing all combinations that cost the same (= iso) total amount
• a higher isocost means higher costs

Question 17

The Malthusian economy

Answer 17

According to Thomas Malthus, resources in an agricultural economy (land) is limited and the population exerts a constant pressure on them. If the population grows beyond available resources, the economy does not produce enough food and the population falls back to the point in which there is not enough food. Therefore their standard of living decreases.

Question 18

Assume preferences for children change. Unlike before, parents now have kids at higher levels of income. Ceteris paribus, how will this change equilibrium income per capita and level of population in the Malthusian economy?

Answer 18

By delaying childbirth, higher income levels are reached which means that families are more likely to have fewer children over their lifetimes
With fewer children to support there is higher accumulation of resources and these resources can be used to invest in a child’s education and health
Therefore, increasing the human capital and productivity and lead to higher income levels.
Therefore, ceteris paribus, where parents have children at higher income levels this leads to an increase in equilibrium per capita.

Question 19

Why technological progress in the Malthusian economy is crucial for an economy to take off.

Answer 19

There is a limited number of resources in a Malthusian economy, therefore technological progress allows a more efficient use of the resources – higher productivity per capita.
Can lead to an increase in living standards and better health outcomes.

Question 20

What are indifference curves?

Answer 20

An indifference curve is a graph that shows the combination of two goods in varying quantities, that provide equal satisfaction (utility) to an individual.
It represents the trade off between the different goods.
It is typically downward sloping and convex to the origin.

Question 21

What is the feasibility frontier?

Answer 21

It’s an economic model that shows the combination of two goods or services produced given the resources available.
It can be used to demonstrate scarcity, opportunity cost, economic growth, efficiency and inefficiency.

Question 22

What is consumer equilibrium?

Answer 22

Consumer equilibrium is when a consumer spends their income purchasing one or more commodity to get maximum satisfaction with no urge to change their level of consumption.

Question 23

Unit 2 summary - technology, population and growth

Answer 23

1. We study the world using models.
2. Economic models help explain the Industrial Revolution, and why it started in Britain.
3. Wages, the cost of capital, material inputs matter for decisions.
4. Population, labour productivity, technologies may deliver economic stagnation (a Malthusian world).
5. The permanent technological revolution allowed sustained growth (modern economic growth).

Question 24

What is creative destruction?

Answer 24

a process by which old technologies and the firms that do not adapt are swept away by the new, because they cannot compete in the market. In his view, the failure of unprofitable firms is creative because it releases labour and capital goods for use in new combinations.

Question 25

Creative destruction Process

Answer 25

1. Incentives of firms to innovate lower unit cost because of increased productivity which translates into lower total costs and higher profit.
2. When competition enters, profits decline, they are shared among a higher number of players.
3. When consumers find substitutes, this will cause profits will decline.

Question 26

What other important factors may explain the rise of energy-intensive technologies in Britain in the eighteenth century?

Answer 26

1. The relative price of coal: In Britain during this period, the cost of labour was relatively high compared to the cost of coal. This price imbalance incentivized entrepreneurs and industries to invest in energy – intensive technologies, such as steam engines which would efficiently replace labour with manual labour. Therefore, the higher relative cost of labour made automation and mechanization economically attractive.
2. Power of Trade Unions: Labour Unions bargained for higher wages and better working conditions, further increasing labour costs. This reinforced the economic incentive to invest in energy-intensive machinery.

Question 27

What other important factors may explain the rise of energy-intensive technologies in Britain in the eighteenth century?

Answer 27

The development of trade routes both domestically and internationally, facilitated the movement of goods and resources. This reduced transportation costs, making it easier for industries to access raw materials and distribute products to larger markets.

The abundance of coal and iron: Britain had a lot of coal and iron, which were two crucial resources for industrialization. This would have driven innovation and production and allowed a transition to energy-intensive technologies.

Question 28

The marginal product of labor (MPL

Answer 28

isthe increase in a company’s total production that results from adding one more unit of labor, while keeping all other factors of production constant.

• As the average declines the MPL declines.

Question 29

Value Functions - Utility - a graphical representation

Answer 29

• the sacrifice you have to make between 2 desirable goods
• along the same indifference curve the utility that you get is the same which makes you equally well
• trade-off substitution - the rate at which you substitute 2 different combinations
• these indifferences flatten out

Question 30

Features of an indifference curve

Answer 30

1. Indifference curves slope downward due to trade-offs: If you give up something, you must get something else in return to stay indifferent.
2. As you move to the right along an indifference curve, it becomes flatter: This reflects the trade-off that a person is willing to make between two goods.
3. Higher indifference curves correspond to higher utility levels: As we move further away from the origin, we move to combinations with more of both goods.
4. Indifference curves are usually smooth: Small changes in the amounts of goods usually don’t cause big jumps in utility.
5. the indifference curves don’t cross

Question 31

The Marginal Rate of Substitution (MRS

Answer 31

The trade-off that a person is willing to make between two goods.
ˆ - the slope of the indifference curve.
ˆ - the worth of one good in terms of the other good.

Question 32

Constrained optimisation problems

Answer 32

arise when a decision-maker seeks to achieve an optimal outcome (like maximizing utility or profit) within specific limitations or constraints. These constraints define the feasible set—the range of values within which decisions can be made.

Question 33

Examples of Constrained optimization problems
1. Utility maximization
2. Profit maximization
3. Other examples: The outcomes from the industrial revolution.

Answer 33

1. utility maximization, a consumer aims to achieve the highest satisfaction possible given budget constraints.
2. Similarly, firms engage in profit maximization, selecting production levels to maximize revenue while considering constraints like cost, labor, and resources.
3. Historical examples, such as those stemming from the Industrial Revolution, illustrate constrained optimization on a societal level. During this era, businesses sought to maximize production and profits while constrained by available technology, resources, and labour conditions. These optimization problems, both in personal and industrial contexts, underscore how constraints shape the feasible set and impact decisions across various domains

Question 34

The outcomes from the industrial revolution

Answer 34

The IR dramatically increased living standards (wages)

• as technology has improved rapidly, revenue rapidly improved so the company is likely to give higher compensation to workers however then workers receive a trade-off Eg. the richer the country, the more free time - but it also depends on the opportunity cost

Question 35

Unit 3 summary - Scarity, work and choice

Answer 35

1. Decision making under scarcity is common: we usually have
   limited means available to meet our objectives.
2. Economists model these situations, first by defining all of the
   feasible actions, then evaluating which of these actions is
   best, given the objectives.
3. Opportunity costs describe the trade-offs in the presence of
   scarcity: satisfying one objective means sacrificing other
   objectives.
4. An example model: optimal leisure/work with a non-zero
   wage.
5. This model also helps to explain:
   ˆ differences in the hours that people work in different
   countries today,
   ˆ and the changes in our hours of work throughout history.

Question 36

Social Interactions

Answer 36

situations in which the actions taken by each person affect other people’s outcomes as well as their own.

Question 37

We model them by using game theory- A way to model social interactions

Answer 37

• A game - a model of strategic interactions specifying
• the players - who is interacting with whom
• the strategies - what are the possible actions - possible course of actions based on other actions
• the payoffs - the outcomes of each strategy of all players
• the rules

Question 38

Dominant strategy equilibrium

Answer 38

An outcome in which every player plays their dominant strategy. - one that yields the highest payoff
for a player, no matter what the other players do.

Question 39

The Prisoners’ Dilemma

Answer 39

a game in which the payoffs in the dominant strategy equilibrium are lower for each player, and also lower in total, than if neither player played their dominant strategy

Question 40

Implications from the 2 games (invisible game and prisoners dilemma)

Answer 40

• self-interest can lead to favourable outcomes (the invisible hand game),
• self-interest can lead to undesirable outcomes (the prisoners’ dilemma game);
• market coordination has limitations
• by coordinating in advance, the players could have averted the
  undesirable outcome.

Question 41

Social Dilemmas

Answer 41

Situations in which the pursuit of private objectives results in inferior outcomes to the ones that could have
occurred if people had acted together

Question 42

Two ways to solve social dilemmas:

Answer 42

1. Altruism/Cooperation: The willingness to bear a cost in order
   to benefit somebody else, e.g. self-sacrifice
2. Government-imposed rules: carbon tax, landfill tax

Question 43

Social (other-regarding) preferences

Answer 43

Preferences that place a
value on what happens to other people, even if it results in lower

Question 44

altruistic preferences

Answer 44

A person who is willing to bear a cost in order to help another person;

Question 45

envy, spiteful preferences:

Answer 45

A person who is willing to bear a
cost in order to punish another person.

Question 46

Nash equilibrium

Answer 46

No player can improve their outcome by changing their strategy

Question 47

Power - an economic interpretation
- Bargaining power

Answer 47

Power: The ability to do and get the things we want in opposition to the intentions of others.
Bargaining power: The extent of your advantage in securing a larger share of the economic rents in an interaction you are in.

Question 48

Ultimatum Game

Answer 48

• The Proposer has a higher bargaining power- the responder will think they are better off as 1 is better than 0

More Respondents → lower bargaining power - you are more likely to accept a lower offer because of high levels of competition who are considering the same offer

Question 49

How to evaluate institutions and outcomes ?
1. Pareto criterion
2. Fairness criterion

Answer 49

Pareto criterion: outcome A Pareto dominates outcome B if at least one party would be better-off with A than B, and nobody would be worse-off. To be desirable, a certain allocation needs to Pareto dominate others.

Fairness criterion: a set of judgements about either the characteristics of an allocation itself, or the way it was
designed, or both.

Question 50

Substantive judgements of fairness

Answer 50

Focuses on whether the outcome itself is fair. For example, large income gaps might be seen as unfair simply because of the inequality they create.

Question 51

Procedural judgments of fairness

Answer 51

Focuses on whether the process leading to the outcome is fair. If rules are applied equally to everyone, the outcome is often considered fair, even if it results in differences.

Question 52

Choice and Conflict - Institutional change
Institutional Reforms

Answer 52

• Ban slavery.
• Introduce property rights (Bruno can exclude Angela from his land).
• Enable voluntary transactions (Angela can choose not to work for Bruno).
• Establish government welfare schemes for subsistence.

Question 53

Voluntary Transactions

Answer 53

• Agents weigh options based on the “rent” or benefit each option offers.
• Reservation option: Angela’s alternative to work—receiving government support instead.

Question 54

Pareto improvement:

Answer 54

A change that benefits at least one person without making anyone else worse-off.

Question 55

Unit 5 summary - Choice and Conflict

Answer 55

1. Institutions determine economic interactions.
2. Biology and technology impose limits on possible outcomes from economic interactions.
3. The equilibrium allocation depends on the bargaining power of each party.
4. Bargaining power depends on the economic institutions.
5. We can evaluate and compare allocations and institutions
   using two criteria: fairness and Pareto efficiency.
6. Economically feasible allocations: those providing
   opportunities for Pareto improvement relative to a reservation option.