Unit 2: Modelling Flashcards
What are models
simplified versions of reality
lets us see the bigger picture
an effective model must distinguish between essential features and unimportant details
Building a model
capture elements of economy that matter for question
describe how agents act and how they interact with each other and elements of model
determine outcomes of these actions
study what happens when conditions change
Equilibrium of a model
situation that is self-perpetuating
something of interest does not change unless an external force is introduced that alters the model’s description of the situation
What makes a good model
clear
makes accurate predictions consistent with evidence
improves communication and helps us understand what we agree about
useful
Ceteris paribus
holding all other things constant
Economic rent
the benefit received from a choice, taking into account the next best alternative
Marginal Product – Opportunity Cost
economic rent is any payment to an owner or factor of production in excess of the costs needed to bring that factor into production
Marginal product is the change in output produced by adding one more unit of input
Explaining industrial revolution
High cost of labour and cheap energy sources (coal)
before revolution, production was labour intensive
so incentive to innovate to bring down cost of production
coal relatively cheap compared to labour
first adopters of new technology will enjoy Schumpeterian rents - larger profits
Firms who don’t react will be swept away
single spinning mule operate by a few people could replace a thousand spinnsters
Firms choice
Maximise profits, minimise costs
Cost = wages x workers + price of tech. x amount of tech
an increase in wages relative to the price of coal creates an incentive to innovate to more capital intensive technology
Use graph of workers against coal using equation C = wL + pR (where R is amount of coal) to show why firm would want lowest isocost line
Why Britain first for the industrial revolution?
wages in Newcastle relative to energy prices were highest
wages relative to the cost of capital increased first in Britain so there was a need to innovate
Technologies developed elsewhere as firms in Britain kept innovating so they had to be adopted elsewhere to not be swept away
Malthus’ model - Diminishing average product of labour
Assumptions
population expands if living standards increase
diminishing average product of labour
Malthus’s model
as more people work their income will fall
in equilibrium living standards are forced to a subsistence level (Malthusian trap)
Population and income will be constant
Malthus’ model farmer example
- Improvement in technology
- average output per farmer rises
- farmers incomes rise
- population rises
- less land per farmer
- Average output per farmer falls
- Farmers income falls
- Equilibrium where subsistence incomes prevail and population constant
Use graphs of real wage against population and population growth
3 conditions for Malthusian trap
- Diminishing average product of labour
- rising population in response to wage increase
- an absence of improvements in technology to offset diminishing APL
the permanent technological revolution meant the 3rd condition didn’t hold and Britain escaped this trap
