Week 3

Question 1

What is opportunity cost?

Answer 1

The value of the next best action not taken

Question 2

What is a reservation option?

Answer 2

The next best alternative

Question 3

What is economic cost?

Answer 3

The direct costs incurred by taking an option + opportunity cost

Question 4

What is economic rent?

Answer 4

Net benefit from option taken - opportunity cost

Question 5

What is innovation rent?

Answer 5

The extra profits made by exploiting an invention -> provides incentives for taking action

Question 6

What are relative prices?

Answer 6

The price of one option relative to another, often expressed as a ratio of the two prices

Question 7

What is production technology?

Answer 7

• the process that a firm uses to
  convert a set of inputs into an output that it can sell.

Question 8

What are factors of production?

Answer 8

The inputs into the production process

Question 9

What is the production function?

Answer 9

A process that tells u how many outputs will be produced given the amount of inputs used.

Question 10

What is an isocost line?

Answer 10

An isocost line represents all combinations of two inputs (usually land and capital) that a firm can PURCHASE for a given cost, at fixed input prices.

The isocost line is derived from the total cost formula.

Question 11

What is the total cost formula?

Answer 11

C = wL + rK

C = Total Cost
W = Wage rate (cost of labour)
L = Quantity of labour
r = rental rate (cost of capital)
K = Quantity of capital

Question 12

How do you calculate the slope of the isocost line?

Answer 12

• (w/r)

This shows the tradeoff between labour and capital : how much capital must be given up to buy more labour while keeping costs constant

Question 13

How does an increase in total cost affect isocost line? What about a decrease in total cost?

What about changes in input prices?

Answer 13

Increase in total cost will raise the line, a decrease will lower it, a change in input prices will rotate it.

Question 14

Why did many countries escape the malthusian trap cerca 1800?

Answer 14

Technological progress
proceeded faster than
population growth.

Improvements in
sanitation and medicine
increased populations in
19th century.

Contraception and family
planning slowed
population growth in the
20th century.

Question 15

What are the four key ideas in a model?

Answer 15

• Equilibrium – a situation that is self-perpetuating, meaning
  that there is no tendency for the situation to change unless an
  external force for change is introduced
• Endogenous variables – variables whose values are
  determined by relationships built into the mode
• Exogenous variables – variables whose values are determined
  outside the model
• Ceteris paribus – holding other things equal

Question 16

What was Adam Smiths book and when was it published??

Answer 16

The Wealth of Nations; An Inquiry into the Nature
and Causes of the Wealth of Nations.

1776

Question 17

What 2 influential schools of thought does Smith critique?

Answer 17

Mercantilism and Physiocracy.

Question 18

What was mercantilism?

Answer 18

The Mercantilists believed that wealth (and hence national wealth and progress) was measured in terms of gold reserves. The aim of national governments therefore should be to facilitate the accumulation of gold (it was a time where the gold standard
operated, notes or promissory notes were backed by gold, this is not true today).

Question 19

What policies did mercantilists advocate for?

Answer 19

Accumulation of gold required: promoting exports and restricting imports…therefore Mercantilist policies advocated restricting trade.
Primarily food imports.

They believed there was no mutual gain from market exchange.

The object of government policy ws to maintain high levels of gold reserve via a consistent trade surplus.

Question 20

What was Physiocracy?

Answer 20

Physiocrats believed that the only net source of wealth was via agriculture. -> this is where real net growth occured

The emerging Manufacturing sector was just changing the form
of objects (ie inputs reshaped into outputs), not creating anything new.

Mainly a french thing

Question 21

What sort of policies did Physiocrats implement?

Answer 21

Policies that supported the agricultural sector and aimed to slow down the manufacturing sector

Question 22

What was Smiths general view on these policies?

Answer 22

He strongly disagreed with them both, arguing in favor of specialisation, exchange and trade along with the emergence of new manufacturing sectors.

Question 23

What is ‘Absolute Advantage’?

Answer 23

When a country can produce a good/service at a lower cost than another.

Question 24

What is the Labour Theory of Value and which economists used it?

Answer 24

Smith, Ricardo and Max.

LTV related the value of a good not to its price but to the amount of labour that went into its production

Question 25

What is the difference between the Labour Value and the Exchange Value of a good/service?

Answer 25

Labour Value = Value of a good determained by amount of labour that went into its production

Exchange value = The Quantity of Money to be exchanged for it

Question 26

What did neo-classical economists replace LTV with?

Answer 26

Subjective Utility Theory of Value
“[goods’] value is wholly independent of the quantity of labour originally necessary to
produce them, and varies with the varying wealth and inclinations of those who are
desirous to possess them.” David Ricardo (1817)

Question 27

What was Smiths 3 classes of differing wealth within society?

Answer 27

• Workers provide Labour (L) and receive Wages (w)
• Landlords provide Land (N) and receive Rents (r)
• Firms/Capitalists provide Capital (K) and receive Profits (s)

Question 28

According to Smith, what is the Natural Price?

Answer 28

The price towards which he thought the system tends to
move towards and stay at over the long term.

Question 29

How does Smith define the ‘natural price’ for wages, rent and profit? L. N and K?

As a result of this, what is the natural price of a good?

Answer 29

When they are being paid a price that is just sufficient to keep them engaged in the activity.

Since the price charged for the good must go to one of those 3 things, then the sum of those 3 natural prices gives the natural price of the good.

Question 30

When does the natural price of a good occur?

Answer 30

When the resources or factors going into production are all being paid at their natural rate

Question 31

What did Adam believe was the role of the state?

Answer 31

• provide national defence;
• administer justice;
• undertake public works (for example build bridges, canals, roads, schools:
  infrastructure).

Question 32

What are the 2 primary schools of economic thought and who are the main economists in each?

Answer 32

Classical Economics
– Adam Smith (1723-1790)
– Thomas Malthus (1766-1834)
– David Ricardo (1772-1823)
– Karl Marx (1818-1883)

The Marginal Revolution & Neoclassical Economics
– Stanley Jevons (1835-1882)
– Leon Walras (1834-1910)
– Carl Menger (1840-1921)