Week 3 Flashcards
What is opportunity cost?
The value of the next best action not taken
What is a reservation option?
The next best alternative
What is economic cost?
The direct costs incurred by taking an option + opportunity cost
What is economic rent?
Net benefit from option taken - opportunity cost
What is innovation rent?
The extra profits made by exploiting an invention -> provides incentives for taking action
What are relative prices?
The price of one option relative to another, often expressed as a ratio of the two prices
What is production technology?
- the process that a firm uses to
convert a set of inputs into an output that it can sell.
What are factors of production?
The inputs into the production process
What is the production function?
A process that tells u how many outputs will be produced given the amount of inputs used.
What is an isocost line?
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.
What is the total cost formula?
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
How do you calculate the slope of the isocost line?
- (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
How does an increase in total cost affect isocost line? What about a decrease in total cost?
What about changes in input prices?
Increase in total cost will raise the line, a decrease will lower it, a change in input prices will rotate it.
Why did many countries escape the malthusian trap cerca 1800?
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.
What are the four key ideas in a model?
- 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
What was Adam Smiths book and when was it published??
The Wealth of Nations; An Inquiry into the Nature
and Causes of the Wealth of Nations.
1776
What 2 influential schools of thought does Smith critique?
Mercantilism and Physiocracy.
What was mercantilism?
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).
What policies did mercantilists advocate for?
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.
What was Physiocracy?
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
What sort of policies did Physiocrats implement?
Policies that supported the agricultural sector and aimed to slow down the manufacturing sector
What was Smiths general view on these policies?
He strongly disagreed with them both, arguing in favor of specialisation, exchange and trade along with the emergence of new manufacturing sectors.
What is ‘Absolute Advantage’?
When a country can produce a good/service at a lower cost than another.
What is the Labour Theory of Value and which economists used it?
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
What is the difference between the Labour Value and the Exchange Value of a good/service?
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
What did neo-classical economists replace LTV with?
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)
What was Smiths 3 classes of differing wealth within society?
- 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)
According to Smith, what is the Natural Price?
The price towards which he thought the system tends to
move towards and stay at over the long term.
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?
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.
When does the natural price of a good occur?
When the resources or factors going into production are all being paid at their natural rate
What did Adam believe was the role of the state?
- provide national defence;
- administer justice;
- undertake public works (for example build bridges, canals, roads, schools:
infrastructure).
What are the 2 primary schools of economic thought and who are the main economists in each?
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)
