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Notes from The Economy Core book unit 2

Economics 1 (The University of Warwick)

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The economy: Unit 2 – Technology, population, and growth

Key points:

How improvements in technology happen and how they sustain growth in sol:

 Economic models help to explain industrial revolution & why it started in Britain
 Wages, cost of machinery, and other prices all matter when people make
economic decisions
 In capitalist economy, innovation creates temporary rewards for them which
provides incentive for improvement in technology which reduces costs
 Rewards are destroyed by competition once innovation diffuses throughout
economy
 Population, productivity of labour, and living standards may interact to produce
a vicious circle of economic stagnation
 Permanent technological revolution associated w capitalism allowed some
countries to make a transition to sustained growth in living standards

Key ideas:

 Idea of Malthusian trap is introduced

 Malthus said that even if technology improved & raised productivity of
labour, people would still have > children as soon as they were somewhat
better off
 Population would grow until living standards would fall halting population
increase
 In Malthus’ lifetime something big was happening in Britain that would
help escape:
 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.

2.1 Economists, historians, and the industrial revolution

Reasons why industrial revolution happened in Britain

 Robert Allen – gives a central role to two features of Britain’s economy at the
time
1) Relatively high cost of labour
2) Low cost of local energy sources

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 Joel Mokyr – claims real sources of technological change are to be found in

Europe’s scientific revolution and its Enlightenment of the century before
 David Lands – emphasizes political & cultural characteristics of nations as a
whole
 Gregory Clark – keys to success for Britain were cultural attributes such as hard
work and savings which were passed onto future generations

2.2 Economic models: how to see more by looking at less

 We use models to show and represent millions of people and how their decisions
affect behaviour of others – as it would be impossible to understand economy by
describe every detail of how they (inter)act
 Mathus’ explanation of why improvements in technology could not raise sol was
also based on a model – a simple description of the relationships between
income and population

How are models built:

1. Construct a simplified description of conditions under which people take actions

2. Describe in simple terms what determines the actions that people take
3. Then determine how each of their actions affects each other
4. Determine outcome of these actions – often an equilibrium
5. Conduct experiments w model to discover the effects of changes in economic
conditions or when certain variables change

2.3 Basic concepts: prices, costs, and innovation rents

Four key ideas in economic modelling:

1) Ceteris paribus
 It means other things equal’. In an economic model it means an analysis ‘holds
other things constant’.
 We see more by looking at less – help us to focus on variable of interest

When trying to produce the simplest model we assume:

 Prices of all inputs are the same for all firms.

 All firms know the technologies used by other firms.
 Attitudes towards risk are similar among firm owners.
2) Incentives
 Economic reward or punishment, which influences the benefits and costs of
alternative courses of action.

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 They matter bc they affect + and – of taking one action as opposed to another
 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
3) Relative prices
 The price of one good or service compared to another.
 They help us compare alternatives
 We are often interested in ratios of things rather than absolute level – it will
matter to people when deciding what/where/how much to buy
 In the industrial revolution energy prices (e.g., price of coal) to the wage rate
played an important part
4) Economic rent
 A payment or other benefit received above and beyond what the individual
would have received in his or her next best alternative.
 Is the basis of how people make choices
 It is one of the reasons why capitalism can be such a dynamic system
economic rent=benefit from option taken benefit from next best option
 It gives us a simple decision rule:
1. If action A would give you an economic rent and nobody else would suffer
– do it
2. If you are already doing action A and it earns you an economic rent –
continue
 Therefore, this decision rule motivates our explanation of why a firm may innovate
by switching from one technology to another

2.4 Modelling a dynamic economy: technology and costs

What is a technology?

 There are two ways in which technology is intensive – labour or capital

 Some technologies dominate others – can be seen below:

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 Technology A dominates C; technology B dominates D. The E-technology does

not dominate any of the other available technologies. We know this because
none of the other four technologies are in the area above and to the right of E.

How does a firm evaluate the cost of production using different technologies?

 Can be calculated:
cost= (wage × workers) + (price of a tonne of coal × number of tonnes) =(𝑤×𝐿)
+(𝑝×𝑅)
 Can be constructed using iso-cost lines to compare costs of all combinations of
output
 Iso-cost lines - A line that represents all combinations that cost a given total
amount.

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 Iso-cost lines can join all the combinations of workers and coal that cost the
same amount

2.5 Modelling a dynamic economy: innovation and profit

 Profit = revenue – costs

 When a lower cost technology is adopted profits are raised
 The first adopter of a technology is called an entrepreneur
 A person who creates or is an early adopter of new technologies,
organizational forms, and other opportunities.
 It is a key part of the explanation for the dynamism of capitalism – innovation
costs will not last forever as when other firms start adopting it, they will also
reduce their costs
 Creative destruction is the 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.

2.6 The British industrial revolution and incentives for new technologies

Why Britain?

 Prices of labour were much higher compared to other countries - labour was
more expensive relative to the cost of energy
 As workers became steadily > expensive relative to capital goods the incentive
to replace workers w machines was increasing

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 The relative prices of labour, energy and capital can help to explain why the
labour-saving technologies of the Industrial Revolution were first adopted in
England

Why the rest of the world? (Factors that promoted diffusion across the world of new
technologies)

1. Firstly, further technological progress, where a new technology is developed

that dominates the existing one in use.
2. Wage growth and falling energy costs (due, for example, to cheaper
transportation, allowing countries to import energy cheaply from abroad). This
made iso-cost lines steeper in poor countries, again providing an incentive to
switch to a labour-saving technology
 Either way, new technologies spread and divergence in technologies and living
standards was eventually replaced by convergence at least among countries where
capitalist revolution had taken off
2.7 Malthusian economics: diminishing average product of labour
 The explanation used to explain technological revolution is part of the
explanation of the upward kink in the hockey stick
- Explaining the long flat part of the stick is another story requiring a different
model

Diminishing average product of labour

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 Total output divided by a particular input, for example per worker (divided by
the number of workers) or per worker per hour (total output divided by the
total number of hours of labour put in).

Example to explain:

 Imagine farmer producing grain – only involves on farm labour and ignore that it
needs spades, grain elevators etc
 Labour and land are called factors of production – input into production process
 In model of technological change above these are energy and labour
 Land is fixed and all of the same quality – land is divided into 800 farms and
each worked by 1 farmer working same total hours during a day to produce all
together 500,000 kg of grain. Average labour:
total output
 Average product of labour =
total number of farmers
 500 000/800 farmers = 625kg per farmer

Production function

 Describes the relationship between the amount of output produced and the
amounts of inputs used to produce it
 Used to understand what will happen when the population grows and there are
> farmers on the same ltd space of farmland

 Line from 0-A or 0-B shows the average produce of labour at each point

2 assumptions can be made based on the production function above:

1. Labour combined with land is productive

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2. As more farmers work on a fixed amount of land – average product of

labour falls – this diminishing average product of labour is one foundation
of Malthus’ model
 Diminishing average product of labour is A situation in which, as more labour
is used in a given production process, the average product of labour typically
falls. Can be caused by:
1. > labour devoted to a fixed quantity of land
2. > inferior land brought into cultivation
2.8 Malthusian economics: population grows when sol rises

Key ideas in Malthus’ model:

 Law of diminishing average product of labour

 Population expands if living standards increase
 His model results in an equilibrium in which there is an income level just sufficient
to allow a subsistence level of consumption. Variables that stay constant in
equilibrium are:
- Size of the population
- Income level of people
 Subsistence level is the level of living standards (measured by consumption
or income) such that the population will not grow or decline.

Malthusian economics: the effect of technological improvement

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 Illustrates how the combination of diminishing average product of labour and

effect of higher incomes on population growth mean that in the very long run
technological improvements will not result in higher incomes for farmers

This model predicts that improvements in technology will not raise living standards if:

 AVL diminishes as > labour is applied to a fixed amount of land

 Population grows in response to increases in real wages

 Two diagrams together explain Malthusian population trap – population will be

constant when the wage is at subsistence level, it will rise when the wage is
above SL, and it will fall when it is below

Introduction of a new technology in a Malthusian economy

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 A technological improvement (for example, better seeds) raises the average

product of labour, and the wage is higher for any level of population. The real
wage line shifts upward. At the initial population level, the wage increases, and
the economy moves to point D.
 A point D the wage has risen above SL and therefore pop starts to grow
 As pop rises, wage falls due to DAPL – economy moves down to real wage D
 At C, wage has reached SL again, pop remains constant & population is higher
than it was at A
2.9 The Malthusian trap and long-term economic stagnation
 The major long-run impact of better technology in this Malthusian world was
therefore > people - this shows a possible explanation of long flat portion of
hockey stick
 Before the 1600s the farmers and wage earners were stuck in a Malthusian trap
– as pop grows the dd for food grows. The limited amount of land used to
produce the food should become > valuable
 Therefore, a rising population should lead to an improvement in the relative
economic positions of landowners
2.10 Escaping from Malthusian stagnation
 Hockey stick graphs of sol assumed that improvements in technology could not
happen at a faster rate than population growth offsetting the DAPL – this is
wrong
 With real wages rising while population was increasing, in the 18th century
countries were able to escape the Malthusian regime

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Process:

1. Starts with technological improvement to increase output per worker –

innovation continues as technological revolution became permanent
displacing many workers
2. Loss of employment reduced workers’ bargaining power keeping wages
low
3. Higher productivity and low wages led to surge in profits. – profits,
competition, and technologies drove businesses to expand – dd for labour
went up
4. Supply of labour fell once child employment was banned – combination of
higher labour dd and lower ss enhanced workers’ bargaining power
5. The power of people increased as they gained right to vote and formed
trade unions – they were able to claim constant or rising share of the
increases in productivity gained from technological revolution

Permanent technological revolution demonstrates influences on wages:

1. How much is produced – size of pie divided between workers and owners of
other inputs
2. Share going to workers – depends on their bargaining power

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