MICROECONOMICS
UNIT 1: The Capitalist Revolution
Economics is the study of how people interact with each other, and with the natural environment, in producing
their livelihoods.
Why are some countries rich and others poor?
There has been a rapid, sustained growth in average living
standards since 1700, a steep increase (after the Industrial
Revolution). Previously, for almost 700 years, the GDP per
capita (how we measure income) was flat, then growth started
to happen (beginning from UK).
We know about income levels in the past thanks to the work of
economists who made great efforts in collecting data (from
historical documents etc.) increasing data availability over
time and across countries is making economics an empirical
discipline. Data on income levels but not only.
Inequality
This graph represents the income level distribution across different countries in 1980.
Each country has a color (from poorer, red, to richer, green)
The width of each country’s bars represents its population.
For every country
the average income of 10% of the population,
ranging from the poorest 10% of people at the
front of the diagram to the richest 10% at the
back
We can use the
country (the rich/poor ratio). Even in a
relatively equal country such as Norway, the
rich/poor ratio is 5.4
Today, global inequality has increased; there are large differences both within and across countries (in opposition
to the past, mainly the difference in average income between countries has changed). For a very long time, living
standards did not grow in any sustained way, when growth occurred it began at different times and in different
places.
The countries that took off economically a century or more ago—UK, Japan, Italy—are now rich, while those that
took off only recently, or not at all, are in the flatlands. This explains why the green tend to stay green, while not
many of the red have managed to move (except for China and India, a bit).
The GDP
Gross Domestic Product (GDP): a measure of the market value of the output of final goods and services in the
economy in a given period. It is the total average income of everyone in a country and in a given period.
Output of intermediate goods that are inputs to final production is excluded to prevent double counting.
We use the GDP per capita to compare living standards in each country. People obtain their incomes by producing
and selling goods and services GDP is the total value of everything produced in a given period (goods and
1
,services) and it is then divided by the country’s population to obtain the average income of people in a country
(GDP per capita).
Diane Coyle: GDP ‘adds up everything from nails to toothbrushes, shoes, haircuts, management consultancy,
street cleaning, yoga teaching, books, and the millions of other services and products in the economy’. Economists
must decide what should be included, but also how to give a value to each of these things to give a value to
each good, they use their prices. By doing this, the value of GDP corresponds to the total income of everyone in
the country.
NOMINAL GDP
Captures the market value of output in the economy as a whole for a given period. Sum over all goods and services
sold in the market.
NominalGDP=∑ p i q i
i
p are prices, q are quantities ex: (price of a yoga lesson)×(number of yoga lessons)+(price of a book)×(number
of books)+…+(price)×(quantity)for all other goods and services
The GDP is usually expressed in per-capita terms (as average income) GDP per capita ≠ Disposable income
Disposable income = Total income (GDP) – taxes + government transfers (e.g. unemployment or disability
benefits, gifts etc.). It is a good measure of living standards (better than GDP) because it is the maximum amount
a person can spend on goods and services (food, housing, clothing) without having to go into debt or selling
possession.
However both GDP and disposable income are imperfect measures of well-being because they do not include
things that matter for our wellbeing:
- Social relationships
- Environmental quality goods that cannot
- Amount of free time (to relax and spend with family/friends) be bought
- Public services: healthcare, education (valued through their cost)
- Goods produced within the household (e.g., meals, childcare)
Average income does not consider income distribution, which instead affects wellbeing and inequality (about
which we care).
Differently, in respect to the goods and services produced by the government (schooling, national defence, law
enforcement) and contributing to wellbeing, GDP per capita (in which these are included) can be considered a
better measure of living standard. However, government services are difficult to value and are typically measured
on how much it cost to produce them.
Einstein
GDP is a measure of living standards: we need to be able to make comparisons across time and between countries.
We want to measure changes or differences in amounts of goods and services; instead, changes or differences in
the prices of the goods and services are not relevant.
Avoid the mistake of assuming that, if the price of something rises in a country but not in another, then
the amount of output has increased in the country.
We can compare output:
- In the same country at two points in time: we need to net out differences in prices between the two points
- In two countries at the same point in time: we need to net out difference in prices between the two
countries
2
,We need to find a common set of prices to compare across countries and times, so that differences in GDP reflect
actual differences in output, and not in nominal prices
REAL GDP: price changes across time
Through real GDP, the measure of the quantity of goods and services purchased, we gauge whether the economy
is growing or shrinking.
Economic growth: increase in the quantity of goods and services purchased. If quantities stay the same across two
years but prices double, then nominal GDP doubles, but real GDP stays the same: no growth in economy.
To track real GDP across years we select a base year, e.g. 2010; we then define real GDP using 2010 prices as equal
to nominal GDP that year
We compute real GDP for the following years as the quantities produced in those years, multiplied by 2010 prices:
GDP at constant prices. If, using the base year prices, GDP has gone up, we can infer that real GDP has increased.
- Any change across years is attributable to changes in quantities, not in prices
REAL GDP: price changes across countries
Comparing GDP across countries requires multiplying quantities produced for the same set of prices. Market
exchange rates are very volatile + price levels in different countries are different. Nominal exchange rates do not
distinguish between the different price levels of different items in economies what you can buy with an euro is
different from country to country= the purchasing power (what you can buy) is different. In terms of money they
have the same, in terms of goods is different
Purchasing Power Parities (PPPs): PPPs convert different currencies to a common currency and, in the process
of conversion, equalize their purchasing power by controlling for differences in price levels between economies
Provide a measure of what an economy’s local currency can buy in another economy
Achieve parity (equality) in the real purchasing power
Calculated based on the prices of items within a common basket of goods and services
“Hockey-stick” growth
change ∈income
Growth rate=
originallevel of income
Example:
- GDP per capita in 2000: y 2000 = 21046
- GDP per capita in 2001: y 2001= 21567
G
y 2001− y2000 21567−21046
rowt h rate= = =2.5 %
y 2000 21046
The “Hockey-stick” curves represent the sustained rapid
growth in GDP per capita experienced by countries
worldwide. If the growth is constant it looks like a
STRAIGHT LINE (ratio scale, used for comparing growth rates). A steeper line in the ratio scale chart means a
faster growth rate.
Timing of growth
3
, Growth take-off occurred at different points in time for different countries: Britain was the first country to
experience sustained economic growth (began around 1650), in Japan, it occurred around 1870 while for China
and India it happened in the second half of the 20th century.
Why these differences?
For some countries, economic change and substantial improvements in people’s living standards was
accompanied by institutional change (e.g. freedom from colonial rule); for others economic growth coincided with
technological change (as in the UK).
ADAM SMITH “The Wealth of Nations” (1776)
- Concept of the “invisible hand” Pursuit of self-interest produces spontaneous coordination without
any person or institution consciously attempting to create or maintain it. “The businessman intends only
his own gain, and he is in this led by an invisible hand to promote an end which was no part of his
intention. (…) By pursuing his own interest he frequently promotes that of the society more effectually
than when he really intends to promote it.”
- Division of labor and specialization is a source of growth: technology improvement
- Requirement of a large market: infrastructure (e.g. navigable canals)
- Markets have failings: collusion, monopolies
The technological revolution
Industrial Revolution = a wave of technological advances starting in Britain in the 18th century, which
transformed an agrarian and craft-based economy into a commercial and industrial economy. It brought about a
high amount of technological innovations, new ideas, discoveries, methods and machines.
In Economics, Technology is a process that uses a set of materials and other inputs - including raw materials, the
work of people and machines - to produce an output.
By reducing the amount of worktime (which fell generation after generation), technological changes allowed
significant increases in living standards + technological progress greatly improved the speed at which information
travels, making the world more connected.
Increased production and population growth have ENVIRONMENTAL CONSEQUENCES. Climate change
resulting from economic activity is a major threat to future human wellbeing, and it illustrates many of the
challenges of designing and implementing appropriate environmental policies.
One way of thinking about the economy: it is part of a larger social system, which is itself part of the biosphere.
People interact with each other, and also with nature, in producing their livelihood. Humans have regarded
natural resources as freely available in unlimited quantities (except for the costs of extracting them). But as
production has soared, so too have the use of our natural resources and degradation of our natural environment.
Global impacts – climate change
Local impacts – pollution in cities (harmful emissions from power plants,
vehicles, and other sources), deforestation, v of the supply of clean water
These effects are the result of both the expansion of the economy and the way it is
organized. We use natural resources in production, which may in turn affect the
environment we live in and its capacity to support future production. The
environment represents a constraint to economic activity.
Capitalism
Together with the emergence of the technological revolution there was the emergence of capitalism (critical for
the industrial revolution itself).
4
UNIT 1: The Capitalist Revolution
Economics is the study of how people interact with each other, and with the natural environment, in producing
their livelihoods.
Why are some countries rich and others poor?
There has been a rapid, sustained growth in average living
standards since 1700, a steep increase (after the Industrial
Revolution). Previously, for almost 700 years, the GDP per
capita (how we measure income) was flat, then growth started
to happen (beginning from UK).
We know about income levels in the past thanks to the work of
economists who made great efforts in collecting data (from
historical documents etc.) increasing data availability over
time and across countries is making economics an empirical
discipline. Data on income levels but not only.
Inequality
This graph represents the income level distribution across different countries in 1980.
Each country has a color (from poorer, red, to richer, green)
The width of each country’s bars represents its population.
For every country
the average income of 10% of the population,
ranging from the poorest 10% of people at the
front of the diagram to the richest 10% at the
back
We can use the
country (the rich/poor ratio). Even in a
relatively equal country such as Norway, the
rich/poor ratio is 5.4
Today, global inequality has increased; there are large differences both within and across countries (in opposition
to the past, mainly the difference in average income between countries has changed). For a very long time, living
standards did not grow in any sustained way, when growth occurred it began at different times and in different
places.
The countries that took off economically a century or more ago—UK, Japan, Italy—are now rich, while those that
took off only recently, or not at all, are in the flatlands. This explains why the green tend to stay green, while not
many of the red have managed to move (except for China and India, a bit).
The GDP
Gross Domestic Product (GDP): a measure of the market value of the output of final goods and services in the
economy in a given period. It is the total average income of everyone in a country and in a given period.
Output of intermediate goods that are inputs to final production is excluded to prevent double counting.
We use the GDP per capita to compare living standards in each country. People obtain their incomes by producing
and selling goods and services GDP is the total value of everything produced in a given period (goods and
1
,services) and it is then divided by the country’s population to obtain the average income of people in a country
(GDP per capita).
Diane Coyle: GDP ‘adds up everything from nails to toothbrushes, shoes, haircuts, management consultancy,
street cleaning, yoga teaching, books, and the millions of other services and products in the economy’. Economists
must decide what should be included, but also how to give a value to each of these things to give a value to
each good, they use their prices. By doing this, the value of GDP corresponds to the total income of everyone in
the country.
NOMINAL GDP
Captures the market value of output in the economy as a whole for a given period. Sum over all goods and services
sold in the market.
NominalGDP=∑ p i q i
i
p are prices, q are quantities ex: (price of a yoga lesson)×(number of yoga lessons)+(price of a book)×(number
of books)+…+(price)×(quantity)for all other goods and services
The GDP is usually expressed in per-capita terms (as average income) GDP per capita ≠ Disposable income
Disposable income = Total income (GDP) – taxes + government transfers (e.g. unemployment or disability
benefits, gifts etc.). It is a good measure of living standards (better than GDP) because it is the maximum amount
a person can spend on goods and services (food, housing, clothing) without having to go into debt or selling
possession.
However both GDP and disposable income are imperfect measures of well-being because they do not include
things that matter for our wellbeing:
- Social relationships
- Environmental quality goods that cannot
- Amount of free time (to relax and spend with family/friends) be bought
- Public services: healthcare, education (valued through their cost)
- Goods produced within the household (e.g., meals, childcare)
Average income does not consider income distribution, which instead affects wellbeing and inequality (about
which we care).
Differently, in respect to the goods and services produced by the government (schooling, national defence, law
enforcement) and contributing to wellbeing, GDP per capita (in which these are included) can be considered a
better measure of living standard. However, government services are difficult to value and are typically measured
on how much it cost to produce them.
Einstein
GDP is a measure of living standards: we need to be able to make comparisons across time and between countries.
We want to measure changes or differences in amounts of goods and services; instead, changes or differences in
the prices of the goods and services are not relevant.
Avoid the mistake of assuming that, if the price of something rises in a country but not in another, then
the amount of output has increased in the country.
We can compare output:
- In the same country at two points in time: we need to net out differences in prices between the two points
- In two countries at the same point in time: we need to net out difference in prices between the two
countries
2
,We need to find a common set of prices to compare across countries and times, so that differences in GDP reflect
actual differences in output, and not in nominal prices
REAL GDP: price changes across time
Through real GDP, the measure of the quantity of goods and services purchased, we gauge whether the economy
is growing or shrinking.
Economic growth: increase in the quantity of goods and services purchased. If quantities stay the same across two
years but prices double, then nominal GDP doubles, but real GDP stays the same: no growth in economy.
To track real GDP across years we select a base year, e.g. 2010; we then define real GDP using 2010 prices as equal
to nominal GDP that year
We compute real GDP for the following years as the quantities produced in those years, multiplied by 2010 prices:
GDP at constant prices. If, using the base year prices, GDP has gone up, we can infer that real GDP has increased.
- Any change across years is attributable to changes in quantities, not in prices
REAL GDP: price changes across countries
Comparing GDP across countries requires multiplying quantities produced for the same set of prices. Market
exchange rates are very volatile + price levels in different countries are different. Nominal exchange rates do not
distinguish between the different price levels of different items in economies what you can buy with an euro is
different from country to country= the purchasing power (what you can buy) is different. In terms of money they
have the same, in terms of goods is different
Purchasing Power Parities (PPPs): PPPs convert different currencies to a common currency and, in the process
of conversion, equalize their purchasing power by controlling for differences in price levels between economies
Provide a measure of what an economy’s local currency can buy in another economy
Achieve parity (equality) in the real purchasing power
Calculated based on the prices of items within a common basket of goods and services
“Hockey-stick” growth
change ∈income
Growth rate=
originallevel of income
Example:
- GDP per capita in 2000: y 2000 = 21046
- GDP per capita in 2001: y 2001= 21567
G
y 2001− y2000 21567−21046
rowt h rate= = =2.5 %
y 2000 21046
The “Hockey-stick” curves represent the sustained rapid
growth in GDP per capita experienced by countries
worldwide. If the growth is constant it looks like a
STRAIGHT LINE (ratio scale, used for comparing growth rates). A steeper line in the ratio scale chart means a
faster growth rate.
Timing of growth
3
, Growth take-off occurred at different points in time for different countries: Britain was the first country to
experience sustained economic growth (began around 1650), in Japan, it occurred around 1870 while for China
and India it happened in the second half of the 20th century.
Why these differences?
For some countries, economic change and substantial improvements in people’s living standards was
accompanied by institutional change (e.g. freedom from colonial rule); for others economic growth coincided with
technological change (as in the UK).
ADAM SMITH “The Wealth of Nations” (1776)
- Concept of the “invisible hand” Pursuit of self-interest produces spontaneous coordination without
any person or institution consciously attempting to create or maintain it. “The businessman intends only
his own gain, and he is in this led by an invisible hand to promote an end which was no part of his
intention. (…) By pursuing his own interest he frequently promotes that of the society more effectually
than when he really intends to promote it.”
- Division of labor and specialization is a source of growth: technology improvement
- Requirement of a large market: infrastructure (e.g. navigable canals)
- Markets have failings: collusion, monopolies
The technological revolution
Industrial Revolution = a wave of technological advances starting in Britain in the 18th century, which
transformed an agrarian and craft-based economy into a commercial and industrial economy. It brought about a
high amount of technological innovations, new ideas, discoveries, methods and machines.
In Economics, Technology is a process that uses a set of materials and other inputs - including raw materials, the
work of people and machines - to produce an output.
By reducing the amount of worktime (which fell generation after generation), technological changes allowed
significant increases in living standards + technological progress greatly improved the speed at which information
travels, making the world more connected.
Increased production and population growth have ENVIRONMENTAL CONSEQUENCES. Climate change
resulting from economic activity is a major threat to future human wellbeing, and it illustrates many of the
challenges of designing and implementing appropriate environmental policies.
One way of thinking about the economy: it is part of a larger social system, which is itself part of the biosphere.
People interact with each other, and also with nature, in producing their livelihood. Humans have regarded
natural resources as freely available in unlimited quantities (except for the costs of extracting them). But as
production has soared, so too have the use of our natural resources and degradation of our natural environment.
Global impacts – climate change
Local impacts – pollution in cities (harmful emissions from power plants,
vehicles, and other sources), deforestation, v of the supply of clean water
These effects are the result of both the expansion of the economy and the way it is
organized. We use natural resources in production, which may in turn affect the
environment we live in and its capacity to support future production. The
environment represents a constraint to economic activity.
Capitalism
Together with the emergence of the technological revolution there was the emergence of capitalism (critical for
the industrial revolution itself).
4
