Introduction to Economics (607.

110)

2. Technological change,
population, & growth

paul.schweinzer@aau.at

October 7, 2022

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2. Technological change, population, & growth

Textbook: core-econ, unit 2.

A. Introduction
B. Economic models
C. Explaining growth
D. Explaining stagnation

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The context of this topic

Unit 1. The recent rapid, sustained increase in income and living

standards is largely due to technological progress.
However, these major changes started very suddenly, 200 years ago:
Ï How did the technological revolution start?
Ï Why did it not start earlier?

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The current topic
Use economic models to explain the rapid growth in real wages and
population in the last two centuries, and the stagnation in the
centuries before that.
800 60

Population in Britain
Real wage
Real wage index (1850 =100)

600 45

Population (millions)
400 30

200 15
Malthusian trap
Escape
Smith Malthus
0 0
1260 1300 1400 1500 1600 1700 1800 1900 2000

Year
Source: Allen (2001), The Great Divergence in European Wages and Prices from the Middle Ages. . .
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B. Why do we need models?

Level one chaos, e.g., the weather, does not react to predictions
about it. Level two chaos reacts to predictions about it, and
therefore cannot be predicted accurately:
“Markets, for example, are a level two chaotic system. What will
happen if we develop a computer program that forecasts with
100% accuracy the price of oil tomorrow? The price of oil will
immediately react to the forecast, which would consequently fail
to materialise. If the current price of oil is $90 a barrel, and the
infallible computer program predicts that tomorrow it will be
$100, traders will rush to buy oil so that they can profit from
the predicted price rise. As a result, the price will shoot up
to $100 a barrel today rather than tomorrow. Then what will
happen tomorrow? Nobody knows.” (Harari, Sapiens, p.67)
What happens in an economy depends on the actions and inter-
actions of millions of people. We use models to see the big picture.

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Building a model

To create an effective model we need to distinguish between:

1. the essential features of the economy that are relevant to the
question we want to answer, which should be included in the
model
2. and unimportant details that can be ignored.
Models necessarily omit many details.
But this is their feature, not a bug!

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Building a model

Based on our model, we are supposed to:

Ï Capture the elements of the economy that we think matter for
our question.
Ï Describe how agents act, and how they interact with each
other and the elements of the model.
Ï Determine the outcomes of these actions (an equilibrium).
Ï Study what happens when conditions change.

Equilibrium of a model: A 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.

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What is a good model?

Ï It is clear: it helps us better understand something important.

Ï It predicts accurately: its predictions are consistent with
evidence.
Ï It improves communication: it helps us to understand what we
agree (and disagree) about.
Ï It is useful: We can use it to find ways to improve how the
economy works.
Ï It may even help us to improve our understanding of the
underlying mechanisms at work.

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Key concepts

Ï Simplification: prices of inputs are the same for all firms; all
firms know & use all technologies equally; risk plays no role.
Ï Less is more: Ceteris paribus is a simplification that involves
“holding other things (in/outside the model) constant.”
E.g., what happens to demand if only one price changes?
Ï Incentives are economic rewards or punishments, which
influence the benefits and costs of alternative courses of
action. E.g., people attempt to to do as well as they can.
Ï Relative prices help us compare alternatives.
Ï Economic rent is the benefit received from a choice, taking
into account the next best alternative (reservation option).
Rents form the basis of how we make choices. E.g., inno-
vation rents after a technological breakthrough (Xerox).

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C. Explaining the Industrial Revolution

Why did the Industrial Revolution happen first in the 18th century,
on an island off the coast of Europe?
There are many alternative explanations:
1. Relatively high cost of labour & cheap local sources of energy.
2. Europe’s scientific revolution and Enlightenment.
3. Political and cultural characteristics of nations as a whole.
4. Cultural attributes such as hard work and savings.
5. Abundance of coal and access to colonies.
We are now trying to come up with a model explaining some
aspects of the Industrial Revolution based on the first set of
observations. There are many other possible models!

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Modelling technology
Technology is a process that uses inputs to produce an output.
Technology # Workers Coal required (tonnes)
10 A 1 6
B 4 2
Say, there are 5 9 C 3 7
D 5 5
different ways, A–E, to 8 E 10 1
produce 100 metres of 7 C

Tonnes of coal
cloth, using labour A
6
(number of workers)
5 D
and energy (tonnes of
coal) as inputs. 4

E-technology is 3
relatively labour- 2 B

intensive; A-technology E
1
is relatively energy-
intensive.
1 2 3 4 5 6 7 8 9 10
Number of workers
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Firm’s choice: inferior technologies

10
Firms choose between
9
technologies (specific
8
combinations of inputs)
7

Tonnes of coal
to produce outputs.
6
Some technologies are
dominated by other 5

technologies. 4
3
These use strictly more
inputs to produce the 2
same output. Hence, C 1
is dominated by A and D
is dominated by B. 1 2 3 4 5 6 7 8 9 10
Number of workers

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Firm’s choice: minimising cost

Firms aim to maximise their profit, which means producing cloth at

the least possible cost.
This is why the firms’ choice of technology depends on economic
information about relative prices of inputs.
Or less conversationally:
cost = (wage × #worker hours) + (price of coal per tonne × #tonnes)

and using symbols:

c = (w × L) + (p × R).

When deciding on their daily optimal input mix, L and R, we

assume that firms take wages, w, and the price of coal, p, as given.

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Isocost lines: c = (w × L) + (p × R)

Isocost lines are combinations of inputs that give the same cost.
Their slope is the relative price of inputs. We can derive the slope
of the isocost lines from the cost equation by re-arranging it:
c w
R= − L.
p p

As we said: in order to maximise profits, the firm will choose the

least-cost technology, taking factor prices as given or constant.
Hence, when comparing different total costs, the ratio w/p is
constant on the next slide.

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Isocost lines c = (w × L) + (p × R) for, e.g., p = 20, w = 10

10

8
Tonnes of coal, R

1
= £150

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Number of workers, L
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Change in relative prices in Britain
10 N

Technology was labour- 9

intensive before the G
8
Industrial Revolution
(technology B). 7

Tonnes of coal
A
6
Wage-increases relative
Cost = £50
to price of coal in Britain 5
create the incentive to 4
J

innovate more capital-

3
intensive technologies B
2
(technology A). Cost = £80
1 Cost = £40
Dashed: p = 20, w = 10. F M H

Solid: p = 5, w = 10. 1 2 3 4 5 6 7 8 9 10
Number of workers

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The benefits of innovation

Because relative prices of inputs changed, a firm that will (is able
to) switch to the new cost-minimising technology will have an
advantage over its competitors.
More formally:
profit = revenue − costs.

The change in profit is equal to the fall in costs associated with

adopting the new technology. This is the innovation rent.

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Schumpeter: Creative destruction

Ï The first adopter is called an entrepreneur. An entrepreneurial

firm is willing & able to try out new technologies and to start
new businesses.
Ï The first adopters will enjoy Schumpeterian (innovation) rents.
Ï 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.
“As a young professor in Austria [Schumpeter] had fought and
won a duel with the university librarian to ensure that students
had access to books. He also claimed that as a young man
he had three ambitions in life: to become the world’s greatest
economist, the world’s greatest lover, and the world’s greatest
horseman. He added that only the decline of the cavalry had
stopped him from succeeding in all three.” (Core, p.64)†

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Technological change in the Industrial Revolution

One of the first sectors to undergo technological change was

textiles:
Ï Before the Industrial Revolution, making clothes for the
household were time-consuming tasks.
Ï By the late 19th century, a single spinning mule operated by a
very small number of people could replace more than 1,000
spinsters.
Ï These machines were powered by water wheels and later
coal-powered steam engines instead of using human labour.

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Why was Britain first?
English wages were higher than wages elsewhere, and coal was
cheaper in Britain than in other countries in the chart Fig. 2.10.
1.8
Wages relative to the cost of capital

1.4

0.9

Englan
France

0.5

0
1580 1600 1620 1640 1660 1680 1700 1720 1740 1760 1780 1800 1820
Year

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Shift to a lower-cost technology
The combination of capacity to innovate and changing relative
prices of inputs led to a switch to energy-intensive technology.
10
1700s (isocost FG)
9 • Steep isocost: relative price of labour to coal is high.
• A-technology now lower cost than the B-technology.
8 G • We know this because B lies outside the line FG.

7
Tonnes of coal

A
6
1600s(isocost HJ)
5 • Firms use technology B.
J • At this relative price, no incentive to develop technology A.
4 • We know this because A costs more (it lies outside the line HJ).
3
B
2
1
F H

1 2 3 4 5 6 7 8 9 10 11 12 13
Number of workers

Eventually, spillover of technological innovation leads to dominance

of even the existing technology at existing prices (abroad).
Hence, our model pretty much explains the Industrial Revolution.
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D. Explaining the economy before the Industrial Revolution
We need a different model to explain the stagnation in population
and living standards before 18th century.

800 60

Population in Britain
Real wage
Real wage index (1850 =100)

600 45

Population (millions)
400 30

200 15
Malthusian trap
Escape
Smith Malthus
0 0
1260 1300 1400 1500 1600 1700 1800 1900 2000

Year
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Diminishing average product of labour
A production function gives the maximum attainable output for a
given set of inputs, called (production) factors.
If we hold one input (land) fixed, and expand the other factor
(labour), the average output per worker (AP) is going to fall.
This is the law of diminishing average product of labour.
900
Workers Grain [kg] AP [kg/worker]
Kg of grain produced (thousands)

B 200 200,000 1,000

The farmers’ production function: 400 330,000 825
675
This shows how the number of 600 420,000 700
farmers working the land
translates into grain harvested.
800 500,000 625
A 1,000 570,000 570
450
At A the average product of labour is 500,000/800 =
1,200 630,000 525
625 kg of grain per farmer. 1,400 684,000 490
At B the average product of labour is 732,000/1,600 = 1,600 732,000 458
458 kg of grain per farmer.
1,800 774,000 430
225
2,000 810,000 405
2,200 840,000 382
Slope = 732,000/1,600 = 458 2,400 864,000 360
0 2,600 882,000 340
0 400 800 1,200 1,600 2,000 2,400 2,800 2,800 894,000 319
Number of farmers

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Malthus’ model (1798)

Arable land is (more or less) fixed but population grows.

Key ideas:
1. Population expands if living standards increase.
2. But the law of diminishing average product of labour implies
that as more people work on the land, their per capita income
will inevitably fall.
In equilibrium, living standards will be forced down to subsistence
level.
In the long run, population and income will stay constant.

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Malthus’ Law

Population Less land

rises per farmer
Farmers’ Average
incomes output per
rise farmer falls

Average Farmers’
output per incomes
farmer rises fall

mprovement
Improvement in technology in technolog Equilibrium
Equilibrium Subsistence incomes
prevail
Subsistence incomes
prevail Population constant at
higher level
Population constant

The model predicts a self-correcting response to new technology.

In the long run, an increase in productivity will result in increased
population but not increased (real) wages.
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Was Malthus correct?
The relationship between real wages and population in England
between 1280-1600 show evidence of this “Malthusian trap.”
But what about the subsequent “hockey-stick” growth?

100
)

0
0
1
= 85
0
6
Real wage index (18

70

55

40
2 3 4 5 6
opulation (millions)

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Revising Malthus’ Law

Three conditions are required to stay in the Malthusian trap:

1. Diminishing average product of labour.
2. Rising population in response to increases in wages.
3. An absence of improvements in technology to offset the
diminishing average product of labour.
The permanent technological revolution (i.e., “better” production
functions) meant that the third condition no longer holds, and
explains why Britain was able to escape the Malthusian trap.

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Escaping the Malthusian trap

100

85

70

55

40
0 5 10 15

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Summary

1. Introduction to economic models:

Ï Less is more: use simplifying assumptions, e.g., ceteris
paribus.
2. Used models for insights on the technological revolution:
Ï Model of a firm: high wages (relative to capital, including
energy) motivated technological innovation.
Ï Malthus’ model: permanent technological change enabled
economies to escape economic stagnation.

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In the next unit

Ï More about models: An economic model of decision making

under constraints.
Ï How individuals respond to technological change: Explaining
trends in choices of working hours across time.

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