Microeconomics

Lecture 2
Technology and Innovation
Prof Ingo Geishecker, PhD
Europa-Universität Viadrina
SoSe 2024

1
…In this lecture:

Today
2.1. Wages Over Time
2.2 Malthusian Economics
2.3 Technology

Literature: The Economy, Chapter 2

2
…In this lecture:

We want to answer the following questions:

• Why of all countries did Industrial Revolution start in
Britain ?
• And why in the 18th century?
• How does innovation take place ?

- check following video as a little introduction:

https://www.youtube.com/watch?v=-vyNOWxprt4

3
2.1 Wages Over Time

800 Wages of craftsmen (skilled workers) in 70

London and the population of Britain
700 60
Real wage index (1850=100)

600
50

Population (million)
500
40
400
Population Real 30
300 wages

20
200
Malthusian trap
100 Escape 10

0 0
1260 1334 1408 1482 1556 1630 1704 1778 1852 1926 2000

Smith Malthus
2.1 Wages Over Time

Real Wage Index?

- for an index a time series is transformed into values
in relation to base year, by dividing values through
value that corresponds to base year
- in previous graph base year is 1850
- see exercise !

5
2.1 Wages Over Time

looking at the graph:

• no sustained increase in real wages up until mid of

19th century

• before industrial revolution: wage increases only

when population shrank

Malthus (1798) “An Essay on the Principle of

Population”: sustained increases in real income
impossible as any increase would foster population
growth thereby bringing down income per capita
6
2.1 Wages Over Time

7
2.1 Wages Over Time

8
2.1 Wages Over Time

9
2.1 Wages Over Time

10
2.1 Wages Over Time

11
2.1 Wages Over Time

looking at the graphs:

• Malthusian is at play way into the 1800s

• However: eventually income growth outpaced

population growth as productivity increases where
sustained and strong enough

• so what changed, how did escape out of Malthusian

trap succeed, and why in Britain?

12
2.2 Malthusian Economics

• we may have theory about how Britain escaped the

Malthusian Trap in the Industrial Revolution (the
upward curve in the hockey stick)

• But first: what happened before? Why are incomes /

wages stagnant for such a long time

• to answer this we build and analyse a (different)

model

13
2.2 Malthusian Economics

Economic Model: is a simplified illustration of real

economy focusing on essential economic features that
are relevant to the question ignoring unimportant
details

- model uses graphical representations or

mathematics

- model makes simplifying assumption

However, any good model also needs to be consistent

with data
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2.2 Malthusian Economics

Model:

• assume simple agricultural economy with 2 inputs

(factors of production), farm labour and a fixed
amount of farm land

• producing one output good, which is grain

• quantity of output is denoted by Y

• quantity of labour is denoted by X

• quantity of fixed land is

15
2.2 Malthusian Economics

How much can grain can the economy produce?

• depends on available land (which is fix) and the

number of farm labour (farmers)

• = ( , ̅ ) ⟶ ( ) as ̅ is not
variable

16
2.2 Malthusian Economics

( )
Kilogrammes of grain produced (thousands)

900

800

700

600
A
500

400 At A: Y=500,000 , X=800

300 ,
Output per farmer : = = 625 !
200

100 Average Product

0
0 400 800 1200 1600 2000 2400 2800
Number of farmers
2.2 Malthusian Economics

Average Product

( )
/ =732,000/1600=458 !
Kilogrammes of grain produced (thousands)

900 At B: Output per farmer :

800
B
700

600
A
500

400 At A: Y=500,000 , X=800

300 ,
200
Output per farmer : = = 625 !
100 Average Product
0
0 400 800 1200 1600 2000 2400 2800
Number of farmers
2.2 Malthusian Economics

It’s the Diminishing Average Product of labour

that generates the trap

• Starting point: 500 farmers and their families, each

producing and consuming 625 kg

• if 625 kg > subsistence level many children are born

• next generation has 800 farmers and their families

who now can only consume 458 kg

• if 458 kg > subsistence level population grows,

consumption per head shrinks
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2.2 Malthusian Economics

• implicit assumption: when income > subsistence

level, population grows

• in the Malthusian economy income and population

fluctuate around and equilibrium level, there are no
lasting increases in income (per head) and
population (Malthusian Trap)

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2.2 Malthusian Economics

How to escape the Malthusian Trap ?

• production function has to change such that more

output per input, i.e. productivity increases

• and productivity increase must be faster than

population growth such that output per worker, i.e.
the Average Product, increases

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2.2 Malthusian Economics

1833 Factory act (No child labour under 9 years)

1844 Factory act (Children work only 6.5 hours day)
400 1847 Ten Hours Act (Limits work hours for women & children)

350
Index (1760=100)

300 Labour
productivity
250

200 1764 Hargreaves’ spinning jenny Real wages

1781 Watt’s steam engine
150

100

50
1918 Voting rights for all males
1928 Universal suffrage
0
1760 1810 1860 1910
2.2 Malthusian Economics

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2.3 Technology

We know already that industrial revolution is

characterised by

• rapid and sustained technological progress

• firms investment in capital goods

• unprecedented use of fossil fuels (coal)

We now build a economic model to explain these

changes

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2.3 Technology

Technology of a firm: a process that uses inputs to

produce output

• Simplifying assumptions for our model: there are

only two production inputs (we call them factors)
namely workers and coal that can be combined to
produce one output good

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2.3 Technology

Different technologies for producing 100 metres of cloth.

10 Technology Number Coal
of workers required
9 (tonnes)
8
7 C A 1 6
Tonnes of coal

A B 4 2
6
5 D C 3 7
4 D 5 5
3
B E 10 1
2
E
1

1 2 3 4 5 6 7 8 9 10
Number of workers
2.3 Technology

• more assumptions of the model: firms maximise

profits

• i.e. for a given output firms must chose the

technology with the lowest costs

• costs, of course, depend on prices for input factors

coal and workers

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2.3 Technology

some technologies are

dominated by other
technologies (regardless of
input prices)

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2.3 Technology

• But deciding between technologies that are not

dominated is slightly more complicated
)*+, = -.!/ · -*1 /1+ + )*.3 415)/ ⋅ ,*77/+ * )*.3
=- ·8 + 4⋅9

• Lets say: Wage = £10, cost of coal = £20 per tonne

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2.3 Technology

Point Number of Coal required Total cost

workers (tonnes) (£)

isocost lines
Wage £10, cost of coal £20 per tonne
10
Cost above
9 £80 P1 2 3 80
8 P2 6 1 80
Cost = £150
7
Tonnes of coal

=; Q1 3 6 150
6
=<
5 Q2 5 5 150
4 J
:;
3 Costs for 100 meters of cloth
Cost = £80
2 £120
:<
1
H

1 2 3 4 5 6 7 8 9 10
Number of
workers
2.3 Technology

)*+, = - · 8 + 4⋅9

let‘s hold costs stable

)*+, = - · 8 + 4⋅9

rearrange
4 ⋅ 9 = )*+, − - · 8
@ABC E
?= − ·F
D D
this is the (linear) functional form of isocost line
;
so for previous example: R= − ·8
< <

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2.3 Technology

isocost lines
E
10 slope of isocost lines =
Cost above
9
8
£80 D
Cost = £150
7
Tonnes of coal

=;
6
=<
5
J
Wage = £10, cost of coal = £20 per tonne
4
3
:;

Cost = £80
GH
2 £120 =
1
:<
H
IH
1 2 3 4 5 6 7 8 9 10
Number of
workers
2.3 Technology

Technol Number of Coal required Total

ogy workers (tonnes) cost (£)
10 Wage £10, cost of coal £20 per tonne
9
B 4 2 80
8 Cost = £50 A 1 2 130
7
Tonnes of coal

A Wage £10, cost of coal £5 per tonne

6
B 4 2 50
5
A 1 6 40
4
Cost = £130
3
2
B Costs for 100 meters of cloth
Cost = £40 Cost = £80
1 technology A is more profitable

1 2 3 4 5 6 7 8 9 10
Number of workers
2.3 Technology

Which technology should the firm chose?

Old Prices: Wage £10, cost of coal £20 per tonne,

Total costs of producing 100 meters cloth:
J: GH · L + IH ⋅ I = MH A: 10 · 1 + 20 ⋅ 6 = 130

New Prices: Wage £10, cost of coal £5 per tonne,

Total costs of producing 100 meters cloth:
B: 10 · 4 + 5 ⋅ 2 = 50 P: GH · G + Q ⋅ R = LH

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2.3 Technology

• Technology B: labour intensive, i.e. it uses relatively

speaking many workers and little coal

• Technology A: capital intensive, i.e. it uses relatively

speaking much coal and little workers

industrial revolution analogy in model: movement from

technology B (no machinery, little coal, mainly muscle
power of workers) to technology A (machinery such as
steam engine with lots of coal and less muscle power)
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2.3 Technology

Why does this movement from B to A happen?

• coal became relatively cheaper than labour

• Which is equivalent to saying, that labour became

relative more expensive than coal

Thus technology A is the new minimal cost technology.

Profit maximising firms chose A.

36
2.3 Technology

Back to our initial question: Why did industrial

revolution happen in Britain and why in 18th century?

Hypotheses derived from model:

• relative high price of labour generates incentive to

find new technology that is less intensive in the use of
labour to save costs

• even more so, when relative price of labour increases

37
2.3 Technology

38
2.3 Technology

39
2.3 Technology

Data on inter-country differences in relative price of

labour and on the development over time support
hypotheses derived from model

Industrial Revolution happened in Britain as labour was

relatively expensive (more so than in other countries)
and became even more expensive over time generating
incentives to find and switch to labour saving capital
and energy intensive technologies.

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Summary

Important concepts:
• Malthusian Trap
• Diminishing Average Product
• technology
• isocost line
• relative price
• incentive to switch technology

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