ECO 1001 — Question Bank

UNITS 1, 2 & 3 · THEORY · CALCULATIONS · DIAGRAMS · MCQS · A P PLI C ATI O NS

Unit 2: Technology, Population, and Growth

ECONOMIC MODELS · ISOCOST LINES · INNOVATION RENTS · MALTHUSI AN T RAP
· DIMINISHING RETURNS

ECONOMIC MODELS & KEY CONCEPTS

What is an economic model? List the four attributes of a good model

Theory 6 pts
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and describe the five steps involved in building and using a model.

MODEL ANSWER

An economic model is a simplified representation of the economy that focuses on what is

important for the question at hand, deliberately ignoring details judged to be of secondary
importance. Like a map, models "see more by looking at less."

Four attributes of a good model:

Clear: It helps us better understand something important.

Predicts accurately: Its predictions are consistent with evidence.
Improves communication: Helps us understand what we agree and disagree about.
Useful: We can use it to find ways to improve how the economy works.

Five steps of model building:

1. Construct a simplified description of the conditions under which people take actions.
2. Describe what determines the actions people take.
3. Determine how each action affects others. ↑
4. Determine the outcome — often an equilibrium.
 5. Study what happens when conditions change (comparative statics).

Define: (a) Economic rent, (b) Reservation option, (c) Innovation rent,
Theory (d) Ceteris paribus, (e) Relative price. Explain the decision rule that 7 pts
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economic rent provides.

MODEL ANSWER

(a) Economic rent: A payment or benefit received above and beyond what the individual would
have received in their next best alternative. It is NOT the same as paying rent for an apartment —
it is something you want to get, not pay.

(b) Reservation option (fallback option): The next best alternative available to a decision-maker.
If you cannot do action A, your reservation option (Plan B) is what you get instead.

(c) Innovation rent (Schumpeterian rent): The extra profit earned by the first firm to adopt a
cost-reducing technology, before competitors copy it. It is a temporary reward that incentivises
innovation.

(d) Ceteris paribus: Latin for "other things equal." The practice of changing only one variable at a
time in an analysis, holding all others constant. This isolates the effect of the variable of interest.

(e) Relative price: The price of one good compared to another (expressed as a ratio). E.g., the
wage-to-coal-price ratio. Relative prices, not absolute prices, determine which technology a firm
chooses.

Decision rule: If action A gives an economic rent (its benefit exceeds the opportunity cost), do it.
If you are already doing A and it earns a rent, keep doing it. This rule explains why firms innovate
when the cost savings exceed zero.

TECHNOLOGY CHOICE & ISOCOST LINES

 A firm can produce 100m of cloth using five technologies. Technology
A: 1 worker, 6 coal. B: 4 workers, 2 coal. C: 3 workers, 7 coal. D: 5
Diagram workers, 5 coal. E: 10 workers, 1 coal. Plot these technologies on a 7 pts
▼

(workers, coal) diagram, identify which are dominated, and explain

why dominated technologies will never be chosen.

MODEL ANSWER

7
C✗

6
A
)sennot( laoC

5
D✗

A dominates
region →

2
B

E
1

1 3 4 5 10
Number of Workers

Technologies C and D are dominated. Pink × = dominated; non-dominated = A, B, E.

Dominated technologies: Technology X dominates Y if X uses at least as little of every input to

produce the same output.

A dominates C: A uses 1 worker (vs. C's 3) AND 6 coal (vs. C's 7). A wins on both inputs.
B dominates D: B uses 4 workers (vs. D's 5) AND 2 coal (vs. D's 5). B wins on both inputs.

Why dominated technologies are never chosen: Since all inputs must be paid for, using a
dominated technology means higher costs for the same output. Any firm using C when A is
available, or D when B is available, is wasting money. A profit-maximising firm will never choose
a dominated technology.
Remaining non-dominated technologies: A, B, E. The choice between these requires knowing
relative prices.

Technologies A (1 worker, 6 coal), B (4 workers, 2 coal), E (10

workers, 1 coal). Wage = £10, price of coal = £20 per tonne. (a)
Calculation Calculate the total cost of each technology. (b) Write the equation 8 pts
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of the isocost line through B. (c) Which technology is chosen and

why?

MODEL ANSWER

(a) Total costs (w=£10, p=£20):

Cost = w × L + p × R

A: 10×1 + 20×6 = £10 + £120 = £130

B: 10×4 + 20×2 = £40 + £40 = £80
E: 10×10 + 20×1 = £100 + £20 = £120

(b) Isocost line through B (cost = £80):

General isocost: wL + pR = c → 10L + 20R = 80

Rearranging: R = c/p − (w/p)L

R = 80/20 − (10/20)L
R = 4 − 0.5L

Slope = −w/p = −10/20 = −0.5

Vertical intercept (L=0): R = 4 (i.e., 4 tonnes coal)
Horizontal intercept (R=0): L = 8 workers

(c) Technology B is chosen. It lies on the lowest isocost line (£80), while A (£130) and E (£120)
both lie on higher (more expensive) isocost lines. The firm minimises cost by choosing B. Note: it
is the relative price (w/p = 0.5) that determines the slope of the isocost, and therefore which
technology lies on the lowest isocost.

Now the price of coal falls to £5 (wage stays at £10). (a)

Recalculate total costs for A, B, E. (b) Which technology is now
Calculation chosen? (c) What is the innovation rent for a firm that switches 8 pts
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first from B to A? (d) What does Schumpeter's "creative

destruction" predict will happen next?
MODEL ANSWER

(a) New costs (w=£10, p=£5):

A: 10×1 + 5×6 = £10 + £30 = £40

B: 10×4 + 5×2 = £40 + £10 = £50
E: 10×10 + 5×1 = £100 + £5 = £105

(b) Technology A is now chosen — it has the lowest cost of £40. The new isocost slope is −w/p =
−10/5 = −2 (steeper). The energy-intensive A is now cheapest.

(c) Innovation rent for switching from B to A:

All competitors still use B at cost £50.

First-adopting firm switches to A at cost £40.
Innovation rent per 100m cloth = £50 − £40 = £10

The firm earns £10 extra profit per unit by using the cheaper technology. Decision rule: economic
rent > 0 → switch!

(d) Creative destruction (Schumpeter): Other firms notice the innovator's higher profits and
adopt A. As more firms switch, supply increases and the price of cloth falls. Eventually, firms
using old technology B cannot cover costs at the new lower price and go bankrupt — "creative
destruction." The old technology and the firms using it are swept away; resources are released
for new uses. Innovation rents disappear as the new technology diffuses.

Draw the isocost diagram for both 1600s Britain (isocost HJ,
technology B is chosen) and 1700s Britain (isocost FG, technology A
Diagram is chosen). Explain what changed in the economy between these two 8 pts
▼

periods to cause the shift, and how this explains the Industrial
Revolution starting in Britain.

MODEL ANSWER
 G

A
)sennot( laoC

1700s isocost (high w/p)

B 1600s isocost (low w/p)

F H

Workers

1600s (HJ, shallow): B chosen. 1700s (FG, steep): A chosen. The steeper slope = higher w/p ratio.

What changed between 1600s and 1700s Britain:

Wages rose relative to the cost of energy (coal). Britain had abundant cheap coal; wages were
rising due to trade expansion and urbanisation.
In Figure 2.11, wages relative to capital goods rose steadily in England but not France after
the mid-17th century.
In Figure 2.10, wages relative to energy prices were highest in Newcastle and London, far
above Paris, Strasbourg, or Beijing.

Effect on isocost slope: Slope = −w/p. Higher wages → steeper slope → the energy-intensive A-
technology (low labour, high coal) lies on a lower isocost than B. Innovation rents could be
earned by switching from B to A.

This explains the Industrial Revolution starting in Britain: The combination of high relative
wages AND abundant cheap coal made it uniquely profitable for British entrepreneurs to adopt
energy-intensive, labour-saving machines (spinning jenny, steam engine). In France, the relative
incentive was weaker.

MALTHUSIAN ECONOMICS
 State and explain the two key assumptions of the Malthusian model.
Theory Why do these two assumptions together imply that improvements in 6 pts
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technology cannot permanently raise living standards?

MODEL ANSWER

Assumption 1: Diminishing average product of labour. As more workers are added to a fixed
amount of land, average output per worker (average product) falls. This is because the best land
is already farmed; additional workers have less and less-good land. Example: 800 farmers →
625 kg/farmer; 1,600 farmers → 458 kg/farmer.

Assumption 2: Population grows when living standards rise above subsistence. Higher
wages/incomes lead to earlier marriage, more children, lower death rates → population growth.
Population falls when incomes are below subsistence.

Why technology cannot permanently raise wages:

1 A new technology (e.g., better seeds) raises average output per worker, temporarily
pushing wages above subsistence.

2 Higher wages → population growth (Assumption 2).

3 More workers on fixed land → diminishing average product → wages fall back (Assumption
1).

4 Equilibrium is restored at subsistence wages — but now with a larger population .

Technology raises the population that can be supported at subsistence, but not the subsistence
income itself. "Malthus's Law" — the vicious circle of poverty.

Draw the two-panel Malthusian model (Figure 2.16). Label the

equilibrium at subsistence wages. Then show (Figure 2.17) how a
Diagram 9 pts
▼
technological improvement affects the economy in the short run and
long run. What are the equilibrium conditions in each case?

MODEL ANSWER
 Left: Wage falls as pop. rises Right: Pop growth rises with wage

After tech ↑

egaW laeR Original

Real
Wage

D →
D' pop rises

A C
A' C'
Subsistenceneg. growth pos. growth

Population Population growth rate

Left: wage-population curve. Right: population-growth-rate curve. Tech improvement: A→D short run; D→C
long run.

Original equilibrium (A, A'): Population is medium-sized, wage = subsistence. Population growth
= 0. Self-perpetuating.

Short-run effect of technology (A→D): Better seeds/tools raise average output per farmer for
every population size — the wage curve shifts up. At the original population, wage jumps to
above-subsistence (point D). Population growth turns positive (D').

Long-run effect (D→C): As population rises, diminishing average product of labour pushes
wages back down. The economy slides along the new wage curve from D toward C. At C, wages
return to subsistence — population stops growing. New equilibrium C has a larger population but
the same subsistence wage.

Key implication: In a Malthusian economy, a better technology supports more people but not
higher living standards. The "blessing" of technology becomes more mouths to feed.

The Black Death (1348–51) killed one-quarter to one-third of

Europe's population. Using the Malthusian model, explain the
Application 6 pts
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subsequent economic effects — including why real wages rose
after the plague and then fell back by 1600.

MODEL ANSWER
Immediate effect: Labour supply fell sharply (1.5 million out of 4 million English people died).
With fewer workers on the same amount of land, the diminishing average product of labour
worked in reverse: average output per surviving farmer rose. Each farmer now had more and
better land.

Result: Real wages rose substantially (from roughly 1350 to 1450). The bargaining power of
surviving workers increased — employers had to offer higher wages to attract them. This led to
social tension: King Edward III tried to cap wages by law in the Statute of Labourers (1351),
contributing to the Peasants' Revolt (1381).

Population recovery (15th–16th century): Higher wages meant higher living standards →
population began to grow again (Malthusian assumption 2). Labour supply increased, land per
worker fell, and the diminishing average product of labour pushed wages back down.

Outcome by 1600: Real wages had fallen back to roughly their pre-plague levels (Figure 2.19).
This is the Malthusian vicious circle in action — a demographic shock temporarily raised
incomes, but population growth restored the equilibrium at subsistence wages. The cycle
confirms the Malthusian model empirically.

Explain how Britain escaped the Malthusian trap after 1800. What two
Theory factors enabled wages and population to rise simultaneously — 5 pts
▼

something the Malthusian model said was impossible?

MODEL ANSWER

The Malthusian model fails when the rate of technological improvement is faster than population
growth — it continuously pushes the wage curve up faster than population can grow along it.

Two enabling factors of the escape:

1. The Permanent Technological Revolution: The spinning jenny, steam engine, and subsequent
industrial innovations raised labour productivity generation after generation. Unlike previous
one-off improvements, this was continuous. Each year, the same worker produced more. This
kept shifting the wage curve upward.

2. Increase in workers' bargaining power: From the 1830s onward, several forces reduced
labour supply (Factory Acts restricting child labour), increased labour demand (factory
expansion), and eventually gave workers political voice (extension of voting rights, trade unions).
The workers' share of the growing economic pie increased. Figure 2.21 shows real wages and
labour productivity rising together after ~1830, with political milestones (1833 Factory Act,
1847 Ten Hours Act) playing key roles.

Result: Both population and real wages rose simultaneously — the "escape" from the Malthusian
regime into a new era of sustained growth in living standards.

From a production function for grain: 800 farmers produce

500,000 kg; 1,600 farmers produce 732,000 kg. (a) Calculate the
average product of labour at each level. (b) Has average product
Calculation 5 pts
▼
increased or decreased? What concept does this illustrate? (c) If
the wage equals the average product of labour, what happens to
wages as population doubles?

MODEL ANSWER

(a) Average product of labour:

APL = Total output / Number of workers

At 800 farmers: APL = 500,000 / 800 = 625 kg/farmer

At 1,600 farmers: APL = 732,000 / 1,600 = 457.5 kg/farmer

(b) Average product has decreased — from 625 to 457.5 kg per farmer as the number of workers
doubled. This illustrates the principle of diminishing average product of labour: as more labour
is applied to a fixed amount of land, average output per worker falls. The underlying cause is that
each successive worker has less (and worse) land to work with.

(c) If wage equals average product, wages fall from 625 kg equivalent to 457.5 kg — a reduction
of about 27%. This is the Malthusian mechanism: population growth → falling wages. If wages
were initially above subsistence (say 625 kg), the fall toward subsistence will slow population
growth until equilibrium is restored.