Unit 1: Managerial Economics Basic

INFORMATION REVOLUTION VS. INDUSTRIAL REVOLUTION

As e-commerce became all the rage in the late 1990s and as the Internet, World Wide Web, and other information technologies rapidly transformed the economic and social environment, many analysts, journalists, and scholars took the time to reflect upon the current transformations and breakthroughs and situate them in a broad, historical context. The fruit of these labors was the conception of the current era as the Information Revolution, akin in its historical importance and impact to previous economic revolutions, particularly the Industrial Revolution.

The attempts to theorize a new economic and social era—particularly one whose effects have yet to be fully realized—inevitably generated widely disparate definitions and characteristics of the Information Revolution, not to mention predictions, prescriptions, and levels of enthusiasm. Several key questions arise: Does the Information Revolution in fact constitute a historical epoch on a par with previous revolutionary transitions? What are the comparative features and effects of the Information Revolution and the Industrial Revolution? How did the Industrial Revolution alter previously existing conceptions of economics, social organization, the nature of work, cultural patterns, and so on? What needs to be done to either take advantage of the benefits of the Information Revolution, or—if one is of a different theoretical persuasion—what steps must be taken to mitigate its worst effects?

Since even the most enthusiastic proponents of the Information Revolution agreed that, in the early 21st century, the new era was still in its infancy, it remained to be seen whether the Information Revolution would truly revolutionize society on a scale comparable with the Industrial Revolution, which produced greater change in just two centuries than occurred in the rest of human history combined.

Defining moments of economics: From Industrial revolution to Information Revolution

• Our understanding of the economic aspects of our lives is conditioned by past events and Our material circumstances were not created overnight. We didn’t wake up one day’ lo discover high technology factories, a complex legal system, an information superhighway, a transportation network, and sophisticated financial markets. All these resources and institutions are the consequence of past events.
• Change occurs sometimes gradually, sometimes Sometimes monumental changes take place that we recognize only after the fact. There are even times when we think change has occurred when it has not-and so it is with economic change.
• Over the past two centuries there have taken place a number of changes so important that they have defined the direction of economics and influenced the lives of million s of people. These “defining moments” have provided the stimulus for the great economic thinkers to provide explanations that became the great theories of economic science.
• A Defining Moment of economics is an event or idea, or a set of related events or ideas over time, that has changed in a fundamental way the manner in which we conduct our everyday lives and the way in which we think about the economy.
• The five Defining Moments of Economics are:

• Each of these Defining Moments illustrates a fundamental idea of The Worldly Philosophers developed powerful and influential theories to explain why each moment happened and what its consequences were. You will frequently encounter these Defining Moments throughout the text, for they define the basic themes, concepts, problems, and puzzles not only of the past but also of contemporary economic life. The issues raised by the Defining Moments-growth, affluence, poverty, cycles, trade, ownership, economic institutions-constitute the major economic issues of the past, the present, and the future.

Technological Change in Global Economy

Changes occur so rapidly in modern society that people find it difficult to adapt to their evolving environment. He argued that the average person is emotionally and intellectually left behind by the rapid pace of technical and cultural change.

Faced with rapid change, many firms have found it difficult to keep pace. Complicating the situation is the need for firms to stay abreast of new developments within their own industry

• Electronics companies must be competitive in using the new digital technologies for their audio and video equipment.
• Automobile manufacturers survive only if they keep costs down by using advanced robotics for assembly.
• Computer suppliers can stay profitable only if their machines include state-of the-art chips, display terminals, and storage devices.

Impact of technological change

• Technological change may involve new products, improvements or cost reductions for existing products, or better ways of managing the operations of a business.
• May be simple or brilliant.
• Technological change can be thought of as altering the firm’s production function.

Neutral Technological Change

• Can cause a shift in the production isoquants.
• Equal reduction in both inputs.

Non- Neutral Technological Change

• increases the marginal product of capital relative to the marginal product of labor.
• Unequal reduction in one of input.

Technological Change, Productivity and Economic Growth

• Productivity = output / inputs
• Labor productivity- output divided by the quantity of labor.
• Technological change is an important source of increased labor productivity.
• Total factor productivity compares changes in both capital and labor.
• E.g. Automobile Production in England and Germany.

Technological Change and the Market Structure

What type of market structure best facilitates the generation of new knowledge?

Does the market structure determine the rate of technological change or does the nature of technology dictate which market structure will prevail?

Effect of Market Structure on Technological Change

• Market power is a necessary condition for rapid technological change.
• Large firms have been responsible for many important developments.
  • E.g. AT&T’s Bell labs devised the transistor and DuPont introduced Nylon.
• Small firms also have impact (competitive)
• In evaluating the effect of market structure on technological change, the key is to consider both the ability and the incentives to be progressive.
• Ability involves being able to fund expensive R & D projects, withstand failures, and wait for results.
• Incentives include the need to remain competitive and being able to capture the rewards of technological advance
• Market structure can affect the rate of technological change
• Technology can also significantly affect the structure of market.
  • e.g. Telecommunication.
• Changes in technology, by reducing or increasing economies of scale, can alter market structures.

Industrial Innovation

• Invention, Innovation and diffusion.
• Invention can be thought of as a creation of new ideas.
• Innovation represents taking those ideas and transforming them into something that is useful for society.
• Diffusion is the process whereby the new product or process becomes available throughout the society.

Market Failure

Market failure does not mean that the given market has ceased functioning. Instead it is a situation in which given market does not efficiently organize production or allocate goods and services to the consumers. Competitive markets fail for four basic reasons:

–       Market power

–       Incomplete information

–       Externalities : The effect of production and consumption activities not directly reflected in markets.

–       Public goods: goods that benefit all consumers

1. Market Power

   • We know that inefficiency arises when a producer or supplier of a factor input as market Suppose, for example, that the producer of food has monopoly power. It therefore chooses the output quantity at which marginal revenue (rather than price) is equal to marginal cost and sells less output at a price higher than in a competitive market.
   • The lower output will mean a lower marginal cost of food Meanwhile, the freed-up production inputs will be allocated to produce clothing, whose marginal cost will increase.
   • As a result, the marginal rate of transformation will Producing too little food and too much clothing is an output inefficiency because firms with market power use a different price in their output decisions than consumers use in their consumption decisions.
   • A similar argument would apply to market power in an input Suppose that unions gave workers market power over the supply of their labor in the production of food.
   • Too little labor would then be supplied to the food industry at too high a wage, and too much labor to the clothing industry at too low a wage.
   • In the clothing industry, the input efficiency conditions would be satisfied but in the food industry, the wage paid would be greater than the wage in the clothing industry. The result is input inefficiency because
   • efficiency requires that the marginal rates of technical substitution be equal in the production of ail goods.

2. Incomplete information

   • If consumers do not have accurate information about market prices or product quality, the market system will not operate efficiently.
   • This lack of information may give producers an incentive to supply too much of some products and too little of others. In others cases, some consumers may not buy a product even though they would benefit from doing so, while other consumers buy products that leave them worse off.
   • For example, consumers may buy pills that guarantee weight loss, only to find that the pills have no medical value. Finally, a lack of information may prevent some markets from ever developing.
   • It may, for example, be impossible to purchase certain kinds of insurance because suppliers of insurance lack adequate information about who us likely to be at risk.
   • Each of these informational problems can lead to competitive market inefficiency.

3. Externalities

   • The price system works efficiently because market prices convey information to both producers and consumers. Sometimes, however, market prices do not reflect the activities of either producers or consumers.
   • There is an externality when a consumption or production activity has an indirect effect on other consumption or production activities, that is not reflected directly in market prices.
   • The word “externality” is used because the effects on others (whether benefits of costs) are external to the market.
   • Suppose, for example, that a steel plant dumps waste in a river, which makes a recreation site downstream unsuitable for swimming or fishing. There is an externality because the steel production does not bear the true cost of waste water and hence uses too much waste water to produce its steel. This causes an input inefficiency. If this externality overcomes throughout the industry, the price of steel (which is equal to the marginal cost of production) will be lower than if the cost of production reflected the waste cost. As a result, too much steel will be produced, and there will be an output inefficiency.

4. Public Goods

   • The last source of market failure arises when the market fails to supply goods that many consumers value.
   • A public good is a good that can be made available cheaply to many consumers, but once the provided to some consumers, it is very difficult to prevent others from consuming it.
   • For example, suppose a firm is considering whether to undertake research on a new technology for which it cannot obtain a patent. Once the invention is made public, others can duplicate it. As long as it is difficult to exclude other firms from selling the product, the research will be unprofitable . Thus, markets undersupply public goods. The government can sometimes resolve this problem either by supplying the good itself or by altering the incentives for private firms to produce it..
   • Public goods have two characteristics: they are nonrival and nonexclusive.

Non-rivalry: This means that when a good is consumed, it doesn’t reduce the amount available for others.

– E.g. benefiting from a street light doesn’t reduce the light available for others but eating an apple would.

Non-excludability: This occurs when it is not possible to provide a good without it being possible for others to enjoy. For example, if you erect a dam to stop flooding – you protect everyone in the area whether they contributed to flooding defenses or not.