Micro-economics
Micro- vs. Macro-economics
What is "an economy?"
Where do aggregates (GDP, unemployment, & inflation) come from?
Micro: [modelling] Choices and consequences
Macro: [modelling] Systemic interaction of choosers & emergent behavior
Economists Speak a Foreign Language...
- Terms you "know" from ordinary life mean very different things to economists:
Cost, efficiency, welfare, competition, marginal, equilibrium, profit, public good, discrimination, elasticity
Using these words' "ordinary" meanings will lead to wrong economic conclusions!
You will need to "relearn" the economic meanings of these words
...But You Can Learn It
- You'll need to master a new vocabulary:
externality, marginal rate of transformation, marginal cost, consumer surplus, allocative efficiency
- I will try to avoid jargon, but many of these concepts are useful in the real world!
...But You Can Learn It
Everyone thinks they are already an economist and can speak this foreign language
Be humble!
Economics is often common sense, but reached via deep analytical thinking
Economics as a Way of Thinking
Economics is a way of thinking based on a few core ideas:
People respond to incentives
- Money, punishment, taxes and subsidies, risk of injury, reputation, profits, sex, effort, morals
Economics as a Way of Thinking
Economics is a way of thinking based on a few core ideas:
People respond to incentives
- Money, punishment, taxes and subsidies, risk of injury, reputation, profits, sex, effort, morals
Environments adjust until they are in equilibrium
- Prices adjust until supply and demand are balanced
- Competing agents adjust their strategies until each is optimal given others’ actions
Incentives Example: Subway I
The NYC Subway bans dogs unless they can be "enclosed in a container"
Incentives Example: Subway II
Pictures Source
Incentives Example: Rat Bounty
Some governments pay bounties to reduce pest populations such as rats.
Example: Suppose the government were to pay $250 for every rat tail turned in.
Takeaways About Incentives I
People respond to (changes in) incentives1
People have different goals they seek to attain
Blocking one alternative \(\neq\) people stop persuing their goals
People will seek (less preferred) alternative methods of attaining their goals
People are creative, and many consequences are unintended
1 Later we'll call these prices.
Equilibrium Example I
Suppose 2 roads connect Frederick and Washington
100 cars commute
Local road travel time: 30 min + 1 min/car
Highway travel time: 1 hour (always)
Equilibrium Example I
Suppose 2 roads connect Frederick and Washington
100 cars commute
Local road travel time: 30 min + 1 min/car
Highway travel time: 1 hour (always)
Assume people optimize: choose road to minimize travel time between cities
Equilibrium Example II
Suppose 2 roads connect Frederick and Washington
100 cars commute
Local road travel time: 30 min + 1 min/car
Highway travel time: 1 hour (always)
Scenario I: There are less than 30 cars on the local road
- What will people do?
Equilibrium Example III
Suppose 2 roads connect Frederick and Washington
100 cars commute
Local road travel time: 30 min + 1 min/car
Highway travel time: 1 hour (always)
Scenario II: There are more than 30 cars on the local road
- What will people do?
Equilibrium Example IV
Suppose 2 roads connect Frederick and Washington
100 cars commute
Local road travel time: 30 min + 1 min/car
Highway travel time: 1 hour (always)
Equilibrium: How many cars are on each road?
- Why?
Equilibrium Example V
Suppose the State doubles the capacity of the local road
Local road travel time: 30 min + 0.5 min/car
Highway travel time: 1 hour (always)
Equilibrium Example V
Suppose the State doubles the width of the local road
Local road travel time: 30 min + 0.5 min/car
Highway travel time: 1 hour (always)
Will this reduce travel time?
Yes! says the State:
- 30 cars use the local road, takes 1 hour
- With wider road it takes them 45 minutes!
Equilibrium Example V
Suppose the State doubles the width of the local road
Local road travel time: 30 min + 0.5 min/car
Highway travel time: 1 hour (always)
Will this reduce travel time?
Yes! says the State:
- 30 cars use the local road, takes 1 hour
- With wider road, now it takes them only 45 minutes!
Is this an equilibrium?
Comparative Statics
- Comparative statics: examining changes in equilibria cased by an external change (in incentives, constraints, etc.)
Optimization and Equilibrium
If people can learn and change their behavior, they will always switch to a higher-valued option
If there are no alternatives that are better, people are at an optimum
If everyone is at an optimum, the system is in equilibrium
Reminder: Positive vs Normative Economics
- You may vehemently disagree with certain policies, institutions, or market outcomes
- All I ask is you allow us to explain why they occur
- You will miss useful explanations (and the ability to improve things you disapprove of) if you are blinded by your judgment
- You may disapprove of gravity, but you are bound by it
Economics Is Broader Than You Think
Real Talk
Real Talk
Real Talk
Why We Model I
Economists often "speak" in models that explain and predict human behavior
The pure language of models is mathematics
- things that are universally true, deducible from axioms, can easily spot errors
- often equations and graphs
- this is what scares students most about economics
Why We Model II
Economists use conceptual models: fictional constructions to logically examine consequences
Very different from other sciences
- No social experiments
- Purposive, strategic human beings
- Introspective understanding
"All models lie. The art is telling useful lies." - George Box
The Two Major Models of Economics as a "Science"
Optimization
Agents have objectives they value
Agents face constraints
Make tradeoffs to maximize objectives within constraints
The Two Major Models of Economics as a "Science"
Optimization
Agents have objectives they value
Agents face constraints
Make tradeoffs to maximize objectives within constraints
Equilibrium
Agents face competition from others that affect prices
Agents adjust their behaviors based on prices
Stable outcomes result where all agents cease adjusting
Model 1: Optimization
Optimization: which action(s) best achieve an objective?
- How long should I keep my old car before buying a new one?
- Should the U.S. legalize marijuana?
- Which college courses should I pick?
- Which political campaign platform will win the most votes?
- Which path minimizes travel time?
Find the optimum using marginal analysis
Model 2: Equilibrium
Equilibrium: how do stable outcomes emerge in the world (and change)?
- Why is there a shortage of affordable housing in big cities?
- Why is the price of Apple iPhones so high?
- Why is there only one provider of electricity in a city?
- Why did the recent election turn out the way it did?
Find the outcome where no agents change their behavior using supply and demand
Model 3: Game Theory
Game Theory: what outcome will we jointly reach if our choices are strategic?
- Can big companies secretly all raise prices together?
- Are markets with only a few sellers actually competitive?
- How can we coordinate our actions to reduce climate change?
- Why is doping so prevalent in professional sports?
Find the outcome where no agents change their behavior (again, but slightly different!)
Remember: All Models are Wrong!
Caution: Don't conflate models with reality!
Models help us understand reality.
A good economist is always aware of:
- "ceterus paribus"
- "...and then what?"
- "...compared to what?"
Your "Textbook"
Course Website
Tips for Success, Or: How to College
Take notes. On paper. Really.
Read the readings.
Ask questions, come to office hours.Don't struggle in silence, you are not alone!
You are learning how to learn
See the reference page for more
Roadmap for the Semester
