Introduction: Microeconomics and Models

Outline Microeconomics A tale on modelling: "The accidental theorist" (by P. Krugman) Models The use of microeconomic models

Microeconomics Studies agent decisions and their coordination - Individuals and firms allocate their resources to make themselves as well off as possible - Economic outcomes result from the interaction of these decisions: Which goods and services are produced How they are produced Who gets the goods Particular attention to: - How this happens in the markets and the role of prices - The role and effects of Government intervention

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A tale on modelling: "The accidental theorist" (by P. Krugman) An economy produces two goods: hot-dogs (H) and buns (B) Consumers insist that every hot-dog come with a bun and viceversa Employment: 120 million workers, L 120 Technology: 2 person-days produce either a hot-dog or a bun That is, sector production functions are H 0. 5L H B 0. 5L B

 Initial equilibrium: 60 million workers in each sector producing 30 million hot-dogs and 30 million buns But some technical change takes place: a worker can now produce a hot-dog in one day rather than two Sector production functions are now H LH B 0. 5L B Reallocation of resources and new equilibrium: 40 million workers produce 40 million hot-dogs and 80 million workers produce 40 million buns Lets see some analyses of the facts:

Famous journalist (real): - Twenty million hot-dog jobs have been destroyed - Productivity growth destroys jobs (not enough demand to go around with supply increments) - It happens everywhere, will happen also over time in the buns industry, the future will see mass unemployment Economist: - Shift in the structure of the industry - No net loss of jobs and no reason to expect this in the future (demand can perfectly increase at the same pace) - Productivity growth reduces employment in one sector but creates new employment in other

 Why is important to understand what happens? - Policy implications are completely different The story is partly real: read the article. The real subject was the behavior of employment . Model tells us of employment in US since the 70s

 Why the analyses diverge? - Journalist look in isolation to one sector and makes a fallacy of composition Lessons: - Journalist is wrong because is an "accidental theorist" (that uses inadvertently bad theory) - One simple model tells more about reality that tons of evidence without criterium - Economic models are economists tools to think of reality

Models Models are simplified descriptions of the relationship between two or more variables - Simplifications are explicited as assumptions - Models constitute the set of tools to make causal predictions, this is theory and formulates testable hypothesis - A positive statement is a testable hypothesis about cause and effect, a normative statement includes a value judgement about what should be done

Use of microeconomic models Predictions are useful for: - Individuals (investment decisions..) - Government (Economic Advisers, impact of policies...) - Firms (products, product quality, pricing, production...)