Discussion: Frontiers of Microeconomics
Discussion: Frontiers of Microeconomics
Economists should observe human behaviors when developing economic models because humans are the ones who will be impacted by economic decisions. In order to make accurate predictions about how people will respond to different economic scenarios, economists need to have a good understanding of human behavior. Behavioral economics provides this understanding by incorporating insights from psychology into traditional economics models. Economists should also observe human behaviors when developing economic models because people are not always rational decision makers (Teitelbaum & Zeiler, 2018). People are often influenced by their emotions and biases, which can lead them to make irrational choices. Behavioral economics takes these aspects of human behavior into account in its models, which allows for more accurate predictions about how people will react to different economic scenarios.
Some of the things that behavioral economists observe include people’s decision-making processes, their preferences, and how they respond to different incentives. By understanding these things, behavioral economists can create models that take into account the ways in which people actually behave, as opposed to assuming that they always make rational decisions. Many economists develop their models without taking human preferences into account. This can lead to inaccurate or incomplete models that do not accurately reflect how people actually behave when making economic decisions (Donohue et al., 2020). Preferences play a major role in how people interact with the economy, so it is important for economists to consider them when creating models. By incorporating human preferences into economic models, economists can create more accurate and realistic representations of how people actually behave when making economic decisions. This can help them to better understand and predict economic outcomes.
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When creating economic models, economists should consider how people respond to different incentives. Taking into account how people respond to incentives is important because it can help economists to better understand human behavior and ultimately create more accurate economic models (Donohue et al., 2020). One way that economists can take into account how people respond to incentives is by using game theory. Game theory allows economists to model different strategic interactions between individuals and analyze how those interactions can lead to different outcomes. By using game theory, economists can better understand how people respond to different incentives and make more accurate predictions about the effects of certain policies.
Donohue, K., Özer, Ö., & Zheng, Y. (2020). Behavioral operations: Past, present, and future. Manufacturing & Service Operations Management, 22(1), 191-202. https://doi.org/10.1287/msom.2019.0828
Teitelbaum, J. C., & Zeiler, K. (Eds.). (2018). Research handbook on behavioral law and economics. Edward Elgar Publishing.
8-2 Discussion: Frontiers of Microeconomics
WRITE A POST ON THE BELOW INFORMATION
Economic behavior is more complex than assumed by conventional economic theory. Political economy explains the functioning of government. Behavioral economics ties psychology into human behavior.
Economists assume that individuals make rational decisions. However real people are more complex.
Based on what you have learned in your assigned reading, answer the following questions in your post:
• What are the human behaviors economists should observe when creating economic models? Example: people tend to find solutions that are good enough, but not the best solutions.
Chapter 1 in a Nutshell
• The fundamental lessons about individual decision making are that people face trade-offs among alternative goals, that the cost of any action is measured in terms of forgone opportunities, that rational people make decisions by comparing marginal costs and marginal benefits, and that people change their behavior in response to the incentives they face.
• The fundamental lessons about interactions among people are that trade and interdependence can be mutually beneficial, that markets are usually a good way of coordinating economic activity among people, and that governments can potentially improve market outcomes by remedying a market failure or by promoting greater economic equality.
• The fundamental lessons about the economy as a whole are that productivity is the ultimate source of living standards, that growth in the quantity of money is the ultimate source of inflation, and that society faces a short-run trade-off between inflation and unemployment.
Chapter 2 in a Nutshell
• Economists try to address their subject with a scientist’s objectivity. Like all scientists, they make appropriate assumptions and build simplified models to understand the world around them. Two simple economic models are the circular-flow diagram and the production possibilities frontier. The circular-flow diagram shows how households and firms interact in markets for goods and services and in markets for the factors of production. The production possibilities frontier shows how society faces a trade-off between producing different goods.
• The field of economics is divided into two subfields: microeconomics and macroeconomics. Microeconomists study decision making by households and firms and the interactions among households and firms in the marketplace. Macroeconomists study the forces and trends that affect the economy as a whole.
• A positive statement is an assertion about how the world is. A normative statement is an assertion about how the world ought to be. While positive statements can be judged based on facts and the scientific method, normative statements entail value judgments as well. When economists make normative statements, they are acting more as policy advisers than as scientists.
• Economists who advise policymakers sometimes offer conflicting advice either because of differences in scientific judgments or because of differences in values. At other times, economists are united in the advice they offer, but policymakers may choose to ignore the advice because of the many forces and constraints imposed on them by the political process.
Chapter 3 in a Nutshell
• Each person consumes goods and services produced by many other people both in the United States and around the world. Interdependence and trade are desirable because they allow everyone to enjoy a greater quantity and variety of goods and services.
• There are two ways to compare the abilities of two people to produce a good. The person who can produce the good with the smaller quantity of inputs is said to have an absolute advantage in producing the good. The person who has the lower opportunity cost of producing the good is said to have a comparative advantage. The gains from trade are based on comparative advantage, not absolute advantage.
• Trade makes everyone better off because it allows people to specialize in those activities in which they have a comparative advantage.
• The principle of comparative advantage applies to countries as well as to people. Economists use the principle of comparative advantage to advocate free trade among countries.
Chapter 4 in a Nutshell
• Economists use the model of supply and demand to analyze competitive markets. In a competitive market, there are many buyers and sellers, each of whom has little or no influence on the market price.
• The demand curve shows how the quantity of a good demanded depends on the price. According to the law of demand, as the price of a good falls, the quantity demanded rises. Therefore, the demand curve slopes downward.
• In addition to price, other determinants of how much consumers want to buy include income, the prices of substitutes and complements, tastes, expectations, and the number of buyers. When one of these factors changes, the quantity demanded at each price changes, and the demand curve shifts.
• The supply curve shows how the quantity of a good supplied depends on the price. According to the law of supply, as the price of a good rises, the quantity supplied rises. Therefore, the supply curve slopes upward.
• In addition to price, other determinants of how much producers want to sell include input prices, technology, expectations, and the number of sellers. When one of these factors changes, the quantity supplied at each price changes, and the supply curve shifts.
• The intersection of the supply and demand curves represents the market equilibrium. At the equilibrium price, the quantity demanded equals the quantity supplied.
• The behavior of buyers and sellers naturally drives markets toward their equilibrium. When the market price is above the equilibrium price, there is a surplus of the good, which causes the market price to fall. When the market price is below the equilibrium price, there is a shortage, which causes the market price to rise.
• To analyze how any event influences the equilibrium price and quantity in a market, we use the supply-and-demand diagram and follow three steps. First, we decide whether the event shifts the supply curve or the demand curve (or both). Second, we decide in which direction the curve shifts. Third, we compare the new equilibrium with the initial equilibrium.
• In market economies, prices are the signals that guide decisions and allocate scarce resources. For every good in the economy, the price ensures that supply and demand are in balance. The equilibrium price then determines how much of the good buyers choose to consume and how much sellers choose to produce.
Chapter 5 in a Nutshell
• The price elasticity of demand measures how much the quantity demanded responds to changes in the price. Demand tends to be more elastic if close substitutes are available, if the good is a luxury rather than a necessity, if the market is narrowly defined, or if buyers have substantial time to react to a price change.
• The price elasticity of demand is calculated as the percentage change in quantity demanded divided by the percentage change in price. If quantity demanded moves proportionately less than the price, then the elasticity is less than one and demand is said to be inelastic. If quantity demanded moves proportionately more than the price, then the elasticity is greater than one and demand is said to be elastic.
• Total revenue, the total amount paid for a good, equals the price of the good times the quantity sold. For inelastic demand curves, total revenue moves in the same direction as the price. For elastic demand curves, total revenue moves in the opposite direction as the price.
• The income elasticity of demand measures how much the quantity demanded responds to changes in consumers’ income. The cross-price elasticity of demand measures how much the quantity demanded of one good responds to changes in the price of another good.
• The price elasticity of supply measures how much the quantity supplied responds to changes in the price. This elasticity often depends on the time horizon under consideration. In most markets, supply is more elastic in the long run than in the short run.
• The price elasticity of supply is calculated as the percentage change in quantity supplied divided by the percentage change in price. If quantity supplied moves proportionately less than the price, then the elasticity is less than one and supply is said to be inelastic. If quantity supplied moves proportionately more than the price, then the elasticity is greater than one and supply is said to be elastic.
• The tools of supply and demand can be applied to many different kinds of markets. This chapter uses them to analyze the market for wheat, the market for oil, and the market for illegal drugs.
Chapter 6 in a Nutshell
• A price ceiling is a legal maximum on the price of a good or service. An example is rent control. If the price ceiling is below the equilibrium price, then the price ceiling is binding, and the quantity demanded exceeds the quantity supplied. Because of the resulting shortage, sellers must in some way ration the good or service among buyers.
• A price floor is a legal minimum on the price of a good or service. An example is the minimum wage. If the price floor is above the equilibrium price, then the price floor is binding, and the quantity supplied exceeds the quantity demanded. Because of the resulting surplus, buyers’ demands for the good or service must in some way be rationed among sellers.
• When the government levies a tax on a good, the equilibrium quantity of the good falls. That is, a tax on a market shrinks the size of the market.
• A tax on a good places a wedge between the price paid by buyers and the price received by sellers. When the market moves to the new equilibrium, buyers pay more for the good and sellers receive less for it. In this sense, buyers and sellers share the tax burden. The incidence of a tax (that is, the division of the tax burden) does not depend on whether the tax is levied on buyers or sellers.
• The incidence of a tax depends on the price elasticities of supply and demand. Most of the burden falls on the side of the market that is less elastic because that side of the market cannot respond as easily to the tax by changing the quantity bought or sold.
Chapter 7 in a Nutshell
• Consumer surplus equals buyers’ willingness to pay for a good minus the amount they actually pay, and it measures the benefit buyers get from participating in a market. Consumer surplus can be found by computing the area below the demand curve and above the price.
• Producer surplus equals the amount sellers receive for their goods minus their costs of production, and it measures the benefit sellers get from participating in a market. Producer surplus can be found by computing the area below the price and above the supply curve.
• An allocation of resources that maximizes total surplus (the sum of consumer and producer surplus) is said to be efficient. Policymakers are often concerned with the efficiency, as well as the equality, of economic outcomes.
• The equilibrium of supply and demand maximizes total surplus. That is, the invisible hand of the marketplace leads buyers and sellers to allocate resources efficiently.
Chapter 10 in a Nutshell
• When a transaction between a buyer and seller directly affects a third party, the effect is called an externality. If an activity yields negative externalities, such as pollution, the socially optimal quantity in a market is less than the equilibrium quantity. If an activity yields positive externalities, such as technology spillovers, the socially optimal quantity is greater than the equilibrium quantity.
• Governments pursue various policies to remedy the inefficiencies caused by externalities. Sometimes the government prevents socially inefficient activity by regulating behavior. Other times it internalizes an externality using corrective taxes. Another public policy is to issue permits. For example, the government could protect the environment by issuing a limited number of pollutions permits. The result of this policy is similar to imposing corrective taxes on polluters.
• Those affected by externalities can sometimes solve the problem privately. For instance, when one business imposes an externality on another business, the two businesses can internalize the externality by merging. Alternatively, the interested parties can solve the problem by negotiating a contract. According to the Coase theorem, if people can bargain without cost, then they can always reach an agreement in which resources are allocated efficiently. In many cases, however, reaching a bargain among the many interested parties is difficult, so the Coase theorem does not apply.
• Markets do not allocate resources efficiently in the presence of market failures such as market power or externalities.
Chapter 13 in a Nutshell
• A firm’s goal is to maximize profit, which equals total revenue minus total cost.
• When analyzing a firm’s behavior, it is important to include all the opportunity costs of production. Some of the opportunity costs, such as the wages a firm pays its workers, are explicit. Other opportunity costs, such as the wages the firm owner gives up by working at the firm rather than taking another job, are implicit. While accounting profit considers only explicit costs, economic profit accounts for both explicit and implicit costs.
• A firm’s costs reflect its production process. A typical firm’s production function gets flatter as the quantity of an input increases, displaying the property of diminishing marginal product. As a result, a firm’s total-cost curve gets steeper as the quantity produced rises.
• A firm’s total costs can be separated into its fixed costs and its variable costs. Fixed costs are costs that do not change when the firm alters the quantity of output produced. Variable costs are costs that change when the firm alters the quantity of output produced.
• From a firm’s total cost, two related measures of cost are derived. Average total cost is total cost divided by the quantity of output. Marginal cost is the amount by which total cost rises if output increases by unit.
• When analyzing firm behavior, it is often useful to graph average total cost and marginal cost. For a typical firm, marginal cost rises with the quantity of output. Average total cost first falls as output increases and then rises as output increases further. The marginal-cost curve always crosses the average-total-cost curve at the minimum of average total cost.
• A firm’s costs often depend on the time horizon considered. In particular, many costs are fixed in the short run but variable in the long run. As a result, when the firm changes its level of production, average total cost may rise more in the short run than in the long run.
Chapter 14 in a Nutshell
• Because a competitive firm is a price taker, its revenue is proportional to the amount of output it produces. The price of the good equals both the firm’s average revenue and its marginal revenue.
• To maximize profit, a firm chooses a quantity of output such that marginal revenue equals marginal cost. Because marginal revenue for a competitive firm equals the market price, the firm chooses quantity so that price equals marginal cost. Thus, the firm’s marginal-cost curve is its supply curve.
• In the short run when a firm cannot recover its fixed costs, the firm will choose to shut down temporarily if the price of the good is less than average variable cost. In the long run when the firm can recover both fixed and variable costs, it will choose to exit if the price is less than average total cost.
• In a market with free entry and exit, profit is driven to zero in the long run. In this long-run equilibrium, all firms produce at the efficient scale, price equals the minimum of average total cost, and the number of firms adjusts to satisfy the quantity demanded at this price.
• Changes in demand have different effects over different time horizons. In the short run, an increase in demand raises prices and leads to profits, and a decrease in demand lowers prices and leads to losses. But if firms can freely enter and exit the market, then in the long run, the number of firms adjusts to drive the market back to the zero-profit equilibrium.
Chapter 15 in a Nutshell
• A monopoly is a firm that is the sole seller in its market. A monopoly arises when a single firm owns a key resource, when the government gives a firm the exclusive right to produce a good, or when a single firm can supply the entire market at a lower cost than many firms could.
• Because a monopoly is the sole producer in its market, it faces a downward-sloping demand curve for its product. When a monopoly increases production by unit, it causes the price of its good to fall, which reduces the amount of revenue earned on all units produced. As a result, a monopoly’s marginal revenue is always less than the price of its good.
• Like a competitive firm, a monopoly firm maximizes profit by producing the quantity at which marginal revenue equals marginal cost. The monopoly then sets the price at which consumers demand that quantity. Unlike a competitive firm, a monopoly firm’s price exceeds its marginal revenue, so its price exceeds marginal cost.
• A monopolist’s profit-maximizing level of output is below the level that maximizes the sum of consumer and producer surplus. That is, when the monopoly charges a price above marginal cost, some consumers who value the good more than its cost of production do not buy it. As a result, monopoly causes deadweight losses similar to those caused by taxes.
• A monopolist can often increase profits by charging different prices for the same good based on a buyer’s willingness to pay. This practice of price discrimination can raise economic welfare by getting the good to some consumers who would otherwise not buy it. In the extreme case of perfect price discrimination, the deadweight loss of monopoly is completely eliminated and the entire surplus in the market goes to the monopoly producer. More generally, when price discrimination is imperfect, it can either raise or lower welfare compared to the outcome with a single monopoly price.
• Policymakers can respond to the inefficiency of monopoly behavior in four ways. They can use the antitrust laws to try to make the industry more competitive. They can regulate the prices that the monopoly charges. They can turn the monopolist into a government-run enterprise. Or, if the market failure is deemed small compared to the inevitable imperfections of policies, they can do nothing at all.
Chapter 16 in a Nutshell
• A monopolistically competitive market is characterized by three attributes: many firms, differentiated products, and free entry and exit.
• The long-run equilibrium in a monopolistically competitive market differs from that in a perfectly competitive market in two related ways. First, each firm in a monopolistically competitive market has excess capacity. That is, it chooses a quantity that puts it on the downward-sloping portion of the average-total-cost curve. Second, each firm charges a price above marginal cost.
• Monopolistic competition does not have all the desirable properties of perfect competition. There is the standard deadweight loss of monopoly caused by the markup of price over marginal cost. In addition, the number of firms (and thus the variety of products) can be too large or too small. In practice, the ability of policymakers to correct these inefficiencies is limited.
• The product differentiation inherent in monopolistic competition leads to the use of advertising and brand names. Critics of advertising and brand names argue that firms use them to manipulate consumers’ tastes and reduce competition. Defenders of advertising and brand names argue that firms use them to inform consumers and compete more vigorously on price and product quality.
Chapter 17 in a Nutshell
• Oligopolists maximize their total profits by forming a cartel and acting like a monopolist. Yet, if oligopolists make decisions about production levels individually, the result is a greater quantity and a lower price than under the monopoly outcome. The larger the number of firms in the oligopoly, the closer the quantity and price will be to the levels that would prevail under perfect competition.
• The prisoners’ dilemma shows that self-interest can prevent people from maintaining cooperation, even when cooperation is in their mutual interest. The logic of the prisoners’ dilemma applies to many situations, including arms races, common-resource problems, and oligopolies.
• Policymakers use the antitrust laws to prevent oligopolies from engaging in behavior that reduces competition. The application of these laws can be controversial because some behavior that can appear to reduce competition may in fact have legitimate business purposes.
Chapter 22 in a Nutshell
• In many economic transactions, information is asymmetric. When there are hidden actions, principals may be concerned that agents suffer from the problem of moral hazard. When there are hidden characteristics, buyers may be concerned about the problem of adverse selection among the sellers. Private markets sometimes deal with asymmetric information with signaling and screening.
• Although government policy can sometimes improve market outcomes, governments are themselves imperfect institutions. The Condorcet paradox shows that majority rule fails to produce transitive preferences for society, and Arrow’s impossibility theorem shows that no voting system can be perfect. In many situations, democratic institutions will produce the outcome desired by the median voter, regardless of the preferences of the rest of the electorate. Moreover, the individuals who set government policy may be motivated by self-interest rather than the national interest.
• The study of psychology and economics reveals that human decision making is more complex than is assumed in conventional economic theory. People are not always rational, they care about the fairness of economic outcomes (even to their own detriment), and they can be inconsistent over time.
REPLY TO THE 2 BELOW POST
BY: Mike Daugherty
Our reading outlines several human behaviors economists should observe when creating economic models. Herbert Simon concluded that instead of humans choosing the best course of action, they make decisions that merely are good enough. As a result of studies of human decision making, it was concluded that people are too sure of their own abilities, people give too much weight to a small number of vivid operations, and people are reluctant to change their minds. I like the analogy our reading uses in regard to a person purchasing a new car. In this case, our reading suggests we give too much weight to the opinion of friend who owns the car that we might be interested in purchasing. Another interesting aspect discussed in the reading is confirmation bias, that is, we tend to interpret evidence to confirm beliefs we already hold. Instead of reading something to learn, we tend to read something to confirm the beliefs we already held.
This chapter also illustrates how people tend to care about fairness. The analogy our book uses is the ultimatum game in which the roles of proposer and responder are assigned to determine how to split a one-hundred-dollar prize. Economists have suggested that when a firm has a good year, workers should be paid according to the increase in revenue. People are also inconsistent over time; people are most likely to procrastinate when assigned a tedious task but will turn to instant gratification to make a decision that isn’t necessarily best for them. Even though the human behaviors discussed in this chapter are assumptions, I find most of them to be true. As humans, we tend to make decisions based on the thoughts of others and acting out of impulse instead of going with our intuition to decide what is best for us. We, as humans, are also reluctant to learn or change our behaviors and instead will do anything to protect what we already believe in. I find the relationship between economics and human behavior to be extremely fascinating as I have never thought about it from this perspective.
Frontiers of Microeconomics!
BY: Emi Fana
Throughout this path, I have discovered approximately economic models and principles and how they practice the macroeconomic issues nations face based totally on human assumptions. Macroeconomics advises us about the overall well-being of a state’s economic system. I have observed that macroeconomics ordinarily centers around issues comparative with countrywide output (expected by using GDP), unemployment, and inflation. Therefore, a country’s macroeconomic health depends on factors such as a state’s trend of living, low employment, and low inflation. Macroeconomic rules are created to help and further these factors. Instances of these policies encompass economic coverage affecting bank lending and interest prices and the economic range relevant to government spending and taxes.
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