1.1 Constructing a Model
Example of an economic model — The market for rented apartments is discussed in this book.
1. Models are simplifications of reality. From the real situation many complicated issues are ignored and only few important issues are considered for analysis using models.
2. For example, we assume all apartments are identical (In reality they are not)
3. Some are close to the university, others are far away
4. Rental price of outer-ring apartments is exogenous — determined outside the model (we are not analyzing)
5. price of inner-ring apartments is endogenous — determined within the model (We want to analyze and find out.)
1.2 Optimization and Equilibrium
Two principles of economics
1. Optimization principle — people choose actions that are in their interest. They want to buy a specific quantity of goods at various prices to increase benefit to them
2. Equilibrium principle — Market prices adjust so that people who want to buy can buy and people who want to sell can sell the quantities of their choice. Thus the intentions of buyers and sellers become consistent with each other with varying prices and quantities.
1.3 The Demand Curve
Constructing the demand curve
1. Find the rent each person is willing to pay and draw a graph in descending order with rent on the y axis.
2. If there are large numbers of people, this curve can become a smooth curve. Otherwise it will be a step curve.
Reserve Price: Economists call a person’s maximum willingness to pay for something that person’s reservation price. The reservation price is the highest price that a given person will accept and still purchase the good.
1.4 The Supply Curve
1. depends on time frame
2. but we’ll look at the short run—when supply of apartments
1.5 Market Equilibrium
1. when demand equals supply
2. price that clears the market
1.6 Comparative Statics
1. how does equilibrium adjust when economic conditions change?
2. “comparative” — compare two equilibria
3. “statics” — only look at equilibria, not at adjustment
4. example — increase in supply lowers price;
5. Complicated example — convert somee rental apartments into condos which can be purchased by renters; no effect on price;
1.7 Other Ways to Allocate Apartments
Other ways to allocate apartments
1. discriminating monopolist
2. ordinary monopolist
3. rent control
1.8 Which Way Is Best?
Comparing different institutions
1. need a criterion to compare how efficient these different
allocation methods are.
1.9 Pareto Efficiency
an allocation is Pareto efficient if there is no way to make
some group of people better off without making someone else
if something is not Pareto efficient, then there is some way
to make some people better off without making someone else
if something is not Pareto efficient, then there is some kind
of “waste” in the system.
1.10 Comparing Ways to Allocate Apartments
Checking Pareto efficiency of different methods
1. free market — efficient
2. discriminating monopolist — efficient
3. ordinary monopolist — not efficient
4. rent control — not efficient
1.11 Equilibrium in the Long Run
In long run supply will change
We have to examine efficiency in this context as well.
1. Economics proceeds by making models of phenomena of interest. Models are simplified representations of reality and using these models our questions of interest can be answered.
2. Economists are guided by two important principles. The optimization principle, which
states that people typically try to choose what’s best for them, and by the equilibrium principle, which says that prices will adjust until demand (quantity demanded at the price) and supply (quantity sellers are willing to sell at that price) are equal.
3. The demand curve measures how much people wish to demand at each price, and the supply curve measures how much people wish to supply at each price.
4. An equilibrium price is one where the amount demanded equals the amount supplied.
5. The study of how the equilibrium price and quantity change when the underlying conditions (conditions that change demand curves and supply curves) change is known as comparative statics.
6. Markets and plans are analyzed on the basis of Pareto efficiency. An economic situation is Pareto efficient if there is no way to make some group of people better off without making some other group of people worse off. The concept of Pareto efficiency can be used to evaluate different ways of allocating resources either based on markets or central planning.