Microeconomics Chapters 1 and 2 1

Microeconomics
Chapter 1: The Market

1.1 Constructing a Model

Economics proceeds by developing models of social phenomena. By a model we mean a simplified

representation of reality.

A model’s power stems from the elimination of irrelevant detail, which allows the economist to focus on
the essential features of the economic reality he or she is attempting to understand.

1.2 Optimization and Equilibrium

Whenever we try to explain the behavior of human beings we need to have a framework on which our
analysis can be based. In much of economics we use a framework built on the following two simple
principles.

The optimization principle:

People try to choose the best patterns of consumption that they can afford.

The equilibrium principle:

Prices adjust until the amount that people demand of something is equal to the amount that is supplied.

Let us consider these two principles. The first is almost tautological. If people are free to choose their
actions, it is reasonable to assume that they try to choose things they want rather than things they don’t
want. Of course there are exceptions to this general principle, but they typically lie outside the domain
of economic behavior.

The second notion is a bit more problematic. It is at least conceivable that at any given time peoples’
demands and supplies are not compatible, and hence something must be changing. These changes may
take a long time to work themselves out, and, even worse, they may induce other changes that might
“destabilize” the whole system.

Summary Chapter 1

1. Economics proceeds by making models of social phenomena, which are simplified representations of
reality.

2. In this task, economists are guided by 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 and supply 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. An equilibrium price is one where the amount
 Microeconomics Chapters 1 and 2 2

demanded equals 4. The study of how the equilibrium price and quantity change when the underlying
conditions change is known as comparative statics.

5. An economic situation is Pareto efficient if there is no way to make some group of people better off
without making the amount supplied.

Summary Chapter 2 Budget Constraitnts

Summary

1. Economists assume that a consumer can rank various consumption possibilities. The way in which the
consumer ranks the consumption bundles describes the consumer’s preferences.

2. Indifference curves can be used to depict different kinds of preferences.

3. Well-behaved preferences are monotonic (meaning more is better) and convex (meaning averages are
preferred to extremes).

4. The marginal rate of substitution (MRS) measures the slope of the indifference curve. This can be
interpreted as how much the consumer is willing to give up of good 2 to acquire more of good 1.