Jay Prag - Microeconomic Essentials: Understanding Economics in the News

Jay Prag

The MIT Press

Cambridge, Massachusetts

London, England

2020 Massachusetts Institute of Technology

All rights reserved. No part of this book may be reproduced in any form by any electronic or mechanical means (including photocopying, recording, or information storage and retrieval) without permission in writing from the publisher.

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Library of Congress Cataloging-in-Publication Data

Names: Prag, Jay, author.

Title: Microeconomic essentials : understanding economics in the news / Jay Prag.

Description: Cambridge, Massachusetts : MIT Press, [2020] | Includes index.

Identifiers: LCCN 2019051434 | ISBN 9780262539272 (paperback)

Subjects: LCSH: Microeconomics.

Classification: LCC HB172 .P693 2020 | DDC 338.5dc23

LC record available at https://lccn.loc.gov/2019051434

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This book was inspired by Peter Kennedys (now Kennedy and Prag) wonderful macroeconomics text Macroeconomic Essentials: Understanding Economics in the News. That book took a practical, applied approach to macroeconomics, providing students in many disciplines a text that is approachable and relevant. Microeconomics, in many ways the more newsworthy half of the discipline right now, needed a similar book.

This text offers a nontechnical, intuitive exposition of the microeconomic concepts and principles that are on display in news stories every day. From labor markets and the dicey issue of minimum wages to the health care market; from trade theory to game theory; this book covers the issues that students need to understand in this ever-changing world.

I have kept the style of the book breezy and straightforward in the hope that students who think economics is too abstract and arcane will see its usefulness. I have minimized the use of heavy-duty mathematics, opting instead for intuition. I have tried, in effect, to return microeconomics to the people.

I would like to thank everyone at the MIT Press who supported me in this project and helped get the final product done. I would especially like to thank Emily Taber at MIT for her immeasurable contribution to my publishing career. And most of all, I would like to thank Amanda Ishak Prag, my wonderful wife, my sounding board, and my editor without whom this book would not exist. It is my fondest hope that our darling daughter, Julianna, will learn microeconomics from this text when she grows up.

Economics is a social science. It uses the approaches of science to study the activities of people. The earliest economists focused on obvious economic activitiesconsumer behavior and the likebut modern economists use their tools to analyze human activity far outside this early view. In the two hundred-plus years since its formalization, economics has helped us develop some powerful tools and a lot of useful, sometimes unexpected insights.

But it is important to note that economics is not a pure science; it is a social science. Human behavior is not really waves and particles that can be modeled and understood the way physicists explain matter or the Universe. People are messy and unpredictable; they are complicated and hard to formalize. Therefore, the nature of the choices and decisions people make means economics is much harderand much less precisethan the pure sciences. So we have to make some choices in teaching and using economics. Sometimes the most accurate model isnt very useful in the real world. Sometimes formulas arent helpful in daily decision-making. And so sometimes economics as an exercise in mathematics needs to be balanced with economics as a social process. That is the task we undertake in this book.

One microeconomic concept that I use in many different classes (which gets full coverage in chapter 4) is utility theory. Built from the observation that people dont usually consume large amounts of just one good all the time, utility theory is a model that employs a mathematical concept in which some things grow at a decreasing rate; that is, every step forward is smaller than the previous step. In math- or calculus-speak, this is represented by an equation that has a positive first derivative (every step is forward) and a negative second derivative (the steps get smaller with each iteration). This is the mathematical approach.

In chapter 4, I relegate this approach to an appendix in favor of a simple table showing levels of consumption and their associated levels of happiness (utility). When I do this in the classroom, occasionally someone who has had a previous class in microeconomics will say, Thats not correct! You cant do it that way! You have to use calculus and derivatives! I will ask the student if she remembers how calculus works: specifically, how big is the change that we represent with a first derivative? The answer: infinitely small. Then I ask, Do you buy in infinitely small increments of something in the real world? The answer is probably not. The point is, neither approach, neither the table nor the calculus, is perfect and right.

The math, the calculus, is more formal and elegant, but it isnt right because people dont behave that way. You dont buy a miniscule piece of a candy bar; you buy a big, lumpy, not-very-derivative-sized candy bar (or sometimes the bulk pack). This is not a knock on calculus and math in economics. It is a reminder that formality is not the same thing as accuracy. What matters in most of our economic models is the concept, not the math. We want to understand why people do what they do by watching how they do it.

The math that we use in economicsgraphs and equationsis the proverbial picture thats worth a thousand words. It summarizes the economic activity. But the math isnt whats right. Sometimes we can communicate the concept without the math, and when we can, we might have a better understanding of the activity in question. This book does not focus on math. Instead, we focus on concepts. That said, there are situations in which math is the very best way to teach and learn a concept (the Bertrand model in chapter 8, for example). What Ive tried to do is use the method for teaching a concept that gets the biggest bang for the buck. Sometimes thats a story, sometimes its graphs, sometimes its calculus.

When you leave much of the math behind, you invariably run into things you cannot explain. Fortunately, the math is still there to help out. What we want to do is avoid getting too deep into the maththe weeds. That too is problematic. When are we using just the right amount of math? That will likely be a point of contention for anyone using this book. Of course, your instructor can always put in more math. My hope is that you will understand the concepts and see how the mathematical models can be used to explain economic activities without depending on them to understand economic realities.

To wit, math in economics always reminds me of my dear departed father and his tendency to constantly correct peoples grammar. If I ever dared call him pedantic, he would paraphrase H. W. Fowler, the author of Modern English Usage, and say, One mans pedantry is another mans irreducible minimum of education. In the same way, one instructors weeds are anothers irreducible minimum of mathematical modeling. Our goal is to find the happy medium. Just remember: the math, in economics, is never right. The human activity that we are trying to explain is the foundation of our discipline. Its what were really studying, after all.