Download Economics?

19
What Is
Economics?
This chapter concludes our survey of microeconomic theory by reexamining the types of problems
studied in economics and the methods used to address them.
Key Terms




Optimization
Equimarginality
Rational
Equilibrium condition
 Nash equilibrium
 Walrasian equilibrium
 Exogenous variable
 Law of one price
 Economic dynamics
 Robust
Key Ideas
 Section 19.1. Like other social scientists, economists attempt to explain and predict human
behavior. The distinguishing feature of economic analysis is its emphasis on rational decision
making in the face of scarcity. Economic analysis generally begins with an explicit set of
assumptions about individuals’ desires and the nature of the constraints that they face. The second
step in economic analysis uses the principle of equimarginality to determine the solution to the
economic problem. Finally, economic analysis requires the choice of an appropriate equilibrium
condition and an analysis of the resulting equilibria.
 Section 19.2. Economists, like all other scientists, make simplifying assumptions to make the
problems they analyze tractable. Economic models start with the simplifying assumption of rational
behavior. In reality, people are often rational enough so that there are no unexploited profit
opportunities; economic behavior in this situation closely resembles that in the imaginary world of
economic models where people are fully rational. Consequently, the rationality assumption
simplifies economic models but leaves them robust.
 Section 19.3. Economic explanations attempt to explain phenomena on the basis of rational
behavior. When faced with behavior that on the surface appears totally foolish, an economist
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Study Guide
Price Theory and Applications
searches for the constraints and incentives which show that the behavior is perfectly rational. If the
resulting explanation has testable implications, it is all the more desirable.
 Section 19.4. Traditionally, economists restricted their study to the production, exchange, and
consumption of marketable commodities. In the past 30 years, economists have shown that their
ideas can be successfully applied to a much wider variety of problems. The economic approach has
been used to study love and marriage, the decision to have children, criminal behavior, legal
institutions, and even medieval agriculture. Economic ideas appear to apply to all humans—past
and present—and even to animals.
Completion Exercises
1.
According to the principle of
, an optimum is reached when the
marginal benefit of any adjustment is exactly offset by its marginal cost.
2.
Economists assume that people act in their own self-interest and optimize when
faced with an economic problem—in other words, economists assume that people
are
3.
.
In a
, each individual optimizes taking market prices
as given.
4.
An economic model is
if slightly different assumptions would
still lead to the same conclusion.
5.
An economist specifies an
in order to describe the interaction
among the various optimization problems faced by economic agents.
True-False Exercises
6. An economic problem is one in which some choice must be made among competing
alternatives.
7. In the simple supply-demand model, the exogenous variables include the tastes of
consumers and the technology available to firms.
CHAPTER NINETEEN
W HAT IS ECONOMICS?
8. Economic models share the common assumption that people are biologically driven.
9. According to the law of one price, people should be paid the same wage for comparable
work.
10. One possible economic explanation for celebrity endorsements is that people mistakenly
believe that endorsements provide good information about product quality.
Multiple Choice Questions
11. At its most basic, an economic problem is one in which an agent must
A. maximize the exogenous variables.
B. ensure constraints are not binding.
C. behave altruistically.
D. choose among competing alternatives.
12. The first step in analyzing an economic problem is to
A. specify people’s goals and the constraints on their behavior.
B. apply the principle of equimarginality.
C. select an equilibrium condition.
D. obtain numerical estimates of exogenous variables.
13. Consider a profit-maximizing firm that drills for oil. According to the principle of
equimarginality, if the marginal cost of drilling for oil is larger than its marginal benefit,
then the firm should
A. shut down all its oil drills.
B. cut back on its drilling for oil.
C. keep the status quo in order to maintain maximum profitability.
D. expand its oil drilling operations.
14. In which stage of economic analysis do economists specify the interactions among the
various agents’ optimization problems and constraints?
A. Formulation.
B. Optimization.
C. Equilibrium.
D. Robustness.
15. What do we call an equilibrium in which each individual optimizes, taking the actions of
other individuals as his constraints?
A. A Nash equilibrium.
B. A Walrasian equilibrium.
C. An efficient equilibrium.
D. A robust equilibrium.
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16. In the basic theory of monopoly, which of the following is treated as an exogenous
variable?
A. The technology available to the monopoly.
B. The price charged by the monopoly.
C. The quantity produced by the monopoly.
D. The profit earned by the monopoly.
17. Modeling the process by which an economic system transits from an old equilibrium to
an new equilibrium is called
A. optimization theory.
B. Walrasian equilibrium.
C. economic dynamics.
D. normative analysis.
18. In an economic model, if a slight change in the assumptions does not invalidate the
model’s conclusions, then we say the model is
A. optimized.
B. tractable.
C. dynamic.
D. robust.
19. Economists typically assume that individuals are perfectly rational. Most of the
conclusions that economists derive from their models would also hold true under the
weaker assumption that there are no
A. artificial barriers to trade.
B. unexploited profit opportunities.
C. dynamically unstable equilibria.
D. monopolized markets.
20. The “sales gimmick” explanation of “99¢ pricing” relies on the assumption that
A. people are irrational.
B. the law of conservation holds.
C. firms care more about revenues than profits.
D. identical goods have identical prices.
CHAPTER NINETEEN
W HAT IS ECONOMICS?
Solutions
Completion Exercises
1.
2.
3.
4.
5.
equimarginality
rational
Walrasian equilibrium
robust
equilibrium condition
True-False Exercises
6.
7.
8.
9.
10.
TRUE.
TRUE.
FALSE. Economic models share the common assumption that people behave rationally.
FALSE. According to the law of one price, identical goods have identical prices.
FALSE. One possible economic explanation for celebrity endorsements is that firms use
celebrity endorsements as a signal that they are not fly-by-nights.
Multiple Choice Questions
11.
12.
13.
14.
15.
16.
17.
18.
19.
20.
D. Economic problems deal with costs and tradeoffs, which necessitate choices.
A. The first step of economic analysis is to formulate an economic problem.
B. When marginal cost exceeds marginal benefit, cutting back on the activity will bring the
firm closer to the optimum.
C. Equilibrium conditions show how one agent’s economic problem is affected by other agents’
optimization problems and constraints.
A. In a Nash equilibrium, each agent takes the actions of others as given.
A. Technology is assumed to be fixed and given in the simple monopoly model.
C. Economic dynamics focuses on the path by which a new equilibrium is attained.
D. A model is robust when its results extend to more general circumstances.
B. If people are rational enough so that all profit opportunities are discovered, then in many
economic models, they would reach the same optimum as when everyone is perfectly rational.
A. Those who argue that people will repeatedly fall for a sales gimmick and never recognize or
correct their error are implicitly assuming that people are irrational.
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