Microeconomic for public
policy
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Chapter 1
ECONOMIC MODELS
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• Economics is the study of how scarce
resources are allocated among
alternative use
• “Economic models” are used for this
purpose
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Economic Models
• Economic models are built to address particular questions.
There is no a 4-W economic model.
• The best model to use will depend on the question, the setting,
the information available…
• Example: How do a increase in the price of potatoes
influence the consumption of potatoes?
– Forces that one could consider:
– price effect: possibility to substitute its consumption. It will
depend on possibilities of storage, transportation costs,
range of products available in the market
– income effect: consumer if poorer than before because he
can buy less potatoes
– endowment effect: consumer is richer if he cultivates
potatoes
– nutrition effect: less consumption of potatoes can decrease
calories intake, hence consumer will work less and his
income decrease further
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Economic Models
• Understanding the interactions of these 4 forces can
be too complicated
• An economic model will tend to ignore those forces
that are believed not be important in the setting or
problem under consideration
– Previous example in New York: ignore
endowment, income, and nutrition effect
– Previous example in a rural village in Bolivia:
ignore substitution effect, and concentrate on
endowment, income and nutrition effect
• Economic models are not pictures of reality
• They are abstractions from reality, incorporating the
main forces to simplify the problem
• The forces to incorporate will depend on the
particular question and setting
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Features of Economic Models
• Ceteris Paribus assumption
• Optimization assumption
• Distinction between positive and
normative analysis
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Ceteris Paribus Assumption
• Ceteris Paribus means “other things the
same”
• Economic models attempt to explain
simple relationships
– focus on the effects of only a few forces at a
time
– other variables are assumed to be unchanged
during the period of study
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Optimization Assumptions
• Many economic models begin with the
assumption that economic actors are
rationally pursuing some goal
– consumers seek to maximize their utility
– firms seek to maximize profits (or minimize
costs)
– government regulators seek to maximize
public welfare
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Positive-Normative Distinction
• Positive economic theories seek to
explain the economic phenomena that
is observed
• Normative economic theories focus on
what “should” be done
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