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  1. Microeconomic for public policy

  2. Chapter 1 ECONOMIC MODELS

  3. Economics is the study of how scarce resources are allocated among alternative use • “Economic models” are used for this purpose

  4. 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

  5. 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

  6. Features of Economic Models • Ceteris Paribus assumption • Optimization assumption • Distinction between positive and normative analysis

  7. 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

  8. 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

  9. Positive-Normative Distinction • Positive economic theories seek to explain the economic phenomena that is observed • Normative economic theories focus on what “should” be done