, Chapter 1 1
Chapter 1
The Market
This chapter was written so I would have something to talk about on the first
day of class. I wanted to give students an idea of what economics was all about,
and what my lectures would be like, and yet not have anything that was really
critical for the course. (At Michigan, students are still shopping around on the
first day, and a good number of them won’t necessarily be at the lecture.)
I chose to discuss a housing market since it gives a way to describe a number
of economic ideas in very simple language and gives a good guide to what lies
ahead. In this chapter I was deliberately looking for surprising results—analytic
insights that wouldn’t arise from “just thinking” about a problem. The two
most surprising results that I presented are the condominium example and the
tax example in Section 1.6. It is worth emphasizing in class just why these results
are true, and how they illustrate the power of economic modeling.
It also makes sense to describe their limitations. Suppose that every con-
dominium conversion involved knocking out the walls and creating two apart-
ments. Then what would happen to the price of apartments? Suppose that the
condominiums attracted suburbanites who wouldn’t otherwise consider renting
an apartment. In each of these cases, the price of remaining apartments would
rise when condominium conversion took place.
The point of a simple economic model of the sort considered here is to focus
our thoughts on what the relevant effects are, not to come to a once-and-for-all
conclusion about the urban housing market. The real insight that is offered by
these examples is that you have to consider both the supply and the demand
side of the apartment market when you analyze the impact of this particular
policy.
The only concept that the students seem to have trouble with in this chapter
is the idea of Pareto efficiency. I usually talk about the idea a little more than
is in the book and rephrase it a few times. But then I tell them not to worry
about it too much, since we’ll look at it in great detail later in the course.
The workbook problems here are pretty straightforward. The biggest problem
is getting the students to draw the true (discontinuous) demand curve, as in
Figure 1.1, rather than just to sketch in a downward-sloping curve as in Figure
1.2. This is a good time to emphasize to the students that when they are given
numbers describing a curve, they have to use the numbers—they can’t just sketch
in any old shape.
,2 Chapter Highlights
The Market
A. Example of an economic model — the market for apartments
1. models are simplifications of reality
2. for example, assume all apartments are identical
3. some are close to the university, others are far away
4. price of outer-ring apartments is exogenous — determined outside the
model
5. price of inner-ring apartments is endogenous — determined within the
model
B. Two principles of economics
1. optimization principle — people choose actions that are in their interest
2. equilibrium principle — people’s actions must eventually be consistent
with each other
C. Constructing the demand curve
1. line up the people by willingness-to-pay. See Figure 1.1.
2. for large numbers of people, this is essentially a smooth curve as in Figure
1.2.
D. Supply curve
1. depends on time frame
2. but we’ll look at the short run — when supply of apartments is fixed.
E. Equilibrium
1. when demand equals supply
2. price that clears the market
F. Comparative statics
1. how does equilibrium adjust when economic conditions change?
2. “comparative” — compare two equilibria
3. “statics” — only look at equilibria, not at adjustment
4. example — increase in supply lowers price; see Figure 1.5.
5. example — create condos which are purchased by renters; no effect on
price; see Figure 1.6.
G. Other ways to allocate apartments
1. discriminating monopolist
2. ordinary monopolist
3. rent control
H. Comparing different institutions
1. need a criterion to compare how efficient these different allocation methods
are.
2. an allocation is Pareto efficient if there is no way to make some group
of people better off without making someone else worse off.
3. if something is not Pareto efficient, then there is some way to make some
people better off without making someone else worse off.
4. if something is not Pareto efficient, then there is some kind of “waste” in
the system.
I. Checking efficiency of different methods
1. free market — efficient
2. discriminating monopolist — efficient
3. ordinary monopolist — not efficient
4. rent control — not efficient
, Chapter 1 3
J. Equilibrium in long run
1. supply will change
2. can examine efficiency in this context as well
Chapter 1
The Market
This chapter was written so I would have something to talk about on the first
day of class. I wanted to give students an idea of what economics was all about,
and what my lectures would be like, and yet not have anything that was really
critical for the course. (At Michigan, students are still shopping around on the
first day, and a good number of them won’t necessarily be at the lecture.)
I chose to discuss a housing market since it gives a way to describe a number
of economic ideas in very simple language and gives a good guide to what lies
ahead. In this chapter I was deliberately looking for surprising results—analytic
insights that wouldn’t arise from “just thinking” about a problem. The two
most surprising results that I presented are the condominium example and the
tax example in Section 1.6. It is worth emphasizing in class just why these results
are true, and how they illustrate the power of economic modeling.
It also makes sense to describe their limitations. Suppose that every con-
dominium conversion involved knocking out the walls and creating two apart-
ments. Then what would happen to the price of apartments? Suppose that the
condominiums attracted suburbanites who wouldn’t otherwise consider renting
an apartment. In each of these cases, the price of remaining apartments would
rise when condominium conversion took place.
The point of a simple economic model of the sort considered here is to focus
our thoughts on what the relevant effects are, not to come to a once-and-for-all
conclusion about the urban housing market. The real insight that is offered by
these examples is that you have to consider both the supply and the demand
side of the apartment market when you analyze the impact of this particular
policy.
The only concept that the students seem to have trouble with in this chapter
is the idea of Pareto efficiency. I usually talk about the idea a little more than
is in the book and rephrase it a few times. But then I tell them not to worry
about it too much, since we’ll look at it in great detail later in the course.
The workbook problems here are pretty straightforward. The biggest problem
is getting the students to draw the true (discontinuous) demand curve, as in
Figure 1.1, rather than just to sketch in a downward-sloping curve as in Figure
1.2. This is a good time to emphasize to the students that when they are given
numbers describing a curve, they have to use the numbers—they can’t just sketch
in any old shape.
,2 Chapter Highlights
The Market
A. Example of an economic model — the market for apartments
1. models are simplifications of reality
2. for example, assume all apartments are identical
3. some are close to the university, others are far away
4. price of outer-ring apartments is exogenous — determined outside the
model
5. price of inner-ring apartments is endogenous — determined within the
model
B. Two principles of economics
1. optimization principle — people choose actions that are in their interest
2. equilibrium principle — people’s actions must eventually be consistent
with each other
C. Constructing the demand curve
1. line up the people by willingness-to-pay. See Figure 1.1.
2. for large numbers of people, this is essentially a smooth curve as in Figure
1.2.
D. Supply curve
1. depends on time frame
2. but we’ll look at the short run — when supply of apartments is fixed.
E. Equilibrium
1. when demand equals supply
2. price that clears the market
F. Comparative statics
1. how does equilibrium adjust when economic conditions change?
2. “comparative” — compare two equilibria
3. “statics” — only look at equilibria, not at adjustment
4. example — increase in supply lowers price; see Figure 1.5.
5. example — create condos which are purchased by renters; no effect on
price; see Figure 1.6.
G. Other ways to allocate apartments
1. discriminating monopolist
2. ordinary monopolist
3. rent control
H. Comparing different institutions
1. need a criterion to compare how efficient these different allocation methods
are.
2. an allocation is Pareto efficient if there is no way to make some group
of people better off without making someone else worse off.
3. if something is not Pareto efficient, then there is some way to make some
people better off without making someone else worse off.
4. if something is not Pareto efficient, then there is some kind of “waste” in
the system.
I. Checking efficiency of different methods
1. free market — efficient
2. discriminating monopolist — efficient
3. ordinary monopolist — not efficient
4. rent control — not efficient
, Chapter 1 3
J. Equilibrium in long run
1. supply will change
2. can examine efficiency in this context as well
