Intermediate Microeconomics

Intermediate Microeconomics:

The Scientific Methodology:

Economics is on a general level about how scarce resources are used in particular societies; how the institutions of a country (such as markets supported by laws and regulations) succeed in using the available land, people, capital and knowledge to produce a reasonable living standard for its citizens.

At a more detailed level we may say that economics studies how individual decision makers choose between different alternatives open to them. The latter perspective is central in microeconomics. The attribute “micro” means precisely that we’re concerned with individual (choice) behavior.

To study individual choice behavior in a systematic, i.e., scientific way, economists have adopted the positivistic methodology. This means that one start by describing the opportunities open to the decision maker. Typically this means delimiting the choice set. The next step is to formulate some principles guiding the individual’s choices. The typical assumption is that people tries to do the best they can under the circumstances they find themselves in. This can also be called the optimization principle.

According to the positivistic methodology the scientist should, based on a careful study of the individual’s choice set and given the assumed optimization principle, proceed to formulate hypotheses about choice behavior, which could (and should) be tested empirically. However, observing a particular choice does not permit such tests in general. But if we observe that the individual choice set is changed, we may formulate hypotheses about how an individual who follows the assumed optimization principle ought to change his/hers actual choices. Thus microeconomics has come to focus on what is called comparative statics. This means that we start by observing the choices by a test group of individuals. We then proceed by changing some exogenous variable (or test variable), which affects the individuals’ choice set, and let them make a new choice. We then record how their choices have changed and check whether these changes are in conformity with our theory.

The comparative static methodology rests on the principle of equilibrium, i.e., that a situation where no further changes occur, is reached then all actors involved think that they cannot reach a better position by changing their behavior.

A major problem in economics is that our ability to perform so called controlled experiments is very limited. Instead we have to go out and observe the actual choices that have been made by people and try to test our theories from data collected in this way. The problem we face if we want to test how individuals’ choice change in response to a change in exogenous variable A, is that we want to hold all other exogenous variables constant at their initial levels; but in actuality both exogenous variable A and B may have changed. If we were able to perform a controlled experiment, we wouldn’t face this problem.

An exogenous variable is one which is outside the control of the decision maker, i.e., a variable which he/she must take as given, at least at a given moment in time. An endogenous variable is a choice variable for the individual, i.e., a variable which will change as a consequence of a change in an exogenous variable. In a market economy the exogenous variables is, for example, prices on individual goods; which are, normally, outside the control of the individual (in some situations it is of course possible to negotiate with a seller to get a lower price, but this is an exception to the rule). The quantity demanded of a particular good is a choice variable for the individual and hence an endogenous variable. The individual’s money income is sometimes treated as exogenous, for simplicity, but is in reality dependent on choices that the individual have made in the past; such as what education he/she has gotten, how many hours per day he/she has chosen to work (e.g. overtime) etc. If we are concerned with choices over a relatively short time period, we may be justified in treating income as exogenous, but in other situations it is better to treat it as an endogenous variable.

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