Microeconomic Theory Methodology

On Exactitude in Science

Jorge Luis Borges, Collected Fictions, translated by Andrew Hurley.

``In that Empire, the Art of Cartography attained such Perfection that the map of a single Province occupied the entirety of a City, and the map of the Empire, the entirety of a Province.

In time, those Unconscionable Maps no longer satisfied, and the Cartographers Guilds struck a Map of the Empire whose size was that of the Empire, and which coincided point for point with it.

The following Generations, who were not so fond of the Study of Cartography as their Forebears had been, saw that that vast Map was Useless, and not without some Pitilessness was it, that they delivered it up to the Inclemencies of Sun and Winters.

In the Deserts of the West, still today, there are Tattered Ruins of that Map, inhabited by Animals and Beggars; in all the Land there is no other Relic of the Disciplines of Geography.''

Suarez Miranda, Viajes de varones prudentes, Libro IV, Cap. XLV, Lerida, 1658.

Mont Sainte Victoire

Photography vs Cézanne

Microeconomic Theory Methodology

Individual agents (consumers, firms, government, etc...) are the basis of the analysis.
Agents act accordingly to their preferences (i.e. consumers maximize utility, firms maximize profits, etc...)
Equilibrium (agents chose optimal actions given the actions of the others).
Exogenous variables (variables that describe the environment in which agents operate, they are given/constants for practical purposes).
Endogenous variables (variables that are chosen/set according to the agents' choices).
Comparative statics: how the equilibrium value of the endogenous variables changes when the exogenous variables change.
If two models deliver the same predictions, stick with the simplest one (Occam's razor).
Descriptive model: tells how agents behave.
Normative model: tells how agents should behave.

Microeconomic Theory Methodology

All economic models are wrong!
``Realism'' is not a good metric to evaluate the quality of a model.
Forecast ability is a better metric but there are others ...
If two models deliver the same predictions, stick with the simplest one (Occam's razor).
Building a model is like creating an impressionist painting. The artist needs to decide which details to include in the model and which details to exclude.
Details may generate dramatically different policy recommendations. Example, if externality are absent, government intervention in a market leads to inefficiencies. But if externalities are present, government intervention may improve overall welfare...
If a detail is important or not, often can only be answered with data and not by theoretical means.

Microeconomic Theory Methodology

Building and analyzing models

Set-up the environment: agents, preferences, and constraints (exogenous variables).
Obtain the agents optimal actions given the environment and choices of other agents (optimal choice or best-response, equilibrium condition).
Require choices of agents to be consistent (equilibrium condition).
Comparative statics (how the equilibrium changes with the changes in the endogenous variables).
Use data to test the model.

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