|Driven to Abstraction: teaching microeconomics
by J. Doug Ohmans
My microeconomics course, which I taught at Red Rocks CC eight times during 2001-03, consisted largely in the presentation of about two dozen "core concepts" or "grids," diagrams selected from a standard introductory textbook which represented the high points or mountain peaks of the journey from scratch to a conceptual understanding of the workings and limitations of the Neo-Classical or marginalist model.
It is not an easy subject for community college students, so I tried to cut through the detail to the essentials. Tests covered each diagram with a multiple choice plus an essay question. Required reading consisted mostly in the more theoretical chapters from the books, while teams of two or three students would present or teach an empirical or descriptive chapter as their term project.
My innovations over courses I had myself taken were, primarily, this simplification and secondly, an abstract focus of the inter-relations of three concepts: average, total and marginal. Thus, marginal cost and marginal revenue were understood as composites of marginalism in general plus cost and revenue, more than as discrete entities. An example of my original method is I stressed that the demand curve represented average revenue while the supply curve showed marginal cost.
The diagrams follow:
1) Two-Dimensional Economics - Two axes cross to form four quadrants. The positive NE corner becomes our workspace. Two data quantities locate a point.
Two points determine a line. Connecting the points provides a good guess as to
new correlations not included in the original data.
2) Slope of a line - It is rise over run. Slope can be positive or negative. Steepness can be increasing or decreasing. Combine these dimensions for four mutually exclusive and all-inclusive possibilities.
3) Production - The production possibility frontier is the first exposure to economics per se. It represents trade-offs between two goods--their opportunity costs--symbolic of n goods. It is convex, with the slope of the tangent increasing from left to right, because of decreasing and increasing returns.
4) Distribution - The marginal cost or supply curve can be derived from the PPF. The
marginal benefit or demand curve is the new information we need to add to discover
an efficient equilibrium.
5) Demand Shift - The demand curve introduces price for the first time as the common denominator. The law of demand yields an inverse relationship. We distinguish between changes in quantity demanded, movements along a single demand curve caused by price changes, and shifts in the entire curve caused by a change in a factor other than price. The demand curve represents marginal benefit but average revenue.
6) Shift in Supply - The supply curve is a simultaneous set of potential quantities offered at different prices, a positive relationship. A change in a factor other than price causes a supply shift, but the distinction between that and change in quantity supplied is not as fundamental as it seems.
7) Equilibrium Price - Where supply and demand intersect is the equilibrium price and quantity, analogous to an auction. It is the first plateau in microeconomics. The analytico-synthetic method has been used to arrive at it, and now one has some insight into previously opaque reality.
8) Simultaneous Shifts - If supply and demand can each shift either right or left, there are four possible simultaneous combinations, whose result depends on the relative magnitude of the shifts. In each instance, either the price or the quantity change is unambiguous, with the other variable so dependent. More profoundly, only a shift in demand yields a change in quantity supplied, and a shift in supply yields a change in quantity demanded.
9) Demand Elasticity - Price elasticity of demand, % change Qd / % change P, is our "default" elasticity among various types. Apples and oranges can be compared. Elasticity will vary along a straight line, because of the changing base against which similar variations of P and Q are measured. Using algebra, elasticity computations can determine e.g. optimum price adjustments to clear the market.
10) Total Revenue test - While the elasticity formula compares marginal changes, it follows that the direction of change in total revenue can signal elastic, unitary or inelastic demand when price is either raised or lowered. When price is raised ten percent and quantity demanded falls by ten percent, total revenue is constant and elasticity is unitary.
11) Consumer Surplus - It arises from the difference between marginal benefit, or utility, and price, or average revenue. The market is a general phenomenon, and consumer surplus (like producer surplus) is an engine which motivates it. It is represented graphically as an area.
12) Efficiency - Perfect competition requires many assumptions, which would yield an optimum allocation (for whom), production (how) and quantity (how much). These points coincide, and deviation from them would carry costs to society.
13) Income Tax - Government action in a mixed economy corrects and perfects the market. An income tax provides public goods and corrects some inequality. Its incidence is divided between employers and workers.
14) Externalities - Strangely, the diagram is same as for income tax. Our "default" externality is a negative production externality. Price rises and quantity falls when social cost is internalized. They underlie environmental economics. Externalities are a "market imperfection," as are public goods, monopoly, and commodification of labor.
15) Budget line - Two goods again symbolize many. But line is straight because price ratio is constant. Budget increase shifts entire line outward. Price change causes it to pivot.
16) Total and Marginal - If MU decreases at a decreasing rate, TU increases at a decreasing rate but never decreases (unless MU is negative). The total is the area (integral) under the marginal.
17) Indifference Curve - Indifference curves are simultaneous, hypothetical, subjective. They are concave because of diminishing returns. For two to cross would be contradictory.
18) Consumer Optimum - Tangency of budget lines with indifference curves--where the rubber meets the road--can generate a demand line, just as the PPF trade-off implied a supply or MC curve. Supposedly trade can occur along the budget line to reach a higher indifference curve, but this excludes transaction costs.
19) Marginal and Average - Whenever the marginal is above the average, the average will be rising. Whenever the marginal is below the average, the average will be falling. Very interesting is the range when the marginal is falling but is still above the average which is therefore rising: it might suggest the business cycle.
20) Aggregation - Downward-sloping demand is faced by an industry as a whole or by a monopolist, and is characteristic of individual psychology. But when the part faces the whole, it is a price-taker and D=MR=AR=P on the horizontal plane. Downward-sloping curves added horizontally become flatter. Ambiguity reflecting the different points of view is one of the flimsiest features of the Neo-Classical model.
21) Profit - Profit-maximizers--perfect competitors, oligopolists, monopolists--all
must operate where MC=MR. This quantity, it can be shown, must be the same as
that where total revenues exceed total costs by the greatest amount: it is no
coincidence (elasticity too was approached either via marginal increments or the total revenue test).
22) Perfect Competition - This is the 2d plateau on the journey. Average total cost
is average cost, not total cost (it is called ATC because it includes fixed and variable costs). Exit and entry occur depending on whether AC is below or above MC=MR, respectively. The perfect competition model is about as complex as a Rubik Cube -
it moves prismatically according to unrealistic (abstract) assumptions, is connected
to the economy via statistical data and constrains thinking.
23) Monopoly - The monopolist restricts quantity and raises price, exploiting inelasticity. The exact point is theoretically available as that wherein MC=MR, while price is still determined along the demand curve (AR). Price exceeds average cost of production.
24) Grid X - A main defect of the Neo-Classical model is that to pay for stuff or utility, labor is viewed as a disutiity or leisure a commodity. Marxism (and Adam Smith) instead began with labor as value. But Marx viewed machinery as an embodiment of average labor, and did not grasp Ricardo's marginalism. Nothing prohibits you or I from making up our own models.