Essay About Market-Clearing Model And Microeconomic Models Of Firms

Microeconomics
Microeconomics
Answers to Textbook Questions
and Problems
Questions for Review
1. Microeconomics is the study of how individual firms and households make decisions,
and how they interact with one another. Microeconomic models of firms and households
are based on principles of optimization—firms and households do the best they can
given the constraints they face. For example, households choose which goods to purchase
in order to maximize their utility, whereas firms decide how much to produce in
order to maximize profits. In contrast, macroeconomics is the study of the economy as a
whole; it focuses on issues such as how total output, total employment, and the overall
price level are determined. These economy-wide variables are based on the interaction
of many households and many firms; therefore, microeconomics forms the basis for
macroeconomics.
2. Economists build models as a means of summarizing the relationships among economic
variables. Models are useful because they abstract from the many details in the economy
and allow one to focus on the most important economic connections.
3. A market-clearing model is one in which prices adjust to equilibrate supply and
demand. Market-clearing models are useful in situations where prices are flexible. Yet
in many situations, flexible prices may not be a realistic assumption. For example,
labor contracts often set wages for up to three years. Or, firms such as magazine publishers
change their prices only every three to four years. Most macroeconomists
believe that price flexibility is a reasonable assumption for studying long-run issues.
Over the long run, prices respond to changes in demand or supply, even though in the
short run they may be slow to adjust.
Problems and Applications
1. The many recent macroeconomic issues that have been in the news lately (early 2002)
include the recession that began in March 2001, sharp reductions in the Federal
Reserves target interest rate (the so-called Federal Funds rate) in 2001, whether the
government should implement tax cuts or spending increases to stimulate the economy,
and a financial crisis in Argentina.
2. Many philosophers of science believe that the defining characteristic of a science is the
use of the scientific method of inquiry to establish stable relationships. Scientists examine
data, often provided by controlled experiments, to support or disprove a hypothesis.
Economists are more limited in their use of experiments. They cannot conduct controlled
experiments on the economy; they must rely on the natural course of developments
in the economy to collect data. To the extent that economists use the scientific