The course begins with an analysis of the scientific method (based on Joseph Schumpeter’s discussion in his History of Economic Analysis, pps. 33-47) with a special focus on the importance definitions and assumptions. The sophistication of a model can be systematically developed by starting with strong (unrealistic) assumptions that simplify the world, then relaxing assumptions to bring more complexity into the model. Through a series of such steps, defining and arranging terms to address the growing complexity at each step, a very sophisticated model can be developed. The course follows this method, relaxing assumptions/building complexity, to construct a very sophisticated (albeit introductory) version of the modern neoclassical general equilibrium micro model.
Starting from an extremely abstract condition (individual choice in isolation with no scarcity), as assumptions are relaxed complexities such as scarcity, the need to produce in order to consume, risk and uncertainty, intertemporal choice, the interdependence of production and exchange, and the role of markets are addressed. With this framework in place, market exchange, market functionality (e.g., own price elasticity), and inter-market interactions (e.g., cross price elasticities or elasticities of input substitution) are developed in detail. To establish the larger “market system” context, the concept of Pareto optimal general competitive equilibrium is developed.
The assumptions of no market power and no market failure are then relaxed. The effects of power on markets (e.g., rent-seeking) and failure in markets (e.g., externalities) are modeled and the distinction between the unique case of Pareto optimal general competitive equilibrium and the array of other possible general equilibria is highlighted. With this mature micro model in place, the course turns to policy. Policy issues and policy tools are explored. You will come to appreciate that the philosophical debate between interventionists and non-interventionists as to whether these policy tools should be deployed depends in a significant way on one’s assumptions about the extent of market power and market failure, and the functionality of Government.
With this Micro foundation in place the course turns to Macro. An Aggregate Demand/Aggregate Supply macro model is constructed. The sources of the forces of Aggregate Demand and Aggregate Supply changes are examined in detail. In the process you will model the Macro implications of consumer behavior (savings rate, confidence, etc.), capital market behavior, government budget actions, trade relations and exchange rates, resource shocks (e.g., oil), etc.. The response of the Macro economy to significant dislocations is examined, contrasting the expected outcome under different assumptions about the nature of Microeconomic markets (Markets generally exist and function smoothly where needed. versus They do not). This last issue provides the basis for an analysis of the Microeconomic foundations of the Macroeconomic policy debate between interventionists and non-interventionists as to the appropriate government action with respect to monetary, fiscal, and trade policy tools. The institutional mechanics of each of these policy tools is developed in detail, and the competing logic of interventionists and non-interventionists as to the value of deploying these tools is contrasted.
Throughout the course the connection between the content of the course and historical and current events is emphasized.