Microeconomics Course Reflection

This course provided a theoretic framework for understanding how individuals, firms, and government entities interact in a market economy. First, we covered the fundamentals of mathematical optimization as the basis for how choices will be made by consumers and producers. It is assumed that rational consumers will optimize their utility subject to their budget and prices, while rational producers will optimize their profits subject to available technologies and market characteristics. Next, the supply-side and demand-side of the market were brought together in a study of partial and general equilibrium models. Through comparative statics, we learned how to evaluate the effects of changes in certain parameters of these models. Through welfare economics, we observed that a completive market equilibrium is also an efficient economy, which theoretically maximizes social welfare. However, this brings up questions of how resources and good ought to be distributed, how markets fail, and how governments can intervene.

Having an operations research background I may be biased, but I think the biggest strength of the greater micro-economic theory is the underpinning of mathematical optimization. Optimization theory is rigorous and objective, which is a key grounding for a study as complex as economics. It also provides the calculus and methods to not only find optimums, but quantify trade-offs and measure how changes in one aspect of an economic system affect another aspect. It is generally true that physical, chemical, and biological systems are always trying to optimize or move towards some equilibrium, so there is good reason to believe that higher-level social and economic systems will behave the same way.

One shortcoming of the micro-economic theory is the set of assumptions made immediately after establishing optimization theory as the basis. This includes the assumptions that consumers are only going to maximize their utility and producers are only going to maximize their profits. While these assumptions are great first-approximations and capture the general paradigms of these entities, they miss some key features of reality. The work of Daniel Kahneman and Amos Tversky alone has shown that individual consumers have inherited psychological biases, which sometimes lead them to make seemingly irrational decisions that are not in their best interest. From my understanding, behavioral economics is attempting to address this issue. Additionally, producers are influenced by social pressures, the personal goals of their leaders, and other exogenous forces that result in decisions that may not maximize profits. It is also not clear (at least to me) how non-profits fit into the micro-economic picture.

My current research focuses on hospital markets in California, and involves many of topics we have discussed in this course. Hospital markets (and healthcare markets generally) in the U.S. exhibit many of the features we associate with market failures. There is a clear asymmetry of information between the physicians who are selling the services and the patients who needs the services. In many cases there is a very low elasticity of demand as patients do not always have a choice (or time to make a choice) between receiving life-saving care or not. The government has actually incentivized the consolidation of health systems, which has improved quality slightly, but also led to significant increases in prices. Finally, one of the most bizarre features of the U.S. healthcare system is the rampant price discrimination. Hospitals prices can range widely based on what type of insurance one has, and most of these prices are highly confidential to the hospital. All of these features give hospitals market power, which they have used to increase prices and costs far beyond any other industrialized country. A question I have upon taking this course is what would equilibrium prices and quantities look like in a competitive hospital market? This analysis would have to be assessed by individual service, or at least by government designated Diagnostic Related Groups (DRGs). I would need to find the marginal cost of providing a given service and chart that against demand for that service at different price levels. Finding the latter would be the most difficult given the lack of price transparency in the current market. Also, the demand for certain types of care and the supply of qualified physicians varies widely across the country, adding another layer of complexity to this question. However, knowing these values could help the government measure the welfare loss from the current system and weigh that against the consequences of major price regulation.

Studying micro-economics through this course has often reminded me of the saying, “all models are wrong, but some are useful.” Micro-economic theory is just that, a wrong model that is useful for comparative analyses. This may be the concept that I find most interesting. The theory doesn’t claim to perfectly model reality, as this would be impossible. Rather, it provides a picture of what we might expect to see, which we can compare to the empirical data to draw insights about reality. Another quote that resonates with me in this study comes from Stanford economist, Thomas Sowell: “There are no solutions. There are only trade-offs.” Micro- economics does not attempt to provide normative solutions, only the quantitative framework with which to evaluate policies. Certain analyses can provide “revealed preferences,” however, it is important to be mindful of the context and environment where these preferences are observed.

This course has both challenged and inspired me to see the world and our society in a different way. I look forward to applying these concepts to my research and taking further courses on market design and economic incentive structures.