Economic modeling What causes what in economic systems? Which variables are determined outside the model(exogenous) Which variables are to be determined by the model (endogenous) At what level of detail shall we model an economic phenomenon?
Economic Modeling What causes what in economic systems? – Which variables are determined outside the model (exogenous) – Which variables are to be determined by the model (endogenous) At what level of detail shall we model an economic phenomenon?
Modeling the apartment Market Central question: How are apartment rents determined? Suppose(simplifying assumptions apartments are close or distant, but otherwise identical distant apartments rents are exogenous and known many potential renters and landlords, i.e, competitive market
Modeling the Apartment Market Central question: How are apartment rents determined? Suppose (simplifying assumptions) – apartments are close or distant, but otherwise identical –distant apartments rents are exogenous and known –many potential renters and landlords, i.e., competitive market
A Normative question Will the allocation of apartments be desirable? Need to know: Who will rent close apartments? At what price?
A Normative Question Will the allocation of apartments be desirable? Need to know: – Who will rent close apartments? – At what price?
Two Principles in economics Optimization: Each person tries to choose the best alternative available to him or her Equilibrium: Market price adjusts until quantity demanded equals quantity supplied
Two Principles in Economics Optimization: Each person tries to choose the best alternative available to him or her. Equilibrium: Market price adjusts until quantity demanded equals quantity supplied
Modeling Individual demand Discrete commodity: 0 or 1 unit Choose either distant or close apartment Close apartments are more desirable but more expensive Tend to choose close apartment if Distant apartments are also expensive Higher income Decide: The maximum rent you are willing to pay for a close apartment
Modeling Individual Demand Discrete commodity: 0 or 1 unit Choose either distant or close apartment Close apartments are more desirable but more expensive Tend to choose close apartment if – Distant apartments are also expensive. – Higher income. Decide: The maximum rent you are willing to pay for a close apartment