CHAPTER 1

The Market

Copyright © 2019 Hal R. Varian

Economic Modeling

• A model is a simplified representation of reality.

• When developing an economic model we need to think about:
o At what level of detail shall we model an economic phenomenon?
o What causes what? Which variable (or variables) causes change in another
variable?
o Which variables are determined outside the model (exogenous) and which
are to be determined by the model (endogenous)?

Copyright © 2019 Hal R. Varian

Modeling the Apartment Market – 1
• How are apartment rents determined?
• Suppose:
• Apartments are close or distant, but otherwise identical.
• Distant apartments’ rents are exogenous and known.
• There are many potential renters and landlords.

Copyright © 2019 Hal R. Varian

Modeling the Apartment Market – 2
• Who will rent apartments?
• At what price?
• Will the allocation of apartments be desirable in any sense?

Ø Can we construct an insightful model to answer these questions?

Copyright © 2019 Hal R. Varian

Economic Modeling Assumptions

• Two basic principles:

• Optimization: Each person tries to choose the best alternative available to

him or her. Each person will do what is in his or her own best interest given
what is affordable.

• Equilibrium: Market price adjusts until quantity demanded equals quantity

supplied.

Copyright © 2019 Hal R. Varian