Abstract
There are many adjectives that one could reasonably use to describe the new open-access textbook, Models in Microeconomic Theory by Martin Osborne and Ariel Rubinstein—terse, rigorous, deep and technically demanding, among them. But to me, the word that best describes their effort is ‘honest’.
Consider, for instance, the manner in which they develop the theory of producer behaviour. They begin with a vignette, concerning a profitable firm that faces a significant demand shortfall. Profit maximization would require laying off about half the workforce, but the firm could remain profitable (to a lesser degree) if it fired fewer people or none at all. Readers of the book are invited to respond to an online survey declaring the choice they would make as managers under the circumstances. At the end of the chapter, the authors note that students of economics tend to lay off more workers than those in other disciplines, but even among economists only about half choose the profit-maximizing option. Accordingly, the chapter itself treats profit maximization as one of several possible objective functions, alongside output maximization subject to a profitability constraint.
For a very different example, consider their discussion of choice under uncertainty. In this chapter, the authors introduce the theory of expected utility, but immediately follow this with a discussion of the Allais paradox, which is inconsistent with the theory. The goal here and throughout the book is to walk the student through some very deep results in microeconomic theory while never losing sight of their limitations as empirical hypotheses.
For students who enjoy intricate formal reasoning on the basis of precisely stated assumptions, the book will be a pleasure to read and to learn from. Although designed for undergraduate courses in intermediate microeconomics, it introduces concepts and results that one would normally find only in graduate texts. These include representation theorems, welfare theorems, the core, subgame perfection, adverse selection, signalling and screening, strategy proof mechanisms, top trading cycles, stable matchings, and preference aggregation. Every stated result is proved, though sometimes in simplified form—existence of competitive equilibrium is shown for an economy with two goods, for example, and existence of Nash equilibrium is demonstrated for finite supermodular games.
One notable innovation worth mentioning is the abandonment of the terms Pareto-efficiency and Pareto-optimality, in favour of the more normatively neutral Pareto-stability. Careful instructors spend a lot of time explaining to students that allocations satisfying this condition can be terribly unequal and unfair, which the new terminology will make easier to do. The authors justify their choice by observing that Pareto-stability is an equilibrium concept, since ‘the force that can upset an allocation is an agreement between all individuals to replace the allocation with another one.’ This assumes, of course, that binding agreements of this kind can be made without cost, which is seldom the case. The book itself is full of examples of equilibrium allocations that fail to satisfy Pareto-stability, but no terminology is perfect and the change proposed here is certainly an improvement.
The manner in which the authors introduce the reader to the idea of an equilibrium is also noteworthy. Instead of considering prices and markets at the outset, they start with a simple non-market allocation problem involving objects and individuals, with each individual having preferences over objects and a level of prestige or power that allows them to claim an object in the possession of someone with less power. An equilibrium in this case is an allocation such that no individual prefers an object that is allocated to someone weaker. Many standard questions about existence, Pareto-stability and externalities (corresponding to preferences over the objects held by others) can be asked and answered with great clarity in this simple setting. The introduction of prices and markets in subsequent chapters can then be done with ease.
This model of power-based allocation is also interesting in its own right. It describes the manner in which street corners are allocated to sellers of illicit drugs, or offices in a new building to employees. In the latter case, power is usually attached to seniority, though I am proud to report that office assignments in my own department were recently made based on reverse seniority, on the grounds that junior faculty had the greatest need for the best working conditions.
While the leanness and brevity of this book is an asset, there is one striking omission that is quite puzzling. In discussing the mismatch between game theoretic predictions and experimental results, the authors often consider the possibility that the preferences of experimental subjects may differ from those assumed in the models. This is clearly an important consideration, but a mismatch between theory and experiment can also arise because theoretical assumptions about reasoning and knowledge may not be satisfied in the laboratory. For instance, there is no discussion in the book of level-k models of strategic reasoning, or the beauty contests or guessing games that have inspired this literature. One of the end-of-chapter problems does ask students to solve for equilibria of the original guessing game proposed by Hervé Moulin but does not link it to the classic experiments of Rosemarie Nagel, or account for the discrepancy between theory and experiment in such environments. This is especially surprising given the authors’ own pioneering contributions to the literature on procedural rationality.
Many undergraduate students (and perhaps even a few instructors) will find the content and presentation in this book quite daunting. Despite being released under a creative commons license, with a free version available online, mass adoption in the United States therefore seems unlikely. But the book will have lasting impact and a committed audience, among which it will be genuinely treasured.