Daniel Lin will be teaching Intermediate Micro – Robert Clower would have told him to be happy about it

See this Facebook update from Daniel Lin who teaches at American University:

Just learned that the economics department has an urgent need for more Intermediate Micro classes in spring 2013. My Public Choice class has been cancelled, and I’ve been reassigned to Intermediate Micro. Disappointing. I’ll keep requesting it, and maybe it’ll happen in another semester.

I can understand Daniel’s hopes to teach Public Choice theory. It is a wonderful and interesting topic. In fact had I not been such a monetary theory nerd I would probably have been blogging about Public Choice theory. However, who can seriously imagine public choice theory without microeconomics?

What do we learn in microeconomics? We learn that individuals make choices. Microeconomics – or rather economics – is about choice. With choices comes benefits and costs. All choices come with costs. If I choose to do something I will not be able to do another thing. I can not write this post and sleep at the same time even though I badly needs sleep. It is the cost of writing the post. However, we can also deduct (we do that a lot in microeconomics – no fancy pancy econometrics here…) that my expected marginal utility of writing this post is higher than my expected marginal cost of doing it. The cost obviously include the opportunity cost of not sleeping.

In microeconomics we learn about comparative advantages, we learn about marginalism. We learn about Welfare Theory – Pareto Optimality. These are terribly important concepts. Unfortunately far too many economists soon forget about these concepts and then instead remembers rather misguided ideas that they learn in “traditional” macroeconomics. That is extremely unfortunate. Microeconomics is the foundation for our science. Economics without microeconomics is Marxism – or something worse.

And Daniel remember that no Public Choice theory is possible without microeconomics. Just imagine my favourite Public Choice model – William Niskanen’s Bureaucrat model. It is 100% microeconomics. We start out with an economic agent. The bureaucrat. He is maximizing utility. Niskanen assumed that what would give the  Bureaucrat maximum utility would be to maximize his institution’s budget. A quite fair assumption I think. Niskanen introduces asymmetrical information in his model. Something that might enter into Daniel’s class quite late in the semester, but nonetheless he will probably have to tell a story about peaches and lemons at some point during the semester. So Daniel have the fun of telling your students that when Joseph Stiglitz tells you why there is information problems in the market for used cars it also teaches us why the World Bank is an overblown bureaucracy.

However, it is not only Public Choice theory that is standing on the shoulders of Microeconomics. That is also the case for monetary theory – and of course macroeconomics. The problem with old-school keynesian macroeconomics – before the days of New Keynesian macroecomomics – was exactly that there was no microeconomic foundation for the “theory” and as a result the policy conclusions from old-school keynesian economics lead us to the insanities of price and wage controls and the idea of the fiscal multiplier (yes, Scott feel free to scream at the screen!).

I have earlier suggested that we can not teach macroeconomics with out starting with microeconomics. Or said in another way we start with microeconomics. In the most generalized form that is some kind of general equilibrium theory – a Walrasian economy.

Let imagine the simplest Walrasian economy. We got two goods A and B. The price of A is PA and the price of B is PB. The production of A and B is terms YA and YB. In the Walrasian economy there is no money. So it mean to buy something we will have to produce something. To buy A I must produce B. That is basically Say’s Law:

PA*YA=PB*YB

This is a recession free economy. Supply and demand will also be in equilibrium. There will never be an net excess supply of either A or B.

This is exactly how Robert Clower started out when he was teaching monetary theory. We have a Walrasian model of the world. What he then did was to introduce a third good called M. He would then set the price of M at 1. Then we have

M*1=PA*YA+PB*YB

Hence, we can buy the production of A and B for the production of M. We can also call M for money. Hence, the production of money – what we call the money supply – must equal the production. This is also what we know as the equation of exchange:

MV=PY

Where PY is an aggregation of the total production in the economy –  PA*YA+PB*YB. V is as we know money-velocity.

So Daniel, Robert Clower would tell you that if you don’t teach your students proper microeconomics how are we able to teach them about monetary policy?  And William Niskanen would equally tell you – with out microeconomics we will never be able to understand the behavior of bureaucrats.

And David Eagle would tell you that you would never figure out the optimal monetary policy rule without Welfare theory (John Taylor did you miss micro 101?) – as would I.

So Daniel go teach your students Intermediate Micro and make sure that they never forget that if they fail to understand Micro they will really never understand anything else. Not even why Sumo wrestlers cheat.

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