Questions and Answers about Chicago Price Theory
Q1. Why study price theory?
Price theory seeks to both explain and predict human behavior. Always tethered to practical questions, it strips down problems to yield testable hypotheses that can be rejected. In the age of big data age this melding of applied theory with empirics offers great insight. This book will change how you think about questions such as whether learning by working on the job is cheaper than formal schooling or whether the availability of e-books reduce the sales of physical books. Price theory can draw meaningful conclusions that answer the why by applying the framework of supply and demand and competition to key questions. The tools of price theory can be used to make out-of-sample predictions such as what are the potential unintended consequences of health insurance regulations on small businesses.
Q2. How is price theory different from microeconomics?
Strategic behavior, such as the interactions among sellers in a market where they are few in number, is a significant part of microeconomics but is not emphasized in the introductory Chicago Price Theory course. Competition is emphasized in large part because for most purposes, it is a reasonable description of most markets and leaves room for mastery of important additional aspects of tastes and technology. Price theory stresses how consumers react to prices, often without reference to utility. Microeconomics, on the other hand, lays out an axiomatic foundation starting with the utility function and individual demand functions and models strategic decisions with game theory. Both price and game theory model behavior as an equilibrium, but the latter typically focuses on interactions among small numbers of agents and strives to make separate predictions for each one. The rest of the market is treated as a constant.
Price theory's market-equilibrium approach says that the most important effects of policy, technical change, and other events are not necessarily found in the immediate proximity of the event. Trained economists are generally aware that market analysis is why the economic incidence of, say, a tax is different from the legal liability for paying the tax. But without price theory, economics training has too little practice in market analysis and results in policy investigations that too quickly presume that, say, the corporate income tax primarily harms corporations or that automation reduces the wages of human workers.
Q3. Why "Chicago" price theory?
Much of modern price theory was developed and expanded at the University of Chicago. In the second half of the 20th century, Chicago distinguished itself from a large part of the economics profession. Whereas many economists focused on alternate approaches including game theory, behavioral economics, and information economics, Chicago's scholars maintained their strong tradition of price theory. Famous Chicago economists such as Milton Friedman, Gary Becker, and George Stigler used price theory and became extremely influential in the development of economic theory and policy. As a result, price theory became strongly associated with the University of Chicago.
Q4. What are the roots of price theory at Chicago?
Most of Chicago's Nobel Laureates used price theory. Milton Friedman used it to explore topics ranging from school choice and occupational licensing to voucher-based alternatives for public housing. He also used it to study consumption over the life cycle in his famous permanent income hypothesis. Chicago's George Stigler developed a price theoretic approach to oligopoly that would become central to the government's evaluation of horizontal mergers. (Many other Chicago economists made important contributions, including Sherwin Rosen and Lester Telser).
Perhaps the greatest efforts to expand price theory came from Gary Becker, who contributes two chapters to the video edition of this course. His thesis derived the demand for discrimination among biased customers and estimated the cost to the firm of being prejudiced. By applying price theory to social phenomena, Becker greatly expanded price theory's scope to fields traditionally viewed as unrelated to economics such as law and sociology and is in disproportionate part responsible for price theory's impact to this day. He studied criminal justice, marriage, lobbying, to name a few. Becker and Murphy revisited the topic of complementary goods, using it to examine addictions, advertising, and social interactions.
Q5. Is the difference between microeconomics and price theory analogous to the difference between mathematical rigor and intuition?
No. While price theory simply focuses on useful applications and knowing which tools to use as opposed to practicing derivations, it is not any less rigorous than microeconomics. Results in this book are derived from fully specified assumptions. In fact, many deductive results in this book have been performed by computers which have no ability to fill in missing implicit assumptions.