14.03 | Fall 2016 | Undergraduate, Graduate

Microeconomic Theory and Public Policy


[Banerjee] = Banerjee, Samiran. Intermediate Microeconomics: A Tool-Building Approach. 1st ed. Routledge, 2014. ISBN: 9780415870054. [Preview with Google Books]

[Mastering] = Angrist, Joshua D., and Jörn-Steffen Pischke. Mastering ‘Metrics: The Path from Cause to Effect. Princeton University Press, 2014. ISBN: 9780691152844. [Preview with Google Books]

Note: If a reading is marked with an *, you are responsible for preparing the paper prior to class.

Part I. Themes: Theory Causal Tests, Evidence, and a First Application

Minimum wages and employment: Theory says?

  • What is 14.03 / 14.003 all about?
  • Application: Minimum wages and employment - Theory and evidence
    • Minimum wage and employment in the standard competitive model
    • Minimum wage and employment in monopsony model
    • How can we empirically distinguish these cases?

Required Reading

[Banerjee] Chapters 10.1 and 10.2: Monopoly.

[Mastering] Chapter 5: Differences-in-Differences.

Buy at MIT Press Krugman, Paul. Development, Geography, and Economic Theory. MIT Press, 1997. ISBN: 9780262611350. [Preview with Google Books]


Testing theory: The fundamental problem of causal evidence

  • The fundamental problem of causal inference (FPCI)
    • The Rubin Causal Model (RCM)
    • Experiments and the RCM
    • Quasi-experiments in economics
  • The method of Differences-in-Differences (DD)

Required Reading

*Card, David, and Alan B. Krueger. “Minimum Wages and Employment: A Case Study of the Fast-Food Industry in New Jersey and Pennsylvania.” The American Economic Review 84, no. 4 (1994): 772–93.

[Mastering] Chapter 1: Randomized Trials.

Dugger, Celia W. “Wage Laws Squeeze South Africa’s Poor.” The New York Times, September 26, 2010.

Dube, Arindrajit. “The Minimum We Can Do.” The New York Times, November 30, 2013.

Neumark, David. “Who Really Gets the Minimum Wage.” The Wall Street Journal, July 6, 2014.

Holland, Paul W. “Statistics and Causal Inference.” Journal of the American Statistical Association 81, no. 396 (1986): 945–60.


Minimum wages and employment: Evidence

  • Card and Krueger

  • Findings and interpretations

  • Overview of 14.03 / 14.003: Substance and themes  

    • What is economic theory for?
    • Causality: How do we know it, how we test it?
    • What do the data say?

Required Reading

[Banerjee] “Mathematical Appendix.”

Math tools for 14.03 / 14.003 (PDF)

Part II. The Foundation of Everything: Consumer Preference, Choice, Optimization, and Demand

Introducing consumer theory: The foundation of microeconomics

  • The axioms of consumer theory
  • Existence of a utility function
  • Properties of utility functions
  • Cardinality versus ordinality
  • Monotone transformations

Required Reading

[Banerjee] Chapter 3: Preferences.


Consumer sovereignty: The Carte Blanche principle

  • Utility maximization and constrained optimization
  • The indirect utility f’n
  • Expenditure minimization and the expenditure function
  • Relationship between expenditure and indirect utility f’ns
  • Applications of consumer theory
    • Lump-sum vs. in-kind transfers
    • Prince changes and consumer surplus

Required Reading

*Waldfogel, Joel. “The Deadweight Loss of Christmas.” The American Economic Review 83, no. 5 (1983): 1328–36.

Thompson, Derek. “If Economists Wrote Christmas Cards.” The Atlantic, December 2013, 1–4.

Blattman, Chrisopther, Nathan Fiala, and Sebastian Martinez. “Generating Skilled Self-Employment in Developing Countries: Experimental Evidence from Uganda.” The Quarterly Journal of Economics 129, no. 2 (2014): 697–752.

Haushofer, Johannes, and Jeremy Shapiro. “The Short-Term Impact of Unconditional Cash Transfers to the Poor: Experimental Evidence from Kenya.” The Quarterly Journal of Economics 131, no. 4 (2016): 1973–2042.


From preferences to demand curves

  • Where demand curves come from
  • Uncompensated (‘Marshallian’) demand
  • Compensated (‘Hicksian’) demand
  • Relationship between indirect utility f’n, expenditure f’n, and demand f’ns

Required Reading

[Banerjee] Chapter 4: Individual Demands.


Income effects, substitution effects, and the design of anti-poverty programs

  • Normal, Inferior, and Giffen goods
  • The Supplemental Nutrition Assistance Program (SNAP, AKA ‘Food Stamps’): Improving choices by constraining them?
  • Incentivizing work: Labor supply and the Earned Income Tax Credit

Required Reading

[Banerjee] Chapter 5.1: Consumer Comparative Statics: Price and Income Consumption Curves.

Williamson, Kevin D. “The White Ghetto.” National Review, December 2013, 1–10.

*Eissa, Nada, and Jeffrey B. Liebman. “Labor Supply Response to the Earned Income Tax Credit.” The Quarterly Journal of Economics 111, no. 2 (1996): 605–37.


Income, substitution, and subsistence

  • Connecting compensated and uncompensated demand curves: The Slutsky equation
  • Testing the theory: Rice and noodle subsidies in China

Required Reading

[Banerjee] Chapter 5.3: Consumer Comparative Statics: Decomposing Price Effects.

*Jensen, Robert, and Nolan Miller. “Giffen Behavior and Subsistence Consumption.” American Economic Review 98, no. 4 (2008): 1553–77.

9 Exam 1 No readings
Part III. From Consumer Demand to Market Demand

Applied competitive analysis: The U.S. sugar program

  • Aggregating individual to market demands
  • Producer and consumer surplus in competitive equilibrium
  • Distinguishing deadweight losses from transfers
  • Application: The U.S. Sugar Program

Required Reading

*Scherer, Fredric M. “The U.S. Sugar Program.” Harvard Kennedy School, Case 1128.0, 1992.

Editorial. “America’s Sugar Daddies.” The New York Times, November 29, 2003.

Malkin, Elizabeth. “In Mexico, Sugar vs. U.S. Corn Syrup.” The New York Times, June 9, 2004.

American Sugar Alliance. “Trade Talks in Works Could Devastate U.S. Sugar Industry.” October 21, 2003.

Driessche, Ray Van. “Sugar is Not Expensive.” USA Today, May 23, 2000.


Applied competitive analysis: The market for real estate brokers

Applied Competitive Analysis: A Second Application

Required Reading

*Hsieh, Chang-Tai, and Enrico Moretti. “Can Free Be Inefficient? Fixed Commissions and Social Waste in the Real Estate Industry.” (PDF) Journal of Political Economy 111, no. 5 (2003): 1076–122. (NBER Working Paper no. 9208)

Part IV. Putting Markets Together: General Equilibrium, Exchange, and International Trade

Putting markets together: The Edgeworth box

  • General Equilibrium in a Pure Exchange Economy: The Edgeworth box
    • Contract curves
    • Gains from trade between consumers
    • The fundamental welfare theorems

Required Reading

[Banerjee] Chapter 6: Exchange Economies.


The gains from market integration: “The Digital Provide”

The principle of arbitage

Required Reading

*Jensen, Robert. “The Digital Provide: Information (Technology), Market Performance, and Welfare in the South Indian Fisheries Sector.” The Quarterly Journal of Economics 122, no. 3 (2007): 879–924.


International trade and comparative advantage

  • Why do countries gain from trade?
  • The principle of comparative advantage
  • Where does comparative advantage come from?
  • Example: The RA problem

Krugman, Paul. “The Accidental Theorist.” Slate, January 1997.

Kristof, Nicholas D. “Let Them Sweat.” The New York Times, June 25, 2002. (Section A)


Does trade raise national income?

  • How do we even test this question?
  • The method of Instrumental Variables (IV) [also known as Two Stage Least Squares, 2SLS]

Required Reading

[Mastering] Chapter 3: Instrumental Variables.

*Feyrer, James. “Trade and Income: Exploiting Time Series in Geography.” NBER Working Paper No. 14910, 2009.


The free trade dilemma

  • Why trade is not Pareto-improving
  • Redistributive effects of trade: Evidence

Required Reading

Autor, David, David Dorn, and Gordon H. Hanson. “The China Syndrome: Local Labor Market Effects of Import Competition in the United States.” American Economic Review 103, no. 6 (2013): 2121–68.

Autor, David. “International Trade and U.S. Worker Welfare: Understanding the Costs and Benefits.” Washington Center for Equitable Growth, October 31, 2016.

Autor, David, David Dorn, and Gordon H. Hanson. “The China Shock: Learning from Labor-Market Adjustment to Large Changes in Trade.” Annual Review of Economics 8 (2016): 205–40.

Part V. Markets Are Not Perfect: Externalities

Externalities: Definition, consequences, and remedies

  • Guest lecture: Colin Gray or Christina Patterson, Graduate students at MIT’s Department of Economics
  • Externalities: Definition, consequences, and remedies
  • The problem of social cost: The Coase Theorem

Required Reading

[Banerjee] Chapter 14: Externalities.

Bergstrom, Theodore. “Lecture 5-Externalities.” UC Santa Barbara, March 2002.


Internalizing externalities: Barbed wire fencing

Enforcement of property rights: The case of barbed wire fencing

Required Reading

*Hornbeck, Richard. “Barbed Wire: Property Rights and Agricultural Development.” The Quarterly Journal of Economics 125, no. 2 (2010): 767–810.


Prediction is difficult, especially about the future: Choice under uncertainty

  • Risky bundles: Expected values, variance
  • The Von Neuman Morgenstern Expected Utility Model
  • Risk averse, risk neutral, and risk seeking preferences

Required Reading

[Banerjee] Chapters 11.1, 11.2, and 11.3: Expected Utility, Attitudes Towards Risk, Stochastic Dominance.

20 Exam 2 No readings
Part VI. Choice Under Uncertainty: Risk Preference, the Value of Safety, and the Market for Risk

Risk preference, the value of time, and the value of statistical life

Using revealed preference to estimate the implicit value of statistical life

Required Reading

*Ashenfelter, Orley, and Michael Greenstone. “Using Mandated Speed Limits to Measure the Value of a Statistical Life.” Journal of Political Economy 112, no. S1 (2004): S226–7.

Newman, Thomas P., Brian D. Johnston, and David C. Grossman. “Effects and Costs of Requiring Child-Restraint Systems for Young Children Traveling on Commercial Airplanes.” Archives of Pediatric Adolescent Medicine 157, no. 10 (2003): 969–74.

Banzhaf, H. Spencer. “Retrospectives: The Cold-War Origins of the Value of Statistical Life.” Journal of Economic Perspectives 28, no. 4 (2014): 213–26.


There’s a market for risk? How insurance works

  • Risk pooling
  • Risk spreading
  • Risk transfer

Required Reading

[Banerjee] Chapter 11.4: Pareto Efficient Risk Sharing.


Moral hazard in the housing market: Subprime lending

  • The Regression Discontinuity method
  • Application: Moral hazard, Securitization and Subprime Lending

Required Reading

[Mastering] Chapter 4: Regression Discontinuity Designs.

*Keys, Benjamin J., Tanmoy Mukkerjee, et al. “Did Securitization Lead to Lax Screening? Evidence from Subprime Loans.” The Quarterly Journal of Economics 125, no. 1 (2010): 307–62.

Part VII. Markets are Not Perfect: TMI or NEMI?

Imperfect information: Signaling in markets

  • Why is information different?
  • Signaling in markets
  • The notion of equilibrium in strategic interactions

Required Reading

Spence, Michael. “Job Market Signaling.” The Quarterly Journal of Economics 87, no. 3 (1973): 355–74.

[Banerjee] Chapter 12 and Chapter 15: Game Theory (especially section 12.3 on Nash Equilibrium), Asymmetric Information.


Why do educated people earn more?

  • Signaling vs. human capital

Required Reading

*Tyler, John H., Richard J. Murnane, and John B. Willett. “Estimating the Labor Market Signaling Value of the GED.” The Quarterly Journal of Economics 115, no. 2 (2000): 431–68.

[Mastering] Chapter 6: The Wages of Schooling.


Mandating a pooling equilibrium: “Ban the Box” legislation

  • Statistical discrimination: Definition and logic
  • Statistical discrimination and “Ban the Box”

Required Reading

*Agan, Amanda, and Sonja Starr. “Ban the Box, Criminal Records, and Statistical Discrimination: A Field Experiment.” (PDF) University of Michigan Law and Economics Research Paper, August 24, 2016.

Autor, David H., and David Scarborough. “Does Job Testing Harm Minority Workers? Evidence from Retail Establishments.” The Quarterly Journal of Economics 123, no. 1 (2008): 219-277.

Doleac, Jennifer L., and Benjamin Hansen. “Does ‘Ban the Box’ Help or Hurt Low-Skilled Workers? Statistical Discrimination and Employment Outcomes When Criminal Histories are Hidden.” NBER Working Paper No. 22469, 2016.

Bartik, Alexander W., and Scott Nelson. “Credit Reports as Résumés: The Incidence of Pre-Employment Credit Screening.” MIT Department of Economics Graduate Student Research Paper 16–01, March 2016.


Adverse selection and the Lemons Problem

  • The Lemons problem
  • Market failure in insurance markets: Theory, data, and evidence

Required Reading

Akerlof, George A. “The Market for “Lemons”: Quality Uncertainty and the Market Mechanism.” The Quarterly Journal of Economics 84, no. 3 (1970): 488–500.

*Einav, Liran, and Amy Finkelstein. “Selection in Insurance Markets: Theory and Empirics in Pictures.” Journal of Economic Perspectives 25, no. 1 (2011): 115–38.

Cutler, David, and Sarah Reber. “Paying for Health Insurance: The Trade-Off between Competition and Adverse Selection.” The Quarterly Journal of Economics 113, no. 2 (1998): 433–66.


Health insurance in practice: Why it works, why it matters

  • Adverse and advantageous selection
  • Does health insurance affect health?

Required Reading

Finkelstein, Amy, and Kathleen McGarry. “Multiple Dimensions of Private Information: Evidence from the Long-Term Care Insurance Market.” American Economic Review 96, no. 4 (2006): 938–58.

*Card, David E., Carlos Dobkin, et al. “Does Medicare Save Lives?The Quarterly Journal of Economics 124, no. 2 (2009): 597–636.

  Exam 3 (during exam period) No readings

Course Info

As Taught In
Fall 2016
Learning Resource Types
Lecture Notes
Problem Sets with Solutions
Instructor Insights