Frontiers of Microeconomics

Asymmetric Information

This occurs when one person in a transaction knows more than the other. This leads to two big problems:

• Moral Hazard: When a person who is being watched (the “agent”) performs a task for someone else (the “principal”). Because the principal can’t perfectly monitor the agent, the agent might not work as hard as they should (shirking). For example, an employee might play on their phone when the boss isn’t looking.
• Adverse Selection: This happens when the “mix” of unobserved traits in a market is lopsided. A classic example is The Market for Lemons: if a buyer can’t tell the difference between a good used car and a bad one (a “lemon”), they will only offer a medium price. Owners of good cars won’t sell for that low price, leaving only the “lemons” in the market.

Political Economy

This field applies the tools of economics to study how government works. It suggests that politicians and voters don’t always act for the “common good”—they often act in their own self-interest.

• Condorcet Paradox: It shows that democratic voting can sometimes fail to produce a clear winner if people’s preferences are “circular” (A beats B, B beats C, but C beats A).
• Arrow’s Impossibility Theorem: A mathematical proof showing that no perfect voting system exists that can satisfy all fair criteria.
• Median Voter Theorem: The idea that political parties will often move toward the center (the “middle” voter) to win the most votes.

Behavioral Economics

This is the intersection of psychology and economics. Traditional economics assumes people are “rational,” but behavioral economics shows we are often “predictably irrational.”

• People aren’t always rational: We care too much about small losses (loss aversion), we are overconfident, and we give too much weight to vivid observations.
• People care about fairness: We might turn down a deal that benefits us if we feel the other person is being “unfair” (the Ultimatum Game).
• People are inconsistent over time: We want to eat healthy tomorrow, but we want a donut right now. This is called “present bias.”