2.2 Some fundamental concepts: maximization, equilibrium, and efficiency

Economists usually assume that each economic actor maximizes something; consumers max. utility, firms maximize profits etc etc.

Economists often say that models assuming maximizing behaviour work because most people are rational, and rationality requires maximization.

A rational consumer should choose the best alternative that the constraints allow. This can mathematically be describes as maximizing.

Feasibility constraint: choosing the best alterntive that the constraints allow corresponds to maximizing the utility function subject to the feasibility constraint.

E.g. when a consumer goes shopping it is said to maximize utility subject to her budget constraint.

Second fundamental concept --> urge to characterize each social phenomenon as an equilibrium in the interaction of maximizing actors.
-Equilibrium: a patterm of interaction that persists uless disturbed by outside forces.

Vital connection between maximization and equilibrium in microeconomic theory. We characterize the behaviour of every individual or group as miximizing something. Maximizing behaviour tends to push these individuals and groups toward a point of rest, an equilibrium.

The third fundamental concept --> several distint definitions of efficiency set by economists.
A production process is said to be productively efficienct if either of 2 conditions holds:
1. It is not possible to produce the same amount of output using a lower-cost combination of inputs, or
2. It is not possible to produce more output using the same combination of inputs.

Other kind of efficiency = pareto efficiency/ allocative efficiency --> concerns the satisfaction of individual preferences.

A particular situation is said to be pareto efficient/allocative efficient if it is impossible to change it so as to make at least one person better off (in his own estimation) without making another person worse off (again, in his own estimation).

Is the allocation pareto efficient?
Yes, if it is impossible to reallocate the bread and umbrellas so as to make either party X or party Y better off without making the other persoon worse off.

These 3 basic concepts are fundamental to explaning economic behaviour, especially in decentralized institutions like markets that involve the coordinated interaction of many different people:
1. Maximization
2. Equilibrium
3. Efficiency