The Economy 2.0: Microeconomics

Citation

The CORE Econ Team. (2024). The Economy 2.0: Microeconomics (version 2.0). CORE Economics Education; print edition Hackett Publishing Company. Free official edition: https://books.core-econ.org/the-economy/

Chapter Summary

The book is divided into ten units, each opening with a real-world puzzle, building a model to explain it, and closing by asking how good the model is. They are listed here as chapters, using the units' own titles.

Chapter 1: Prosperity, inequality, and planetary limits

The opening unit sets out the facts the rest of the book tries to explain: "history's hockey stick" of GDP per capita, a matching hockey stick in carbon dioxide and temperature, the fall in extreme poverty, and the large gaps in income between countries. It introduces the production function and the diminishing average product of labour, and uses them to build Malthus's model of a population trap that explains the long flat part of the curve. Capitalism is defined by three institutions (private property, markets and firms), and the unit then discusses structural transformation, causation versus correlation, an application on whether British colonisation lowered Indian living standards, varieties of capitalism, and the economy as part of the biosphere.

Chapter 2: Technology and incentives

Starting from Kutesmart, a Chinese firm that automated made-to-measure tailoring, the unit asks why the Industrial Revolution began in eighteenth-century Britain. It introduces opportunity cost, economic rent and innovation rents, comparative advantage and specialisation, and then a model of technology choice with isocost lines: high wages and cheap coal made labour-saving, energy-intensive methods the cheapest option. Later sections discuss what makes a good economic model (ceteris paribus, equilibrium, endogenous and exogenous variables), the role of colonies and slavery in supplying cotton, calories and markets, the escape from the Malthusian trap, and the link between "capitalism plus carbon" and climate change, before comparing the explanations of economic historians.

Chapter 3: Doing the best you can: Scarcity, wellbeing, and working hours

Prompted by the question of whether you would work fewer hours if your wage doubled, this unit develops the constrained choice model: preferences shown by indifference curves and the marginal rate of substitution, a feasible set with its marginal rate of transformation, and the optimum where the two slopes are equal. It then separates the income and substitution effects of a wage rise and uses the model to explain long-run falls in working hours, the Veblen effect of inequality on work, gender differences in paid and unpaid work, and differences between countries. Sections 3.2 to 3.5 are flagged as a self-contained "building block" reused later in the book.

Chapter 4: Strategic interactions and social dilemmas

Using climate negotiations as the motivating case, the unit introduces game theory: players, strategies, pay-off matrices, best responses, Nash equilibrium and dominant strategies, worked through farmers' rice–cassava and pest-control games and the prisoners' dilemma. It evaluates outcomes with the Pareto criterion, then turns to public good games, altruism and other social preferences, and experimental evidence that peer punishment sustains cooperation. The ultimatum game, with results from Kenyan farmers and US students, shows the role of fairness norms, and coordination games such as the hawk–dove game are applied back to climate policy.

Chapter 5: The rules of the game: Who gets what and why

This unit asks how institutions and power determine the distribution of a surplus. After a story about the written articles of a pirate ship, it builds a two-person model of Angela, a farmer, and Bruno, a landowner, and compares an independent farmer with three institutional cases: forced labour, a take-it-or-leave-it contract, and bargaining in a democracy where workers can change the law. The comparison separates efficiency from fairness and introduces reservation options, joint surplus, the Pareto efficiency curve, and structural versus bargaining power. The unit ends with endowments and the distribution of income, the Lorenz curve and Gini coefficient, a West Bengal land reform application, and bargaining over wages and pollution.

Chapter 6: The firm and its employees

Beginning with a case of defective tyres traced to a period of labour conflict at the factory that made them, the unit looks inside the firm: owners, managers and workers, the separation of ownership and control, and how labour markets match workers to jobs. It builds a hiring-and-quitting model (the firm's reservation wage curve) and a labour discipline model in which, because effort cannot be written into a contract, the employer pays a wage that gives workers an employment rent they would lose if dismissed. Combining the two gives the wage-setting model and the no-shirking wage curve, which is used to explain why unemployment never disappears, how employers exercise power, why a minimum wage can raise employment when firms have labour market power, and how worker-owned cooperatives differ.

Chapter 7: The firm and its customers

The unit models a firm selling a differentiated product, from a breakfast cereal (Apple Cinnamon Cheerios, whose demand curve was estimated from weekly sales data) to a small car maker called Beautiful Cars. It covers cost functions (fixed, variable, average and marginal costs, short and long run), economies of scale, the price elasticity of demand, and the profit-maximising choice where an isoprofit curve touches the demand curve (equivalently, marginal revenue equals marginal cost). It measures consumer and producer surplus and the deadweight loss from pricing above marginal cost, and discusses product differentiation and advertising, strategic pricing with few firms, natural monopoly, and competition policy, including digital markets.

Chapter 8: Supply and demand: Markets with many buyers and sellers

Opening with the effect of the American Civil War on world cotton prices, the unit develops supply and demand for markets with many buyers and sellers: willingness to pay and to accept, market clearing, price-taking and competitive equilibrium, and the firm's supply curve as its marginal cost. It shows that competitive equilibrium exhausts the gains from trade, analyses shocks through the case of quinoa, and separates short-run from long-run equilibria. Applications cover the oil market, how competition turns a cartel into a prisoners' dilemma, the arrival of mobile phones in Kerala's fish markets, tax incidence and price controls such as rent ceilings, with a frank section on when the competitive model is a good guide.

Chapter 9: Lenders and borrowers and differences in wealth

Starting with moneylenders in Chambar, Pakistan, the unit distinguishes income from wealth and uses the constrained choice framework to model borrowing (bringing consumption forward), lending, storing and investing (moving it to the future), with situational and intrinsic impatience. An application uses discount rates to discuss how we should value the welfare of future generations under climate change. The central argument is that credit is a principal–agent relationship with incomplete contracts, so lenders demand collateral or equity; those with little wealth are therefore excluded or charged more, take fewer risks and can stay trapped. The unit closes with behavioural limits of the model and policies such as home value insurance and ways of funding higher education, including an income-contingent graduate tax.

Chapter 10: Market successes and failures: The societal effects of private decisions

The final unit pulls the book together through the case of a pesticide used on Caribbean banana plantations that poisoned fisheries. It defines market failure as a gap between private and social costs or benefits, and compares remedies: Coasean bargaining over property rights, regulation, Pigouvian taxes and legal compensation. It then classifies goods by rivalry and excludability (public goods, club goods, open-access and common-pool resources), analyses hidden actions (moral hazard) in insurance and credit, and hidden attributes (adverse selection), and ends by discussing merit goods and markets that people find repugnant.

Key Concepts

Chapter 1: Prosperity, inequality, and planetary limits

• History's hockey stick: the pattern of near-flat living standards for centuries followed by a sharp, sustained rise, which the unit links to a parallel rise in carbon emissions.
• Diminishing average product of labour: as more people work a fixed amount of land, output per worker falls, which is the engine of the Malthusian trap.
• Capitalism: an economic system defined by private property, markets and firms in which owners of capital goods hire labour to produce for profit.

Chapter 2: Technology and incentives

• Economic rent: the payment or benefit above what a person would get from their next best alternative (reservation option).
• Innovation rent: the temporary extra profit a firm earns by adopting a cheaper technology before rivals catch up.
• Isocost line: all combinations of inputs that cost the same at given prices; its slope reflects relative prices and decides which technology is cheapest.

Chapter 3: Doing the best you can: Scarcity, wellbeing, and working hours

• Marginal rate of substitution (MRS): the trade-off between two goods a person is willing to make, shown by the slope of an indifference curve.
• Marginal rate of transformation (MRT): the trade-off the feasible frontier forces on the decision-maker; the best choice is where MRS equals MRT.
• Income and substitution effects: the two opposing pulls of a wage rise on free time, one from being richer and one from free time becoming more costly.

Chapter 4: Strategic interactions and social dilemmas

• Nash equilibrium: a set of strategies in which each player's choice is a best response to the others'.
• Social dilemma: a situation, such as the prisoners' dilemma or a public good game, where individually rational choices produce an outcome worse for everyone.
• Social preferences: concerns such as altruism, reciprocity and inequality aversion, documented in experiments like the ultimatum game.

Chapter 5: The rules of the game: Who gets what and why

• Institutions: the laws and informal rules that set who does what and how gains are divided.
• Structural and bargaining power: power that comes from the quality of each side's alternative options, and power over how a surplus is split.
• Gini coefficient: a measure of inequality from 0 to 1, read off the Lorenz curve.

Chapter 6: The firm and its employees

• Incomplete contract: a contract that cannot enforce everything that matters, such as how hard someone works.
• Employment rent: what a worker would lose by losing the job, which the employer uses to motivate effort.
• No-shirking wage curve: the lowest wage that both recruits a given number of workers and keeps them working hard.

Chapter 7: The firm and its customers

• Price elasticity of demand: the percentage change in quantity demanded per percentage change in price; a low elasticity allows a high markup.
• Marginal revenue equals marginal cost: the condition for the profit-maximising quantity of a price-setting firm.
• Deadweight loss: the gains from trade lost when price is above marginal cost.

Chapter 8: Supply and demand: Markets with many buyers and sellers

• Competitive equilibrium: a market-clearing price at which all buyers and sellers are price-takers and no gains from trade are left unexploited.
• Disequilibrium rents: the opportunities for extra profit that arise when a market is out of equilibrium and drive it back towards it.
• Tax incidence: how the burden of a tax is shared between buyers and sellers, depending on the elasticities.

Chapter 9: Lenders and borrowers and differences in wealth

• Consumption smoothing: using borrowing, saving or investing to keep consumption steadier than income.
• Collateral and equity: wealth a borrower pledges or contributes to reduce the lender's risk, which those with little wealth cannot supply.
• Credit market exclusion: being unable to borrow at all, or only on poor terms, because of limited wealth.

Chapter 10: Market successes and failures: The societal effects of private decisions

• Marginal social cost: the private marginal cost plus the marginal external cost; efficiency requires it to equal marginal social benefit.
• Pigouvian tax: a tax equal to the external cost, designed to make decision-makers take that cost into account.
• Moral hazard and adverse selection: market failures caused by hidden actions and hidden attributes respectively.

Critical Analysis

Strengths

• Questions first, models second. Every unit starts with a concrete case (Kutesmart's tailoring, pirate ships, exploding tyres, Chambar's moneylenders, chlordecone in Martinique) and introduces only the model needed to explain it. Each unit has a "how good is the model?" discussion, so students learn to judge models as well as use them.
• A wider modern toolkit than a standard principles book. The note to instructors sets out explicitly what is added: strategic interaction, incomplete contracts, principal–agent problems, social preferences, economic rents, power and fairness. Wage-setting and credit markets get full units, and game theory appears early (Unit 4) rather than as an optional extra.
• Data and history are built in. Figures draw on long-run historical series and many link to interactive data from Our World in Data; "How economists learn from facts" boxes walk through natural experiments and difference-in-differences studies, and "Great economists" boxes cover figures from Smith and Marx to Ostrom and Joan Robinson.
• Mathematics is layered rather than required. The main text uses diagrams, numerical examples and simple algebra, while about 27 optional extensions add calculus treatments of the same models. Each unit also has multiple-choice questions with feedback and discussion exercises, and the instructor note identifies "building blocks" (constrained choice in 3.2–3.5, Nash equilibrium in 4.2–4.3) that make the units modular.

Limitations

• The usual principles sequence is reordered. Supply and demand arrive only in Unit 8, after price-setting firms in Unit 7; students who must also follow a conventional syllabus, or sit exams built around one, will need to map topics carefully.
• Some standard topics are thin. There is no separate treatment of international trade policy, of factor markets beyond labour and credit, or of the cost-curve taxonomy of perfect competition, monopolistic competition and oligopoly that many courses expect.
• A distinct point of view. The book's emphasis on power, inequality, colonialism and climate is deliberate and argued for in the preface; it is a strength for many readers, but instructors wanting a neutral survey should know that the framing is part of the design.
• Best used online. Interactive figures, videos and data links are integral, and the print-style EPUB loses some of this; the text is licensed CC BY-NC-ND, so it can be shared but not adapted.

Where It Fits in the Course

Among the books listed for Principles of Economics, The Economy 2.0: Microeconomics and OpenStax's Principles of Economics 3e are both free introductory texts, but they take different routes. The OpenStax book follows the conventional sequence (supply and demand early, then elasticity, consumer and producer choice, and market structures) and covers macroeconomics in the same volume, whereas CORE spends its microeconomics volume on institutions, contracts, power and social preferences. Many students will benefit from using CORE as the main text and the OpenStax book as a reference for standard diagrams and definitions, or the reverse in a conventional course. Mankiw's Principles of Economics is generally described as a conventional principles text and plays a similar role to the OpenStax book.

Sloman, Garratt and Guest's Economics is a broad survey for students who want more depth across standard topics. The two upper-level books — Samuel Bowles's Microeconomics: Behavior, Institutions, and Evolution and Acemoglu and colleagues' Microeconomics — come after a first course; CORE's emphasis on incomplete contracts and institutions is a natural lead-in to Bowles in particular. CORE's own closing essay recommends a related text, Bowles and Halliday's Microeconomics: Competition, Conflict, and Coordination, as the next step.

How to Use This Book

The book is written for a first university course and has also been used in secondary schools and master's programmes. No economics is assumed; the main text needs only basic algebra and comfort with graphs, and calculus appears only in the optional extensions, each of which states its own prerequisites.

The note to instructors suggests about one unit per week for a 10–12 week semester. Only a few units are strict prerequisites: Unit 1 before Unit 2, and Unit 7 before Unit 8. For a shorter course, it suggests Units 1 and 2, the constrained choice and game theory building blocks from Units 3 and 4, and then Units 7, 8 and 10; Units 6 (wage-setting) and 9 (credit) can be dropped if time is short, though they contain much of what is distinctive about the book. Each unit's "Before you start" box lists exactly which earlier sections it relies on.

To study effectively, work through the step-by-step figure animations online rather than just reading the final diagrams, answer the multiple-choice questions as you go (they come with explanations), and attempt the discussion exercises, several of which ask you to work with real data. Students with calculus should try the extensions to see the same models stated precisely. CORE's companion Doing Economics project, linked from the text, provides empirical projects in spreadsheets, R or Python. The macroeconomics volume follows directly, and the instructor note shows how to combine units from both volumes in a year-long course.

Edition and Sources

This guide is based on The Economy 2.0: Microeconomics, version 2.0.0 (© CORE Economics Education 2023, preface dated November 2024; print ISBN 978-1-64792-160-6), read in the official EPUB downloaded from CORE Econ's site and checked against the online edition at https://books.core-econ.org/the-economy/. The guide draws on the preface, the note to instructors, the introduction to mathematical extensions, the full table of contents, and for all ten units the opening section, every section and subsection heading, the opening of every section and the full unit summary and list of concepts, with Sections 6.10 and 10.1 and the closing essay "Looking forward to economics after The Economy 2.0" read in more detail.