F---ing microeconomics, how do they work?
December 23, 2010 4:08 PM   Subscribe

Help me understand how to apply microeconomics concepts to a simulation with a very small number of actors.

I'm OK at microeconomics. I took the class not so many years ago, and I think I understand all the underlying concepts in the theoretical micro world.

Right now I'm working on a hobby project, writing a computer game where people buy and sell houses. But I am having the damnedest time with seemingly simple problems, like "how much will person A pay for houses X, Y, and Z? how many houses, and of which type, will developer B build, given the preferences of the various buyers?" e.g., there are 50 people walking around in a real estate world, each of whose preferences and finances I want to simulate.

Does anybody know any good sources to learn about how this stuff is modeled? I've composed a utility function for each buyer -- but I have no idea how to extrapolate the prices they're willing to pay from the utility functions. My naive attempts don't work well, at all. Even a list of useful keywords to Google would help.
posted by zvs to Grab Bag (5 answers total)
Response by poster: To be more specific, it's a world with a finite amount of everything. 30 1/4 acre lots, 30 people who need a place to live...
posted by zvs at 4:10 PM on December 23, 2010

Best answer: The microeconomic concept of supply and demand requires them to be independent and requires an outside constraint that limits supply. The wikipedia article on Supply and Demand is a decent place to start.

To start, having the only 30 houses being from one developer means that he has a total monopoly. Technically, he would be best served by building fewer than 30 houses and letting the highest bidders take whatever houses they want. Eventually all of the buyers in the market that prioritize shelter will be paying their absolute max to have it and everyone else would be homeless. To get rid of that you need a way to implement downward pressure on the housing prices (excess supply or a competing developer).

You also need to think about the utility function of the developer (remember, supply and demand need to be independent). Both homebuyers and developers need to be rational parties in your simulation.

Keep on truckin'
posted by milqman at 4:19 PM on December 23, 2010

Best answer: Firstly, let me help you with the words you need to be searching for. Breaking into a new topic is often, as you've discovered, a catch-22 struggle of knowing enough about something you know little about in order to know more. Here is a list, with a brief reason why you'd want to search for it:
  • Agent-based economic simulations: you want to model a bunch of abstract models of people, each with resources and motivations, seeking to maximise some notion of utility, so this is a textbook agent simulation.
  • Game theory: when you're talking about models of agents interacting over time game theory may enter the picture, moreso if you want your model to be complex. How do buyers assess the trustworthiness of the developers, and the quality and future viability of the land they're purchasing? How do developers assess the quality of buyers? How do buyers react to the competition of fellow buyers, i.e. an irrational "Keeping up with the Joneses" complication?
That being said, I think you've started off on the wrong foot - it's not the utility function you need for an agent but the marginal utility that's more important. Think of it this way - why are diamonds more expensive than water? Surely the utility of water is much higher than diamonds, because without water...we'd die! But at the margin, i.e. the last unit of water consumed, given that the supply of water is much greater than the supply of diamonds, water is hence cheaper than diamonds. My explanation is rather lacklustre; I recommend reading a decent microecon textbook.

(It's not even the marginal utility of a given product that determines that price a buyer/seller seeks for the product. From what I remember of my university courses, consumers seek to maximise the product of all marginal utilities of all products they consume. The final piece of the puzzle is the "law of diminishing marginal utility", which says that as we consume anything the "next slice of utility" we get out of it will be smaller, and this forms part of the basis of the laws of supply and demand. But again, a good textbook will serve you well).

Other economics phrases to search for:
  • Marginal rate of substitution
  • Marginal rate of transformation
  • "The Market for Lemons" (a Nobel-prize winning Economics paper from the 70's by Akerlof, to get you in the mood of thinking of a market more concretely)
Start it off like you would start of a mathematical proof by induction; consider time=0, how do all the agents start, how are prices announced, how do transactions occur, what are the agents' thought processes, etc. Presumably your objective is, after surrounding your simulation in a set of assumptions, to prove that a neoclassical equilibrium price shows up in the market?

Good luck; I envy your ambition. Start small, start simple, then build it up!
posted by asymptotic at 2:48 PM on December 25, 2010

Response by poster: Thanks. Very helpful starting points.

I always say this at the end of my AskMe, but if any latecomer wanders in and has a comment, please don't hold back.
posted by zvs at 11:31 AM on December 26, 2010

Response by poster: Yeah, see, I would never have come up with "Agent-Based Computational Economics", which is the exact concept I'm trying to implement. Awesome.
posted by zvs at 11:36 AM on December 26, 2010

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