Book Review Studies in Microeconomics

9(1) 128­–129, 2021

© The Author(s) 2021
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Martin J. Osborne and Ariel Rubinstein, Models in Microeconomic

Theory., Open Book Publishers, 2020

There are many adjectives that one could reasonably use to describe the new
open-access textbook, Models in Microeconomic Theory by Martin Osborne and
Ariel Rubinstein—terse, rigorous, deep and technically demanding, among them.
But to me, the word that best describes their effort is ‘honest’.
Consider, for instance, the manner in which they develop the theory of producer
behaviour. They begin with a vignette, concerning a profitable firm that faces a
significant demand shortfall. Profit maximization would require laying off about
half the workforce, but the firm could remain profitable (to a lesser degree) if it
fired fewer people or none at all. Readers of the book are invited to respond to an
online survey declaring the choice they would make as managers under the
circumstances. At the end of the chapter, the authors note that students of economics
tend to lay off more workers than those in other disciplines, but even among
economists only about half choose the profit-maximizing option. Accordingly, the
chapter itself treats profit maximization as one of several possible objective
functions, alongside output maximization subject to a profitability constraint.
For a very different example, consider their discussion of choice under
uncertainty. In this chapter, the authors introduce the theory of expected utility,
but immediately follow this with a discussion of the Allais paradox, which is
inconsistent with the theory. The goal here and throughout the book is to walk the
student through some very deep results in microeconomic theory while never
losing sight of their limitations as empirical hypotheses.
For students who enjoy intricate formal reasoning on the basis of precisely
stated assumptions, the book will be a pleasure to read and to learn from. Although
designed for undergraduate courses in intermediate microeconomics, it introduces
concepts and results that one would normally find only in graduate texts. These
include representation theorems, welfare theorems, the core, subgame perfection,
adverse selection, signalling and screening, strategy proof mechanisms, top
trading cycles, stable matchings, and preference aggregation. Every stated result
is proved, though sometimes in simplified form—existence of competitive
equilibrium is shown for an economy with two goods, for example, and existence
of Nash equilibrium is demonstrated for finite supermodular games.
One notable innovation worth mentioning is the abandonment of the terms
Pareto-efficiency and Pareto-optimality, in favour of the more normatively neutral
Pareto-stability. Careful instructors spend a lot of time explaining to students that
allocations satisfying this condition can be terribly unequal and unfair, which the
new terminology will make easier to do. The authors justify their choice by
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observing that Pareto-stability is an equilibrium concept, since ‘the force that can
upset an allocation is an agreement between all individuals to replace the allocation
with another one.’ This assumes, of course, that binding agreements of this kind
can be made without cost, which is seldom the case. The book itself is full of
examples of equilibrium allocations that fail to satisfy Pareto-stability, but no
terminology is perfect and the change proposed here is certainly an improvement.
The manner in which the authors introduce the reader to the idea of an
equilibrium is also noteworthy. Instead of considering prices and markets at the
outset, they start with a simple non-market allocation problem involving objects
and individuals, with each individual having preferences over objects and a level
of prestige or power that allows them to claim an object in the possession of
someone with less power. An equilibrium in this case is an allocation such that no
individual prefers an object that is allocated to someone weaker. Many standard
questions about existence, Pareto-stability and externalities (corresponding to
preferences over the objects held by others) can be asked and answered with great
clarity in this simple setting. The introduction of prices and markets in subsequent
chapters can then be done with ease.
This model of power-based allocation is also interesting in its own right. It
describes the manner in which street corners are allocated to sellers of illicit drugs,
or offices in a new building to employees. In the latter case, power is usually
attached to seniority, though I am proud to report that office assignments in my
own department were recently made based on reverse seniority, on the grounds
that junior faculty had the greatest need for the best working conditions.
While the leanness and brevity of this book is an asset, there is one striking
omission that is quite puzzling. In discussing the mismatch between game
theoretic predictions and experimental results, the authors often consider the
possibility that the preferences of experimental subjects may differ from those
assumed in the models. This is clearly an important consideration, but a mismatch
between theory and experiment can also arise because theoretical assumptions
about reasoning and knowledge may not be satisfied in the laboratory. For
instance, there is no discussion in the book of level-k models of strategic reasoning,
or the beauty contests or guessing games that have inspired this literature. One of
the end-of-chapter problems does ask students to solve for equilibria of the
original guessing game proposed by Hervé Moulin but does not link it to the
classic experiments of Rosemarie Nagel, or account for the discrepancy between
theory and experiment in such environments. This is especially surprising given
the authors’ own pioneering contributions to the literature on procedural rationality.
Many undergraduate students (and perhaps even a few instructors) will find the
content and presentation in this book quite daunting. Despite being released under
a creative commons license, with a free version available online, mass adoption in
the United States therefore seems unlikely. But the book will have lasting impact
and a committed audience, among which it will be genuinely treasured.

Rajiv Sethi
Barnard College, Columbia University
E-mail: rs328@columbia.edu