Microeconomics - Development

Development

The modern field of microeconomics arose as an effort of neoclassical economics school of thought to put economic ideas into mathematical mode. An early attempt was made by Antoine Augustine Cournot Researches on the Mathematical Principles of the Theory of Wealth (1838) in describing a spring water duopoly that now bears his name. Latter William Stanley Jevons's Theory of Political Economy (1871), Carl Menger's Principles of Economics (1871), and Léon Walras's Elements of Pure Economics (1874–1877) gave way to what was called the Marginal Revolution. Some common ideas behind those works were models or arguments characterized by rational economic agents maximizing utility under a budget constrain. This arose as a necessity of arguing against the labour theory of value associated with classical economists such as Adam Smith, David Ricardo and Karl Marx.

Walras also went as far as developing the concept of general equilibrium of an economy.

Alfred Marshall's textbook, Principles of Economics was published in 1890 and became the dominant textbook in England for a generation. His main point was that marginalists went too far in emphasizing utility as an attempt to explain prices over costs of production. To correct that he presented the idea that prices were determined by supply and demand curves. The demand curve could be derived by aggregating individual consumer demand curves, which were themselves based on the consumer problem of maximizing utility. The supply curve could be derived by aggregating individual producer supply curves, which depended first on constructing cost curves and then analyzing how much each producer was willing to sell his goods at a given price level. The cost curves depended on solving a producer problem of minimizing costs under a given production function. He also introduced the notion of different market periods: mainly short run and long run. This set of ideas gave way to what was latter called perfect competition.

A new impetus was given to field when around 1933. Joan Robinson and Edward H. Chamberlin, published respectively, The Economics of Imperfect Competition (1933) and The Theory of Monopolistic Competition (1933), introducing models of imperfect competition. Although Marshall himself had already considered both the monopoly case and Cournot had built his duopoly model, a whole new set of models grew out of this new literature. In particular the monopolistic competition model results in a non efficient equilibrium. Latter on some market models were built using game theory, particularly regarding oligopolies.

In 1937 The Nature of the Firm was published by Ronald Coase introducing the notion of transaction costs (the term itself was coined in the fifties), which explained why firms have an advantage over a group of independent contractors working with each other. The idea was that there were transaction costs in the use of the market: search and information costs, bargaining costs, etc. which give an advantage to a firm which can internalize the production process required to deliver a certain good to the market. A related result was published by Coase in his “The Problem of Social Cost” (1960) which deals with problem of externalities: the presence of transaction costs prevents agents from bargaining among themselves to arrive at mutually beneficial agreement. This then becomes relevant in context of regulations.

Around the seventies the study of market failures came again into focus with the study of information asymmetry. In particular three authors emerged from this period: George Akerlof, Michael Spence and Joseph Stiglitz. Akerlof considered the problem of bad quality cars driving good quality cars out of the market in his classic “The Market for Lemons” (1970) because of the presence of asymmetrical information between buyers and sellers. Spence explained that signaling was fundamental in the labour market, because since employers cant know beforehand which of the candidates are the most productive, a college degree becomes a signaling device which allows a firm to hire new personnel.

More recently Kahneman and Tversky published their paper "Prospect Theory: An Analysis of Decision under Risk" in 1979 criticizing the very idea of the rational economic agent. The main point is that there an asymmetry in the psychology of the economic agent which gives a much higher value to losses that to gains. This article is usually regarded as the beginning of behavioral economics and has consequences particularly regarding the world of finance.