History of microeconomics

Microeconomics is the study of the behaviour of individuals and small impacting organisations in making decisions on the allocation of limited resources.

Utilitarianism as a distinct ethical position only emerged in the 18th century, usually credited to Jeremy Bentham, but there were earlier writers, such as Epicurus who presented similar theories.

Daniel Bernoulli wrote in 1738 this about risk:[2][3] "EVER SINCE mathematicians first began to study the measurement of risk there has been general agreement on the following proposition: Expected values are computed by multiplying each possible gain by the number of ways in which it can occur, and then dividing the sum of these products by the total number of possible cases where, in this theory, the consideration of cases which are all of the same probability is insisted upon.

If this rule be accepted, what remains to be done within the framework of this theory amounts to the enumeration of all alternatives, their breakdown into equi-probable cases and, finally, their insertion into corresponding classifications.

"My most honorable cousin the celebrated Nicolas Bernoulli, Professor utriusque iuris at the University of Basle, once submitted five problems to the highly distinguished mathematician Montmort.

Some common ideas behind those works were models or arguments characterized by rational economic agents maximising utility under a budget constraint.

As Mr. Senior most accurately says, "Utility denotes no intrinsic quality in the things which we call useful it merely expresses then relations to the pains and pleasures of mankind".

Several gallons a day may possess much utility for such purposes as cooking and washing; but after an adequate supply is secured for these uses, any additional quantity is a matter of indifference.

(Theory, p. 1) This statement seems to be no less one-sided and fragmentary, and much more misleading, than that into which Ricardo often glided with careless brevity, as to the dependence of value on cost of production; but which he never regarded as more than a part of a larger doctrine, the rest of which he had tried to explain.

We must not indeed forget that, at the time at which he wrote, the demand side of the theory of value had been much neglected; and that he did excellent service by calling attention to it and developing it.

Perfect competition requires a perfect knowledge of the state of the market; and though no great departure from the actual facts of life is involved in assuming this knowledge on the part of dealers when we are considering the course of business in Lombard Street, the Stock Exchange, or in a wholesale Produce Market; it would be an altogether unreasonable assumption to make when we are examining the causes that govern the supply of labour in any of the lower grades of industry.

For instance, as Sir R. Giffen has pointed out, a rise in the price of bread makes so large a drain on the resources of the poorer labouring families and raises so much the marginal utility of money to them, that they are forced to curtail their consumption of meat and the more expensive farinaceous foods: and, bread being still the cheapest food which they can get and will take, they consume more, and not less of it.

An early formulation of the concept of production functions is due to Johann Heinrich von Thünen,[17] which presented an exponential version of it.

He also explains that: It should be made clear that these long-run results only hold if producer are rational actors, that is able to optimise their production so as to have an optimal scale of plant.

He also argues that clustering of stores is wasteful from the point of view of transportation costs and that public interest would dictate more spatial dispersion.

This may seem counterintuitive since Marshall considered that economic behavior might change in the long run and that "an equilibrium is stable; that is, the price, if displaced a little from it, will tend to return, as a pendulum oscillates about its lowest point",[25] Nicholas Kaldor was aware of this problem: economic equilibrium is not always stable and not always unique since it depends on the shapes of both the demand curve and the supply curve, he explained the situation in 1934 as follows:[26] "We shall examine these objections in turn by enumerating, in each case, the conditions which are necessary to make them inoperative( or in the absence of which they would be operative).

(E.g. a change in the price of rubber may not influence the rate of supply for a period of seven years, at the end of which the full quantitative reaction may take place at once.

Similarly, we shall call an adjustment completely continuous, if it proceeds at a steady rate in time, or if the time-lags between the appearance of successive quantitative changes are such as can be neglected.

The reason for this is simply that economics is far too difficult a science to permit its construction rapidly, especially in view of the very limited knowledge and imperfect description of the facts with which economists are dealing.

"A major problem discussed in this book if that of rational behavior under strategic situations involving other participants: "First, the "rules of the game," i.e. the physical laws which give the factual background of the economic activities under consideration may be explicitly statistical.

Such models are theoretical constructs with a precise, exhaustive and not too complicated definition; and they must be similar to reality in those respects which are essential in the investigation at hand.

The construct must not be unduly complicated, so that the mathematical treatment can be brought beyond the mere formalism to the point where it yields complete numerical results.

"Game theory considers very general types of payoffs, therefore Von Neumann and Morgestein defined the axioms necessary for rational behavior using utility; William Baumol provided in his 1977 paper the current formal definition of a natural monopoly where "an industry in which multiform production is more costly than production by a monopoly" (p. 810):[29] mathematically this equivalent to subadditivity of the cost function.

According to Baumol this equilibrium emerges endogenously due to the nature of contestable markets, that is the only industry structure that survives in the long run is the one which minimizes total costs.

He argues against the Pigovian tradition:[33] "...The problem which we face in dealing with actions which have harmful effects is not simply one of restraining those responsible for them.

In a world in which there are costs of rearranging the rights established by the legal system, the courts, in cases relating to nuisance, are, in effect, making a decision on the economic problem and determining how resources are to be employed.

It was argued that the courts are conscious of this and that they often make, although not always in a very explicit fashion, a comparison between what would be gained and what lost by preventing actions which have harmful effects.

But there is a real danger that extensive Government intervention in the economic system may lead to the protection of those responsible for harmful being carried too far.

[34] He then gives a description of what is now called the free rider problem: "However no decentralised pricing system can serve to determine optimally these levels of collective consumption.

The authors conclude: "The paper thus casts a new light on the First Fundamental Theorem of Welfare Economics asserting the Pareto efficiency of competititve equilibrium.