Supply and demand

In microeconomic theory, the partial equilibrium supply and demand economic model originally developed by Alfred Marshall attempts to describe, explain, and predict changes in the price and quantity of goods sold in competitive markets. The model is only a first approximation for describing an imperfectly competitive market. It formalizes the theories used by some economists before Marshall and is one of the most fundamental models of some modern economic schools, widely used as a basic building block in a wide range of more detailed economic models and theories. The theory of supply and demand is important for some economic schools' understanding of a market economy in that it is an explanation of the mechanism by which many resource allocation decisions are made. However, unlike general equilibrium models, supply schedules in this partial equilibrium model are fixed by unexplained forces.

Decision making

Much of economics assumes that individuals seek to maximize their happiness or utility; however, whether they rationally attempt to optimize their well-being given available information is a source of much debate. In this view, which underpins much of economic writing, individuals make choices between alternatives based on their estimation of which will yield the best results. Many important economic ideas, such as the "efficient market hypothesis", rest on this view of decision making.

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However, this framework, once called "homo economicus", has for decades been the focus of unease even by those who apply it. Milton Friedman once defended the idea by saying that inaccurate assumptions could produce accurate results. Alfred Marshall was careful to differentiate the tendency to maximize happiness with maximizing economic well-being. The limits of rationality have been the subject of intense study, for example, Herbert Simon's model for "bounded rationality", which was awarded a Nobel Prize in 1978. More recently, irrational behavior and imperfect information have increasingly been the subject of formal modeling, often referred to as behavioral economics, for which Daniel Kahneman won a Nobel Prize in 2002. An example is the growing field of behavioral finance, which combines previous theory with cognitive psychology.

Related Topics:
Homo economicus - Milton Friedman - Herbert Simon - Bounded rationality - Nobel Prize - 1978 - Daniel Kahneman - 2002 - Behavioral finance - Cognitive psychology

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The new model of information and decision making focuses on asymmetrical information, when some participants have key facts that others do not, and on decision making based not on the economic pressures but on the decisions of other economic actors. Asymmetrical information and behavioral dynamics lead to different conclusions: in a world of asymmetrical information, markets are generally not efficient, and inefficiencies grow up as means of hedging against information. While not yet universally accepted, it is increasingly influential in policy, for example, the writing of Joseph Stiglitz and financial modeling.

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