In This Chapter

Paying tribute to some great thinkers

Realizing that microeconomics is the result of many great thinkers

In this chapter we introduce you to some great economists who inspired us to discover microeconomics. Microeconomics has become a broad and deep subject, and although we can’t possibly do justice to all their work, we want to give you a flavor of some of their important results.

Many microeconomists have also made contributions to other subjects: macroeconomics, mathematics, sociology, law, and history being the most common. In fact, some people say that no such thing as a pure microeconomist exists! We have some agreement with that view, given the areas into which some of these greats have moved.

So what follows is a — perhaps slightly eccentric — list of inspiring and challenging thinkers. But they’re just the tip of a huge iceberg, and we apologize — in some cases, sadly, posthumously — to all those we leave out. This job was as difficult as picking an all-time Fantasy Football team or the top ten greatest singles. We hope that given the scarcity of available places, you’ll forgive the omissions.

Alfred Marshall (1842–1924)

The approach to microeconomics that we pursue in this book — which is the mainstream approach for the profession — is sometimes called marginalism, and much of it is due to Alfred Marshall. He started as a mathematician before switching to philosophy — this was before economics became a discipline in its own right. That change led him to look again at the work of the utilitarian philosophers and develop a theory based on their work that could improve the lives of the working classes.

Among his greatest achievements Marshall wrote Principles of Economics, which was a standard textbook for around 70 years, made economics a discipline in its own right at Cambridge, and invented the supply and demand graphs that economists know and love today.

Marshall’s style was to try to communicate in the most understandable way, aiming much of his work outside the profession — with the meaty stuff going in technical appendices. Among the people he taught were John Maynard Keynes and Arthur Pigou, making him an important father figure to modern economics.

Joseph Alois Schumpeter (1883–1950)

Born in Triesch, in what’s now the Czech Republic but was then part of Hapsburg Austria, Joseph Schumpeter made many great contributions to microeconomics, though not all were appreciated during his lifetime. He began his studies as a law student, but moved on into economics, eventually serving on the board of two private banks (both of which eventually ran into the ground) before moving to America to lecture at Harvard. There Schumpeter finally began to build the reputation that he has today.

Among Schumpeter’s many contributions to economics was the idea of creative destruction. This applies theories of evolution to reasoning about the way firms innovate — over time. Old ideas, products, and firms may be destroyed by the way newer rivals create new ideas and businesses. In his great book Capitalism, Socialism, and Democracy (1942), he provided an account of how capitalism itself would come to an end, largely through its own successes — successful companies in capitalist societies would come to exert influence on politics, leading to demands for socialist policies and a falling rate of innovation instead of the revolutionary crises foreseen by Karl Marx. He was profoundly driven to understand the mysteries of entrepreneurship, producing two complementary accounts of how it happens — one as the result of heroic visionaries with a kind of spirit or outlook driving them and one as a result of large companies having the capital to invest.

Schumpeter was a famously devoted teacher and had a keen sense of humor. He wrote that he’d only had three goals: to be the greatest economist in the world, the best horseman in Austria, and the greatest lover in Vienna. He quipped that he’d only achieved two of the three, but never spelt out which two.

Gary S. Becker (1930–2014)

If you’ve seen articles in the popular press applying economic reasoning to all kinds of things — such as marriage, discrimination, or the political system — you’ve come across the work of Gary Becker, who held a chair at the famous department of Economics at the University of Chicago. He applied his rigorous understanding of the consumer behavior (introduced in Chapter 2) to all kinds of issues — generally things studied in sociology departments rather than economics ones.

Becker is famous, among other things, for his ground-breaking study of discrimination against minority groups. His analysis showed that the costs of discrimination tend also to fall upon people or firms who discriminate, meaning that they tend to incur higher production costs: Therefore, discrimination isn’t really in the economic interests of a majority group. His insights into lobby groups and the democratic process are equally startling — showing that democratic and nondemocratic societies can both have a problem with the external costs imposed on other voters (in democracies) or other citizens (in nondemocratic societies) by overly successful lobbyists.

Most startlingly, Becker points out that utility maximization itself isn’t necessarily selfish. If you place value on acting altruistically, it maximizes your utility to help others, and so criticisms of the utility model are misplaced and have more to do with framing than with reality.

Ronald Coase (1910–2013)

Ronald Coase was a British economist who spent much of his career as a professor at the University of Chicago, where he was practicing economics. He published his final book at the age of 102, long after most people have retired. Although Coase’s career covered many areas of microeconomics, he’s probably most famous for his analyses of law — he edited the famous Journal of Law and Economics.

Two papers of Coase’s are considered absolute classics in microeconomics:

• “The Nature of the Firm”: This essay from the 1930s looks at the motivations for forming companies. Speaking in the abstract, no real reason exists for having large complex companies do anything: Probably a lot of other structures could do the job. So why do these large companies get created?

  His answer has to do with the costs of using the market itself — transactions costs — such as the cost of finding someone to do business with, the cost of getting the deal done, and the cost of enforcing the deal afterwards. An organization such as a company is a way to minimize these costs in one place so that they’re easier to coordinate, and often it does so by making them internal to the company, where they become the costs of administration.

  So you can see companies as a cycle: When transactions costs are high, companies form; and when the costs are fully internalized, the administrative burden can choke the company, leading to a breakup and the formation of new companies.

• “The Problem of Social Cost”: This paper contributed to dealing with externality. Coase’s insight was that without transactions costs, to whom or to which side of a deal a property right is allocated makes no difference to achieving an efficient outcome. But with transactions costs, it does matter: The rights should go to the person whose action will lead to the economically efficient outcome. Later, his reasoning became widely known as the basis for “the Coase theorem” — even though he never felt that it was truly based on his work. We discuss the theorem, externality, and property rights in Chapter 14.

Elinor Ostrom (1933–2012)

Any list of great scholars in the academy is likely to be dominated by men. In fact, historically, economics as a discipline has a male bias (don’t worry, microeconomists are already studying why, of course). But of all the recent winners of the Nobel Prize in Economics, perhaps one of the most important is Elinor Ostrom, the only woman to win the prize so far.

Ostrom was a professor at Indiana University, working on public choice economics — the area that studies how people and institutions interact. On field trips to Africa and Himalayan Asia she codified an approach to dealing with the problems of looking after things that no one owns — what microeconomists call common pool or property resources, such as the ecosystem of the plains of the Serengeti.

By looking at how indigenous peoples did things, she advanced a strong criticism of many of the approaches people used to deal with the Tragedy of the Commons (discussed in Chapter 14). She pointed out that as long as people can agree on certain principles, indigenous societies are perfectly capable of managing the commons without ecological collapse. This result challenges most traditional schools of economic or political analysis.

Ostrom did much of her work on these kinds of problems, which meant that she studied areas such as reciprocity or trust that aren’t immediately or obviously parts of the economist’s toolkit. Along the way, she also co-wrote one of the most important textbooks on modeling cooperation using game theory (the subject of Chapter 16).

William Vickrey (1914–96)

Canadian economist William Vickrey was posthumously awarded the Nobel Prize in 1996, largely for his work applying game theory and incentive theory to situations with asymmetric information (see Chapter 15). He was a professor at Columbia University for much of his career, and in that role he turned out a stunning amount of work, stretching over many areas of economics — we wouldn’t have even attempted Chapter 18 (on auctions) without his work. Vickrey’s most famous paper was his study of stamp collector auctions in 1961, where he rediscovered and worked out the logic behind the traditional use of a second-price winner in auctions. He then showed how to use this insight to prevent winner’s curse problems (again, see Chapter 18).

Vickrey’s contribution to public economics, and his applied work looking at government, is also extremely important. For instance, levying a charge on drivers in congested traffic zones in London is based on some of the work that Vickrey did looking at road pricing.

A devout Quaker, Vickrey also believed that full employment in society was a moral question and devoted much of his other research time to proposing schemes to remedy idleness. In this aim, he was less successful.

George Akerlof (born 1940)

George Akerlof, currently a professor at Georgetown University, won his Nobel Prize in 2001 (together with Joseph Stigliz and Michael Spence) for his research on information problems or imperfect information in market trades. His famous “Market for Lemons” in Chapter 15 is a fine example and a classic paper to many microeconomists.

Akerlof’s work on information problems extended to his work on signaling in labor markets (see Chapter 19). He points out that paying higher wages may not be sub-optimal if the threat of losing a wage premium when going to a rival company is enough to keep worker productivity higher in the higher-paying company. He co-wrote this paper with his substantially more famous wife, Janet Yellen, who’s currently the Chair of the Board of Governors of the Federal Reserve System.

More recently, Akerlof looked at how psychology is central to decision making, exploring how people’s sense of identity affects their decisions. People don’t just have preferences on which they act, they also have to respect certain types of social norm, which conditions how markets behave in reality.

Joseph Stiglitz (born 1943)

Joe Stiglitz, a professor at Columbia University, is considered to be one of the most influential economists alive — in 2011, Time magazine named him one of the 100 most influential people in the world. Stiglitz's most famous work is on how markets work under imperfect and asymmetric information (Chapters 15 and 19) for which he shared the Nobel Prize in 2001 with George Akerlof and Michael Spence.

His research calls into question the efficiency of markets when information is imperfect and there is uninsured risk. Stiglitz makes the case for government intervention in the market much stronger and the case for the “invisible hand” much weaker. The policy debate today, informed by Stiglitz’s research, is about finding the right balance between the market and government. Besides having written seminal academic papers in economics, Stiglitz is also the author of several books, his most recent being The Great Divide: Unequal Societies and What We Can Do About Them (W.W. Norton, 2015).

William Baumol (born 1922)

A professor of economics at New York University, William Baumol is one of the most prolific authors in the field of microeconomics. Perhaps his most important contribution is looking at entrepreneurship, bringing Joseph Schumpeter’s insights into mainstream economics and coming up with ways of dealing with one of the most important gaps in the traditional microeconomic literature.

Microeconomics’ problems in understanding innovation are many and being worked on as we write. One of the problems is captured in an old joke about how long it will take to pick up a $100 bill that is dropped in the middle of Wall Street. The punchline — “If there really were a bill, someone would’ve picked it up by now” — expresses a dilemma in entrepreneurship and innovation: If there was a new and profitable idea, then someone would have already invented it. Baumol drew on the Schumpeterian tradition by providing an account of what entrepreneurs do to begin new companies and how they make new kinds of business work. Baumol has also written about macroeconomics, the tendency of costs in service industries to rise without corresponding rises in productivity — often called Baumol’s cost disease — and how the threat of entry can keep monopolies from raising their prices. He’s also famous for his interest in the economics of the arts, writing a spectacular paper on the economics of composition in Mozart’s Vienna.

Arthur Cecil Pigou (1877–1959)

Although we haven’t gone through the enormous economic literature on the environment — yes, many economists have studied it — we do want to pay tribute to British economist Arthur Cecil Pigou. He was Alfred Marshall’s successor as Professor of Political Economy at Cambridge University, and a friend — though you wouldn’t believe it from their arguments — of John Maynard Keynes.

Pigou wrote about many subjects, including contributions on which modern labor economics is built. But perhaps his most enduring and best remembered work is on welfare (see Chapter 12) – his 1920 book The Economics of Welfare introduced the concept of externality to economics. He came up with the idea of using what are now called Pigovian taxes to remedy some of the social costs of private actions (check out Chapter 14 for details). His influence is still felt to this day in the existence of the Pigou Club, an informal and nonparty-aligned group of economists who want to see carbon taxes implemented.

A conscientious objector in the First World War, he spent his vacations from Cambridge serving with the Friends Ambulance Unit on the front line — volunteering for the most dangerous rescue and recovery missions.