Editing Economics (section)

== Microeconomics ==
{{Main|Microeconomics|Market (economics)}}
[[File:Ballard Farmers' Market - vegetables.jpg|thumb|Economists study trade, production, and consumption decisions, including those that occur in a traditional [[marketplace]]|alt=A vegetable vendor in a marketplace.]]
[[File:Sao Paulo Stock Exchange.jpg|thumb|[[São Paulo Stock Exchange]] in [[Brazil]], an [[electronic trading]] network that brings together buyers and sellers through an [[electronic trading platform]]|alt=Two traders sit at computer monitors with financial information.]]
Microeconomics examines how entities, forming a [[market structure]], interact within a [[Market (economics)|market]] to create a [[market system]]. These entities include private and public players with various classifications, typically operating under scarcity of tradable units and [[regulation]]. The item traded may be a tangible [[product (business)|product]] such as apples or a [[Service (economics)|service]] such as repair services, legal counsel, or entertainment.

Various market structures exist. In [[perfect competition|perfectly competitive markets]], no participants are large enough to have the [[market power]] to set the price of a homogeneous product. In other words, every participant is a "price taker" as no participant influences the price of a product. In the real world, markets often experience [[imperfect competition]].

Forms of imperfect competition include [[monopoly]] (in which there is only one seller of a good), [[duopoly]] (in which there are only two sellers of a good), oligopoly (in which there are few sellers of a good), [[monopolistic competition]] (in which there are many sellers producing highly differentiated goods), [[monopsony]] (in which there is only one buyer of a good), and [[oligopsony]] (in which there are few buyers of a good). Firms under imperfect competition have the potential to be "price makers", which means that they can influence the prices of their products.

In [[partial equilibrium]] method of analysis, it is assumed that activity in the market being analysed does not affect other markets. This method aggregates (the sum of all activity) in only one market. [[General equilibrium|General-equilibrium]] theory studies various markets and their behaviour. It aggregates (the sum of all activity) across ''all'' markets. This method studies both changes in markets and their interactions leading towards equilibrium.<ref>{{unbulleted list citebundle|{{harvp|Blaug|2017|pp=347–349}}.|{{cite encyclopedia |author-link=Hal R. Varian |last=Varian |first=Hal R. |date=1987 |dictionary=The New Palgrave Dictionary of Economics |publisher=Palgrave Macmillan |edition= |editor-first1=John |editor-last1=Eatwell |editor-first2=Murray |editor-last2=Milgate |editor-first3=Peter |editor-last3=Newman |chapter-url=http://www.dictionaryofeconomics.com/article?id=pde1987_X001460 |doi=10.1057/9780230226203.3086 |isbn=978-0-333-78676-5 |chapter=Microeconomics |pages=1–5 |access-date=4 October 2017 |archive-date=5 October 2017 |archive-url=https://web.archive.org/web/20171005051338/http://www.dictionaryofeconomics.com/article?id=pde1987_X001460 |url-status=live }}}}</ref>

=== Production, cost, and efficiency ===
{{Main|Production (economics)|Opportunity cost|Economic efficiency|Production–possibility frontier}}
[[File:Production Possibilities Frontier Curve.svg|thumb|An example [[production–possibility frontier]] with illustrative points marked]]
In microeconomics, [[Production (economics)|production]] is the conversion of [[factor of production|inputs]] into [[Output (economics)|outputs]]. It is an economic process that uses inputs to create a [[good (economics)|commodity]] or a service for [[trade|exchange]] or direct use. Production is a [[Stock and flow|flow]] and thus a rate of output per period of time. Distinctions include such production alternatives as for [[Consumption (economics)|consumption]] (food, haircuts, etc.) vs. [[Investment#In economics or macroeconomics|investment goods]] (new tractors, buildings, roads, etc.), [[Public good (economics)|public good]]s (national defence, smallpox vaccinations, etc.) or [[private good]]s, and [[Guns versus butter model|"guns" vs "butter"]].

Inputs used in the production process include such primary [[factors of production]] as [[Labour (economics)|labour services]], [[Capital (economics)|capital]] (durable produced goods used in production, such as an existing factory), and [[Land (economics)|land]] (including natural resources). Other inputs may include [[intermediate good]]s used in production of final goods, such as the steel in a new car.

[[Economic efficiency]] measures how well a system generates desired output with a given set of inputs and available [[technology]]. Efficiency is improved if more output is generated without changing inputs. A widely accepted general standard is [[Pareto efficiency]], which is reached when no further change can make someone better off without making someone else worse off.

The [[production–possibility frontier]] (PPF) is an expository figure for representing scarcity, cost, and efficiency. In the simplest case, an [[economy]] can produce just two goods (say "guns" and "butter"). The PPF is a table or graph (as at the right) that shows the different quantity combinations of the two goods producible with a given technology and total factor inputs, which limit feasible total output. Each point on the curve shows [[Potential output|potential total output]] for the economy, which is the maximum feasible output of one good, given a feasible output quantity of the other good.

[[Scarcity]] is represented in the figure by people being willing but unable in the aggregate to consume ''beyond the PPF'' (such as at ''X'') and by the negative slope of the curve.<ref>{{cite encyclopedia|last=Montani |first=Guido |date=1987 |dictionary=The New Palgrave: A Dictionary of Economics |edition= |editor-first1=John |editor-last1=Eatwell |editor-first2=Murray |editor-last2=Milgate |editor-first3=Peter |editor-last3=Newman |chapter-url=http://www.dictionaryofeconomics.com/article?id=pde1987_X001949 |doi=10.1057/9780230226203.3485 |title=The New Palgrave Dictionary of Economics |isbn=978-0-333-78676-5 |chapter=Scarcity |pages=1–4 |access-date=4 October 2017 |archive-date=5 October 2017 |archive-url=https://web.archive.org/web/20171005051007/http://www.dictionaryofeconomics.com/article?id=pde1987_X001949 |url-status=live }}</ref> If production of one good ''increases'' along the curve, production of the other good ''decreases'', an [[inverse relationship]]. This is because increasing output of one good requires transferring inputs to it from production of the other good, decreasing the latter.

The [[slope]] of the curve at a point on it gives the [[trade-off#Examples from common life|trade-off]] between the two goods. It measures what an additional unit of one good costs in units forgone of the other good, an example of a ''real opportunity cost''. Thus, if one more Gun costs 100 units of butter, the opportunity cost of one Gun is 100 Butter. ''Along the PPF'', scarcity implies that choosing ''more'' of one good in the aggregate entails doing with ''less'' of the other good. Still, in a [[market economy]], movement along the curve may indicate that the [[utility|choice]] of the increased output is anticipated to be worth the cost to the agents.

By construction, each point on the curve shows ''[[productive efficiency]]'' in maximizing output for given total inputs. A point ''inside'' the curve (as at ''A''), is feasible but represents ''production inefficiency'' (wasteful use of inputs), in that output of ''one or both goods'' could increase by moving in a northeast direction to a point on the curve. Examples cited of such inefficiency include high [[unemployment]] during a [[business cycle|business-cycle]] [[recession]] or economic organisation of a country that discourages full use of resources. Being on the curve might still not fully satisfy [[allocative efficiency]] (also called [[Pareto efficiency]]) if it does not produce a mix of goods that consumers prefer over other points.

Much [[applied economics]] in [[public policy]] is concerned with determining how the efficiency of an economy can be improved. Recognizing the reality of scarcity and then figuring out how to organise society for the most efficient use of resources has been described as the "essence of economics", where the subject "makes its unique contribution."{{sfnp|Samuelson|Nordhaus|2010|loc= ch. 1, p. 5 (quotation) and sect. C, "The Production-Possibility Frontier", pp. 9–15; ch. 2, "Efficiency" sect.; ch. 8, sect. D, "The Concept of Efficiency}}

=== Specialisation ===
{{Main|Division of labour|Comparative advantage|Gains from trade}}
[[File:Late Medieval Trade Routes.jpg|thumb|upright=1.4|A map showing the main [[trade route]]s for goods within [[Late Middle Ages|late medieval Europe]]]]
Specialisation is considered key to economic efficiency based on theoretical and [[empirical]] considerations. Different individuals or nations may have different real opportunity costs of production, say from differences in [[stock and flow|stocks]] of [[human capital]] per worker or [[capital (economics)|capital]]/[[labor force|labour]] ratios. According to theory, this may give a [[comparative advantage]] in production of goods that make more intensive use of the relatively more abundant, thus ''relatively'' cheaper, input.

Even if one region has an [[absolute advantage]] as to the ratio of its outputs to inputs in every type of output, it may still specialise in the output in which it has a comparative advantage and thereby gain from trading with a region that lacks any absolute advantage but has a comparative advantage in producing something else.

It has been observed that a high volume of trade occurs among regions even with access to a similar technology and mix of factor inputs, including high-income countries. This has led to investigation of economies of [[Returns to scale|scale]] and [[economies of agglomeration|agglomeration]] to explain specialisation in similar but differentiated product lines, to the overall benefit of respective trading parties or regions.<ref>{{cite journal |author-link=Paul Krugman |last=Krugman |first=Paul |date=December 1980 |title=Scale Economies, Product Differentiation, and the Pattern of Trade |journal=[[American Economic Review]] |volume=70 |issue=5 |pages=950–959 |url=http://www.princeton.edu/~pkrugman/scale_econ.pdf |jstor=1805774 |access-date=16 August 2010 |archive-date=18 May 2013 |archive-url=https://web.archive.org/web/20130518075839/http://www.princeton.edu/~pkrugman/scale_econ.pdf |url-status=live }}</ref><ref>{{cite journal |first=William C. |last=Strange |date=2008 |editor-first1=Steven N. |editor-last1=Durlauf |editor-first2=Lawrence E. |editor-last2=Blume |journal=The New Palgrave Dictionary of Economics |publisher=Palgrave Macmillan |edition=2nd |url=http://www.dictionaryofeconomics.com/article?id=pde2008_U000064 |doi=10.1057/9780230226203.1769 |pages=533–536 |isbn=978-0-333-78676-5 |title=Urban agglomeration |access-date=16 August 2010 |archive-date=10 October 2017 |archive-url=https://web.archive.org/web/20171010211747/http://www.dictionaryofeconomics.com/article?id=pde2008_U000064 |url-status=live |url-access=subscription }}</ref>

The general theory of specialisation applies to trade among individuals, farms, manufacturers, [[Service (economics)|service]] providers, and [[economy|economies]]. Among each of these production systems, there may be a corresponding ''[[division of labour]]'' with different work groups specializing, or correspondingly different types of [[Capital (economics)|capital equipment]] and differentiated [[Land (economics)|land]] uses.<ref>{{unbulleted list citebundle
|1 = {{cite journal|last=Groenewegen |first=Peter |date=2008 |editor-first1=Steven N. |editor-last1=Durlauf |editor-first2=Lawrence E. |editor-last2=Blume |journal=The New Palgrave Dictionary of Economics |edition=2nd |url=http://www.dictionaryofeconomics.com/article?id=pde2008_D000176 |doi=10.1057/9780230226203.0401 |pages=517–526 |isbn=978-0-333-78676-5 |title=Division of labour |access-date=16 August 2010 |archive-date=10 October 2017 |archive-url=https://web.archive.org/web/20171010211714/http://www.dictionaryofeconomics.com/article?id=pde2008_D000176 |url-status=live |url-access=subscription }}
|2 = {{cite web |last=Johnson |first=Paul M. |date=2005 |url=http://www.auburn.edu/~johnspm/gloss/specialization |title=Specialization |website=A Glossary of Political Economy Terms |publisher=Department of Political Science, [[Auburn University]] |access-date=27 March 2008 |archive-date=29 January 2013 |archive-url=https://web.archive.org/web/20130129085436/http://www.auburn.edu/~johnspm/gloss/specialization |url-status=live }}
|3 = {{cite book|last1=Yang|first1=Xiaokai|last2=Ng|first2=Yew-Kwang|title=Specialization and Economic Organization: A New Classical Microeconomic Framework|url=https://books.google.com/books?id=xuG4AAAAIAAJ&pg=PP1|year=1993|publisher=North-Holland|isbn=978-0-444-88698-9}}
}}</ref>

An example that combines features above is a country that specialises in the production of high-tech knowledge products, as developed countries do, and trades with developing nations for goods produced in factories where labour is relatively cheap and plentiful, resulting in different in opportunity costs of production. More total output and utility thereby results from specializing in production and trading than if each country produced its own high-tech and low-tech products.

Theory and observation set out the conditions such that market [[price]]s of outputs and productive inputs select an allocation of factor inputs by comparative advantage, so that (relatively) [[Production-possibility frontier#Opportunity cost|low-cost]] inputs go to producing low-cost outputs. In the process, aggregate output may increase as a [[invisible hand|by-product]] or by [[mechanism design|design]].<ref>{{cite book|last=Cameron|first=Rondo E.|author-link=Rondo Cameron|title=A Concise Economic History of the World: From Paleolithic Times to the Present|url=https://books.google.com/books?id=aEHX63g1XsYC&pg=PA25|edition=2nd|year=1993|publisher=Oxford University Press|isbn=978-0-19-507445-1|pages=25–25, 32, 276–280|access-date=10 October 2017|archive-date=1 August 2020|archive-url=https://web.archive.org/web/20200801065517/https://books.google.com/books?id=aEHX63g1XsYC&pg=PA25|url-status=live}}</ref> Such specialisation of production creates opportunities for [[gains from trade]] whereby resource owners benefit from [[trade]] in the sale of one type of output for other, more highly valued goods. A measure of gains from trade is the ''increased income levels'' that trade may facilitate.<ref>{{unbulleted list citebundle|{{harvp|Samuelson|Nordhaus|2010|pages=37, 433, 435}}.|{{cite journal|last=Findlay |first=Ronald |date=2008 |editor-first1=Steven N. |editor-last1=Durlauf |editor-first2=Lawrence E. |editor-last2=Blume |journal=The New Palgrave Dictionary of Economics |publisher=Palgrave Macmillan |edition=2nd |url=http://www.dictionaryofeconomics.com/article?id=pde2008_C000254 |doi=10.1057/9780230226203.0274 |pages=28–33 |isbn=978-0-333-78676-5 |title=Comparative advantage |access-date=16 August 2010 |archive-date=11 October 2017 |archive-url=https://web.archive.org/web/20171011021521/http://www.dictionaryofeconomics.com/article?id=pde2008_C000254 |url-status=live |url-access=subscription }}|{{cite encyclopedia |last=Kemp |first=Murray C. |date=1987 |dictionary=The New Palgrave Dictionary of Economics |publisher=Palgrave Macmillan |editor-first1=John |editor-last1=Eatwell |editor-first2=Murray |editor-last2=Milgate |editor-first3=Peter |editor-last3=Newman |edition= |chapter-url=http://www.dictionaryofeconomics.com/article?id=pde1987_X000902 |doi=10.1057/9780230226203.2613 |pages=1–3 |isbn=978-0-333-78676-5 |chapter=Gains from trade |access-date=10 October 2017 |archive-date=10 October 2017 |archive-url=https://web.archive.org/web/20171010211136/http://www.dictionaryofeconomics.com/article?id=pde1987_X000902 |url-status=live }}}}</ref>

=== Supply and demand ===
{{Main|Supply and demand}}
[[File:Supply-demand-right-shift-demand.svg|thumb|The [[supply and demand]] model describes how prices vary as a result of a balance between product availability and demand. The graph depicts an increase in demand from D<sub>1</sub> to D<sub>2</sub> and the resulting increase in price and quantity required to reach a new equilibrium point on the supply curve (S).|alt=A graph depicting Quantity on the X-axis and Price on the Y-axis]]
[[Prices and quantities]] have been described as the most directly observable attributes of goods produced and exchanged in a [[market economy]].<ref>{{cite encyclopedia|last=Brody |first=A. |date=1987 |dictionary=The New Palgrave: A Dictionary of Economics |edition= |editor-first1=John |editor-last1=Eatwell |editor-first2=Murray |editor-last2=Milgate |editor-first3=Peter |editor-last3=Newman |chapter-url=http://www.dictionaryofeconomics.com/article?id=pde1987_X001748 |doi=10.1057/9780230226203.3325 |title=The New Palgrave Dictionary of Economics |pages=1–7 |isbn=978-0-333-78676-5 |chapter=Prices and quantities |access-date=10 October 2017 |archive-date=11 October 2017 |archive-url=https://web.archive.org/web/20171011071908/http://www.dictionaryofeconomics.com/article?id=pde1987_X001748 |url-status=live }}</ref> The theory of supply and demand is an organizing principle for explaining how prices coordinate the amounts produced and consumed. In [[microeconomics]], it applies to price and output determination for a market with [[perfect competition]], which includes the condition of no buyers or sellers large enough to have price-setting [[market power|power]].

For a given market of a [[Good (economics and accounting)|commodity]], ''demand'' is the relation of the quantity that all buyers would be prepared to purchase at each unit price of the good. Demand is often represented by a table or a graph showing price and quantity demanded (as in the figure). [[consumer theory|Demand theory]] describes individual consumers as [[rational choice theory|rationally]] choosing the most preferred quantity of each good, given income, prices, tastes, etc. A term for this is "constrained utility maximisation" (with income and [[Wealth (economics)|wealth]] as the [[budget constraint|constraints]] on demand). Here, [[utility]] refers to the hypothesised relation of each individual consumer for ranking different commodity bundles as more or less preferred.

The [[law of demand]] states that, in general, price and quantity demanded in a given market are inversely related. That is, the higher the price of a product, the less of it people would be prepared to buy (other things [[ceteris paribus|unchanged]]). As the price of a commodity falls, consumers move toward it from relatively more expensive goods (the [[substitution effect]]). In addition, [[purchasing power]] from the price decline increases ability to buy (the [[income effect]]). Other factors can change demand; for example an increase in income will shift the demand curve for a [[normal good]] outward relative to the origin, as in the figure. All determinants are predominantly taken as constant factors of demand and supply.

''Supply'' is the relation between the price of a good and the quantity available for sale at that price. It may be represented as a table or graph relating price and quantity supplied. Producers, for example business firms, are hypothesised to be ''profit maximisers'', meaning that they attempt to produce and supply the amount of goods that will bring them the highest profit. Supply is typically represented as a function relating price and quantity, if other factors are unchanged.

That is, the higher the price at which the good can be sold, the more of it producers will supply, as in the figure. The higher price makes it profitable to increase production. Just as on the demand side, the position of the supply can shift, say from a change in the price of a productive input or a technical improvement. The "Law of Supply" states that, in general, a rise in price leads to an expansion in supply and a fall in price leads to a contraction in supply. Here as well, the determinants of supply, such as price of substitutes, cost of production, technology applied and various factors inputs of production are all taken to be constant for a specific time period of evaluation of supply.

[[Market equilibrium]] occurs where quantity supplied equals quantity demanded, the intersection of the supply and demand curves in the figure above. At a price below equilibrium, there is a shortage of quantity supplied compared to quantity demanded. This is posited to bid the price up. At a price above equilibrium, there is a surplus of quantity supplied compared to quantity demanded. This pushes the price down. The [[Model (economics)|model]] of supply and demand predicts that for given supply and demand curves, price and quantity will stabilise at the price that makes quantity supplied equal to quantity demanded. Similarly, demand-and-supply theory predicts a new price-quantity combination from a shift in demand (as to the figure), or in supply.

=== Firms ===
{{Main|Theory of the firm|Industrial organisation|Business economics|Managerial economics}}

People frequently do not trade directly on markets. Instead, on the supply side, they may work in and produce through ''firms''. The most obvious kinds of firms are [[corporation]]s, [[partnerships]] and [[trusts]]. According to [[Ronald Coase]], people begin to organise their production in firms when the costs of doing business becomes lower than doing it on the market.<ref>{{cite journal |last=Coase |first=Ronald | author-link=Ronald Coase |year=1937 |title=The Nature of the Firm |journal=[[Economica]] |volume=4 |issue=16 |pages=386–405 |jstor=2626876 |doi=10.1111/j.1468-0335.1937.tb00002.x|title-link=The Nature of the Firm }}</ref> Firms combine labour and capital, and can achieve far greater [[economies of scale]] (when the average cost per unit declines as more units are produced) than individual market trading.

In [[perfect competition|perfectly competitive]] markets studied in the theory of supply and demand, there are many producers, none of which significantly influence price. [[Industrial organisation]] generalises from that special case to study the strategic behaviour of firms that do have significant control of price. It considers the structure of such markets and their interactions. Common market structures studied besides perfect competition include monopolistic competition, various forms of oligopoly, and monopoly.<ref>{{cite encyclopedia |last=Schmalensee |first=Richard |author-link=Richard L. Schmalensee |date=1987 |dictionary=The New Palgrave: A Dictionary of Economics |edition= |editor-first1=John |editor-last1=Eatwell |editor-first2=Murray |editor-last2=Milgate |editor-first3=Peter |editor-last3=Newman |chapter-url=http://www.dictionaryofeconomics.com/article?id=pde1987_X001118 |doi=10.1057/9780230226203.2788 |title=The New Palgrave Dictionary of Economics |pages=1–9 |isbn=978-0-333-78676-5 |chapter=Industrial organization |series=Students business book series |hdl=2027/uc1.$b37792 |publisher=Chicago |hdl-access=free |access-date=10 October 2017 |archive-date=11 October 2017 |archive-url=https://web.archive.org/web/20171011022150/http://www.dictionaryofeconomics.com/article?id=pde1987_X001118 |url-status=live }}</ref>

[[Managerial economics]] applies [[microeconomic]] analysis to specific decisions in business firms or other management units. It draws heavily from quantitative methods such as [[operations research]] and programming and from statistical methods such as [[regression analysis]] in the absence of certainty and perfect knowledge. A unifying theme is the attempt to [[Optimization (mathematics)|optimise]] business decisions, including unit-cost minimisation and profit maximisation, given the firm's objectives and constraints imposed by technology and market conditions.<ref>{{unbulleted list citebundle
|1 = {{cite encyclopedia |author=<!-- Staff Writers --> |date=5 May 2013 |title=Managerial Economics |encyclopedia=Encyclopædia Britannica Online |url=https://www.britannica.com/topic/managerial-economics |access-date=10 October 2017 |archive-date=11 October 2017 |archive-url=https://web.archive.org/web/20171011023121/https://www.britannica.com/topic/managerial-economics |url-status=live }}
|2 = {{cite encyclopedia|last=Hughes |first=Alan |date=1987 |dictionary=The New Palgrave Dictionary of Economics |location=London |publisher=Palgrave Macmillan |edition= |editor-first1=John |editor-last1=Eatwell |editor-first2=Murray |editor-last2=Milgate |editor-first3=Peter |editor-last3=Newman |chapter-url=http://www.dictionaryofeconomics.com/article?id=pde1987_X001379 |doi=10.1057/9780230226203.3017 |isbn=978-0-333-78676-5 |chapter=Managerial capitalism |pages=1–5 |access-date=10 October 2017 |archive-date=11 October 2017 |archive-url=https://web.archive.org/web/20171011072045/http://www.dictionaryofeconomics.com/article?id=pde1987_X001379 |url-status=live }} <!-- check definitions because entries say they went online in 2016 -->
}}</ref>

=== Uncertainty and game theory ===
{{Main|Information economics|Game theory|Financial economics}}

[[Uncertainty]] in economics is an unknown prospect of gain or loss, whether quantifiable as [[Risk#Risk and uncertainty|risk]] or not. Without it, household behaviour would be unaffected by uncertain employment and income prospects, [[financial market|financial]] and [[capital market]]s would reduce to exchange of a single [[financial instrument|instrument]] in each market period, and there would be no [[communication]]s industry.<ref>{{cite encyclopedia |author-link1=Mark J. Machina |last1=Machina |first1=Mark J. |title=The New Palgrave Dictionary of Economics |pages=190–197 |author-link2=Michael Rothschild |last2=Rothschild |first2=Michael |date=2008 |edition=2nd |editor-first1=Steven N. |editor-last1=Durlauf |editor-first2=Lawrence E. |editor-last2=Blume |chapter-url=http://www.dictionaryofeconomics.com/article?id=pde2008_R000152 |doi=10.1057/9780230226203.1442 |isbn=978-0-333-78676-5 |chapter=Risk |publisher=Palgrave Macmillan UK |access-date=2 March 2011 |archive-date=11 October 2017 |archive-url=https://web.archive.org/web/20171011071806/http://www.dictionaryofeconomics.com/article?id=pde2008_R000152 |url-status=live }}</ref> Given its different forms, there are various ways of representing uncertainty and modelling economic agents' responses to it.<ref>{{cite encyclopedia |last=Wakker |first=Peter P. |date=2008 |edition=second |editor-first1=Steven N. |editor-last1=Durlauf |editor-first2=Lawrence E. |editor-last2=Blume |chapter-url=http://www.dictionaryofeconomics.com/article?id=pde2008_U000005 |doi=10.1057/9780230226203.1753 |title=The New Palgrave Dictionary of Economics |pages=428–439 |isbn=978-0-333-78676-5 |chapter=Uncertainty |publisher=Palgrave Macmillan UK |access-date=2 March 2011 |archive-date=30 December 2010 |archive-url=https://web.archive.org/web/20101230071633/http://www.dictionaryofeconomics.com/article?id=pde2008_U000005 |url-status=live }}</ref>

[[Game theory]] is a branch of [[applied mathematics]] that considers [[Strategy#Strategies in game theory|strategic interactions]] between agents, one kind of uncertainty. It provides a mathematical [[microfoundation|foundation]] of [[industrial organisation]], discussed above, to model different types of firm behaviour, for example in a solipsistic industry (few sellers), but equally applicable to wage negotiations, [[Bargaining#Game theory|bargaining]], [[Contract theory|contract design]], and any situation where individual agents are few enough to have perceptible effects on each other. In [[behavioural economics]], it has been used to model the strategies [[Agent (economics)|agents]] choose when interacting with others whose interests are at least partially adverse to their own.<ref>{{unbulleted list citebundle|{{harvp|Samuelson|Nordhaus|2010|loc=ch. 11, "Uncertainty and Game Theory" and [end] Glossary of Terms, "Economics of information", "Game theory", and "Regulation"}}.|{{cite book |last=Camerer |first=Colin F. |author-link=Colin F. Camerer |date=2003 |title=Behavioral Game Theory: Experiments in Strategic Interaction |url=https://books.google.com/books?id=cr_Xg7cRvdcC&pg=PP1 |chapter=Chapter 1: Introduction |chapter-url=http://assets.press.princeton.edu/chapters/i7517.pdf |publisher=Princeton University Press |isbn=978-1-4008-4088-5}}}}</ref>

In this, it generalises maximisation approaches developed to analyse market actors such as in the [[supply and demand]] model and allows for incomplete information of actors. The field dates from the 1944 classic ''[[Theory of Games and Economic Behavior]]'' by [[John von Neumann]] and [[Oskar Morgenstern]]. It has significant applications seemingly outside of economics in such diverse subjects as the formulation of [[nuclear strategies]], [[Game theory#Philosophy|ethics]], [[Game theory#Political science|political science]], and [[evolutionary biology]].<ref>{{cite encyclopedia |title=Game Theory |dictionary=The New Palgrave Dictionary of Economics |url=http://www.dictionaryofeconomics.com/article?id=pde2008_G000007 |access-date=2 March 2011 |last=Aumann |first=R. J. |date=2008 |author-link=Robert Aumann |editor-last1=Durlauf |editor-first1=Steven N. |edition=2nd |archive-url=https://web.archive.org/web/20101229164520/http://www.dictionaryofeconomics.com/article?id=pde2008_G000007 |archive-date=29 December 2010 |editor-first2=Lawrence E. |editor-last2=Blume |url-status=live}}</ref>

[[Risk aversion]] may stimulate activity that in well-functioning markets smooths out risk and communicates information about risk, as in markets for [[insurance]], commodity [[futures market|futures contracts]], and [[financial instruments]]. [[Financial economics]] or simply [[finance]] describes the allocation of financial resources. It also analyses the pricing of financial instruments, the [[capital structure|financial structure]] of companies, the efficiency and fragility of [[financial market]]s,<ref>{{cite journal |author-link1=Ben Bernanke |last1=Bernanke |first1=Ben |author-link2=Mark Gertler (economist) |first2=Mark |last2=Gertler |date=February 1990 |title=Financial Fragility and Economic Performance |journal=Quarterly Journal of Economics |volume=105 |issue=1 |pages=87–114 |jstor=2937820 |doi=10.2307/2937820 |s2cid=155048192 |url=http://www.nber.org/papers/w2318.pdf |access-date=3 September 2019 |archive-date=26 November 2019 |archive-url=https://web.archive.org/web/20191126210951/https://www.nber.org/papers/w2318.pdf |url-status=live }}</ref> [[Financial crisis|financial crises]], and related government policy or [[Financial regulation|regulation]].<ref>{{cite encyclopedia |title=The New Palgrave Dictionary of Economics |editor-first1=Steven N. |editor-last1=Durlauf |editor-first2=Lawrence E. |editor-last2=Blume |edition=2nd |date=2008}}</ref><ref>{{cite encyclopedia |author-link=Stephen Ross (economist) |last=Ross |first=Stephen A. |title=Finance |url=http://www.dictionaryofeconomics.com/article?id=pde2008_F000071 }}</ref><ref>{{cite encyclopedia |last1=Burnside |first1=Craig |first2=Martin |last2=Eichenbaum |first3=Sergio |last3=Rebelo |title=Currency Crises Models |url=http://www.dictionaryofeconomics.com/article?id=pde2008_S000204 |access-date=2 March 2011 |archive-date=26 March 2012 |archive-url=https://web.archive.org/web/20120326015628/http://www.dictionaryofeconomics.com/article?id=pde2008_S000204 |url-status=live }}</ref><ref>{{cite encyclopedia |last=Kaminsky |first=Graciela Laura |title=Currency Crises |url=http://www.dictionaryofeconomics.com/article?id=pde2008_C000468 |access-date=2 March 2011 |archive-date=26 March 2012 |archive-url=https://web.archive.org/web/20120326015551/http://www.dictionaryofeconomics.com/article?id=pde2008_C000468 |url-status=live }}
</ref><ref>{{cite encyclopedia |last=Calomiris |first=Charles W. |title=Banking Crises |url=http://www.dictionaryofeconomics.com/article?id=pde2008_B000051 |access-date=2 March 2011 |archive-date=3 January 2015 |archive-url=https://web.archive.org/web/20150103021252/http://www.dictionaryofeconomics.com/article?id=pde2008_B000051 |url-status=live }}</ref>

Some market organisations may give rise to inefficiencies associated with uncertainty. Based on [[George Akerlof]]'s "[[Market for Lemons]]" article, the [[paradigm]] example is of a dodgy second-hand car market. Customers without knowledge of whether a car is a "lemon" depress its price below what a quality second-hand car would be.<ref>{{cite journal |last=Akerlof |first=George A. |date=August 1970 |title=The Market for 'Lemons': Quality Uncertainty and the Market Mechanism |journal=Quarterly Journal of Economics |volume=84 |issue=3 |pages=488–500 |jstor=1879431 |doi=10.2307/1879431 |s2cid=6738765 |url=http://hydrogen.its.ucdavis.edu/eec/education/EEC-classes/eeclimate/class-readings/akerlof-the%20market%20for%20lemons.pdf |archive-url=https://web.archive.org/web/20110818045155/http://hydrogen.its.ucdavis.edu/eec/education/EEC-classes/eeclimate/class-readings/akerlof-the%20market%20for%20lemons.pdf |archive-date=18 August 2011}}</ref> [[Information asymmetry]] arises here, if the seller has more relevant information than the buyer but no incentive to disclose it. Related problems in insurance are [[adverse selection]], such that those at most risk are most likely to insure (say reckless drivers), and [[moral hazard]], such that insurance results in riskier behaviour (say more reckless driving).<ref name="sciencedirect">{{cite encyclopedia |last1=Lippman |first1=S.S. |title=International Encyclopedia of the Social & Behavioral Sciences |pages=7480–7486 |first2=J.J. |last2=McCall |date=2001 |publisher=Elsevier |doi=10.1016/B0-08-043076-7/02244-0|isbn=978-0-08-043076-8 |chapter=Information, Economics of }}</ref>

Both problems may raise insurance costs and reduce efficiency by driving otherwise willing transactors from the market ("[[incomplete markets]]"). Moreover, attempting to reduce one problem, say adverse selection by mandating insurance, may add to another, say moral hazard. [[Information economics]], which studies such problems, has relevance in subjects such as insurance, [[contract theory|contract law]], [[mechanism design]], [[monetary economics]], and [[health economics|health care]].<ref name="sciencedirect" /> Applied subjects include market and legal remedies to spread or reduce risk, such as warranties, government-mandated partial insurance, [[restructuring]] or [[bankruptcy law]], inspection, and [[Regulatory economics|regulation]] for quality and information disclosure.<ref>{{harvp|Samuelson|Nordhaus|2010|loc=ch. 11, "Uncertainty and Game Theory" and [end] Glossary of Terms, "Economics of information", "Game theory", and "Regulation"}}</ref><ref>{{cite book |title=The New Palgrave Dictionary of Economics |editor-first1=Steven N. |editor-last1=Durlauf |editor-first2=Lawrence E. |editor-last2=Blume |publisher=Palgrave Macmillan |edition=2nd |date=2008}}</ref><ref>{{cite encyclopedia |last=Wilson |first=Charles |title=Adverse Selection |url=http://www.dictionaryofeconomics.com/article?id=pde2008_A000040 |access-date=2 March 2011 |archive-date=16 October 2017 |archive-url=https://web.archive.org/web/20171016225939/http://www.dictionaryofeconomics.com/article?id=pde2008_A000040 |url-status=live }}</ref><ref>{{cite encyclopedia |last=Kotowitz |first=Y. |title=Moral Hazard |url=http://www.dictionaryofeconomics.com/article?id=pde2008_M000259 |access-date=2 March 2011 |archive-date=17 October 2017 |archive-url=https://web.archive.org/web/20171017041859/http://www.dictionaryofeconomics.com/article?id=pde2008_M000259 |url-status=live }}
</ref><ref>{{cite encyclopedia |author-link=Roger B. Myerson |last=Myerson |first=Roger B. |title=Revelation Principle |url=http://www.dictionaryofeconomics.com/article?id=pde2008_R000137 |access-date=2 March 2011 |archive-date=29 December 2010 |archive-url=https://web.archive.org/web/20101229164407/http://www.dictionaryofeconomics.com/article?id=pde2008_R000137 |url-status=live }}</ref>

=== Market failure ===
{{Main|Market failure}}
{{see also|Government failure|Information economics|Environmental economics|Ecological economics|Agricultural economics}}
[[File:Smokestack in Detroit.jpg|thumb|[[Pollution]] can be a simple example of market failure; if [[costs of production]] are not borne by producers but are by the environment, accident victims or others, then prices are distorted.|alt=A smokestack releasing smoke]]
[[File:Field Trip- water sampling.jpg|thumb|An [[environmental scientist]] sampling water|alt=A woman takes samples of water from a river.]]
The term "[[market failure]]" encompasses several problems which may undermine standard economic assumptions. Although economists categorise market failures differently, the following categories emerge in the main texts.{{efn|Compare with [[Nicholas Barr]] (2004), whose list of market failures is melded with failures of economic assumptions, which are (1) producers as price takers (i.e. presence of oligopoly or monopoly; but why is this not a product of the following?) (2) equal power of consumers (what labour lawyers call an imbalance of bargaining power) (3) complete markets (4) public goods (5) external effects (i.e. externalities?) (6) increasing returns to scale (i.e. practical monopoly) (7) perfect information (in {{cite book |title=The Economics of the Welfare State |url=https://books.google.com/books?id=gWxfQgAACAAJ&pg=PP1 |edition=4th |year=2004 |publisher=Oxford University Press |isbn=978-0-19-926497-1 |pages=72–79}}).<br />&nbsp;&nbsp; • [[Joseph E. Stiglitz]] (2015) classifies market failures as from failure of competition (including [[natural monopoly]]), [[information asymmetries]], [[incomplete markets]], [[externalities]], [[Public good (economics)|public good]] situations, and [[macroeconomic]] disturbances (in {{cite book |title=Economics of the Public Sector |chapter-url=https://books.google.com/books?id=miPeCgAAQBAJ&pg=PP1 |edition=4th International Student |year=2015 |publisher=W.W. Norton & Company |isbn=978-0-393-93709-1 |pages=81–100 |chapter=Chapter 4: Market Failure}}).}}

[[Information asymmetries]] and [[incomplete markets]] may result in economic inefficiency but also a possibility of improving efficiency through market, legal, and regulatory remedies, as discussed above.

[[Natural monopoly]], or the overlapping concepts of "practical" and "technical" monopoly, is an extreme case of ''failure of competition'' as a restraint on producers. Extreme [[economies of scale]] are one possible cause.

[[Public goods]] are goods which are under-supplied in a typical market. The defining features are that people can consume public goods without having to pay for them and that more than one person can consume the good at the same time.

[[Externalities]] occur where there are significant social costs or benefits from production or consumption that are not reflected in market prices. For example, air pollution may generate a negative externality, and education may generate a positive externality (less crime, etc.). Governments often tax and otherwise restrict the sale of goods that have negative externalities and subsidise or otherwise promote the purchase of goods that have positive externalities in an effort to correct the price [[distortions (economics)|distortions]] caused by these externalities.<ref>{{cite encyclopedia |author-link=Jean-Jacques Laffont |last=Laffont |first=J.J. |date=1987 |dictionary=The New Palgrave Dictionary of Economics |edition= |editor-first1=John |editor-last1=Eatwell |editor-first2=Murray |editor-last2=Milgate |editor-first3=Peter |editor-last3=Newman |pages=263–265 |chapter-url=http://www.dictionaryofeconomics.com/article?id=pde1987_X000773 |doi=10.1057/9780230226203.2520 |isbn=978-0-333-78676-5 |chapter=Externalities |access-date=16 October 2017 |archive-date=16 October 2017 |archive-url=https://web.archive.org/web/20171016230115/http://www.dictionaryofeconomics.com/article?id=pde1987_X000773 |url-status=live }}</ref> Elementary demand-and-supply theory predicts equilibrium but not the speed of adjustment for changes of equilibrium due to a shift in demand or supply.{{sfn|Blaug|2017|p=347}}

In many areas, some form of [[price stickiness]] is postulated to account for quantities, rather than prices, adjusting in the short run to changes on the demand side or the supply side. This includes standard analysis of the [[business cycle]] in [[macroeconomics]]. Analysis often revolves around causes of such price stickiness and their implications for reaching a hypothesised long-run equilibrium. Examples of such price stickiness in particular markets include wage rates in labour markets and posted prices in markets [[Imperfect competition|deviating]] from [[perfect competition]].

Some specialised fields of economics deal in market failure more than others. The [[economics of the public sector]] is one example. Much [[environmental economics]] concerns externalities or "[[public bad]]s".

[[Policy]] options include regulations that reflect [[cost–benefit analysis]] or market solutions that change incentives, such as [[Emissions trading|emission fees]] or redefinition of property rights.<ref>{{unbulleted list citebundle
|1 = {{cite encyclopedia |last1=Kneese |first1=Allen V. |first2=Clifford S. |last2=Russell |date=1987 |dictionary=The New Palgrave Dictionary of Economics |edition= |editor-first1=John |editor-last1=Eatwell |editor-first2=Murray |editor-last2=Milgate |editor-first3=Peter |editor-last3=Newman |pages=159–164 |chapter-url=http://www.dictionaryofeconomics.com/article?id=pde1987_X000715 |doi=10.1057/9780230226203.2480 |isbn=978-0-333-78676-5 |chapter=Environmental economics |author1-link=Allen V. Kneese |access-date=16 October 2017 |archive-date=30 December 2010 |archive-url=https://web.archive.org/web/20101230143754/http://www.dictionaryofeconomics.com/article?id=pde1987_X000715 |url-status=live |doi-access=free }}
|2 = {{harvp|Samuelson|Nordhaus|2010|loc=ch. 18, "Protecting the Environment."}}
}}</ref>

=== Welfare ===
{{main|Welfare economics}}

Welfare economics uses microeconomics techniques to evaluate [[well-being]] from [[Allocation of resources|allocation]] of [[factors of production|productive factors]] as to desirability and [[economic efficiency]] within an [[economy]], often relative to competitive [[general equilibrium]].<ref>{{Cite encyclopedia |last=Deardorff |first=Alan V. |dictionary=Deardorffs' Glossary of International Economics |date=2016 |orig-date=2006 |title=Welfare economics |via=Alan Deardorff at University of Michigan |url=http://www-personal.umich.edu/~alandear/glossary/w.html#WelfareEconomics |archive-url=https://web.archive.org/web/20170320065124/http://www-personal.umich.edu/~alandear/glossary/w.html |archive-date=2017-03-20 }}</ref> It analyses ''social [[Well-being|welfare]]'', however [[Social welfare function|measured]], in terms of economic activities of the individuals that compose the theoretical society considered. Accordingly, individuals, with associated economic activities, are the [[methodological individualism|basic units]] for aggregating to social welfare, whether of a group, a community, or a society, and there is no "social welfare" apart from the "welfare" associated with its individual units.