UTULITY AND SATISFACTION - William Jevons ( , English economist) - Utility is the satisfaction derived from consuming a good. U=f(X, Y) X and Y are two goods - Marginal utility is the extra utility derived from consuming an extra unit of the good. MU X = ∂U/∂X - Marginal utility diminishes as more of a good is consumed. This is called the law of diminishing marginal utility. - By using the law of diminishing marginal utility we can derive the demand curve - Demand is inversely related to price. This means that consumers will only buy more of a good if the price falls because each extra unit consumed gives less pleasure than the previous one. - There are exceptions to the law of demand: 1.Addictive goods, such as drugs or alcohol, seem to be exceptions—the more they are consumed the more they are enjoyed. 2.The principle also makes certain assumptions, such as “consumption should be continuous.” Eating a whole box of chocolates at one time, for instance, is more likely to demonstrate the principle of DMU than eating them spaced out over a day. An applications of the law of diminishing marginal utility: - If the government is to take 1 dollar from the rich and give it to a very poor person, the total utility of the society should increase. More equal distribution of income - Utility theory has been extended to situations in which individuals have to make decisions in the face of uncertainty and risk. Leonard J. Savage: Decisions are made on the basis of not just utility but risk. There are risk-loving and risk-averse people.

TOTAL UTULITY AND MARGINAL UTILITY - William Jevons ( , English economist)

THE COMPETITIVE MARKET Assumptions: 1.Large number of firms and consumers/profit maximization-utility maximization 2.Identical product – homogeneity 3.Free entry and exit for firms 4.Full information (“going price” is known by every buyer; cost of production is known, etc.; Law of one price) Example: Foreign currency market (many buyers and sellers; homogeneous; easy entry and exit) The graph of a firm making excess profit: Firms are price-takers not price-makers; price is determined by the industry In the long run only normal profit (in which case price just covers the costs of production) is possible for competitive markets, due to free entry and exit. However, if there is monopoly excess profit is possible in the long run. Monopoly charges a higher price and produces less output compared to perfect competition. Controversies Around Marshall’s Model of Perfect Competition 1.There are few – if any – real industries that come close to the assumptions required for the model to be useful. Not even currency and agricultural markets are perfectly competitive due to the existence of large firms and government manipulation. Only a theoretical, ideal form of market structure; used as a benchmark against other market forms 2.It is said that there is no competition in the model. Firms make identical products, react passively to prices and accept normal prices. This is a long way from the situation suggested by Smith – firms make different, higher-quality products; introduce new technologies to reduce costs 3.Friedrich Hayek: Competition is a dynamic discovery process, in which entrepreneurs seek new profit opportunities

SPENDING PARADOXES Sir Robert Giffen ( 1837 – 1910), was a Scottish statistician and economist. The concept of a Giffen good is named after him. Commodities for which demand rises as their prices rise are known as Giffen goods. Giffen goods rely on a number of assumptions:  The commodity has to be an inferior good  The consumers must spend a large portion of their income on this product  There must be no alternative to the product Income and substitution effects: When the price of a commodity changes demand changes due to two effects. 1.Substitition effect: Relative price changes; the effect is negative 2.Income effect: Purchasing power changes; the effect may be negative or positive

SPENDING PARADOXES  Alfred Marshall wrote in the third (1895) edition of his Principles of Economics: As Mr. 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. Scholars have not been able to identify any passage in Giffen's writings where he pointed this out.  Francis Edgeworth ( , English economist) criticises Marshall in relation to Giffen goods on the basis of scant evidence.  Veblen goods: Demand for these goods increase as their prices rise. Unlike Giffen goods, however, which must be inferior, these goods must signal high status. The concept of a Veblen good is named after him. The theory of Conspicuous consumption  Thorstein Bunde Veblen (1857 – 1929, American economist) was an economist and sociologist, and leader of the institutional economics movement. Besides his technical work he was a popular and witty critic of capitalism, as shown by his best known book The Theory of Leisure Class (1899).  Robert Jensen and Nolan Miller: Evidence of a Giffen good: rice for poor families in China

ECONOMIC EQUILIBRIUM (OPTIONAL) Newton had found laws of motion – Léon Walras ( , a French economist) thought if it was possible to find similar relationships in the complex changing world of markets? ((I. Every object in a state of uniform motion tends to remain in that state of motion unless an external force is applied to it. It is called law of inertia (eylemsizlik kanunu: dış kuvvet tarafından hareket ettirilmediği sürece hareket halindeki cisimlerin hareket halinde kaldıklarını ve hareketsiz olan cisimlerin de hareketsiz kaldıklarını belirten kanun) II. The relationship between an object's mass m, its acceleration a, and the applied force F is F = ma III. For every action there is an equal and opposite reaction.)) Francis Edgeworth in his Mathematical Psychics explored relationships between economic variables and formulated them as equations. Johann von Thünen (1783 – 1850) developed equations for a fair working wage and the most profitable use of land. Léon Walras is considered, by some, the greatest of all economists. He thought that it is possible to make economics a pure moral science; his general equilibrium theory was devised to explain the production, consumption and prices across an entire economy. He thought that every thing depends on everything else.

ECONOMIC EQUILIBRIUM (OPTIONAL) Walras derived two conclusions from his studies: 1.A state of general equilibrium is theoretically possible 2.Wherever the economy started, a free market could move it towards general equilibrium Flaws in the model: 1.The world is too complex and chaotic for a true state of equilibrium 2.Walras’s complex equations were too difficult - John von Neumann: negative prices -John Maynard Keynes: economies are never in equilibrium - Kenneth Arrow ( ), Lionel Wilfred McKenzie (1919 – 2010) and Gérard Debreu ( ) derived conditions under which Walras’s general economic equilibrium would hold.

EFFICIENCY AND FAIRNESS (OPTIONAL) - Utilitarians: the happiness of individuals can be measured and added up – cardinal utility - Vilfredo Pareto (1848 – 1923, an Italian economist): Ranking of relative happiness – ordinal utility - Pareto optimality or Pareto efficiency: If everyone follows their own tastes, society will soon reach a point where no one can be made better off without hurting someone else. It could be expressed in two dimensions: - Efficiency in consumption: A redistribution of resources from some consumers to others cannot cause some utilities to increase without a loss in others - Efficiency in production: A reallocation of resources from one use to another cannot cause some outputs to increase without a loss in other outputs - Production possibility curve: A graph that shows the various combinations of the amounts of two goods that could be produced by using a fixed amount of recourses. - Efficiency and fairness are two different things.