Origin of the Idea

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11.1 Monopolistic Competition

The year 1933 was a watershed year for development of the theory of monopolistic competition. Two economists, Edward Chamberlin (1899-1967) and Joan Robinson (1903-1983), working independently, each published theories of imperfect competition.

Born in La Conner, Washington, Chamberlin did his undergraduate work at the University of Iowa, and earned his Ph.D. from Harvard, where he would later go on to teach. His work, The Theory of Monopolistic Competition, merged theories of monopoly and perfect competition to form the model illustrated in the text.

Robinson, an English economist and student of Alfred Marshall, published The Economics of Imperfect Competition just a few months after Chamberlin's work came out. In this book, she not only developed the theory of monopolistic competition similar to that of Chamberlin, but also a theory of monopsony – a single buyer. Her monopsony model is discussed in a later chapter of the textbook.

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11.2 Game Theory

Game theory was developed by John von Neumann (1903-1957) and Oskar Morganstern (1902-1977). In 1944, the Princeton University colleagues authored Theory of Games and Economic Behavior. John von Neumann was first and foremost a physicist. Born in Hungary, he taught physics at the universities of Berlin and Hamburg before migrating to the United States to join the faculty at Princeton. While at Princeton he wrote Mathematical Foundations of Quantum Mechanics, a well-known work in physics. While economists recognize von Neumann for his contributions to game theory, his more significant accomplishment was as a co-inventor of the atomic bomb.

Morganstern, an economist at Princeton, migrated to the United States from Vienna in 1925. Despite their development of game theory, von Neumann and Morganstern never won the Nobel Prize in economics. There were, however, later game theorists who did. In 1994, John Harsanyi, John Nash, and Reinhard Selten shared the prize for their work on game theory. Of particular interest is John Nash (b. 1927), who, at age 22, published two articles on game theory while at MIT. These highly mathematical papers developed what is now referred to as Nash Equilibrium. A Nash equilibrium occurs when neither party in a game can improve their expected outcome (also called a payoff) by changing their present strategy. After Nash's accomplishment, his life took a sad twist. Nine years after publishing his famous works, he was diagnosed with paranoid schizophrenia and involuntarily committed to a Boston-area hospital. After his release, Nash moved to Princeton, New Jersey, where he has lived the last 30 years, still dealing with his condition. To the locals in Princeton, news of the Nobel Prize came as something of a shock. As Time magazine reported:

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When photographs of John Nash appeared in the press last week, a common reaction in and around Princeton, New Jersey, was a shock of recognition: "Oh, my gosh, it's him!" Nash, who shared the Economics Prize with John Harsanyi of the University of California and Reinhard Selten of the University of Bonn, is a familiar eccentric in the university town – a quiet, detached man who frequently spends his time riding the local "Dinky" train on its short hop between Princeton and Princeton Junction, reading newspapers discarded by other passengers. Some knew him as the author of the enormously complicated mathematical equations that appeared on [Princeton] classroom blackboards from time to time – the product of a splendid but troubled mind working out his thoughts when no one was around.⁽¹⁾

Besides its use in oligopoly theory, as shown in the text, game theory is applied in both micro- and macroeconomics to understanding areas such as collective bargaining, international trade, and monetary policy.

Photograph courtesy of: (c)Corbis # CBO40327;