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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.
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 modelling, 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.
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 inefficiences 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 modelling.
Attempts to determine how supply and demand interact began with Adam Smith's The Wealth of Nations, first published in 1776. In this book, he mostly assumed that the supply price was fixed, but that the demand would increase or decrease as the price decreased or increased. David Ricardo in 1817 published the book Principles of Political Economy and Taxation , in which the first idea of an economic model was proposed. In this, he more rigoursly laid down the idea of the assumptions that were used to build his ideas of supply and demand.
During the late 19th century the marginalist school of thought emerged. This field mainly was started by Stanley Jevons, Carl Menger, and Léon Walras. The key idea was that the price was set by the most expensive price, i.e. the price at the margin. This was a substantial improvement over Adam Smith's thoughts on determining the supply price.
Finally, most of the basics of the modern theory of supply and demand was finalized by Alfred Marshall and Léon Walras when they combined the ideas about supply and the ideas about demand and began looking at the equilbrium point where the two curves crossed. They also began looking at the effect of markets on each other. Since the late 19th century, the theory of supply and demand has mainly been unchanged. Most of the work has been in examining the exceptions to the model (like oligarchy, transaction costs, non-rationality).
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