More than any other economist, Paul Samuelson raised the level of mathematical analysis in the profession. Until the late 1930s, when Samuelson started his stunning and steady stream of articles, economics was typically understood in terms of verbal explanations and diagrammatic models. Samuelson wrote his first published article, “A Note on the Measurement of Utility,” as a twenty-one-year-old doctoral student at Harvard. He introduced the concept of “revealed preference” in a 1938 article. His goal was to be able to tell by observing a consumer’s choices whether he or she was better off after a change in prices, and indeed, Samuelson determined the circumstances under which one could tell. The consumer revealed by choices his or her preferences—hence the term “revealed preferences.” Samuelson’s magnum opus, which did more than any other single book to spread the mathematical revolution in economics, is Foundations of Economic Analysis. Based on his Harvard Ph.D. dissertation, this book shows how virtually all economic behavior can be understood as maximizing or minimizing subject to a constraint. John R. Hicks did something similar in his 1939 book, Value and Capital. But while Hicks relegated the math to appendixes, “Samuelson,” wrote former Samuelson student Stanley Fischer, “flaunts his in the text.”1 Samuelson’s mathematical techniques brought a new rigor to economics. As fellow Nobel Prize winner Robert Lucas put it, “He’ll take these incomprehensible verbal debates that go on and on and never end and just end them; formulate the issue in such a way that the question is answerable, and then get the answer.”2 Samuelson is among the last generalists to be incredibly productive in a number of fields in economics. He has contributed fundamental insights in consumer theory and welfare economics, international trade, finance theory, capital theory, dynamics and general equilibrium, and macro-economics.     Swedish economist Bertil Ohlin had argued that international trade would tend to equalize the prices of factors of production. Trade between India and the United States, for example, would narrow wage-rate differentials between the two countries. Samuelson, using mathematical tools, showed the conditions under which the differentials would be driven to zero. The theorem he proved is called the factor price equalization theorem. In finance theory, which he took up at age fifty, Samuelson did some of the initial work that showed that properly anticipated futures prices should fluctuate randomly. Samuelson also did pathbreaking work in capital theory, but his contributions are too complex to describe in just a few sentences. Economists had long believed that there are goods that the private sector cannot provide because of the difficulty of charging those who benefit from them. National defense is one of the best examples of such a good. Samuelson, in a 1954 article, was the first to attempt a rigorous definition of a public good. In macroeconomics Samuelson demonstrated how combining the accelerator theory of investment with the Keynesian income determination model explains the cyclical nature of business cycles. He also introduced the concept of the neoclassical synthesis—a synthesis of the old neoclassical microeconomics and the new (in the 1950s) Keynesian macroeconomics. According to Samuelson, government intervention via fiscal and monetary policies is required to achieve full employment. At full employment the market works well, except at providing public goods and handling problems of externalities. james tobin called the neoclassical synthesis one of Samuelson’s greatest contributions to economics. In Linear Programming and Economic Analysis Samuelson and coauthors Robert Dorfman and Robert Solow applied optimization techniques to price theory and growth theory, thereby integrating these previously segregated fields. A prolific writer, Samuelson has averaged almost one technical paper a month for more than fifty years. Some 338 of his articles are contained in the five-volume Collected Scientific Papers (1966–1986). He also has revised his immensely popular textbook, Economics, nearly every three years since 1948; it has been translated into many languages. Samuelson once said, “Let those who will write the nation’s laws if I can write its textbooks.” In 1970 Paul Samuelson became the first American to receive the Nobel Prize in economics. It was awarded “for the scientific work through which he has developed static and dynamic economic theory and actively contributed to raising the level of analysis in economic science.” Samuelson began teaching at the Massachusetts Institute of Technology in 1940 at the age of twenty-six, becoming a full professor six years later. He remains there at the time of this writing (2006). In addition to being honored with the Nobel Prize, Samuelson also earned the John Bates Clark Award in 1947—awarded for the most outstanding work by an economist under age forty. He was president of the American Economic Association in 1961. Samuelson was born in Gary, Indiana. At age sixteen he enrolled at the University of Chicago, where he studied under Frank Knight, Jacob Viner, and other greats, and alongside fellow budding economists Milton Friedman and George Stigler, who were then graduate students. Samuelson went on to do his graduate work at Harvard University. Samuelson, like Friedman, had a regular column in Newsweek from 1966 to 1981. But unlike Friedman, he did not and does not have a passionate belief in free markets—or for that matter in government intervention in markets. His pleasure seemed to come from providing new proofs, demonstrating technical finesse, and turning a clever phrase. Samuelson himself once said: “Once I asked my friend the statistician Harold Freeman, ‘Harold, if the Devil came to you with the bargain that, in exchange for your immortal soul, he’d give you a brilliant theorem, would you do it?’ ‘No,’ he replied, ‘but I would for an inequality.’ I like that answer.” Selected Works   1938. “A Note on the Pure Theory of Consumers’ Behavior.” Economica, n.s., 5 (February): 61–71. 1939. “Interactions Between the Multiplier Analysis and the Principle of Acceleration.” Review of Economics and Statistics (May): 75–78. 1947. Foundations of Economic Analysis. Cambridge: Harvard University Press. 2d ed. 1982. 1948 (with William Nordhaus). Economics. 18th ed. New York: McGraw-Hill, 2004. 1948. “International Trade and the Equalization of Factor Prices.” Economic Journal 58 (June): 163–184. 1954. “The Pure Theory of Public Expenditure.” Review of Economics and Statistics (November): 387–389. 1958 (with Robert Dorfman and Robert Solow). Linear Programming and Economic Activity. New York: McGraw-Hill.   Footnotes 1. Stanley Fischer, “Paul Anthony Samuelson,” in John Eatwell, Murray Milgate, and Peter Newman, eds., The New Palgrave: A Dictionary of Economics, vol. 4 (New York: Stockton Press, 1987), p. 235.   2. Arjo Klamer, Conversations with Economists (Totowa, N.J.: Rowman and Allanheld, 1983), p. 49.   (0 COMMENTS)

  Although recognized equally for his contributions to economic policy, methodology, and the history of ideas, Lionel Robbins made his name as a theorist. In the 1920s he attacked Alfred Marshall’s concept of the “representative firm,” arguing that the concept was no help in understanding the equilibrium of the firm or of an industry. He also did some of the earliest work on labor supply, showing that an increase in the wage rate had an ambiguous effect on the amount of labor supplied (see supply). Robbins’s most famous book is An Essay on the Nature and Significance of Economic Science, one of the best-written prose pieces in economics. That book contains three main thoughts. First is Robbins’s famous all-encompassing definition of economics, still used to define the subject today: “Economics is the science which studies human behavior as a relationship between given ends and scarce means which have alternative uses” (p. 16). Second is the bright line Robbins drew between positive and normative issues. Positive issues are questions about what is; normative issues are about what ought to be. Robbins argued that the economist qua economist should be studying what is rather than what ought to be. Economists still widely share Robbins’s belief. Robbins’s third major thought is that economics is a system of logical deduction from first principles. He was skeptical about the feasibility and usefulness of empirical verification. In this view he resembled the Austrians—not surprising since he was a colleague of the famous Austrian economist Friedrich Hayek, whom he had brought from Vienna in 1928. In 1930, when Keynesianism was starting to take over in Britain, Robbins was the only member of the five-man Economic Advisory Council to oppose import restrictions and public works expenditures as a means of alleviating the depression. Instead, Robbins sided with the Austrian view that the depression was caused by undersaving (i.e., too much consumption), and he built on this concept in The Great Depression, which exemplifies his anti-Keynesian views. Although he remained an opponent of Keynesianism for the remainder of that decade, Robbins’s views underwent a profound change after World War II. In The Economic Problem in Peace and War Robbins advocated Keynes’s policies of full employment through control of aggregate demand. The London School of Economics was home to Robbins for almost his entire adult life. He completed his undergraduate education there in 1923, taught as a professor from 1929 to 1961, and continued to be associated with the school on a part-time basis until 1980. During World War II he served briefly as an economist for the British government. Although Robbins was an advocate of laissez-faire, he made numerous ad hoc exceptions. His most famous was his view, known as the Robbins Principle, that the government should subsidize any qualified applicant for higher education who would not otherwise have the current income or savings to pay for it. His view was adopted in the 1960s and led to an expansion of higher education in Britain in the 1960s and 1970s. Selected Works   1932. An Essay on the Nature and Significance of Economic Science. London: Macmillan. 1934. The Great Depression. London: Macmillan. 1934. “Remarks upon Certain Aspects of the Theory of Costs.” First published in Economic Journal (1934). Reprinted in James M. Buchanan and G. F. Thirlby, eds., L.S.E. Essays on Cost. London: Weidenfeld and Nicolson, 1973. Available online at: http://www.econlib.org/library/NPDBooks/Thirlby/bcthLS2.html 1939. The Economic Basis of Class Conflict. London: Macmillan. 1939. The Economic Causes of War. London: Jonathan Cape. 1947. The Economic Problem in Peace and War. London: Macmillan. 1971. Autobiography of an Economist. London: Macmillan.   (0 COMMENTS)

  David Ricardo was one of those rare people who achieved both tremendous success and lasting fame. After his family disinherited him for marrying outside his Jewish faith, Ricardo made a fortune as a stockbroker and loan broker. When he died, his estate was worth more than $100 million in today’s dollars. At age twenty-seven, after reading Adam Smith’s The Wealth of Nations, Ricardo got excited about economics. He wrote his first economics article at age thirty-seven and then spent the following fourteen years—his last ones—as a professional economist. Ricardo first gained notice among economists over the “bullion controversy.” In 1809 he wrote that England’s inflation was the result of the Bank of England’s propensity to issue excess banknotes. In short, Ricardo was an early believer in the quantity theory of money, or what is known today as monetarism. In his Essay on the Influence of a Low Price of Corn on the Profits of Stock (1815), Ricardo articulated what came to be known as the law of diminishing marginal returns. One of the most famous laws of economics, it holds that as more and more resources are combined in production with a fixed resource—for example, as more labor and machinery are used on a fixed amount of land—the additions to output will diminish. Ricardo also opposed the protectionist Corn Laws, which restricted imports of wheat. In arguing for free trade, Ricardo formulated the idea of comparative costs, today called comparative advantage—a very subtle idea that is the main basis for most economists’ belief in free trade today. The idea is this: a country that trades for products it can get at lower cost from another country is better off than if it had made the products at home. Say, for example, Poorland can produce one bottle of wine with five hours of labor and one loaf of bread with ten hours. Richland’s workers, on the other hand, are more productive. They produce a bottle of wine with three hours of labor and a loaf of bread with one hour. One might think at first that because Richland requires fewer labor hours to produce either good, it has nothing to gain from trade. Think again. Poorland’s cost of producing wine, although higher than Richland’s in terms of hours of labor, is lower in terms of bread. For every bottle produced, Poorland gives up half of a loaf, while Richland has to give up three loaves to make a bottle of wine. Therefore, Poorland has a comparative advantage in producing wine. Similarly, for every loaf of bread it produces, Poorland gives up two bottles of wine, but Richland gives up only a third of a bottle. Therefore, Richland has a comparative advantage in producing bread. If they exchange wine and bread one for one, Poorland can specialize in producing wine and trading some of it to Richland, and Richland can specialize in producing bread. Both Richland and Poorland will be better off than if they had not traded. By shifting, say, ten hours of labor out of producing bread, Poorland gives up the one loaf that this labor could have produced. But the reallocated labor produces two bottles of wine, which will trade for two loaves of bread. Result: trade nets Poorland one additional loaf of bread. Nor does Poorland’s gain come at Richland’s expense. Richland gains also, or else it would not trade. By shifting three hours out of producing wine, Richland cuts wine production by one bottle but increases bread production by three loaves. It trades two of these loaves for Poorland’s two bottles of wine. Richland has one more bottle of wine than it had before, and an extra loaf of bread. These gains come, Ricardo observed, because each country specializes in producing the good for which its comparative cost is lower. Writing a century before Paul Samuelson and other modern economists popularized the use of equations, Ricardo is still esteemed for his uncanny ability to arrive at complex conclusions without any of the mathematical tools now deemed essential. As economist David Friedman put it in his 1990 textbook, Price Theory, “The modern economist reading Ricardo’s Principles feels rather as a member of one of the Mount Everest expeditions would feel if, arriving at the top of the mountain, he encountered a hiker clad in T-shirt and tennis shoes.”1 One of Ricardo’s chief contributions, arrived at without mathematical tools, is his theory of rents. Borrowing from Thomas Malthus, with whom Ricardo was closely associated but often diametrically opposed, Ricardo explained that as more land was cultivated, farmers would have to start using less productive land. But because a bushel of corn from less productive land sells for the same price as a bushel from highly productive land, tenant farmers would be willing to pay more to rent the highly productive land. Result: the landowners, not the tenant farmers, are the ones who gain from productive land. This finding has withstood the test of time. Economists use Ricardian reasoning today to explain why agricultural price supports do not help farmers per se but do make owners of farmland wealthier. Economists use similar reasoning to explain why the beneficiaries of laws that restrict the number of taxicabs are not cab drivers per se but rather those who owned the limited number of taxi medallions (licenses) when the restriction was first imposed. Selected Works   1817. On the Principles of Political Economy and Taxation. In The Works and Correspondence of David Ricardo. 11 vols. Edited by Piero Sraffa, with the collaboration of M. H. Dobb. Cambridge: Cambridge University Press, 1951–1973. Available online at http://www.econlib.org/library/Ricardo/ricP.html   Footnotes 1. David D. Friedman, Price Theory: An Intermediate Text, 2d ed. (Cincinnati: South-Western Publishing, 1990), p. 618.   (0 COMMENTS)

  With The Wealth of Nations Adam Smith installed himself as the leading expositor of economic thought. Currents of Adam Smith run through the works published by David Ricardo and Karl Marx in the nineteenth century, and by John Maynard Keynes and Milton Friedman in the twentieth. Adam Smith was born in a small village in Kirkcaldy, Scotland, where his widowed mother raised him. At age fourteen, as was the usual practice, he entered the University of Glasgow on scholarship. He later attended Balliol College at Oxford, graduating with an extensive knowledge of European literature and an enduring contempt for English schools. He returned home, and after delivering a series of well-received lectures was made first chair of logic (1751), then chair of moral philosophy (1752), at Glasgow University. He left academia in 1764 to tutor the young duke of Buccleuch. For more than two years they traveled throughout France and into Switzerland, an experience that brought Smith into contact with his contemporaries Voltaire, Jean-Jacques Rousseau, François Quesnay, and Anne-Robert-Jacques Turgot. With the life pension he had earned in the service of the duke, Smith retired to his birthplace of Kirkcaldy to write The Wealth of Nations. It was published in 1776, the same year the American Declaration of Independence was signed and in which his close friend David Hume died. In 1778 he was appointed commissioner of customs. In this job he helped enforce laws against smuggling. In The Wealth of Nations, he had defended smuggling as a legitimate activity in the face of “unnatural” legislation. Adam Smith never married. He died in Edinburgh on July 19, 1790. Today Smith’s reputation rests on his explanation of how rational self-interest in a free-market economy leads to economic well-being. It may surprise those who would discount Smith as an advocate of ruthless individualism that his first major work concentrates on ethics and charity. In fact, while chair at the University of Glasgow, Smith’s lecture subjects, in order of preference, were natural theology, ethics, jurisprudence, and economics, according to John Millar, Smith’s pupil at the time. In The Theory of Moral Sentiments, Smith wrote: “How selfish soever man may be supposed, there are evidently some principles in his nature which interest him in the fortune of others and render their happiness necessary to him though he derives nothing from it except the pleasure of seeing it.”1 At the same time, Smith had a benign view of self-interest, denying that self-love “was a principle which could never be virtuous in any degree.”2 Smith argued that life would be tough if our “affections, which, by the very nature of our being, ought frequently to influence our conduct, could upon no occasion appear virtuous, or deserve esteem and commendation from anybody.”3 Smith did not view sympathy and self-interest as antithetical; they were complementary. “Man has almost constant occasion for the help of his brethren, and it is in vain for him to expect it from their benevolence only,” he explained in The Wealth of Nations.4 Charity, while a virtuous act, cannot alone provide the essentials for living. Self-interest is the mechanism that can remedy this shortcoming. Said Smith: “It is not from the benevolence of the butcher, the brewer, or the baker, that we can expect our dinner, but from their regard to their own interest” (ibid.). Someone earning money by his own labor benefits himself. Unknowingly, he also benefits society, because to earn income on his labor in a competitive market, he must produce something others value. In Adam Smith’s lasting imagery, “By directing that industry in such a manner as its produce may be of greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.”5 The Wealth of Nations, published as a five-book series, sought to reveal the nature and cause of a nation’s prosperity. Smith saw the main cause of prosperity as increasing division of labor. Using the famous example of pins, Smith asserted that ten workers could produce 48,000 pins per day if each of eighteen specialized tasks was assigned to particular workers. Average productivity: 4,800 pins per worker per day. But absent the division of labor, a worker would be lucky to produce even one pin per day. Just how individuals can best apply their own labor or any other resource is a central subject in the first book of the series. Smith claimed that an individual would invest a resource—for example, land or labor—so as to earn the highest possible return on it. Consequently, all uses of the resource must yield an equal rate of return (adjusted for the relative riskiness of each enterprise). Otherwise reallocation would result. George Stigler called this idea the central proposition of economic theory. Not surprisingly, and consistent with another Stigler claim that the originator of an idea in economics almost never gets the credit, Smith’s idea was not original. The French economist turgot had made the same point in 1766. Smith used this insight on equality of returns to explain why wage rates differed. Wage rates would be higher, he argued, for trades that were more difficult to learn, because people would not be willing to learn them if they were not compensated by a higher wage. His thought gave rise to the modern notion of human capital. Similarly, wage rates would also be higher for those who engaged in dirty or unsafe occupations (see Job Safety), such as coal mining and butchering; and for those, like the hangman, who performed odious jobs. In short, differences in work were compensated by differences in pay. Modern economists call Smith’s insight the theory of compensating wage differentials. Smith used numerate economics not just to explain production of pins or differences in pay between butchers and hangmen, but to address some of the most pressing political issues of the day. In the fourth book of The Wealth of Nations—published, remember, in 1776—Smith told Great Britain that its American colonies were not worth the cost of keeping. His reasoning about the excessively high cost of British imperialism is worth repeating, both to show Smith at his numerate best and to show that simple, clear economics can lead to radical conclusions: A great empire has been established for the sole purpose of raising up a nation of customers who should be obliged to buy from the shops of our different producers all the goods with which these could supply them. For the sake of that little enhancement of price which this monopoly might afford our producers, the home-consumers have been burdened with the whole expense of maintaining and defending that empire. For this purpose, and for this purpose only, in the two last wars, more than a hundred and seventy millions [in pounds] has been contracted over and above all that had been expended for the same purpose in former wars. The interest of this debt alone is not only greater than the whole extraordinary profit, which, it ever could be pretended, was made by the monopoly of the colony trade, but than the whole value of that trade, or than the whole value of the goods, which at an average have been annually exported to the colonies.6 Smith vehemently opposed mercantilism—the practice of artificially maintaining a trade surplus on the erroneous belief that doing so increased wealth. The primary advantage of trade, he argued, was that it opened up new markets for surplus goods and also provided some commodities from abroad at a lower cost than at home. With that, Smith launched a succession of free-trade economists and paved the way for David Ricardo’s and John Stuart Mill’s theories of comparative advantage a generation later. Adam Smith has sometimes been caricatured as someone who saw no role for government in economic life. In fact, he believed that government had an important role to play. Like most modern believers in free markets, Smith believed that the government should enforce contracts and grant patents and copyrights to encourage inventions and new ideas. He also thought that the government should provide public works, such as roads and bridges, that, he assumed, would not be worthwhile for individuals to provide. Interestingly, though, he wanted the users of such public works to pay in proportion to their use. Many people believe that Smith favored retaliatory tariffs. A retaliatory tariff is one levied by, say, the government of country A against imports from country B to retaliate for tariffs levied by the government of country B against imports from country A. It is true that Smith thought they might be justified, but he was fairly skeptical. He argued that causing additional harm to one’s own citizens is a high price to pay that tends not to compensate those who were harmed by the foreign tariff while also hurting innocent others who had no role in formulating the tariff policy. He wrote: There may be good policy in retaliations of this kind, when there is a probability that they will procure the repeal of the high duties or prohibitions complained of. The recovery of a great foreign market will generally more than compensate the transitory inconveniency of paying dearer during a short time for some sorts of goods. To judge whether such retaliations are likely to produce such an effect does not, perhaps, belong so much to the science of a legislator, whose deliberations ought to be governed by general principles which are always the same, as to the skill of that insidious and crafty animal, vulgarly called a statesman or politician, whose councils are directed by the momentary fluctuations of affairs. When there is no probability that any such repeal can be procured, it seems a bad method of compensating the injury done to certain classes of our people to do another injury ourselves, not only to those classes, but to almost all the other classes of them. When our neighbours prohibit some manufacture of ours, we generally prohibit, not only the same, for that alone would seldom affect them considerably, but some other manufacture of theirs. This may no doubt give encouragement to some particular class of workmen among ourselves, and by excluding some of their rivals, may enable them to raise their price in the home-market. Those workmen, however, who suffered by our neighbors prohibition will not be benefited by ours. On the contrary, they and almost all the other classes of our citizens will thereby be obliged to pay dearer than before for certain goods. Every such law, therefore, imposes a real tax upon the whole country, not in favour of that particular class of workmen who were injured by our neighbours prohibition, but of some other class. (An Inquiry into the Nature and Causes of the Wealth of Nations, par. IV.2.39) Some of Smith’s ideas are testimony to his breadth of imagination. Today, vouchers and school choice programs are touted as the latest reform in public education. But Adam Smith addressed the issue more than two hundred years ago: Were the students upon such charitable foundations left free to choose what college they liked best, such liberty might contribute to excite some emulation among different colleges. A regulation, on the contrary, which prohibited even the independent members of every particular college from leaving it, and going to any other, without leave first asked and obtained of that which they meant to abandon, would tend very much to extinguish that emulation.7 Smith’s own student days at Oxford (1740–1746), whose professors, he complained, had “given up altogether even the pretense of teaching,” left him with lasting disdain for the universities of Cambridge and Oxford. Smith’s writings are both an inquiry into the science of economics and a policy guide for realizing the wealth of nations. Smith believed that economic development was best fostered in an environment of free competition that operated in accordance with universal “natural laws.” Because Smith’s was the most systematic and comprehensive study of economics up until that time, his economic thinking became the basis for classical economics. And because more of his ideas have lasted than those of any other economist, some regard Adam Smith as the alpha and the omega of economic science. Selected Works   1759. The Theory of Moral Sentiments. Edited by D. D. Raphael and A. L. Macfie. Oxford: Clarendon Press; New York: Oxford University Press, 1976. Available online at: http://www.econlib.org/library/Smith/smMS.html 1776. An Inquiry into the Nature and Causes of the Wealth of Nations. Edited by Edwin Cannan. Chicago: University of Chicago Press, 1976. Available online at: http://www.econlib.org/library/Smith/smWN.html   Footnotes 1. Smith 1759, part I, section I, chap. I, para. 1; available online at: http://oll.libertyfund.org/192/39008/908774.   2. Ibid., part VII, section II, chap. iii, para. 12; available online at: http://oll.libertyfund.org/192/39125/909478.   3. Ibid., part VII, section II, chap. iii, para. 18; available online at: http://oll.libertyfund.org/192/39125/909484.   4. Smith 1776, book I, chap. 2, para. 2; available online at: http://oll.libertyfund.org/220/111839/2312795.   5. Ibid., book IV, chap. 2, para. 9; available online at: http://oll.libertyfund.org/220/111910/2313856.   6. Ibid., book IV, chap. VIII, para. 53; available online at: http://oll.libertyfund.org/200/111936/2316261.   7. Ibid., book V, chap. 1, para. 140 [OUP article ii, para. 12]; available online at: http://oll.libertyfund.org/200/111942/2316475.   (0 COMMENTS)

In 1978 American social scientist Herbert Simon was awarded the Nobel Prize in economics for his “pioneering research into the decision-making process within economic organizations.” In a stream of articles, Simon, who trained as a political scientist, questioned mainstream economists’ view of economic man as a lightning-quick calculator of costs and benefits. Simon saw people’s rationality as “bounded.” Because getting information about alternatives is costly, and because the consequences of many possible decisions cannot be known anyway, argued Simon, people cannot act the way economists assume they act. Instead of maximizing their utility, they “satisfice”; that is, they do as well as they think is possible. One way they do so is by devising rules of thumb (e.g., save 10 percent of after-tax income every month) that economize on the cost of collecting information and on the cost of thinking. Simon also questioned economists’ view that firms maximize profits. He proposed instead that because of their members’ bounded rationality and often contradictory goals and perspectives, firms reach decisions that can only be described as satisfactory rather than the best. Not surprisingly for one who believes that decision making is costly, Simon also worked on problems of artificial intelligence. After earning his Ph.D. in political science from the University of Chicago, Simon joined the school’s faculty. In 1949 he left for Pittsburgh, where he helped start Carnegie Mellon University’s new Graduate School of Industrial Administration. Selected Works   1957. Models of Man. New York: Wiley. 1958 (with James March). Organization. New York: Wiley. 1976. Administrative Behavior. 3d ed. New York: Macmillan. 4th ed., New York: Free Press. 1997. 1981. The Sciences of the Artificial. 2d ed. Cambridge: MIT Press. 1982. Models of Bounded Rationality and Other Topics in Economic Theory. 2 vols. Cambridge: MIT Press.   (0 COMMENTS)

  British economist Joan Robinson was arguably the only woman born before 1930 who can be considered a great economist. She was in the same league as others who received the Nobel Prize; indeed, many economists expected her to win the prize in 1975. Business Week was so sure of it that it published a long article on her before that year’s prize was announced. It did not happen. Was the Swedish Royal Academy biased against Robinson? Many economists believe it was, but not because Robinson was a woman. Rather, her political views became more left wing as she aged, to the point where she admired Mao Zedong’s China and Kim Il Sung’s North Korea. These extreme views should not have affected her chances of getting an award for her intellectual contributions, but they probably did. Robinson’s first major book was The Economics of Imperfect Competition. In it she laid out a model of competition between firms, each of which had some monopoly power. Along with American economist Edward H. Chamberlin, whose Theory of Monopolistic Competition had appeared only a few months earlier, Robinson began what is known as the monopolistic competition revolution. Many economists believe that most industries are neither perfectly competitive nor complete monopolies. Robinson’s and Chamberlin’s books are what led them to that belief. Robinson’s first book and early articles show a distinctive writing style. She was clear and analytical, and she managed to put complex mathematical concepts into words. Later in the 1930s Robinson became part of the “Cambridge Circus,” a group of young economists that included later Nobel Prize winner James Meade; Roy Harrod; Richard Kahn; her husband, Austin Robinson; and Piero Sraffa. These economists met regularly to discuss their work and especially to discuss John Maynard Keynes’s famous General Theory of Employment, Interest and Money (1936), both before and after it was published. Much of Robinson’s work published at that time, especially her Introduction to the Theory of Employment, clarifies ideas that Keynes had not made clear. Robinson was the first to define macroeconomics, which became a separate field of inquiry only with Keynes’s book, as the “theory of output as a whole.” In 1954 Robinson’s article “The Production Function and the Theory of Capital” started what came to be called the Cambridge controversy. Robinson attacked the idea that capital can be measured and aggregated. This became the position in Cambridge, England. Across the Atlantic, Paul Samuelson and Robert Solow defended the by-then traditional neoclassical view that capital can be aggregated. Robinson won the battle. As historian Mark Blaug puts it, Samuelson made a “declaration of unconditional surrender.” Yet most economists still think that aggregating capital is useful and continue to do it anyway. Whether or not Robinson’s gender prevented her from winning the Nobel Prize, it seems to have slowed her advance in academia. She taught at Cambridge University from 1928 until retiring in 1971, but in spite of a very productive career, she did not become a full professor until 1965. Perhaps not coincidentally, this was the year her husband retired from Cambridge. Selected Works   1933. The Economics of Imperfect Competition. London: Macmillan. 2d ed., 1969. 1937. Introduction to the Theory of Employment. London: Macmillan. 1942. An Essay on Marxian Economics. London: Macmillan. 1956. The Accumulation of Capital. London: Macmillan. 1962. Economic Philosophy. London: C. A. Watts. 1970. The Cultural Revolution in China. London: Penguin Books. 1971. Economic Heresies: Some Old-fashioned Questions in Economic Theory. London: Macmillan.   (0 COMMENTS)

  In 1990 American economists William F. Sharpe, harry markowitz, and merton h. miller shared the Nobel Prize “for their pioneering work in the theory of financial economics.” Their early contributions established financial economics as a separate field of study. In the 1960s Sharpe, taking off from Markowitz’s portfolio theory, developed the Capital Asset Pricing Model (CAPM). One implication of this model is that a single mix of risky assets fits in every investor’s portfolio. Those who want a high return hold a portfolio heavily weighted with the risky asset; those who want a low return hold a portfolio heavily weighted with a riskless asset, such as an insured bank deposit. A measure of the portfolio risk that cannot be diversified away by mixing stocks is “beta.” A portfolio with a beta of 1.5, for example, is likely to rise by 15 percent if the stock market rises by 10 percent and is likely to fall by 15 percent if the market falls by 10 percent. One implication of Sharpe’s work is that the expected return on a portfolio in excess of a riskless return should be beta times the excess return of the market. Thus, a portfolio with a beta of 2 should have an excess return that is twice as high as the market as a whole. If the market’s expected return is 8 percent and the riskless return is 5 percent, the market’s expected excess return is 3 percent (8 minus 5) and the portfolio’s expected excess return is therefore 6 percent (twice the market’s expected excess return of 3 percent). The portfolio’s expected total return would then be 11 percent (6 plus the riskless return of 5). Sharpe was a Ph.D. candidate at the University of California at Los Angeles and an employee of the RAND Corporation when he first met Markowitz, who was also employed at RAND. Sharpe chose Markowitz as his dissertation adviser, even though Markowitz was not on the faculty at UCLA. Sharpe taught first at the University of Washington in Seattle and then at the University of California at Irvine. In 1971 he became a professor of finance at Stanford University. In 1986 Sharpe founded William F. Sharpe Associates, a firm that consulted to foundations, endowments, and pension plans. He returned to Stanford as a professor of finance in 1993 and is now a professor emeritus there. Selected Works   1964. “Capital Asset Prices: A Theory of Market Equilibrium Under Conditions of Risk.” Journal of Finance 19 (September): 425–442. 1977. “The Capital Asset Pricing Model: A ‘Multi-Beta’ Interpretation.” In H. Levy and M. Sarnat, eds., Financial Decision Making Under Uncertainty. New York: Harcourt Brace Jovanovich, Academic Press.   (0 COMMENTS)

French economist J. B. Say is most commonly identified with Say’s Law, which states that supply creates its own demand. Over the years Say’s Law has been embroiled in two kinds of controversy—the first over its authorship, the second over what it means and, given each meaning, whether it is true. On the first controversy, it is clear that Say did invent something like Say’s Law. But the first person actually to use the words “supply creates its own demand” appears to have been James Mill, the father of john stuart mill. Say’s Law has various interpretations. The long-run version is that there cannot be overproduction of goods in general for a very long time because those who produce the goods, by their act of producing, produce the purchasing power to buy other goods. Say wrote: “How could it be possible that there should now be bought and sold in France five or six times as many commodities as in the miserable reign of Charles VI?”1 With this statement Say had the long run in mind. Certainly the long-run version is correct. Given enough time, supply does create its own demand. There can be no long-run glut of goods. But Say also said that even in the short run there could be no overproduction of goods relative to demand. It was this short-run version that thomas robert malthus attacked in the nineteenth century and john maynard keynes attacked in the twentieth. They were right to attack it. Say was the best-known expositor of Adam Smith’s views in Europe and America. His Traité d’économie politique was translated into English and used as a textbook in England and the United States. But Say did not agree with Adam Smith on everything. In particular, he took issue with Smith’s labor theory of value. Say was one of the first economists to have the insight that the value of a good derives from its utility to the user and not from the labor spent in producing it. Say was born in Lyons. During his life he edited a journal, operated a cotton factory, and served as a member of the Tribunate under the Consulate of Napoleon. He was the first to teach a public course on political economy in France and continued his stay in academia first at the Conservatoire des Arts et Métiers, and then at the College de France in Paris. Say was a friend of Thomas Robert Malthus and david ricardo. Selected Works   1803. Traité d’économie politique. Translated from the 4th edition of the French by C. R. Prinsep. A treatise on political economy; available online at: http://www.econlib.org/library/Say/sayT.html.   Footnotes 1. Say, A Treatise on Political Economy, book 1, chap. XV, para. 4.   (0 COMMENTS)

In 1979 Theodore Schultz was awarded the Nobel Prize along with W. Arthur Lewis for their “pioneering research into economic development … with particular consideration of the problems of developing countries.” Schultz’s focus was on agriculture, a natural interest for someone who had grown up on a South Dakota farm. In 1930 Schultz began teaching agricultural economics at Iowa State College (now Iowa State University). He left in protest in 1943 when the college’s administration, bowing to political pressure from some of the state’s dairy farmers, suppressed a report that recommended substituting oleomargarine for butter. Schultz moved to the University of Chicago’s economics department, where he spent the rest of his academic career. Early on at Chicago, Schultz became interested in agriculture worldwide. In his 1964 book, Transforming Traditional Agriculture, Schultz laid out his view that primitive farmers in poor countries maximize the return from their resources. Their apparent unwillingness to innovate, he argued, was rational because governments of those countries often set artificially low prices on their crops and taxed them heavily. Also, governments in those countries, unlike in the United States, did not typically have agricultural extension services to train farmers in new methods. A persistent theme in Schultz’s books is that rural poverty persists in poor countries because government policy in those countries is biased in favor of urban dwellers. Schultz was always optimistic that poor agricultural nations would be able to develop if this government hostility to agriculture disappeared. “Poor people in low-income countries,” he stated, “are not prisoners of an ironclad poverty equilibrium that economics is unable to break.” Schultz was an empirical economist. When he traveled to serve on commissions or to attend conferences, he visited farms. His visits to farms and interviews with farmers led to new ideas, not the least of which was on human capital, which he pioneered along with Gary Becker and Jacob Mincer. After World War II, while interviewing an old, apparently poor farm couple, he noticed their obvious contentment. When he asked them why they were so contented even though poor, they answered that they were not poor because they had used up their farm to send four children to college and that these children would be productive because of their education. This led Schultz quickly to the concept of human capital—capital produced by investing in knowledge. Schultz was president of the American Economic Association in 1960, and in 1972 he won the Francis A. Walker Medal, the highest honor given by that association. Selected Works   1950. “Reflections on Poverty Within Agriculture.” Journal of Political Economy 43 (February): 1–15. 1961. “Investment in Human Capital.” American Economic Review 51 (March): 1–17. 1963. The Economic Value of Education. New York: Columbia University Press. Translated into Spanish, Portuguese, Japanese, and Greek. 1964. Transforming Traditional Agriculture. New Haven: Yale University Press. Translated into Japanese, Korean, Portuguese, and Spanish. Reprint. New York: Arno Press, 1976.   (0 COMMENTS)

  Myron Scholes, along with robert merton, was awarded the 1997 Nobel Prize in economics “for a new method to determine the value of derivatives.” The particular derivative they studied was stock options (see futures and options markets). A call option gives its owner the right to buy a stock at a particular price, called the strike price, during a set time period. A put option gives its owner the right to sell a stock at the strike price during a set time period. Scholes and his coauthor, the late Fischer Black, derived the formula for pricing a stock option in 1970. They submitted the article to the Journal of Political Economy, and it was rejected without even being reviewed. merton miller (who received the Nobel Prize in 1990) and Eugene Fama, two financial economists at the University of Chicago, where the journal is edited, persuaded the editors to take another look, and the journal published the article in 1973. The issue of how to price stock options may sound unimportant, but it is hugely important. Stock options, like other financial derivatives, are attractive for one main reason: they allow people to reduce risk at a low cost. This has given huge benefits to major companies and even to small investors. Say you have invested in a stock index fund and you are comfortable with the risk of a 15 percent drop in the Standard and Poor’s (S&P) 500 index, but you want to cover yourself in case the S&P 500 falls by more than 15 percent. Then you can buy a put on the S&P 500 with a strike price 20 percent below the current price. You have just used the options market to buy insurance. Virtually all major firms now use options and other derivatives to hedge against changes in exchange rates, raw-materials prices, and interest rates. Financial derivatives, in fact, have played an underappreciated role in making recessions less severe. Before Scholes’s and Black’s work, no one knew how to value options precisely. Traders understood the basics. The higher the strike price, for example, the lower the value of a call option. The longer the time period in which the option could be exercised, the higher the value of an option. The higher the interest rate, the lower the value of an option. But how to handle risk? Scholes and Black worked away on the risk issue until they had a “Eureka” moment: they realized that the risk was already embodied in the price of the stock. They showed that risk canceled out of the relevant equation, which means that they did not need to know risk in order to value the stock option. Coincidentally, the Chicago Board Options Exchange (CBOE) was begun in April 1973, just one month after the Black-Scholes article was published. Now options traders had a tool for scientifically pricing options. The effect was electric—literally. By 1977, traders were roaming the CBOE floor with special financial calculators programmed with the Black-Scholes options-pricing model. In his Nobel lecture, Scholes told of his request to Texas Instruments for royalties. TI refused, citing the fact that the formula was in the public domain. Said Scholes, “When I asked, at least, for a calculator, they suggested that I buy one. I never did.”1 Even though economists often have insights about the markets they study, rarely do the day-to-day players in those markets draw directly on what economists know. They usually do not need to. When an economist finds, for example, that an increase in the minimum wage causes employers to fire low-skilled workers, employers do not need to know that—they are already doing it. But the research on options pricing actually did improve the day-to-day activities of options traders. As economist J. W. Henry Watson and economic journalist Ida Walters wrote, “This marked the first time economic models became an explicit, integral part of a major market.”2 By 1984, the CBOE was second only to the New York Stock Exchange in the dollar value of financial assets traded. Many important theories and findings in economics rely on options-pricing theory. These include the theory of the capital structure of a firm, analyses of the value of federal deposit insurance, decision making under uncertainty, and the value of flexibility. Scholes was born in Canada. He earned his B.A. in economics at McMaster University in Hamilton, Ontario, and his M.B.A. (1964) and Ph.D. (1969) degrees at the University of Chicago. He was a professor at MIT from 1968 to 1973, at the University of Chicago from 1973 to 1983, and at Stanford University from 1983 to 1996. Since 1996 he has been a professor emeritus at Stanford. Along with co-winner Robert Merton, Scholes helped form Long Term Capital Management in 1993. LTCM exploited small arbitrage opportunities on a big scale; in Scholes’s memorable phrasing, LTCM acted like a giant vacuum cleaner sucking up nickels that everyone else had overlooked. The strategy worked well for a few years but turned out not to be risk free. The Federal Reserve Board helped arrange a bailout in 1998, and LTCM was liquidated in 2000. Virtually all observers agree that had Fischer Black not died in 1995, he would have been a co-recipient of the 1997 prize. Selected Works   1972 (with Fischer Black). “The Valuation of Option Contracts and a Test of Market Efficiency.” Journal of Finance 27 (May): 399–418. 1973 (with Fischer Black). “The Pricing of Options and Corporate Liabilities.” Journal of Political Economy 81: 637–654. 1976. “Taxes and the Pricing of Options.” Journal of Finance 31: 319–332. 1992 (with Mark A. Wolfson). Taxes and Business Strategy: A Planning Approach. Englewood Cliffs, N.J.: Prentice Hall. 1996. “Global Financial Markets, Derivative Securities and Systemic Risks.” Journal of Risk and Uncertainty 12: 271–286.   Footnotes 1. See http://nobelprize.org/economics/laureates/1997/scholeslecture.pdf.   2. J. W. Henry Watson and Ida Walters, “The New Economics and the Death of Central Banking,” Liberty 10, no. 6 (1997): 21.   (0 COMMENTS)