In 1972 American economist Kenneth Arrow, jointly with Sir John Hicks, was awarded the Nobel Prize in economics for “pioneering contributions to general equilibrium theory and welfare theory.” Arrow is probably best known for his Ph.D. dissertation (on which his book Social Choice and Individual Values is based), in which he proved his famous “impossibility theorem.” He showed that under certain assumptions about people’s preferences between options, it is always impossible to find a voting rule under which one option emerges as the most preferred. The simplest example is Condorcet’s paradox, named after an eighteenth-century French mathematician. Condorcet’s paradox is as follows: There are three candidates for office; let us call them Bush (B), Clinton (C), and Perot (P). One-third of the voters rank them B, C, P. One-third rank them C, P, B. The final third rank them P, B, C. Then a majority will prefer Bush to Clinton, and a majority will prefer Clinton to Perot. It would seem, therefore, that a majority would prefer Bush to Perot. But in fact a majority prefers Perot to Bush. Arrow’s more complicated proof is more general. Arrow went on to show, in a 1951 article, that a competitive economy in equilibrium is efficient and that any efficient allocation can be reached by having the government use lump-sum taxes to redistribute and then letting the market work. One clear-cut implication of this finding is that the government should not control prices to redistribute income, but instead, if it redistributes at all, should do so directly. Arrow’s insight is part of the reason economists are almost unanimously against price controls. Arrow also showed, with coauthor Gerard Debreu, that under certain conditions an economy reaches a general equilibrium—that is, an equilibrium in which all markets are in equilibrium. Using new mathematical techniques, Arrow and Debreu showed that one of the conditions for general equilibrium is that there must be futures markets for all goods. Of course, we know that this condition does not hold—one cannot buy a contract for future delivery of many labor services, for example. Arrow was also one of the first economists to note the existence of a learning curve. His basic idea was that as producers increase output of a product, they gain experience and become more efficient. “The role of experience in increasing productivity has not gone unobserved,” he wrote, “though the relation has yet to be absorbed into the main corpus of economic theory.” More than forty years after Arrow’s article, the learning curve insight has still not been fully integrated into mainstream economic analysis. Arrow has also done excellent work on the economics of uncertainty. His work in that area is still a standard source for economists. Arrow has spent most of his professional life on the economics faculties of Stanford University (1949–1968 and 1980–present) and Harvard University (1968–1979). He earned his B.A. in social science at the City College of New York and his M.A. and Ph.D. in economics from Columbia University. Selected Works   1951. Social Choice and Individual Values. New York: Wiley. 1954 (with Gerard Debreu). “Existence of a Competitive Equilibrium for a Competitive Economy.” Econometrica 22, no. 3: 265–290. 1962. “The Economic Implications of Learning by Doing.” Review of Economic Studies 29 (June): 155–173. 1971. Essays in the Theory of Risk-Bearing. Amsterdam: North-Holland. 1971 (with Frank Hahn). General Competitive Analysis. San Francisco: Holden-Day.   (0 COMMENTS)

Armen Alchian, an American economist born in Fresno, California, is in many ways like ronald coase. Like Coase, Alchian has published only a few articles, but very few are unimportant. And like Coase’s, many of Alchian’s articles are widely cited. Many students and others who read economics are disturbed by economists’ assumptions that companies maximize profits. One of their objections is that managers of companies do not know enough to be able to maximize profits. In 1950 Alchian presented a thoughtful response to this objection in his first major article, “Uncertainty, Evolution and Economic Theory.” Alchian argued that even though all companies may not maximize profits, those that survive will be ones whose managers, by luck or by design, came close to maximizing profits. Therefore, those that we observe will have maximized profits. So for the long term at least, argued Alchian, for economists to derive the standard conclusions from the profit-maximization assumption, they do not need to show that all companies try to maximize profits. While in the U.S. Army Air Forces during World War II, Alchian did some of the early work on the learning curve—the curve that relates unit costs to cumulative output. His article on the learning curve in aircraft production was based on statistical work he did during the war, but it could not be published until 1963 because it was based on classified information. Alchian is also known for University Economics (now called Exchange and Production), coauthored with William R. Allen, a textbook that is unique in economics. It is much more literary and humorous than any other modern economics textbook that deals with complex issues for an undergraduate audience. Example: “Since the fiasco in the Garden of Eden, most of what we get is by sweat, strain, and anxiety.” It also welcomes controversy rather than shying away from it, in the process daring the reader to disagree. Take, for example, the book’s discussion of violence: Before condemning violence (physical force) as a means of social control, note that its threatened or actual use is widely practiced and respected—at least when applied successfully on a national scale. Julius Caesar conquered Gaul and was honored by the Romans; had he simply roughed up the local residents, he would have been damned as a gangster. Alexander the Great, who conquered the Near East, was not regarded by the Greeks as a ruffian, nor was Charlemagne after he conquered Europe. Europeans acquired and divided—and redivided—America by force. Lenin is not regarded in Russia as a subversive. Nor is Spain’s Franco, Cuba’s Castro, Nigeria’s Gowon, Uganda’s Amin, China’s Mao, our George Washington. Because of its literary quality and complexity, the textbook generally did not work with undergraduate or even M.B.A. classes. But its impact was out of all proportion to its sales. Many graduate students, particularly at the University of California at Los Angeles, where Alchian began teaching in 1946, and at the University of Washington (where Alchian student Steven Cheung taught), learned their basic economics from this book. Some of the University of Washington students went on to write best-selling textbooks that made many of Alchian and Allen’s insights more understandable to an undergraduate audience. Alchian and Allen’s textbook was truly a public good—a good that created large benefits for which its creators could not charge. And while Alchian played the role of selfish cynic in his class, some who studied under him had the feeling that he put so much care and work into his low-selling text—and into his students—because of his concern for humanity. Other than through his text, Alchian’s largest impact has been in the economics of property rights (he wrote the article on property rights in this encyclopedia). Most of his work in property rights can be summed up in one sentence: You tell me the rules and I’ll tell you what outcomes to expect. In their textbook, for example, Alchian and Allen ask why the organizers of the Rose Bowl refuse to sell tickets to the highest bidders and instead give up wealth by underpricing the tickets. Their answer is that the people who make the decision on ticket prices do not have property rights in the tickets, so the wealth that is given up by underpricing would not have accrued to them anyway. But the decision makers can give underpriced tickets to their friends and associates. Thomas Hazlett, former chief economist at the Federal Communications Commission, used this same line of reasoning to explain why Rep. John Dingell blocked the Federal Communication Commission’s early attempts to auction off the electromagnetic spectrum and instead favored giving it away. Alchian also used the analysis of property rights to explain the incidence of discrimination. In a paper coauthored with Reuben Kessel, Alchian, who was himself subject to discrimination as an Armenian, and Kessel pointed out that discrimination was more pervasive in private firms whose profits were regulated by the government, and then explained that this is what the analysis of property rights would predict. Discrimination is costly—not just to those discriminated against, but also to those who discriminate. The discriminators give up the chance to deal with someone with whom they could engage in mutually beneficial exchange. Therefore, argued Alchian and Kessel, discrimination would be more prevalent in situations where those who discriminate do not bear much of the cost from doing so. A for-profit company whose profits are not regulated would see the cost of discrimination in its bottom line in the form of lower profits. A company whose profits are limited and that is already at the limit would face no cost from discriminating. Alchian and Kessel used this analysis to explain why regulated utilities discriminated against Jews and why labor unions discriminated against blacks. This analysis explains why Alchian has never trusted government—but has trusted free markets—to reduce discrimination. Before teaching at UCLA, Alchian was an economist with the RAND Corporation. Selected Works   1950. “Uncertainty, Evolution and Economic Theory.” Journal of Political Economy 58 (June): 211–221. 1965. “Some Economics of Property Rights.” II Politico 30: 816–829. 1972 (with W. R. Allen). University Economics. Belmont, Calif.: Wadsworth. 1977. Economic Forces at Work. Indianapolis: Liberty Press.   (0 COMMENTS)

  In 1988 Maurice Allais became the first French citizen to receive the Nobel Prize in economics. He won it for his contribution to the understanding of market behavior and the efficient use of resources. Allais also showed that his insights could be applied to help set efficient prices for state-owned monopolies, of which France had many. Allais’s work paralleled, and sometimes preceded, similar work done by English-speaking economists Sir John Hicks and Paul Samuelson. He also proved a result in growth theory in 1947 that had been credited to Edmund Phelps (in 1961). Allais did not get credit as early as his English counterparts because his work was in French. “Had Allais’ earliest writings been in English,” commented Samuelson, “a generation of economic theory would have taken a different course.” Allais also helped revive the quantity theory of money (monetarism). In utility theory, Allais discovered and resolved a paradox about how people behave when choosing between various risks that is now called the Allais paradox. From 1937 to 1944, Allais worked in the French stateowned mine administration. In 1944 he became a professor at the Ecole National Supérieure des Mines de Paris and spent his career there. He is also the research director at the National French Research Council. He was named an officer of the Legion of Honor in 1977. Selected Works   1965. “The Role of Capital in Economic Development.” In The Econometric Approach to Development Planning. Amsterdam: North-Holland. 1966. “A Restatement of the Quantity Theory of Money.” American Economic Review 56 (December): 1123–1157. 1969. “Growth and Inflation.” Journal of Money, Credit and Banking 1, no. 3: 355–426.   (0 COMMENTS)

  George Akerlof, along with Michael Spence and Joseph Stiglitz, received the 2001 Nobel Prize “for their analyses of markets with asymmetric information.” Although much of economics is built on the assumption of perfect information, various economists in the past had considered the effects of imperfect information. Two giants in this area were ludwig von mises and friedrich hayek, who predicted that socialism would fail because central planners could not possibly have the information they needed to plan an economy. One of the next steps in relaxing the perfect-information assumption was to assume, realistically, that one side of a market has better information than the other. That is what all three of the 2001 Nobel Prize winners did. In his classic 1970 article, “The Market for Lemons” Akerlof gave a new explanation for a well-known phenomenon: the fact that cars barely a few months old sell for well below their new-car price. Akerlof’s model was simple but powerful. Assume that some cars are “lemons” and some are high quality. If buyers could tell which cars are lemons and which are not, there would be two separate markets: a market for lemons and a market for high-quality cars. But there is often asymmetric information: buyers cannot tell which cars are lemons, but, of course, sellers know. Therefore, a buyer knows that there is some probability that the car he buys will be a lemon and is willing to pay less than he would pay if he were certain that he was buying a high-quality car. This lower price for all used cars discourages sellers of high-quality cars. Although some would be willing to sell their own cars at the price that buyers of high-quality used cars would be willing to pay, they are not willing to sell at the lower price that reflects the risk that the buyer may end up with a lemon. Thus, exchanges that could benefit both buyer and seller fail to take place and efficiency is lost. Akerlof did not conclude that the lemon problem necessarily implies a role for government. Instead, he pointed out that many free-market institutions can be seen as ways of solving or reducing “lemon problems.” One solution Akerlof noted is warranties, because these give the buyer assurance that the car is not a lemon, and the buyer is therefore willing to pay more for the car with a warranty. Also, the sellers who are willing to offer the warranty are those who are confident that they are not selling a lemon. Another market solution that has come along since Akerlof’s article is Carfax, a very low-cost way of finding out a car’s history of repairs. Akerlof also went beyond cars and showed that the same kind of issues arise in credit markets and health insurance markets, to name two. Akerlof, along with coauthor Janet Yellen, also did some of the pioneering work in new keynesian economics. They considered the case of firms with market power that follow a rule of thumb on pricing. The rule of thumb they considered was that firms do not increase price when demand increases and do not reduce price when demand falls. They showed that such a rule of thumb is “near rational”; that is, firms do not lose much profit from following this strategy relative to a strategy of immediately adjusting prices. They also showed, however, that if many firms followed this strategy, the effect on the overall economy was substantial. This lack of adjustment of prices, they noted, would mean that increases in money-supply growth (see Money Supply) would increase the growth of real output, and short-run drops in money-supply growth would reduce the growth of real output. More recently, Akerlof has tried to explain the persistence of high poverty rates and high crime rates among black Americans. He and coauthor Rachel Kranton argue that many black people face a choice between going along with the mainstream culture and succeeding economically or acting in opposition to that culture and sabotaging themselves. The incentives are high, they argue, for doing the latter. Akerlof earned his B.A. in economics at Yale in 1962 and his Ph.D. in economics at MIT in 1966. For most of his professional life, he has been an economics professor at the University of California at Berkeley. In 1973–1974, he was a senior economist with President Richard M. Nixon’s Council of Economic Advisers; from 1978 to 1980, he was an economics professor at the London School of Economics. Selected Works   1970. “The Market for ‘Lemons’”: Quality Uncertainty and the Market Mechanism.” Quarterly Journal of Economics 84: 353–374. 1976. “The Economics of Caste and of the Rat Race and Other Woeful Tales.” Quarterly Journal of Economics 90: 599–617. 1985 (with Janet Yellen). “Can Small Deviations from Rationality Make Significant Differences to Economic Equilibria?” American Economic Review 75: 708–720. 1985 (with Janet Yellen). “A Near Rational Model of the Business Cycle with Wage and Price Inertia.” Quarterly Journal of Economics 100 (suppl.): 823–838. 1990. “The Fair Wage Hypothesis and Unemployment.” Quarterly Journal of Economics 97: 543–569. 1996 (with Janet Yellen and Michael Katz). “An Analysis of Out-of-Wedlock Childbearing in the United States.” Quarterly Journal of Economics 111: 277–317. 2000 (with Rachel Kranton). “Economics and Identity.” Quarterly Journal of Economics 115: 715–753.   (0 COMMENTS)