Armen Alchian

by on February 19, 2013 at 11:00 am in Economics, History | Permalink

Armen Alchian has died. Alchian was both clever and wise, an unusual combination. His 1950 paper Uncertainty, Evolution and Economic Theory applied basic insights from evolutionary theory to suggest new approaches to economic ideas.  Alchian, particularly with Demsetz, began the analysis of property rights not only what property rights do but how they evolve with changing circumstances (the link goes to Alchian’s entry on this topic in the CEE). Alchian’s textbook with Allen, University Economics which became Exchange and Production, is a classic; never a bestseller among students but avidly read by masters. The Alchian-Allen theorem, sometimes called the third law of demand, continues to bedevil theorists despite its simplicity. I am a fan of his paper Costs and Outputs which generalized some ideas about production and time and inspired Fisher Black.  I never met Alchian but have always profited from reading his papers and I was truly grateful and also thrilled when he blurbed my book Entrepreneurial Economics. Fred McChesney has a good appreciation including Alchian’s pioneering event study which was suppressed for national security reasons; Bob Higgs remembers Alchian’s legendary class at UCLA and here is Larry White interviewing William Allen about A Life Among the Econ his memoir of UCLA economics during its glory years.

You can find all of these works and more in Alchian’s Collected Works.

Chris February 19, 2013 at 11:06 am

By way of Cox and McCubbins, the paper by Alchian and Demsetz’s on team production (“Production, Information Costs, and Economic Organization”) has done a lot to influence the study of legislative politics.

Thylacinus cynocephalus February 19, 2013 at 11:22 am

Rest in peace

Rich Berger February 19, 2013 at 11:36 am

Just read the Alchian-Allen theorem. That’s a great logical tool.

Thelonious_Nick February 19, 2013 at 11:36 am

I’d never heard of the Alchian-Allen theorem before though the principle is obvious once I read about it. Would also apply to labor, no? Adding a fixed cost to labor (say, health care costs) makes firms go for higher-quality employees since they’re now comparatively less expensive?

wiki February 19, 2013 at 12:01 pm

Not only does it apply but it helps provide a public choice explanation for minimum wages and labor regulation. Such rules add costs that favor high salary, high productivity jobs often requiring more credentials. Those who want to skew the market towards their areas might want to promote regulations that ostensibly “help the poor” while really serving to bolster the market for their “non-poor” services.

derek February 19, 2013 at 12:06 pm

Or raise the minimum wage makes more expensive (and productive) workers preferable.

It could as well make the perceived standard of living higher. If say building standards are increased, the higher costs will incent people to spend more than they otherwise would have on other things, creating a perception of a higher standard of living. This is alright as long as the ability to pay exists. Otherwise, it won’t be done at all.

Neal February 19, 2013 at 11:59 am

This anecdote always sticks out at me:

The year before the H-bomb was successfully created [in the 1950s], we in the economics division at RAND were curious as to what the essential metal was—lithium, beryllium, thorium, or some other. The engineers and physicists wouldn’t tell us economists, quite properly, given the security restrictions. So I told them I would find out. I read the U.S. Department of Commerce Year Book to see which firms made which of the possible ingredients. For the last six months of the year prior to the successful test of the bomb, I traced the stock prices of those firms. I used no inside information. Lo and behold! One firm’s stock prices rose, as best I can recall, from about $2 or $3 per share in August to about $13 per share in December. It was the Lithium Corp. of America. In January, I wrote and circulated within RAND a memorandum titled “The Stock Market Speaks.” Two days later I was told to withdraw it. The bomb was tested successfully in February, and thereafter the stock price stabilized.

Neal February 19, 2013 at 12:04 pm

This is in “Principles of Professional Advancement,” Economic Inquiry Jul 96, Vol. 34 Issue 3, p 520. Here’s a longer excerpt regarding his work at RAND:

RAND was not sure what an economist would do. I certainly didn’t know either. But I learned a lot about “big real world problems’–too big to comprehend, usually. Since it wasn’t clear at first what an economist could do that was pertinent, the task was to snoop around, look at the problems being analyzed (defense problems, usually) and try to see how economics could help.
What we economists did first was detect how economics was being ignored, in particular how costs and interest rates were ignored in making military-strategy decisions. Another “complicated, surprising” proposition was that for assigning nuclear material to the Air Force versus the Navy, it was not deemed necessary to know whether it was more important for the Navy or the Air Force to have more fissile material. But of course, that would be very desirable to know. With the idea of indifference curves between nuclear material and labor (as inputs), marginal rates of substitution between the two in the Navy and also in the Air Force would indicate directions in which to revise the allocations. That “revelation” gave the economics group some extra clout.

I cite these as two examples of how the simplest concepts and propositions in economics have mega-ton power. In that vein, I like to brag that I did the first “event study” in corporate finance, back in the 1950s and 1960s. The year before the H-bomb was successfully created, we in the economics division at RAND were curious as to what the essential metal was–lithium, beryllium, thorium, or some other. The engineers and physicists wouldn’t tell us economists, quite properly, given the security restrictions. So I told them I would find out. I read the U.S. Department of Commerce Year Book to see which firms made which of the possible ingredients. For the last six months of the year prior to the successful test of the bomb, I traced the stock prices of those firms. I used no inside information. Lo and behold! one firm’s stock prices rose, as best I can recall, from about $2 or $3 per share in August to about $13 per share in December. It was the Lithium Corp. of America. In January, I wrote and circulated within RAND a memorandum titled “The Stock Market Speaks.” Two days later I was told to withdraw it. The bomb was tested successfully in February, and thereafter the stock price stabilized.

In the economics division I was working with Stephen Enke, under the strong support and leadership of Charles Hitch.(n2) one thing we discovered was that engineers didn’t quite understand why “cost” had something to do with a choice of armaments. To help them learn how and why costs and things like interest rates weren’t just financial shenanigans, we collected cost data on production and operations of airplanes. I quickly noticed that the production engineers kept saying marginal costs decreased and continued to decease, lower and lower. To the contrary, as every economist knew, marginal costs begin to rise at some stage. And our textbook diagrams and cost theory proved it.

So what mistake were the engineers making? After too long a time, with embarrassment, I discovered that “output)’ meant something entirely different to production engineers than it appeared to mean to economists. Output to engineers was measured in units of accumulated total output, not in rate of output. Simple, but spectacularly different. Yet, not a single economics textbook, advanced or elementary, mentioned that. In fact most of the time the texts left unclear what was meant by “amount of output.” The engineers were explicitly clear–it was the accumulated number of units produced, with nothing whatever about the rate of production of that aggregated volume of output. Economists, judging by the relations posited to exist with “output,” had if anything the “rate of output” in mind, unconscious of the importance of the difference between rate and volume of produced output.

Barkley Rosser February 19, 2013 at 1:31 pm

Three is a curious story about Alchian from his work at RAND and from just after his seminal 1950 paper. He participated in the original prisoner’s dilemma game experiments run by the mathematicians Dresher and Flood, even prior to its being named by Al Tucker, John Nash’s major professor. The original experiments involved 100 repeated rounds. Alchian was one of the subjects along with a mathematician. Apparently the mathemetician was the first to try to cooperate, with Alchian taking his sweet time about reciprocating, but eventually did so, although this would break down just before the end, as expected. Nash was visiting at RAND at the time and was so upset at the failure of the subjects to follow his equilibrium and just defect all the time that he reportedly turned from working on game theory. As it was, in the experiment when the mathematician was trying to cooperate and Alchian was being the rational economic agent that Nash approved of, the mathematician reportedly became upset and asked somebody, “What is the matter with this guy? Can’t he figure out what is the best thing for both of us to do?” In any case, he did so eventually.

Carola Binder February 19, 2013 at 1:59 pm

What a great story, thanks!

David R. Henderson February 19, 2013 at 2:27 pm

Barkley, Thanks for the great story. I think Sylvia Nasar tells it in A Beautiful Mind, but I don’t remember if it has that degree of detail.
Best,
David (a former Alchian student)

Barkley Rosser February 19, 2013 at 4:21 pm

You are both welcome. Yes, it is in A Beautiful Mind, although the details about Albert W. Tucker are not. As it is, I knew him personally. He passed through RAND at the time the experiments were being done and his student, Nash, was getting all upset. Indeed, it was Tucker who got Nash into RAND in the first place, his one link with the military, which the movie blows up into a big, if delusional, thing. Tucker first gave the game its name in an address to the American Psychology Association shortly after Dresher and Flood did their experiments. I also note that Tucker completely disappears in the movie version of A Beautiful Mind. They make the Judd Hirsh character be his major prof, who also is Chair when Nash arrives at Princeton and gives a speech about math and the military. That was actually Solomon Lefschetz, who also coined the word, “topology.” Later, when Nash returns to Princeton to lurk about being the “Ghost of Fine Hall,” they have his best friend and rival from grad school be the department chair who helps support hiim. In real life that friend was the great John Milnor, but it was Al Tucker who was the department chair who quietly supported Nash at the time. It might also be noted that the leading advocate for Nash to get the Nobel was Harold Kuhn, who with Tucker proved the Kuhn-Tucker theorem, of some significance in micro theory.

Wonks Anonymous February 19, 2013 at 5:47 pm

I remember reading that online a while back, but most links to it now don’t work. The actual comments of each player on each round (plus an analysis of what was going on) can be viewed here:
http://web.archive.org/web/20080513211155/http://www.j-bradford-delong.net/economists/prisoners_dilemma.html

Barkley Rosser February 19, 2013 at 7:28 pm

It was Poundstone where I read about the story.

gab February 19, 2013 at 2:49 pm

And to think, I could have had Alchian, a giant in his field, for Econ 1,

Instead I got Sowell, a lilliputian…

FC February 19, 2013 at 3:55 pm

The opposite of Lilliputian is Brobdingnagian, you Lilliputian.

gab February 19, 2013 at 5:23 pm

Notice the lack of capitalization?

lil·li·pu·tian

/ˌliləˈpyo͞oSHən/

Noun:

A trivial or very small person or thing.

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