Armen Alchian

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.