In Memoriam: Armen Alchian
Department of Economics UCLA
Armen Alchian was born on April 12, 1914 in Fresno, California. In 1932 he attended Fresno State College, and transferred to Stanford in 1934. He obtained his B.A. from Stanford in 1936. He continued at Stanford as a graduate student, finishing his Ph.D. dissertation on "The Effects of Changes in the General Wage Structure" in 1943. In 1940-41 he was at the NBER and Harvard, and in 1942 he was an instructor at the University of Oregon. He served in the U.S. Army Air Forces from 1942-46 doing statistical work. He arrived at UCLA in 1946, becoming associated with RAND at the same time. He became a full professor at UCLA in 1958. He received numerous awards and honors over the years, and became a Distinguished Fellow of the American Economic Association in 1996.
Armen Alchian was known to his students and colleagues and others as the founder of the "UCLA tradition" in economics, a tradition that continues to this day. This tradition emphasizes that individual behavior is self-seeking and "rational" and that this has many unanticipated consequences. It recognizes that "rationality" is the outcome of evolution and learning, and emphasizes the frictions such as uncertainty that act as brakes on individual's ability to make decisions and coordinate with one another.
Above all, Alchian was known for the impact he has had on generations of UCLA graduate students, largely through his first year course in microeconomics. His best known student is William F. Sharpe, who received the Nobel Memorial Prize in Economic Science in 1990 for his work on finance.
Armen was an avid golfer. He was an equally avid computer user; among his other accomplishments he was the first member of the UCLA Economics Department to have a PC in his office, and was an early adopter of such important innovations as email.
Alchian had not been a prolific writer, but has rather contributed articles of major significance. Here is a review of some of his most significant contributions.
- Evolution and learning
A constant theme in Alchian's work is the rational self-seeking view of economic man. Armen, however, was far ahead of his time in seeing individual rationality as a consequence rather than as an assumption. This evolutionary point was clearly laid out in 1950: he argued that regardless of the underlying motivations, efficient behaviors survive, and inefficient behavior does not. Learning and uncertainty is a constant theme of Armen's work throughout his career; of particular interest is his empirical work on the learning curve from the early 1960's in which he studies how the output of airframes increases over time with the same level of input.
"Uncertainty, Evolution and Economic Theory," Journal of Political Economy, 58 (1950): 211-221.
"Reliability of Progress Curves in Airframe Production," Econometrica, 31 (1963): 679-693.
Law and econonomics
Alchian was one of the founding fathers of the "law and economics" school, and in particular what has come to be known as the property rights approach. This approach emphasizes the implications of property rights for risk bearing and incentive reasons, and the inefficiencies that can result from common ownership.
"Some Economics of Property Rights," Il Politico, 30 (1965): 816-829.
- Transactions costs and the theory of organizations
Alchian's interest in law and economics and property rights led him in a natural way to investigate the operation of the firm and other organizations. In the early 1970's he and Harold Demsetz published a landmark paper on the theory of the firm. This emphasized the way in which the firm can internalize externalities associated with incentive problems. The difficulties of monitoring in the presence of shirking were emphasized, and the article represents the beginning of the modern literature on incentive contracts and moral hazard. Alchian's work on the theory of organizations continued into the late 1970's as his work with Robert Crawford and Benjamin Klein studied the way in which specific investment creates hold up problems that can be solved in part by vertical integration among business units.
"Production, Information costs and Economic Organization," (with Harold Demsetz) American Economic Review, 62 (1972): 777-795."
"Vertical Integration, Appropriable Rents, and the Competitive Contracting Process," (with Robert Crawford and Bejamin Klein), Journal of Law and Economics (1978)
- Information costs and resource unemployment
Alchian was also a pioneer of the idea that information costs can lead to resource unemployment, especially of labor. Typical of Armen, his work on the subject was kept "in the drawer" for many years and used largely in his graduate teaching, until colleagues urged him to publish. In addition to the basic idea of unemployed resources searching for more productive uses, Armen emphasized the role of middlemen in the facilitation of resource employment. This paper represents one of beginnings of a large literature on search and employment that continues to this day.
"Information Costs, Pricing and Resource Unemployment," Economic Inquiry, 7 (1969): 109-128.
Alchian had also had a lifetime fascination with the role of money as a facilitator of trade. Closely connected to his work on information costs and resource unemployment, he has emphasized how the use of money in conjunction with middlemen serves to lower the costs of conducting trade.
"Why Money?" Journal of Money, Credit and Banking, 9 (1977): 133-140.
- Exchange and Production
Alchian was also widely known as the author (with Wiliam Allen) of the first year undergraduate textbook Exchange and Production which has appeared in numerous editions since 1964. This book, familiar to many generations of undergraduates and graduate students alike, is unique. Unlike most elementary undergraduate texts, which are excessively bland, Exchange and Production is bitingly ironic, poking fun at political correctness, long before it had a name. It is unique as well in that it incorporated the Alchian and Allen's latest thinking about issues such as property rights and unemployment when most other textbooks are content to regurgitate the state of economic theory of some 20 years ago.
Exchange and Production, (with William R. Allen), Wadsworth Publishing Company, Belmont California
by David K. Levine
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Armen was the economist who set the standards that lifted UCLA into the top echelon. In recognition, the economics department celebrated his 60th birthday in 1974 with a small conference. The four invited speakers were Paul Samuelson, Ken Arrow, Milton Friedman and George Stigler. Over the years I got to know them all, especially Paul. Each deeply respected Armen as an economist and a person.
Armen was both aware and caring. Soon after my arrival at UCLA in 1973, I went down to the faculty club on my own. Out on the patio the round table of economists was full. I hesitated and thought "Perhaps I should sit at another table?" While still hovering, it was the most senior person at the table who spotted me, leapt to his feet, insisted that I take his chair and raced off to get another one. Of course that was Armen Alchian.
Armen also had a great sense of humor. I first met him on my recruiting trip from a wintry Boston. As I entered his office I caught a glimpse of a shimmering blue Pacific. "Wow!" I said gazing out the window. "Come with me," he said. We raced up 4 flights of stairs to the Bunche Hall rooftop (open to visitors in those days). The view was stunning. There was Catalina Island, looking as though I could almost touch it even though it was about 40 miles from UCLA. "A typical LA day!" said Armen triumphantly. But I noticed a twinkle in his eye. I looked around. "I don't know Armen, if that were true why would there be over 50 people up here right now!" He laughed. As I later learned, in 1973 this was a view only after a major storm. He knew it and so did a lot of others at UCLA. As we retraced our steps to his office I felt that I had passed my first UCLA test.John G. Riley
Department of Economics
February 20, 2013
In 1975, I attended a week-long conference in Connecticut at which the star attraction was Friedrich Hayek. Hayek, who had shared the 1974 Nobel Prize in economics with Swedish economist Gunnar Myrdal, was doing a kind of victory tour of the United States. I told him that I thought Armen Alchian, one of my mentors when I earned a Ph.D. at UCLA, also deserved the Nobel Prize. I asked Hayek what he thought. Hayek gave his characteristic wince, paused, and said, "There are two economists who deserve the Nobel prize because their work is important but won't get it because they didn't do a lot of work: Ronald Coase and Armen Alchian." Sixteen years later, in 1991, Ronald Coase did win the Nobel Prize. When I got the news, I called Armen and told him the story. He got a kick out of it and seemed to have a new hope that he would win. He didn't, and now he can't. Armen Alchian died on Tuesday at the fine age of 98.
What was so important about Alchian's work? There were three aspects. First, he was one of the last economists of his generation to communicate mainly in words and not equations. Second, although economists often use the word "unrigorous" to refer to communication in words rather than math, Alchian was profoundly rigorous, writing clearly and carefully and using basic logic to reach sometimes-startling conclusions. As a result, many of Alchian's papers, even those from the 1950s, are still widely cited. Third, Alchian is known for his textbook, "University Economics," first published in 1964 and later called "Exchange and Production," coauthored with UCLA colleague William R. Allen. That text 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."
Alchian had his largest impact on the economic analysis of property rights. Most of his work in this area 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 the prices don't have property rights in the tickets, so the wealth that is given up by underpricing wouldn't 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 and now a professor at George Mason University Law School, used this same line of reasoning to explain why Michigan Congressman John Dingell blocked the FCC's early attempts to auction off the electromagnetic spectrum and, instead, favored giving it away. Auctioning would have reduced Mr. Dingell's power. Alchian also used the analysis of property rights to explain racial and ethnic discrimination. In a 1962 paper coauthored with the late University of Chicago economist Reuben Kessel, Alchian-himself subject to anti-Armenian discrimination early in his life-pointed out that discrimination was more pervasive in private firms whose profits were regulated by the government. Alchian and Kessel explained that 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 don't bear much of the cost from doing so. A company whose profits are not regulated would see the cost of discrimination in the form of lower profits. A company whose profits were limited and that was already at the limit would face no cost from discriminating.
Alchian first major article, "Uncertainty, Evolution and Economic Theory," was published in 1950. It was his response to a controversy about whether companies really do maximize profits. Alchian argued that even though all companies may not maximize profits, those that survive will be ones whose managers, by luck or design, came close to maximizing profits. Therefore, those that we observe will have maximized profits. So, for the long term at least, Alchian argued that economists don't need to show that all companies try to maximize profits in order to derive the standard conclusions from the profit-maximization assumption.
My personal favorite of his published papers is "The Economic and Social Impact of Free Tuition" (1968). Alchian pointed out that government aid to higher education is a transfer to the relatively rich. That's because people who can make it through college, even though they may have a low current income, have a high wealth. He compared subsidizing college to subsidizing drilling expenses for someone sitting on a large pool of oil. The untapped student's potential is the analogue of the untapped oil. Alchian argued that lack of current income might be a justification for loans to aspiring college students but not for outright subsidies. He cinched the argument with the following story: One poor, "uneducated" resident of Watts, upon hearing Ralph Bunche [winner of the 1950 Nobel Peace Prize for his work in Palestine] say that he could not have had a college education unless tuition were free, opined, "Perhaps it's time to repay out of his higher income for that privilege granted him by taxes on us Negroes who never went to college."
I still make Alchian's point in my classes and, although it upsets my students, not a single one has been able to undercut the fundamental soundness of Alchian's argument.David R. Henderson
Henderson earned his Ph.D. in economics from the
University of California, Los Angeles, in 1976.
February 20, 2013
I was a student in Northwestern University's Ph.D. program when I first met Armen. He had come to Northwestern to present his in-process paper on rethinking the way economcs treated business firm costs. It was an insightful call to pay attention to the total run of a product as well as to the rate at which it was produced. He came this topic while consulting at the RAND Corporation, where people had been busy studying the cost of producing military aircraft. The presentation was as clear as could be, a few black board curves accompanied by simple oral discussion of the impact of total run on cost per unit and how this might differ from measures derived from calculations based only on rate of output. His performance was important in drawing me later to UCLA and away from the University of Michigan. His work always received my full attention, as did from many others, and he never deviated from offering significant ideas and work in this simple, straightforward way. Students and fellow economists learned a great from him. Armen and I teamed up for several years to teach economics to law professors and Federal Judges at Henry Manne's Center for Law and Economics. Armen's two weeks of lecturing were followed by my two weeks, so I was able to learn what our students thought of his lecturing. They loved him!
Especially his challenging questions and examples. This shows in all his students and in readers of his articles and of the great beginning text he and Bill Allen coauthored. Not many of us can validly claim to have improved the profession's understanding of their subject and of its explanatory power. Armen could, but did not. He was too modest.Harold Demsetz
March 1, 2013
On February 19, 2013 in Los Angeles, died professor Armen A. Alchian. In April this year he would have turned 99 years old, so he was born in 1914. Since 1946 he was a member of the economics faculty of the University of California at Los Angeles (UCLA), since 1958 in the position of Full Professor. UCLA, he has remained faithful throughout his life. Until the 80s, he was the central figure and the shining light of its business school. He was in my view one of the few fascinating economists of our time.
Personally, I knew Armen Alchian over 30 years ago. His name I first heard in 1969. During a lecture at the University of Hamburg said Professor Karl Brunner on the then relatively new textbook "University Economics" of Armen Alchian and William Allen. The micro-economic chapter of the book came from the pen of Alchian, the macroeconomic and internationally oriented sections of Allen. Later the microeconomic part separated and separately under the heading "Exchange & Production - Competition, Coordination, and Control" published. The last edition of "Exchange & Production" is from 1983, the book is 30 years old. Nevertheless, it is in my view still the best micro-textbook that I have ever had in my hand. That is also the reason why I still use this textbook for my events at the University of Luxembourg. I experience it every year that even negative preprogrammed students studied the relevant chapters within the lecture extensively. I had expressed my enthusiasm in September 1984 in a book review, it is still today.
What is special about this book? The essential feature is the basic idea that economic theory is not an end in itself. The theory provides methods and tools to explain important practical problems. The problem to decide which theory concept must be discussed. "Modern" textbooks argue the other way around: after the presentation of various theorems - if ever - discussed a few applications.
Content, it is - the following subtitles - competition issues as well as coordination and control problems. Unlike typical micro-texts not primarily marginal conditions are discussed. In the center of the discussion are concepts like property rights, conflicts of interest, political power monopolies, regulation, incentive conditions, control systems. With each application, a given check-list is processed. The points are: Which alternatives, the decision-makers? What are the relevant costs? What constraints must be respected? If these points in mind, you have the almost certain guarantee of finding a workable solution. And you have a good chance of classifying statements of lobbyists, lobbyists or politicians as usable or unusable.
Besides the mentioned textbook, there are some truly groundbreaking magazine article by Armen Alchian. I need only mention my two "favorites". That's one part of the article "Information Costs, Pricing and Resource Unemployment". This is about principles of information economics. And that's the other "Why Money". Here Information arguments are used to justify the existence of money. I can say that both contributions have shaped my thinking to change.
During my time at UCLA, I regularly attended the PhD seminars of Armen Alchian. About an experience I want to conclude with a brief report. The presentation of the speaker was interrupted after about 20 minutes of Armen Alchian: "I just do not understand come to the blackboard, please.". He urged the students to write the problem its underlying system of equations on the board. What then happened was, for me, magical trains. After two or three equations developed a question-and-answer session. Alchian asked the questions so that the student has been out with your own thoughts and your own answers to the right path. It was almost a Platonic dialogue. After about an hour and after the countless fixes the appropriate equations for the problem was at his desk. I was speechless. The students had left the room. I was still sitting in my seat. Armen Alchian asked what was wrong with me. My explanation he would not accept. Even today I remember meticulously on this lesson. I've always wanted to be a university teacher as Armen Alchian. Unfortunately, I never managed it.
March 21, 2013
Like most of you, I am a professional brooder on scarcity and sin, with the latter being a partial function of the former. As such, I am not one to indulge lightly in levity. Living is serious activity. But when I purported to have taught Armen most of the good stuff he understood, he seemed to suppose that I was joking. Still, he does make this acknowledgement in his Collected Works: “I … have a William Allen as co-author of a textbook …, in which he claims he wrote all the even words while I wrote the very odd ones.”
In the Allen family, I have had two older brothers. Both – one a professor of economics, the other a professor of law – were uncommonly competent and accomplished. They were at once demanding and supportive of me, and I learned much from them. That is not the entirety of my story. With Armen, for over 60 years, I have had a virtual third brother. He too was demanding and supportive – and I learned much from him. I greatly miss them all.
Remarks of William R. Allen
at the Armen Alchian Rememberance
March 24, 2013