Price Theory as Prophylactic against Popular Fallacies
Peter J. Boettke ∗ and Rosolino A. Candela +
Abstract
The articles collected in the three-volume set of Chicago Price Theory illustrate
elements of continuity and change in the development of the Chicago
School. Its editors stress a continuity in price theory at Chicago that runs
from Frank Knight to Gary Becker. Our main contribution in this review
essay is to emphasize the discontinuity in the Chicago price theory tradition
between the Knight/Viner/Simons generation and the post-war
Friedman/Stigler/Becker generation. Moreover, we argue that a more logical
continuation runs from the Knight/Viner/Simons generation to the
Alchian/Buchanan/Coase generation of Chicago price theory. The element
of continuity we stress is one of understanding price theory as a study of
market adjustment and adaptation under alternative institutional
arrangements, rather than using price theory to identify a unique solution to
an allocative problem. Whereas the former understanding of price theory
was underemphasized under Friedman/Stigler/Becker, the latter
understanding of Chicago price theory tradition was continued by
Alchian/Buchanan/Coase.
JEL CODES: B21; B31; D60
Keywords: Chicago Price Theory; Alternative Institutional Arrangements;
Market Equilibrium
∗
Email: pboettke@gmu.edu. Address: Department of Economics, George Mason University, Mason Hall
D109, Fairfax, VA 22030, USA.
+
Email: rcandela@masonlive.gmu.edu. Address: Department of Economics, George Mason University, Mason
Hall D121, Fairfax, VA 22030, USA.
1
“Academic economics is primarily useful, both to the student and to the political leader, as a
prophylactic against popular fallacies.” – Henry Simons (1983, p. 3)
I. Introduction
In his forthcoming Journal of Economic Literature article, Glen Weyl defines price theory as an
“analysis that reduces rich and often incompletely-specified models into ‘prices’
(approximately) sufficient to characterize solutions to simple allocative problems” (2015).
The array of prices prevailing on the market, in other words, solve the problem of allocating
scarce time of economic actors and the resources in their possession to their highest valued
uses. Price theory is about understanding how this “solution” is brought about through the
interaction of individuals and depicting the consequences of such interaction. From its
foundations in Alfred Marshall’s Principles of Economics to Gary Becker’s Economic Theory, the
hallmark of research and teaching in the Chicago price theory tradition has what Becker refers
to more accurately as “practical general equilibrium analysis” (Becker 1971, p. 5) for realworld empirical applications.
It is this richness and diversity in the research and teaching of Chicago price theory,
as exemplified by the collection of classic papers and book chapters brought together by
Hammond, Medema, and Singleton, that makes this edited volume truly worthy of praise
and interest to all students and scholars of economics. 1 As shown by the complete list of the
table of contents provided in an appendix below, the breadth and depth of the topics
covered in Chicago Price Theory extend from methodology, consumer behavior, and
production, to public policy and welfare economics.
1 J. Daniel Hammond, Steven G. Medema and John D. Singleton, eds., Chicago Price Theory, 3 volumes,
International Library of Critical Writings in Economics 274 (Cheltenham, UK: Edward Elgar Publishing, 2013),
pp. 847, $1350.
2
The underlying theme of our essay is that an examination of the evolution of price
theory throughout the history of “Chicago School” economists reveals a shift in analytical
emphasis from the institutional arrangements that provide “the social organization of economic
activity” (Knight 2013 [1933], Vol. I, p. 176, italics original), to the relentless and unflinching
application of the rational choice analysis to all human behavior (Becker 2013 [1976], Vol. I,
p. 294). It is often argued that at its core there is a logical continuity that runs from Frank
Knight to Gary Becker in “Chicago price theory”. Melvin Reder, for example, argued that
the Chicago economics of the 1930’s was the precursor of what became Chicago economics
in the 1960’s and 1970’s, with Frank Knight being the “baton passer” of Chicago price
theory, first to Milton Friedman and George Stigler, and eventually to Gary Becker (2013
[1982], Vol. I, p. 138).
The association of price theory with the University of Chicago, according to Glen
Weyl, is largely an outgrowth of a segregation of “Chicago” from the rest of the economics
profession during the critical decades when that "baton" was being passed -- 1940s and
1950s.
2
During the second half of the 20th century microeconomic theory moved
increasingly away from elaborating elementary price theory and towards the formulation of
proofs of the existence, uniqueness, and stability of general competitive equilibrium. The
Arrow-Hahn-Debreu project was a far cry from the persistent and consistent application of
the economic way of thinking in the early development of neoclassical price theory from
Phillip Wicksteed to Frank Knight. Henry Simons summarized this early project in the
economic way of thinking as follows:
2
It is probably useful to remember that Friedman and Stigler overlapped as students during the 1930s, and
were students of the Frank Knight/Jacob Viner/Henry Simons tradition, but their return to Chicago to join the
faculty was first Friedman in 1946 and then Stigler in 1958. Becker was a student in the 1950s and joined the
faculty in 1968. The "Tight Prior Equilibrum" assumption that Reder talks about comes to be embedded in the
hard-core of Chicago price theory more or less with the work of Stigler and Becker, even more so than
Friedman, and as such is a defining characteristic of the approach only in the late 1950s onward.
3
Traditional price theory consists primarily in analysis of the pricing process
under a free enterprise economy – under a system characterized by private property,
free contract, and free exchange. Assuming given underlying conditions (given
conditions, broadly, as to tastes, technology, resources, and ownership), it
attempts to show how consumption and production are controlled through
the pricing process and, above all, to describe (a) the arrangements under
which the system will be in equilibrium and (b) how departure from the
equilibrium arrangements will set in motion forces to restore equilibrium. The
central conception of price theory is that of an equilibrium adjustment with respect to
relative prices and relative production. (Simons 1983, p. 6, emphasis added)
As this quote and the epigraph from Simons written above suggests, the University of
Chicago economist, both through their graduate teaching of price theory as well as through
their research, understood that the purpose of their efforts was to prevent the spread of
popular fallacies in economic discussions. According to Knight, for example, economics is
applied common-sense and the puzzle for the economists is why men too often ignore the
basic teachings of economics. As he argued in his presidential address to the American
Economic Association, “The serious fact is that the bulk of the really important things that
economics has to teach are things that people would see for themselves if they were willing
to see” (Knight 1951, p.4). The study of economics opens one’s eyes to a world in which
individuals are not trapped in a zero-sum game, or worse, a negative-sum game, but one in
which it is possible to engage in productive specialization and peaceful social cooperation.
Knight as well as other economists of the pre-WWII Chicago price theory tradition realized
that the harmony of interests and unintended results of the invisible hand did not operate in
an institutional vacuum.
As already mentioned, it is our contention that this emphasis on the institutional
framework within which prices emerge to guide exchange and productive activity receded to the
background of analysis in Chicago price theory after WWII. What came to the foreground
was the analysis of the price system as providing a sufficient solution to allocation problems.
This derivation of what Reder refers to as the “Tight Prior Equilibrium” was utilized to
4
impose intellectual discipline in our understanding of complex realities. This version of the
Chicago School came to define the economic approach of human behavior with
“maximizing behavior, maximizing equilibrium, and stable preferences” (Becker 2013 [1976],
Vol I., p. 294) as the working hypotheses for the examination of all social phenomena. The
implication of this theoretical perspective is that prevailing prices equal marginal costs, and
all least cost technologies are being employed in production. In short, after fully accounting
for all of the costs and benefits in decision-making, the optimal course will be revealed to
have already been chosen by rational actors through the filter of competitive markets.
Chicago price theory in the Friedman/Stigler/Becker generation was not defined by the
comparative analysis of the institutional conditions within which the constant adjustments
and adaptations by economic actors to changing conditions produces a tendency towards
equilibrium, as it had been under the Knight/Simons/Viner generation. Instead, price theory
in the hands of Friedman/Stigler/Becker became an exercise in defining the optimality
conditions given any situation within which human actors find themselves.
If price theory is to be a “prophylactic against popular fallacies,” then it seems vital
to ask which approach proves to be more effective in addressing popular fallacies in
economic theory and policy, particularly the notion that government is a necessary corrective
to a litany of “market failures.” Our essay will be framed in terms of this inquiry. As
Hammond, Medema, and Singleton of Chicago Price Theory indicate, the evolution of the
Chicago price theory tradition has neither been necessarily chronological nor exclusive to its
development within the Department of Economics at the University of Chicago (2013, Vol.
I, p. xix). But we push this argument a bit farther and argue that it is outside the University
of Chicago that the logical continuation of Chicago price theory in the Knightian tradition
had been passed to another generation of “Chicago” economists, namely Armen Alchian,
5
James Buchanan, and Ronald Coase, who developed an alternative branch of price theory at
UCLA and UVA. The UCLA property-rights school and the Virginia School of Political
Economy as they developed in the 1950’s to the 1970’s drew analytic attention to the
“economic forces at work” (Alchian 1977) with its emphasis on exchange and the
institutions within which exchange takes place in market and non-market settings. As we
explain, the UCLA and Virginia School developments also draw on the early Austrian School
and the London School of Economics tradition that was inspired by the Austrian branch of
neoclassical price theory (see Buchanan 1999 [1969]; Buchanan and Thirlby 1981 [1973).
The Alchian/Buchanan/Coase generation of price theorists, we ultimately conclude,
provides the more effective “prophylactic against the popular fallacies” of market failure and
the notion that government intervention will correct such failures. Rather than explain away
the notion of market failures by way of the "Tight Prior Equilibrium" assumption, this
“neglected branch of Chicago price theory” (see Boettke and Candela 2014) emphasized the
importance of comparative institutional arrangements, namely the changes in rules and property
rights assignments that generate market processes, which ameliorate “market failures” such
as externalities, asymmetric information, and monopoly power.
There is no doubt that a coherent narrative could be told linking the
Knight/Viner/Simons generation to the Friedman/Stigler/Becker generation at a
methodological, analytical, and ideological level. However, rather than stressing the
continuity between these two generations of Chicago school, we argue that emphasizing the
discontinuities is perhaps where a more fruitful interpretative schema will be found,
particularly for understanding the evolution of modern economic theory. Furthermore, in
brining such discontinuities to the foreground of analysis, the continuity running from
Knight/Viner/Simons to Alchian/Buchanan/Coase will perhaps become more apparent
6
and illustrate what elements of Chicago price theory had become lost in the more dominant
paradigm of Friedman/Stigler/Becker.
II. Chicago Price Theory: A View from Virginia
In 1946, after serving his country in the Navy during WWII, James Buchanan enrolled at the
University of Chicago to pursue his PhD in economics. Buchanan’s class notes from all 3
courses he took in price theory at Chicago survive and are at the moment in the process of
being properly archived for future use by scholars at George Mason University. 3 Buchanan
learned Chicago Price Theory from Knight and then two sections with the newly hired
Milton Friedman.
Friedman’s hiring at Chicago is a story in and of itself, and has recently been the
subject of work by David Mitch (forthcoming), and also can be gleaned from the
correspondence between Friedman and Stigler in the wonderful volume, Making Chicago Price
Theory, edited by J. Daniel Hammond and Claire H. Hammond (2006). As it turns out, the
department was split on the hiring of either George Stigler 4 or Paul Samuelson, and that split
led to the choice of Milton Friedman. All 3 of these towering figures in post-WWII
economics were students at Chicago during the 1930s, and this episode of departmental
politics and academic gamesmanship once again demonstrates just how fundamentally human
the enterprise of science is, and the contingent nature of the evolution of scientific progress.
It would be hard to imagine what the “Chicago School of Economics” would be if it were
not for Milton Friedman, yet he could easily have not ended up teaching there. Had the
3
We gratefully acknowledge the Center for Study of Public Choice in cooperation with the George Mason
University Library for granting us access to this archival material
4 As Reder states, “The Economics Department had approved an offer to Stigler in 1946, but due to an
unsatisfactory interview (with Stigler), the President of the University, Ernest Colwell, refused to approve it.
The position was then offered to Friedman who (evidently) had better luck with the University Administration”
((2013 [1982], Vol. I, p. 141).
7
Cowles Commission folks won the battle Stigler would most likely not have ended up there
later as well. 5 But Friedman and Stigler did end up at Chicago, and, along with Becker, they
reconstructed Chicago Price Theory after Frank Knight, Henry Simons, and Jacob Viner
passed the torch in the late 1940’s.
But let’s go back to Buchanan’s notes from Knight’s class before we get started in
our discussion of this magnificent three volume collection organized by Hammond, Medema
and Singleton. Buchanan often stressed that prior to Knight’s class he was a socialist in
political leanings, but after a few weeks of Knight’s class he was weaned off of his socialist
predilections and afterwards understood the power of the price system and the competitive
market economy to coordinate economic affairs so that peaceful cooperation and productive
specialization would be achieved among free individuals. On that first day of Knight’s class,
Buchanan’s notes have Knight explaining the following:
Neo-Classical Tradition --- Theoretical principles based on a priori sources.
Historical economics
American institutionalism
Statistical economics
}
} both factual as opposed to
} theoretical
Keynes – opposed to neo-classical economics
The required textbooks for Knight’s class were Marshall’s Principles of Economics and Stigler’s
The Theory of Price. The overall reading list that was provided to all graduate students and
which was to form the common knowledge for graduate students in the 1930-1940s also
5
A history of the Cowels Commission and its influence on the transformation of economic science during the
critical decades of the mid-20th century is a most worthy topic. At Chicago, the Cowles Commission for
Economic Research was at Chicago from 1939 until 1955, when Tjalling Koopmans moved the research group
to Yale and renamed it the Cowles Foundation. The battles between Cowles and Chicago Price Theory are
critical to understanding the segregation that Weyl talks about, but also our thesis about the institutional
analysis and exchange perspective version of Chicago Price Theory being neglected.
8
contained Bohm-Bawerk, Wicksteed, Wicksell, Mises, and Hayek. Recently, Economics in the
Rear-View Mirror posted the reading list from Jacob Viner’s price theory class from Milton
Friedman’s notes, and we can see that Menger, Wieser, and Bohm-Bawerk were featured
prominently. 6 From our perspective, it is important to stress that these reading lists provide
evidence that in a critical sense, circa 1930’s and 1940’s, the so-called “Austrian school” was
simply part of the common knowledge that all students of ‘neoclassical’ price theory were
expected to learn. 7
In that first set of notes from Knight’s class, Buchanan is learning about the
important insights of the classical economists, the role of economic efficiency, the difference
between the physical sciences and the social sciences, and the moral framework of liberalism.
Buchanan’s vantage point is unique because his student experience falls smack in the middle
of the transition from the first generation of the Chicago price theory tradition (dominated
by Knight and Viner) to the second generation (of Friedman and Stigler) which would
evolve to the third generation (defined by Becker). Buchanan began graduate school at
Chicago in 1946, which is also when Friedman joined the faculty.
See http://www.irwincollier.com/chicago-economics-reading-assignments-economic-theory-econ-301-vinerfall-1932/
7
This was not just the case for graduate students being educated at the University of Chicago. While
interviewing F.A. Hayek in 1978 at UCLA, Alchian discusses his education in the Economics Department at
Stanford University, where he began graduate studies in 1934. Among the main texts used in his first year,
Alchian talks about one of them being Hayek’s Prices and Production. In the interview, Alchian remarks to Hayek
that the book “has a particularly warm place in my heart.” Furthermore, he also states “it was a book that set a
tone of thinking for me” (quoted from Hayek 1983, p. 381) in thinking about economic theory in terms of
relative price adjustments.
In addition, Ronald Coase was educated at the London School of Economics (LSE), where began his
studies for a Bachelor of Commerce degree in 1929. Before enrolling as an undergraduate at the LSE, Coase
had already been exposed to the ideas of the Austrian School, where he attended a lecture in 1928 at the LSE
given by Ludwig von Mises (Kitch 1983, p. 211). While attending the LSE, Coase came under the influence of
F.A. Hayek and Arnold Plant, the former arriving in 1931 as Tooke Professor of Economic Science and
Statistics and the latter being appointed Professor of Commerce in 1930. Both as a student (1929-1932) and
later as a faculty member (1935-1951), the development of Coase’s argument in “The Nature of the Firm”
(1937) was heavily influenced by the Socialist Calculation Debate as communicated to him through Plant and
Hayek.
6
9
As Hammond, Medema and Singleton (2013, p. xiii-xxvii) explain in their
introductory essay to Chicago Price Theory, while there is definitely a discernable continuity in
the history of Chicago price theory, there are also tensions and points of disjunction at a
methodological, method, and application level. As stressed in several of the interpretative
papers on the teaching of economics at Chicago (found in Vol. 1), Knight was decidedly
non-empiricist in a way that the later Chicago school would come to be defined by their
strong commitment to empiricism. On a slightly different yet also ironic point, Buchanan
stressed a disjuncture between what he termed the “Old Chicago School” and the “New
Chicago School” and he emphasized how the “New Chicago School” tended to ignore the
institutional framework within which economic activity takes place. Thus the “New Chicago
School” didn’t pay enough attention to how dysfunctions in the framework could distort the
operation of the market economy (see Buchanan 2010).
III. A Neglected Branch of Chicago Price Theory
Throughout the time covered in this collection, the intellectual alternatives of Chicago price
theory included not only German historicism, American institutionalism, and Keynesian
macroeconomics, but also through the Cowles Commission (later Foundation) the
formalistic development of competitive equilibrium theory, which eventually embodied a
new consensus in Mas-Colell, Whinston, and Green’s Microeconomic Theory (1995). The
underlying element unifying the Chicago price theory tradition, which differentiated it from
its intellectual alternatives, is its recognition of rational choice as an axiom of economic
science. As Frank Knight argues in The Ethics of Competition:
there is a science of economics, a true, and even exact, science, which reaches
laws as universal as those of mathematics and mechanics…There are no laws
regarding the content of economic behaviour, but there are laws universally
valid as to its form…We cannot tell what particular goods any person will
10
desire, but we can be sure that within limits he will prefer more of any good
to less, and that there will be limits beyond which the opposite will be true
(1997 [1935], p. 127)
However, Knight did not equate economic science as a whole with rational choice. Rather,
economics as science consisted of the logic of rational choice, which was deductive and a
priori, as well as subsidiary empirical propositions of time and place, namely institutions.
While Knight considered economic theory as a priori and a necessary condition for “the
analysis of social interaction and coordination through the price mechanism” (1997 [1935],
p. 132), he did not consider it sufficient for understanding how relative price adjustments
structure the trade-offs of rational decision-making as well as generate a tendency towards
equilibrium. For Knight, the axiom of rational choice underlying economic theory was
always institutionally contingent. Thus economic science for Knight consisted of pure theory,
which is deductive in nature, as well as applied theory, which is inductive and structures the
logic of rational choice within a particular set of institutional arrangements. Thus, the laws of
economics:
work within an institutional setting, and upon institutional material;
institutions supply much of their content and furnish the machinery by which
they work themselves out, more or less quickly and completely, in different
actual situations. Institutions may determine the alternatives of choice and fix
the limits of freedom of choice, but the general laws of choice among
competing motives or goods are not institutional – unless rational thinking
and an objective world are institutions, an interpretation which would make
the term meaningless (1997 [1935], p. 129).
Thus, for Knight economics was a social science, but one which could derive universal laws
about human action that had the same ontological status as the natural sciences, yet
accounted for the open-ended creativity and complexity of human choice. However, the new
consensus in economic reasoning among the generation of economists educated since the
1990s, trained with Mas-Colell, Whinston, and Green’s Microeconomic Theory, constitutes a new
intellectual alternative, which we refer to as “formalistic historicism”, with an effort to
11
substitute a tool-kit for the analysis of particular problems for economic theory as
conceptualized by Knight (see Boettke 2012a, p. 316-329). That is, antithetical to the last
point made by Knight, formalistic historicism represents a vision of economic science in
which human action reveals only particular truths specific to time and place, not universal
economic laws, yet uses formal language (i.e. mathematics) to prove any particular
proposition, purging the human actor of any choice within an institutional context.
Therefore, under a given set of institutional conditions, the logic of choice does not yield a
tendency towards a unique equilibrium, but a multiple set of possible equilibria which does
not necessarily hold in all the cases with similar circumstances.
To earlier generations of economists, as emphasized by Knight, there were certain
universal propositions about how the world worked that followed from neoclassical analysis
that could be expressed in various languages, including mathematics.
As the classical
political economist Nassau Senior argues, the political economist:
must necessarily reason, from assumptions, not from facts. It is built upon
hypotheses strictly analogous to those which, under the name of definitions,
are the foundation of the other abstract sciences. Geometry presupposes an
arbitrary definition of a line, 'that which has length but not breadth.' Just in
the same manner does Political Economy presuppose an arbitrary definition
of man, as a being who invariably does that by which he may obtain the
greatest amount of necessaries, conveniences, and luxuries, with the smallest
quantity of labour and physical self-denial with which they can be obtained in
the existing state of knowledge. It is true that this definition of man is not
formally prefixed to any work on Political Economy, as the definition of a
line is prefixed to Euclid's Elements; and in proportion as, by being so
prefixed, it would be less in danger of being forgotten, we may see ground
for regret that it is not done. It is proper that what is assumed in every
particular case, should once for all be brought before the mind in its full
extent, by being somewhere formally stated as a general maxim… Political
Economy, therefore, reasons from assumed premises-from premises which
might be totally without foundation in fact, and which are not pretended to
be universally in accordance with it. The conclusions of Political Economy,
consequently, like those of geometry, are only true, as the common phrase is,
in the abstract; that is, they are only true under certain suppositions in which
none but general causes-causes common to the whole class of cases under
consideration-are taken into account (Senior 1852, pp. 60-61).
12
From Nassau Senior to Frank Knight, economists were all apriorists of some sort or another.
Economic theorems, as these economists contended, were derived from ‘‘self-evident’’
axioms. Far from out of step, this is the way that economic theorizing was done by classical
as well as economists of the pre-WWII Chicago School.
The current situation is different and could be described as one where what is
universal is the language or form in which arguments are made, but there are no unifying
propositions about how the world in fact works. A great history of modern economic
thought project would be to survey the dominate price theory texts in the elite PhD
programs and to see how that impacts the character of economic thinking 10-20 years hence.
Prior to Mas-Colell, Whinston, and Green, there was Kreps’s A Course in Microeconomic Theory
(1990), which was preceded by Varian’s Microeconomic Analysis (1978) and before that there
was Henderson and Quandt’s Microeconomic Theory: A Mathematical Approach (1958), and so
forth until you trace back to Marshall and Stigler. But the character of economics shifts with
each changing core textbook used to teach economics. Samuelson’s Foundations of Economic
Analysis (1947) compels those schooled in its approach to view the scientific enterprise of
economic differently than say those who trained working through Friedman’s Price Theory
(1962), or Stigler’s The Theory of Price (1946) let alone Armen Alchian’s University Economics
(1964). To put this another way, Walrasian economics is different from Marshallian
economics, and Wicksteedian economics is different from both. Chicago price theory is
decidedly Marshallian, but perhaps more accurately -- at least in the Knight/Viner/Simons
tradition as Wicksteedian. Friedman once famously said that we curtsey to Marshall, but we
walk with Walras. But for Knight, it might have been more accurate to say that he didn't
13
curtsey or walk, but instead waltzed with Wicksteed -- as economics was in his hands an
elegant dance through the complexities of life. 8
Gary Becker often said that it was from Friedman that he learned that economics is
not just a clever game to be played by smart academics, but a vital tool for understanding the
world in which we live. There is something in that claim that sets Chicago price theory apart
from the teaching of economics at the other elite centers of excellence in economic research
and graduate education. In fact, earlier in this decade, the Becker Center at University of
Chicago ran an intense summer “boot” camp in Chicago Price Theory for graduate students
at other elite programs precisely because of the belief that a generation of economists were
not learning the right lessons about economic theory and in particular about market theory
and the price system. Cleverness is no doubt valuable in an individual thinker, but not as
much as creativity and certainly not as much as the consistent and persistent pursuit of the
logic of economic analysis and careful empirical analysis.
Back in the 1980’s, a visitor from Harvard at George Mason University described the
difference between Chicago and Harvard/MIT in terms of the graduate student education as
follows --- ‘we study the same models of the market and the price system as they do at
Chicago, but at Chicago they actually believe the models, where at Harvard/MIT we don’t.’
In many ways this characterization translates into the “saltwater” versus “freshwater”
debates in the public imagination of economic discourse. The “freshwater” thinkers rely on
8
Wicksteed’s analysis of how the system achieves equilibrium is different from either Walras or Marshall.
“Wicksteed’s approach,” Lionel Robbins (1932, p. xix) writes in his introduction to The Common-Sense of Political
Economy, “is by no means the same as Pareto’s. His analysis of the conditions of equilibrium is much less an end
in itself, much more a tool with which to explain the tendencies of any given situation.” Wicksteed’s economics
is an economics of active human decision makers, adjusting their behavior to one another to realize gains from
trade, and thus the gains from social cooperation under the division of labor. Wicksteed represents an
interesting, yet under explored, connection between Chicago and LSE as The Common-Sense of Political Economy
was a standard on the reading lists at both schools. Buchanan’s Cost and Choice (1999 [1969]) identifies
Wicksteed as one of the critical thinkers in the persistent and consistent application of opportunity cost
reasoning which could be taken as foundational for the economic way of thinking.
14
abstract models of the economy to show the superiority of free markets while the
“saltwater” economists show the fragility of these models to real-world imperfections. As
economists trained in the Virginia School of Political Economy, where the point is to
reconcile and marry the best ideas from the property rights economics (Alchian), law and
economics (Coase), public choice analysis (Buchanan), and market-process economics
(Mises, Hayek, and Kirzner), the authors of this essay believe that both Harvard/MIT and
Chicago had framed the debate the wrong way (see Buchanan 2015, p. 260).
We value the Chicago persistence and the Harvard/MIT skepticism of unrealistic
depictions. In the 1980’s, for example, Stiglitz in many ways seemed to have the better
argument to Stigler on information economics, and to Lucas on macroeconomics of
unemployment. If not the "better" argument, Stiglitz seems to offer an approach that is at
least a more subtle and sophisticated modeling of the complexities of economic reality.
However, both schools of thought are guilty of the fact that their modeling of prices as
sufficient statistics are as serviceable to defenders of the market as well as its critics: they
allow the economist either to condemn capitalism for failing to measure up to the model of
perfect competition, or to praise capitalism as a utopia of perfect knowledge and rational
expectations. Whether the “Tight Prior Equilibrium” assumption is held as an “as if”
description of reality in the case of Chicago economists or as a normative benchmark for
policy evaluation in the case of Harvard/MIT economists, “in both cases the heuristic value of
equilibrium is sacrificed” (Boettke 1997, p. 24). In a world of uncertainty and constant change,
the equilibrium model aids the analysis by providing a “foil”, or a “method of contrast”
thought experiment that enables the theorist to isolate the consequences of change. 9 What
the Chicago “Tight Prior Equilibrium” and the Harvard/MIT “market failure” schools
9
In “The Use of Knowledge in Society”, Hayek writes that “It is, perhaps, worth stressing that economic
problems arise always and only in consequence of change” (2013 [1945], Vol. I, p. 243).
15
missed was that the “success” or “failure” market prices to deliver information is
fundamentally a contextual question of a comparative institutional nature.
Certain
institutional arrangements, Hayek (1937) argued, are more conducive to the discovery and
utilization of the knowledge necessary for the complex coordination of economic plans to
emerge through processes of exchange and production. As he contends, the division of
knowledge “is quite analogous to, and at least as important as,” the division of labor (1937,
p.49). How is it, Hayek asks, that “the spontaneous interactions of a number of people, each
possessing only bits of knowledge, brings about a state of affairs in which prices correspond
to costs, etc” (1937, p. 49).
Rather than focusing on how alternative institutional
environments impact this social learning process, we too often “fall in effect back on the
assumption that everybody knows everything and so evade any real solution of the problem”
(1937, p. 49). In short, from this perspective, the Chicago “Tight Prior Equilibrium” ‘solves’
the problem by denying it, while the Harvard/MIT “market failure” deny any solution is
possible within the system.
Perhaps it is useful to remember that the professional consensus was entirely
different in economics from the time of Knight/Viner/Simons to the emerging post-WWII
Chicago School of Friedman/Stigler/Becker. In American academic circles, Samuelson’s
Economics (1948) and Foundations of Economic Analysis (1947) had effectively cornered the
educational market at the undergraduate and graduate level, respectively, and in the process
transformed opinion within the community of economic researchers and teachers to such an
extent that the prevailing conventional wisdom by 1960 was the Keynesian focus on
macroeconomic aggregate demand volatility, and microeconomic inefficiency due to
monopoly power, externalities, and public goods. As we have stressed, since this essay is
about price theory, we leave the macroeconomic debate alone. But in microeconomics there
16
were three ways in which the academic economist responded to the Samuelsonian argument
concerning pervasive “market failure” by emphasizing either (1) conceptual clarity, or (2) the
role of institutional arrangements and (3) entrepreneurial solutions. For ease of exposition,
we will combine comparative institutional analysis with entrepreneurship into one category
and juxtapose with conceptual clarity.
From the “price theory as prophylactic” perspective, the different type of
argumentative responses raises the question as to whether or not the proposed argument is
intellectually robust to the original critique. For an argument to be intellectually robust, it requires
the academic economist not only grant their opponent the most charitable interpretation of
their argument, but also engage in an immanent response on the terms established by the
opponent, not a transcendent response that denies the problem that others believe they have
identified exists. (Boettke 2012b, p. 512)
But in engaging the immanent critique, the
argument moves from intellectual robustness to institutional robustness. That is, by engaging one’s
intellectual opponent by granting them a charitable interpretation of market failure theory,
one must draw upon the robustness of institutional/entrepreneurial solutions in ameliorating
the presence of market failures.
An institutionally robust argument would take into account the worst-case scenario of
knowledge problems associated with the mobilization of the dispersed knowledge throughout
the economic system, and the problems of opportunistic behavior associated with ensuring
incentive compatibilities in any proposed institutional remedy to social ills. Private actors, as
well as public entities, must continually adjust and adapt to the circumstances of knowledge
problems and the problems of opportunism. To ignore these problems is only to doom
proposed institutional solutions as impracticable due to either incoherence and
“impossibility” or vulnerability to strategic behavior on the part of opportunistic actors.
17
In the subsections that follow, we will compare the Friedman/Stigler/Becker branch
of Chicago price theory with the Alchian/Buchanan/Coase branch theory in terms of the
two argumentative strategies listed above to address the notion of market failure. What will
be shown is that conceptual clarity, exemplified by the use of the “Tight Prior Equilibrium”
by Friedman, Stigler, and Becker, will prove not to be intellectually robust. Instead, Alchian,
Buchanan, and Coase, by emphasizing the role of institutional arrangements and the
entrepreneurial solutions, offer not only an intellectually robust argument, but offer an
institutionally robust solution. To sharpen our exposition, consider the recent critique of the
market economy offered by George Akerlof and Robert Shiller in Phishing for Phools:
However, free markets do not just deliver this cornucopia that people want.
They also create an economic equilibrium that is highly suitable for economic
enterprises that manipulate or distort our judgement, using business practices
that are analogous to biological cancers that make their home in the normal
equilibrium of the human body...Insofar as we have any weakness in knowing
what we really want, and also insofar as such a weakness can be profitably
generated and primed, markets will seize the opportunity to take us in on
those weaknesses. They will zoom in and take advantage of us. They will
phish us for phools (2015, p. x).
How would the different approaches take up their challenge? Conceptual clarity would reveal
the intellectual incoherence in Akerlof and Shiller’s presentation. On the other hand, the
institutional/entrepreneurial approach would begin by stating, for sake of argument, that
Akerlof and Shiller have indeed identified a serious problem. However, the analysis would
shift to how alternative institutional arrangements and entrepreneurial innovations in the
market can ameliorate the identified failures. Institutional problems demand institutional
solutions. From an institutional/entrepreneurial perspective, today’s inefficiencies are
tomorrow’s profit opportunities for alert individuals who can correctly identify and fix the
problem.
18
1. Conceptual Clarity
The hallmark of the Friedman/Stigler/Becker generation of Chicago economists was to
utilize conceptual clarity to expose the loose reasoning involved in identifying so-called
market failures. The idea behind using conceptual clarity is to provide a hermetically sealed,
water-tight argument that transcended the existence of market failure by correctly identifying
the marginal costs and marginal benefits of any given market situation. As we stated in the
introduction, Friedman/Stigler/Becker utilized price theory as a sufficient solution for
analyzing market equilibrium. The description of perfectively competitive equilibrium is
confined to “defining conditions in which its conclusions are already implicitly contained
and which may conceivably exist but of which it does not tell us how they can ever be
brought about” (Hayek 1948, p. 94). This rendition of Chicago price theory is characterized
as follows:
First, the theory exudes confidence that rational behavior succeeds in
realizing mutally beneficial exchange opportunities. Second, it counts the
individual – whether consumer, laborer, or business owner – as unimportant,
despite its reliance on self-interested behavior; it uses aggregations of the
behavior of individuals to construct its equilibria, and in doing so it deprives
the individual of any force in the economic system. Third, it relies on
Marshall’s two-bladed scissors, supply and demand, to construct these
aggregations of the behavior of individuals (Demsetz 2013 [1993], Vol I, p.
96).
This conception of price theory is one in which rational behavior, price formation, and
market equilibrium are not by-products of competitive activity within an underlying
institutional framework, but are assumed ex-ante to be already approximated by the analysis.
The “Tight Prior Equilibrium” is a state in which “all actions are perfectly coordinated, each
market participant dovetailing his decisions with those which he (with complete accuracy)
anticipates others will make”, and all individual plans approximate complete coordination
(Kirzner 1973, p. 218). The “Tight Prior Equilibrium” is utilized as a benchmark not only to
19
defend a particular theoretical meaning of competition, but also extended to applied topics
such as the economics of information and industrial organization.
In “The Economics of Information” (2013 [1961], Vol. I) Stigler argues that
individuals will optimally search for the information necessary to accomplish their goals in
the market. Unlike Hayek, Stigler treated the concept of information like an objective
commodity, for which individuals deliberately search but in an optimal manner by
comparing the marginal cost of information with the marginal benefit of continuing to
search for it (Boettke 2002, p. 265). In other words, Stigler joined the informational content
of markets with the assumption that equilibrium models should be seen as describing actual
behavior. In Stigler’s view, there was economic ignorance in the real world, but it was an
optimal level of ignorance. As he puts it, “Ignorance is like subzero weather: by a sufficient
expenditure its effects upon people can be kept within tolerable or even comfortable
bounds, but it would be wholly uneconomic entirely to eliminate all of its effects” (2013
[1961], Vol. I, p. 659).
Stigler showed that the Law of One Price was not inherent in the structure of the
“Tight Prior Equilibrium”, but arises only in the special case where the information costs
about offer prices are negligible and transaction costs are identical for all possible trading
pairs (e.g. on an organized exchange). The attempt to eliminate the remaining ignorance
would be inefficient, entailing searches for information that were more costly than the
benefits they could produce. Thus in the presence of search costs the existence of multiple
prices was shown to be compatible, even required by efficiency. For Stigler, information
acquisition does not entail entrepreneurial discovery through rivalrous competition in the
market, but represents a costly factor of production in the efficient allocation of output. As
Stigler writes in “Information in the Labor Market” (2013 [1962], Vol. III, p. 580), “the
20
function of information is to prevent less efficient employers from obtaining labor, and
inefficient workers from obtaining better jobs. In a regime of ignorance, Enrico Fermi would
have been a gardener, Von Neumann a checkout clerk at a drugstore”. By denying the
existence of genuine ignorance, Stigler treats price as a sufficient statistic for efficient
resource allocation, embodying all available information.
However, in making the move to transform the “Tight Prior equilibrium” as an “as
if” description of reality, Stigler’s version of information economics proved not to be
intellectually robust against the arguments provided by Stiglitz and Grossman (1976). To
counter the Stiglerian argument of informational efficiency, Stiglitz and Grossman argued
that prices would be informationally inefficient. Following an immanent criticism strategy,
Stiglitz and Grossman take the “Tight Prior Equilibrium” claim seriously, but utilize it as a
normative benchmark rather than as an “as if” description of reality.
Maximizing agents
acting on market prices alone would, they conclude, undersupply knowledge of market
conditions:
But there is a fundamental problem; if, as one would expect, individuals
eventually come to realize that the futures price is a perfect predictor of the
future spot price, then they will no longer base their demands on their own
information, but rather base it solely on the market information. Since the
futures price predicts the spot price perfectly (with zero variance) there is no
need for hedging and there will be no trade. But without trade, there is no
market; but without a market; their beliefs will differ. This paradox can be
put another way. If the market aggregated their information perfectly,
individuals' demands would not be based on their own information, but then,
how would it be possible for markets to aggregate information perfectly?
(Grossman and Stiglitz 1976, p. 250).
Stiglitz and Grossman would regard this statement as a counterargument that rejects both
Stigler as well as Hayek’s rendition of the informational superiority of markets. While this
rejection may apply to Stigler, with whom Stiglitz and Grossman argue in terms of
equilibrium, Hayek’s discussion of the competitive market process and price formation was
21
never in equilibrium terms. From a Hayekian perspective, Stiglitz and Grossman put too
much theoretical weight on equilibrium prices, and remain silent on the coordinative
processes set in motion by disequilibrium prices (Boettke 2002, p. 270; see also Boettke
1996, p.189 and Boettke and O’Donnell 2013). Therefore, Stiglitz and Grossman’s
arguments simply illustrate the non-commensurability of arguing in terms of competitive
equilibrium absent comparative institutional analysis (Wagner 2010, p. 111).
Chicago price theory, especially in terms of perfect competition, “leaves no room for
the survival of incompetency. In equilibrium, owners of firms, as suppliers of goods, do not
waste resources” (Demsetz 2013 [1993], Vol. I, pp. 103-104). It is not simply the case that
the effects of monopoly power are negligible 10 in the long-run due to the threat of entry and
exit by other competitors (see Harberger 2013 [1954], Vol. II). For Stigler, the presumed
existence of monopoly power and the ability of the firm to restrict output and raise prices is
a failure of the economist to conceptually clarify the scope of competition in the industry.
In “The Extent and Bases of Monopoly” (2013 [1942], Vol II.), Stigler is led
“unambiguously to the conclusion that the major factor in the decline of competition has
been governmental support of monopoly” (2013 [1942], Vol. II, p.484). In the other sectors
of the economy which have allegedly become monopolistic through market competition, “A
reasonable approximation is all that is needed” (2013 [1943], Vol. II, p. 467). Stigler identifies
two “grave defects” with the use of statistics measuring concentration ratios for particular
industries. The first is the omission of imports that compete with products made by
domestic industries, such as automobiles. By including imports, the extent of monopoly in
the domestic automobile industry would be greatly minimized. Overlooking the presence of
As Arnold Harberger states regarding the welfare loss generated by monopoly misallocation of resources,
“we have labored at each stage to get a big estimate of the welfare loss, and we have come out in the end with
less than a tenth of a per cent of the national income” (2013 [1954], Vol. II, p. 592).
10
22
substitutes of a particular product is another grave defect in measuring market
concentration, “making it reasonably certain that monopolistic powers are in general small”
(Stigler 2013 [1943], Vol. III, p. 472). Moreover, the inclusion of secondary markets, such as
a used-car market, into statistical analyses of market concentration would further minimize
the extent of monopoly power. For Stigler, “it is doubtful whether the monopoly question
will ever receive much illumination from large scale statistical investigations” (Stigler 2013
[1943], Vol. III, p. 472).
We agree with Stigler that governmental support is prima facie evidence for the
presence of monopoly power as well as the fact that statistical investigations between
monopoly power and market concentration overestimate the extent of monopoly. However,
the idea that the notion of competition as a process is analogous to the market structure of
perfect competition “is based on an incorrect understanding of competition or rivalry” 11
(Demsetz 1968, p.55). Moreover, judging empirically the degree of concentration in an
industry in terms of perfect competition by itself does not yield any a priori relationship
between market concentration and competition. If we are to simply deny the existence of
monopoly power by assuming it away empirically, or fitting the observed market structure in
terms of perfect competition, then what prophylactic is left for the free market against the
popular fallacy that there exists a theoretical relationship between market concentration and
competition?
Harold Demsetz 12 argued in “Why Regulate Utilites?” that “The important thing that
needs stressing is that we have no theory that allows us to deduce from the observable degree of
McNulty makes this same point in “Economic Theory and the Meaning of Competition,” where he states
“Clearly, the failure to distinguish between the idea of competition and the idea of market structure is at the
root of much of the ambiguity concerning the meaning of competition (1968, p. 641).
12 Our late colleague Henry G. Manne, the founder of the Law & Economics Center at George Mason
University, had pointed out to us in an earlier draft of our paper “Alchian, Buchanan, and Coase: A Neglected
11
23
concentration in particular market whether or not price and output are competitive” (emphasis original,
1968, pp. 59-60). Competition is not inconsistent with market concentration when we
consider the distinction between “competition for the field” and “competition within the
field” (Demsetz 1968, p. 57, fn. 7). If the meaning of competition is one of a dynamic
process of entrepreneurial discovery, then whether or not competition within the field
approximates a particular market structure, such as monopoly or perfect competition,
matters much less than whether or not the rules of game obstruct the entry of competitors.
The importance of this latter point is illustrated by the
supposed necessity of public policy in regulating natural monopolies. The general argument
for the regulation of monopoly, such as in the case of public utilities, is twofold. First,
allowing one firm to operate will allow it to expand unencumbered to exploit economies of
scale and minimize average costs. Secondly, a public utility that achieves its monopoly
position even through market competition will, after driving out its competitors, restrict
quantity and raise price to monopoly levels, resulting in a deadweight losses and a deviation
from perfect competition. Yet what Demsetz pointed out was that the alleged threat of
market failure in the hands of natural monopoly was a problem regarding property rights
assignments for the industry, not the absence of competition within the industry. The idea that
without economies of scale there would “excessive duplication” by competing firms “is a
problem of externalities and not of scale economies” (Demsetz 1968, p. 63), the latter of
which are internalized when property rights include the right of sale (Demsetz 1967, p. 349).
Secondly, although a single firm may ultimately survive for efficiency reasons, as long as
residual claimancy over the firm can be transferred, there is no clear or necessary reason for
Branch of Chicago Price Theory” the importance of including Demsetz amongst those economists of the
UCLA/UVA branch of the Chicago Price theory tradition, particularly of his pivotal role in developing the
economics of property rights and the theory of the firm along with Alchian. It is in honor of him that we
gratefully acknowledge his excellent comments and incorporate them into this paper.
24
production scale economies to decrease the number of bidders who compete to be the single
supplier (Demsetz 1968, p. 57). As Hayek states, “A monopoly based on superior efficiency,
on the other hand, does comparatively little harm so long as it is assured that it will disappear
as soon as anyone else becomes more efficient in providing satisfaction to the consumers”
(1948, p. 105).
2 Alternative Institutional Arrangements and Entrepreneurial Solutions
As the preceding paragraphs demonstrate, the conceptual clarity of a market failure often
leads to an analysis of alternative institutional arrangements. For Hayek, as well as Alchian,
Buchanan, and Coase, price theory rests on “what institutional arrangements are necessary in
order that the unknown persons who have knowledge specially suited to a particular task are
most likely to be attracted to that task” (1948, p. 95). In building his case about the
informational dysfunctions of a market economy, Stiglitz may have raised some critical issues
to a Stiglerian rendition of “information economics,” but he did not have the superior
argument to a properly understood Hayek and the exchange perspective of economics as
developed in their own way by Alchian, Buchanan, and Coase. Each developed a theory of
the institutional robustness of the market economy to reconcile conflicts through the Smithian
process of the “higgling and bargaining of the market, according to that sort of rough
equality which, though not exact, is sufficient for carrying on the business of common life”
(1981 [1776], p. 49). 13 Situations of social conflict are turned into opportunities for mutual
gain through social cooperation. This “alchemy” of the market is accomplished by the
13 “The chief concern of the great individualist writers,” Hayek (1948, 12-13) writes, “was indeed to find a set of
institutions by which man could be induced, by his own choice and from the motives which determined his
ordinary conduct, to contribute as much as possible to the need of all others; and their discovery was the
system of private property did provide such inducements to a much greater extent than had yet been
understood.” (emphasis added)
25
rearrangement of the institutional environment within which economic actors pursue their
plans, or through the entrepreneurial recognition by some within the process who recognize
that today’s inefficiency is potentially tomorrow’s profit if they are able to address the
problem successfully.
From this perspective, private property rights are “entrepreneurial filters” (see
Boettke and Candela, forthcoming). By structuring the costs and benefits of exchange,
private property rights economize on the emergence of certain patterns of behavior by 1)
filtering in productive entrepreneurship, leading to a more efficient partitioning of property
rights and the amelioration of market failures as its unintended outcome, and 2) filtering out
unproductive entrepreneurship that leads to a politicized redistribution of property rights
and the exacerbation of market failures as its unintended consequence. Well defined private
property rights and entrepreneurial action generate a convergence of private and social costs
by incentivizing the concentration of rewards and costs more directly on the individual
decision-maker and enabling individuals to specialize in applying their particularized
knowledge of time and circumstance in the discovery of previously unnoticed profit
opportunities, conducive to reducing the presence of monopoly power, asymmetric
information, and externalities (Alchian 1965, p. 823).
Economics is about exchange and the institutions within which exchange takes place.
The “exchange” branch of the Chicago price theory tradition constantly draws analytical
attention to the study of how individuals bargain towards efficient solutions. This neglect is
manifested not by a lack of recognition. Otherwise, articles by Alchian, Buchanan, and Coase
would not be reproduced in these volumes. Rather, if we take “Tight Prior Equilibrium”
assumption as the “Chicago View” (2013, p. 141), as Reder puts it, dominating Chicago price
theory, then what is neglected in the Chicago price theory tradition is the logical extension of
26
institutional
analysis
from
Knight/Viner/Simons
to
its
continuation
under
Alchian/Buchanan/Coase, namely in their pioneering of property rights economics, Public
Choice, and law and economics, respectively, each of which extended and contributed to a
more refined elaboration of the theory of the market process. Critical to our narrative is to note
how in their respective work Alchian, Buchanan and Coase all followed Buchanan’s
rendition of the market process in “What Should Economists Do?”, one in which the
market is viewed from an “exchange paradigm”, not an “allocation paradigm” (see Coyne
2010, Kohn 2007, Kohn 2004, and Wagner 2007)14. As Buchanan states:
A market is not competitive by assumption or by construction. A market
becomes competitive, and competitive rules come to be established as institutions
emerge to place limits on individual behavior patterns. It is this becoming
process, brought about by the continuous pressure of human behavior in
exchange, that is the central part of our discipline, if we have one, not the
dry-rot of postulated perfection (italics original 1964, p. 218).
The “dry rot” of the model of perfectly competitive equilibrium is that it transforms
“individual choice behavior from a social-institutional context to a physical-computational
one” (Buchanan 1964, p. 218). In such a model, price is a sufficient statistic to a complex
allocation problem, but “surely this is nonsensical social science” (Buchanan 1964, p. 218). It
is a situation, by construction, in which competition and exchange along multiple margins of
adjustment have been ruled out.
Central to the common-sense of political economy from Phillip Wicksteed and later to
economists of the Chicago School was the notion of the “equimarginal principle”, which
stipulates that individuals will pursue a maximum amount of utility along both monetary and
non-monetary margins of utility adjustment until they are fully equalized to each other. 1516
14 For a further elaboration on the “exchange paradigm” in economics, see Volume 20, Issue 2-3, September
2007 Special Issue on Value and Exchange of The Review of Austrian Economics.
15 Regarding the role of monetary prices in generating mutual adjustments according to the equimarginal
principle, Alfred Marshall (emphasis added, 1997 [1920], pp. 117-118) writes: “This illustrates a general
27
This principle is not a condition of the market that is assumed ex ante. Rather, it is through
the competitive market process and “the systematic way in which plan revisions are made as a
consequence of the disappointment of earlier plans” (emphasis original, Kirzner 1962, p. 381) that
these multiple margins of adjustment are discovered ex post. As Kirzner further elaborates,
the market process is one in which:
price signals themselves are developed through a process of learning that is
governed step by step by the interim sets of prices; it is the latter process to
which we refer as a process of communication of information. This learning
process at the same time nudges individual plans into closer and closer
coordination. The rule is simple and obvious: coordination of information
ensures coordination of action (emphasis original, Kirzner 1973, p. 219).
The equimarginal principle is realized only when all plans completely dovetail, but
when individuals are disappointed in the fulfillment of their goals (i.e. pursuing maximum
utility), then a tendency will arise among individuals to systematically revise their decisions.
This systematic revision of plans generates the market process in which different courses of
action will be pursued until each plan gives an equal amount of marginal benefit. These
margins of adjustment are not only pecuniary, but also non-pecuniary in nature as well, and
different institutional arrangements will determine the relative cost of adjusting on these
principle, which may be expressed thus: – if a person has a thing which he can put to several uses, he will
distribute it among these uses in such a way that it has the same marginal utility in all. For if it had a greater
marginal utility in one use than another, he would gain by taking away some of it from the second use and
applying it to the first…But when commodities have become very numerous and highly specialized, there is
urgent need for the free use of money, or general purchasing power; for that alone can be applied easily in an
unlimited variety of purchases. And in a money-economy, good management is shown by so adjusting the margins
of suspense on each line of expenditure that the marginal utility of a shilling’s worth of goods on each line shall
be the same.
As Wicksteed writes in The Common Sense of Political Economy (italics original 1910, pp. 183-184)
illustrating how social cooperation under the division labor is generated along multiple margins of adjustment
through the price system: “That London is fed day by day, although no one sees to it, is itself a fact so
stupendous as to excuse, if it does not justify, the most exultant paeans that were ever sung in hour of the
laissez-faire laissez-passer theory of social organisation. What a testimony to the efficiency of the economic
nexus is borne by the very fact that we regard it as abnormal that any man should perish for want of any one of
a thousand things, no one of which he can either make or do for himself. When we see the world, in virtue of
its millions of mutual adjustments, carrying itself on from day to day, and ask, ‘Who sees to it all?’ and receive
no answer, we can well understand the religious awe and enthusiasm with which an earlier generation of
economists contemplated those ‘economic harmonies’, in virtue of which each individual, in serving himself, of
necessity serves his neighbour,”
16
28
margins. Moreover, alternative institutional arrangements not only determine the conditions
within which money prices emerged, but it also generates pricing on non-monetary margins
as well. Alchian argued that:
“The more ‘side’ conditions asked the less money price available, with private
property, the open-market provides each person the broadest opportunities
to find exchanges on the best terms possible…The old principle of
‘equalizing differentials’ applies to all exchange – not merely to labor and
wage markets. The lower is one desired component, the larger must be the
equalising differential. The lower is the monetary payment asked by the seller,
the more will he be able to get it in non-monetary forms of equalising
differentials” (emphasis original 1967, p. 371).
These “side” conditions included non-monetary preferences for beauty, love, environmental
pollution, and racial discrimination. How individuals negotiate these multiple margins of
adjustment will be determined by their relative costs, which in turn are determined by the
rules of the game, namely the ability to transfer private property rights.
Alchian and Kessel (2013 [1962], Vol. III) argue in “Competition, Monopoly, and
the Pursuit of Monopoly” that the direction in which relative costs are affected by activities
or variables that enhances a person’s utility are not a function of differing market structures,
but are a function differing property rights arrangements. For example, they argue that the
tendency for monopolistic enterprises to discriminate based on sex, race, and religion more
than competitive enterprises, or more generally, why the former pursues greater
nonpecuniary wealth relative to pecuniary wealth than the latter is because monopolistic
enterprises are constrained in their ability to maximize monetary profits. Therefore, since
wealth cannot be taken as monetary income in the form of private property, the relative
costs of earning greater monetary profits will be higher. Owners therefore have relatively
weak incentives to try to increase profits through more efficient management or operation.
Firm owners will then have relatively strong incentives to use the resources of the firm for
their own personal interests, but in ways that will count as company costs. These
29
expenditures are consistent with utility maximization since it is relative cheaper for the firm
owner to indulge his non-monetary preferences, which may include larger officers, prettier
secretaries, and hiring employees of a certain race or creed (2013 [1962], Vol. III, p. 508510).
For Coase as well as Alchian, because of the existence of positive transaction costs in
the real world, what are traded on the market are not physical goods and services, but rights
to perform certain actions with such goods and services, including the rights to discriminate
or pollute on different margins. As Coase argues in the “The Problem of Social Cost”, “If
factors of production are thought of as rights, it becomes easier to understand that the right
to do something which has a harmful effect (such as the creation of smoke, noise, smells,
etc.) is also a factor of production” (2013 [1960], Vol. III, p. 697). What came to be dubbed
as the Coase Theorem was first formulated by Stigler in his 3rd edition of The Theory of Price
(1966, p. 113), in which he “asserts that under perfect competition private and social costs
will be equal.” That is, in a world of zero transaction costs and well-defined property rights,
the outcome of the bargaining between individuals will be that which maximizes the value of
output, irrespective of the initial assignment of property rights.
While Stigler’s rendition of the Coase Theorem follows from a particular reading of
Coase’s original argument, it hides the significance of Coase’s argument, which were
threefold. The first significance was that it undermined the public policy conclusion of
Arthur Pigou’s analysis of externalities, which required taxation to reduce the
overproduction of a negative externality or subsidies to increase the under provision of a
positive externality, so as to render social marginal costs and benefits equal to private
marginal costs and benefits, respectively. Given that Pigou had based his argument in terms
of perfect competition, Coase’s analysis of the Pigouvian remedy for externalities, namely
30
government regulation, would be either redundant or non-operational for the internalization
of externalities. Under a zero-transaction cost scenario, government action would be
redundant because any divergence between private and social costs would be negotiated
away between conflicting parties through private bargaining, irrespective of the initial
assignment of property rights (Coase 1992, p.717). However, in a world of positive
transaction costs, Coase argued that government regulation in the form of taxation or
subsidies would be non-operational because government officials would lack the requisite
knowledge to set the appropriate tax or subsidy to align private costs and benefits with social
costs and benefits. For Coase, the provision of markets is an “entrepreneurial activity,”
(1988, p. 8) in which market failures and other impediments to the gains from trade “are
easily handled by normal price theory, whereas the absence of transaction costs in the theory
makes the effect of a reduction in them difficult to incorporate into the analysis” (emphasis
added, Coase 1988, p. 9-10).
Secondly, it disregards the significance of alternative institutional arrangements, such
as law, property rights, and money for mitigating social conflict in a world of positive
transaction costs (Coase 1992: 717). The problems that Coase illustrated regarding the
Pigouvian solution to externalities were not only made in “The Problem of Social Cost,” but
were implicit in a previous article, “The Federal Communications Commission” (1959),
dealing with the problem of allocating radio and television frequencies. Coase argued the
following:
This "novel theory" (novel with Adam Smith) is, of course, that the
allocation of resources should be determined by the forces of the market
rather than as a result of government decisions. Quite apart from the
malallocations which are the result of political pressures, an administrative
agency which attempts to perform the function normally carried out by the
pricing mechanism operates under two handicaps. First of all, it lacks the
precise monetary measure of benefit and cost provided by the market.
Second, it cannot, by the nature of things, be in possession of all the relevant
31
information possessed by the managers of every business which uses or
might use radio frequencies, to say nothing of the preferences of consumers
for the various goods and services in the production of which radio
frequencies could be used (1959, p. 18).
In this quote, Coase’s approach to comparative institutional analysis is combining the
insights developed by Mises and Hayek on economic calculation and those of Buchanan on
public choice and interest group politics. Coase’s quote is a restatement of Mises-Hayek
argument (1920; 1922; see also Boettke 1998) that absent the ability to exchange property
rights and utilize money prices to assess the relative scarcity of resources, government
officials will not be able allocate resources efficiently. Government officials are precluded
from access to the information possessed by business managers, not because of lack of
effort or incentive, but because the type of knowledge generated through the market process
is contextual, meaning that it can only arise and be communicated through the exchange of
private property rights utilizing money prices as the common denominator of exchange
(Hayek 2013 [1945], Vol. I).
Without the requisite market knowledge about the relative scarcity of resources
provided by money prices, government officials will not know how to allocate resources in
the general interest. Rather, they will be motivated to allocate resources based on the only
knowledge available to political officials, namely to exercise discretion over such resources
for their own private gain, which is by concentrating benefits on well-organized and wellinformed special interest groups and dispersing costs on the ill-organized and ill-informed
general population. Coasean political economy is fundamentally about processes of conflict
resolution under alternative institutional arrangements, and not the assumption that conflicts
are automatically bargained away without cost. Exchange relations reconcile conflict, but any
approach that pre-reconciles such exchange relations necessarily is going to be missing the
point of Coase. Scarcity implies competition is ubiquitous, but the manner in which
32
competition manifests itself is institutionally contingent. A Stiglerian rendition of the Coase
Theorem assumes away not only competitive processes, but also the importance of
institutions in providing alternative possibilities of bargaining towards conflict resolution,
which Coase was advocating in assessing comparative institutional arrangements.
Third, by rendering Coasean political economy in terms of the “Tight Prior
Equilibrium,” Stigler conceals the logical continuity in Coase’s argument against Pigou from
that made by Frank Knight in his article “Some Fallacies in the Interpretation of Social
Coast” (2013 [1924], Vol III). In his criticism of Pigou, Knight is illustrating that the
equimarginal principle is necessary, but not a sufficient condition for the equalization of
social cost and private cost (2013 [1924], Vol III., pp. 595-596). Knight criticizes the
argument made by Pigou that individual profit-seeking will lead to a divergence in private
and social costs, such as that between the overuse of a high-quality resource and the
underutilization of a low-quality resource, namely roads. As a result, the equimarginal
principle will fail to operate, requiring government action to tax the use of the high-quality
roads and subsidize the use of the low-quality roads. However, what is sufficient for the
operation of the equimarginal principle and internalization of externalities are well-defined
private property rights, rendering Pigouvian remedies to externalities unnecessary and
redundant. As Knight states:
It is in fact the social function of ownership to prevent this excessive investment in superior
situations. Professor Pigou’s logic in regard to the roads is, as logic, quite
unexceptionable. Its weakness is one frequently met with in economic
theorizing, namely that the assumptions diverge in essential respects form the
facts of real economic situations. The most essential feature of competitive conditions
is reversed, the feature namely, of the private ownership of the factors practically significant
for production. If the roads are assumed to be subject to private appropriation
and exploitation, precisely the ideal situation which would be established by
the imaginary tax will be brought through the operation of ordinary
economic motives (emphasis added, Knight 2013 [1924], Vol. III, pp. 597598)
33
In the last part of the quote, Knight is illustrating how the invisible hand of the market
process aligns individual self-interest with the public interest via the incentive structure of
private property rights. This rendition of the market process is what was passed onto the
Alchian/Buchanan/Coase generation of Chicago price theory and what was lost in
translation once the “Tight Prior Equilibrium” came to define the methodological position
of Chicago price theory. As Israel Kirzner states, “despite the careful attention which so
original a ‘Chicagoan’ as Professor Knight has devoted to the theory of uncertainty and
profit, the entrepreneur hardly occupies the center of attention in ‘Chicago’ economics”
(1967, p.106), specifically the Chicago economics of Friedman, Stigler, and Becker. To this
point, Knight argued the following:
The problem of conditions of equilibrium among given forces – “statics” in
the proper sense – is often important in economics, but is after all subsidiary,
as indeed it is in physical mechanics. The larger question is that of whether
the forces acting under given conditions tend to produce an equilibrium, and
if so how, and if not what is their tendency; that is, it is a problem in
dynamics. This type of problem has been too largely passed over hitherto,
leaving a fatal gap in the science (1997 [1935], p. 133).
This gap that Knight talks about is one which Israel Kirzner attempted to fill in price theory
as it always been understood by economists going back to Adam Smith. Kirzner’s rendition
of the market process in Market Theory and the Price System (1963) is important here because it
can be understood as bridging a gap between the neoclassical view of the market, which he
learned from Stigler’s Theory of Price as a graduate student at New York University, and what
he understood from Mises as well as Knight and Wicksteed about the dynamic adjustments
of individuals according to patterns imposed by the activities of other individuals. Consider
how Kirzner develops this notion of the market process as communicating knowledge to
facilitate the mutual dovetailing of individual plans towards equilibrium:
If a market is not in equilibrium, we have seen, this must be the result of
ignorance by market participants of relevant market information. The
34
market process, as always, performs its functions by impressing upon those
making decisions those essential items of knowledge that are sufficient to
guide them to make decisions as if they possessed the complete knowledge
of the underlying facts (2011 [1963], p. 240).
The reason we bring Kirzner into our discussion on Chicago price theory is to emphasize
our alternative account about where to find a logical continuation running within the
broader “Chicago” school. Returning to the thesis stated in our introduction, we argued that
while indeed a logical continuation can be drawn from Frank Knight to Gary Becker, as
emphasized by Hammond, Medema, and Singleton, Kirzner’s exposition of price theory in
Market Theory and the Price System reveals that Stigler and later Becker took a logical turn that
diverged from Frank Knight. What Kirzner sought to communicate in his textbook that
differed from Stigler’s The Theoy of Price, not to mention Becker’s Economic Theory, were the
basic insights about price theory that he learned not only from Mises and Knight about the
role of the entrepreneur in a dynamic market process, but also how both Austrians and
“Chicagoans” shared a common knowledge embodied in price theory as it was understood not
only by Menger and Bohm-Bawerk, but also Marshall and Wicksteed (2011 [1963], p.xvii).
This common knowledge included not only the equilibrium properties of markets as
discussed in Stigler and Kirzner, but more importantly it also recognized that the bulk of
economic explanation focused on the coordinative processes of continual adjustment that is
guided by relative price movements and the lure of profits as well as the discipline of losses.
The role in which relative prices guide production “amid the bewildering throng of
economic possibilities” (Mises 1951, p. 117) is twofold. First, prices serve the ex ante role of
guiding production in their capacity as relative prices. Secondly, prices serve an ex post role
of assessing previous economic decisions in their capacity as inputs into profit and loss
accounting. Overall, the constellation of relative prices serve a discovery role in their capacity
of steering the adjustments and adaptations that follow from the discrepancy between the ex
35
ante expectations and the ex post realizations in market experimentation. This process of
adjustment never takes place in an institutional vacuum, but “is conditioned by certain social
institutions. It can operate only in an institutional setting of the division of labor and private
ownership of the means of production in which goods and services of all orders are bought
and sold against a generally used medium of exchange, i.e., money” (Mises 1966 [1949], p.
229).
Conceptual clarity, however, presumes that prices reveal all available information,
such that we can redraw cost curves so we have an optimal amount of deception and
ignorance and thus the market system is not threatened from any divergences in private and
social cost. Our perspective is that the myriad of institutional innovations made by alert
entrepreneurs ameliorate the deceptions and curtail the phishing. By not acknowledging the
possibility of any market failure, conceptual clarity throws the baby out with the bathwater.
That is, once the problem of market failure has been assumed away, it also rules out any
possibility of an institutional/entrepreneurial solution to market failures. We argue that
markets 'fail' all the time but the market system works to constantly adjust and erase such
failures.
In concluding this section, we should emphasize that we are not unsympathetic to
the notion of conceptual clarity in addressing market failure. However, many of the mistaken
attacks on the free-market, “Chicago Fundamentalism” (Freedman 2008), and that Chicago
economics is a “well funded”, though not a “well founded” line of research (Stigltiz 1994, p.
120) stem from the same analytical starting point with which Chicago price theorists have
defended the free market: preoccupation with the optimality conditions of the “Tight Prior
Equilibrium”. Both adherents to and critics of this rendition of Chicago price theory have
overlooked the institutional arrangements within which entrepreneurial solutions are
36
discovered for the amelioration of market failure. The more effective argumentative strategy
is not to assume away the existence of market failure ex-ante by pre-reconciling the plans of
individuals with conditions of equilibrium. Rather, it is to admit the existence of problems
such as asymmetric information, externalities, and monopoly power but identify institutional
solutions, such as the clarification, enforcement, and (re)assignment of property rights. Once
property rights are well-defined, if no mutual consistency of individual plans exists, it will be
in the interest of the parties to continue to seek a better situation than they are currently
realizing because property rights provide individuals the incentive to do so. The exchange of
property rights generates relative prices that guide our decision making, profits lure us in our
decisions, and losses discipline us in our decisions. This is how the price system impresses
upon us the essential items of knowledge required for plan coordination and alleviation of
market failure and the amelioration of social ills.
IV. Chicago Economics, Welfare Economics, and Constitutional Political Economy
Whether or not the “Tight Prior Equilibrium” conceptually clarifies the “efficiency” of
market phenomena also has implications for public economics, welfare economics, and the
role of the economists as a reformer. To understand this we can contrast the arguments
made by Stigler in “The New Welfare Economics” (2013 [1943), Vol. III) and Buchanan in
“Positive Economics, Welfare Economics, and Political Economy” (1959). Whereas
Buchanan’s approach to welfare economics focuses on modifying the rules of the game,
Stigler proceeds to argue for conceptual clarity within the given structure of existing rules.
Stigler argues that at “the level of economic policy, then, it is totally misleading to
talk of ends as individual and random; they are fundamentally collective and organized. If
this conclusion be accepted, and accept it we must, the economist may properly exceed the
37
narrow confines of economic analysis. He may cultivate a second discipline, the
determination of the ends of his society particularly relevant to economic policy” (2013
[1943], Vol. III, p. 628). By inferring the intentions of voters from the outcomes of public
policy, following the logic of the “Tight Prior Equilibrium” consistently and persistently,
Stigler concludes that the role of the economist is to infer that voters have chosen such a
policy because they wanted it, and to say otherwise would mean the economists are
substituting his or her value judgements for those of voters, abandoning their role as a
scientist for that of a reformer (2013 [1943], Vol. III, p. 629).
Moreover, the presumption that there are benefits to the overall economy to a
change in public policy, such as the abolition of tariffs against imports or sugar subsidies,
according to Stigler, would imply that the economist has not properly identified all of the
costs that would entail changing such a policy. If it would have been less costly for
policymakers to compensate interest groups the capitalized value of the rents they derive
from an existing policy, then it would have been efficient for policymakers to have done so
already. Moreover, for Stigler, the idea that free trade would be a more beneficial policy to
society neglects the fact that those individuals who benefit from restrictions on trade at any
moment have supported laws which are designed to prevent trade. Stigler takes the
prevailing social consensus as the efficient equilibrium from which to assign a rational choice
explanation as to why societies choose particular policies, inferring intentions from
outcomes to understand the efficiency propositions of a particularly policy.
Like Stigler, Buchanan takes the prevailing consensus as given, but in contrast to
Stigler, he uses it as a starting-point, as opposed to an end-point, in the economist’s role of
recommending reform policies, namely by discovering alternative institutional rules for
generating alternative policies. However, unlike Stigler, Buchanan combines the reformist
38
zeal of the economist in a manner not inconsistent with his role of a positive economist.
Rather than approaching political economy from a “Tight Prior Equilibrium” approach,
which takes tastes and preferences as stable and given (see Becker 2013 [1976], Vol. I, p.
294), Buchanan begins from the idea that “Political economy has a non-normative role in
discovering ‘what is the structure of individual values’” (emphasis added, Buchanan 1959, p.
137). In essence, positive political economy is comparative institutional analysis.
According to Buchanan, there are two levels of political exchange that must be
studied. The formation of the rules of the game is the constitutional level of analysis; and the
strategic play of the game within the established rules of the game which is postconstitutional level of the analysis of politics. In Buchanan’s rendering of constitutional
political economy, the two levels of analysis must be engaged since relevant questions about
law and order cannot be answered unless the social philosophical analysis of “good” rules is
informed by the predictive analysis of how different political institutions will operate.
In contrast to the understanding of markets in terms of ubiquitous efficiency,
Buchanan argued that such an “overly restricted conception of market behavior” neglects
the propensity of individuals to discover voluntarily more inclusive institutional
arrangements within which efficiency emerges. Efficiency considerations are not eliminated
from Buchanan’s conception, since “the motivation for individuals to engage in trade, the
source of the propensity, is surely that of efficiency” (Buchanan 1964, p. 219). Rather,
efficiency, or moving from a less-preferred to a more preferred position, is a constant
propensity of human behavior within the rules of game, but the manner in which efficiency
manifests itself is dependent on the truck, barter, and exchange of the institutions
themselves. The proposition that exchange must be extended to the constitutional level rules
is not inconsistent with the tendency towards efficiency within a given institutional context.
39
In “Positive Economics, Welfare Economics, and Political Economy” (1959),
Buchanan presents an argument that combines the economist’s reformist zeal with positive
analysis while avoiding the pitfalls of social engineering. The positive role that the economist
can play in policy formation is one of ‘‘diagnosing social situations and presenting to the
choosing individuals a set of possible changes’’ (Buchanan 1959, p. 127). The scope for
those changes must be limited to ‘‘those social changes that may legitimately be classified as
‘changes in law,’ that is changes in the structural rules under which individuals make choices’’
(Buchanan 1959, p. 131).
The political economist contributes to science and reform by analyzing alternative
institutional arrangements, and offering changes in the rules of the game as hypotheses to be
tested in the arena of collective action. In devising such changes in the rules of the game
Buchanan stresses two critical building blocks. The first building block concerns the position
of the status quo. The positive political economy of reform must begin with the ‘‘here and
now,’’ and never some imaginary start state where opposition to change is non-existent. In
doing this, Buchanan is not attributing any normative weight to the status quo. All he is
doing is insisting that ‘‘it is what it is’’ and that must be the starting point of any assessment
of relevant alternatives. The second building block follows from the recognition that we
begin with the ‘‘here and now,’’ and that is the compensation principle. Any shift in the rules
of the game will change the nature of the payoffs in the game. Those who currently gain
from the status quo will lose, while others currently not in a position of privilege with
respect to existing institutions will gain from the change. The winners must compensate the
losers in the proposed change, not because the losers have any normative claim to their
existing benefits but because unless compensated the beneficiaries of the status quo will fight
40
to defeat any proposed changes in the structure of rules. 17 Buchanan’s conception of positive
political economy has both positive and normative implications, which “may be summed up
in the familiar statement: There exist mutual gains from trade” (1959, p. 137). Fundamentally, for
Buchanan, “Political economy is concerned exclusively with the modifications of the rules of
the game, and this branch of the discipline has no place in the discussion of strategic action
taken by either side in the game itself” (1959, p. 133, fn. 11).
This harks back to the older Chicago Price Theory of Knight/Viner/Simons with its
focus on the relative prices in guiding the adjustments in the market system. It is not
behavioral assumptions of actors in the market or in government that drive the analysis, but
institutional variation within which economic activity is played out. In other words, same
players under different rules produce different games (see Buchanan 2008). The explanatory
variable is institutional arrangements, and not the behavioral assumptions of actors in the model.
So the problem situation that actors find themselves engaged in need not be simplified via
heroic cognitive assumptions in order for the actors to coordinate their plans, but instead
rather “thin” behavioral assumptions (i.e. individuals strive to better their situation; or they
prefer more rather than less) can be employed. Individuals can still find themselves operating
in complex environments and yet find institutional remedies that ameliorate the tensions and
enable individuals to coordinate their plans with one another. For Buchanan, the task of
economists is broader than the study of the efficiency propositions of the market; it also
includes “the study of all such cooperative trading arrangements which become merely
extensions of markets as more restrictively defined” (1964, p. 220). The example that
Buchanan provides in “What Should Economists Do?” is the draining of a local swamp.
17 See Michael Trebilcock’s recent Dealing with Losers: The Political Economy of Policy Transitions (2015) for a current
attempt to address Tullock’s “transitional gains trap” (1975) and Buchanan’s politics as exchange. Also see
Tollison and Wagner’s “Romance, Realism, and Economic Reform” (1991).
41
Economics understood in terms of its equilibrium properties would lead us to conclude that
the voluntary provision of drainage to reduce the breeding of mosquitoes would be
undersupplied by the market, generating a “failure”. Yet if we extend exchange behavior to
include the rules of the game as well as social interactions emerging within such rules,
individuals that would have otherwise undersupplied the drainage of a mosquito-infested
swamp can modify the rules of game to generate patterns of interaction that will reduce the
transaction costs of voluntarily providing of drainage, namely by “allowing for more flexible
property arrangements and for introducing excluding devices” (1965, p. 14).
All of these aspects of Virginia Political Economy as discussed by Buchanan are
outlined in a University of Virginia Newsletter describing the Thomas Jefferson Center for
Studies in Political Economy from 1958 (p. 5):
Political economists stress the technical economic principles that one must
understand in order to assess alternative arrangements for promoting
peaceful cooperation and productive specialization among free men. Yet
political economists go further and frankly try to bring out into the open the
philosophical issues that necessarily underlie all discussions of the
appropriate functions of government and all proposed economic policy
measures.
Contrast this research and educational mission with the later-day Chicago Price Theory
approach. As we have argued can be seen in the argumentative evolution contained in these
volumes, during the Friedman/Stigler/Becker years, Chicago price theory came to be
defined as a set of presumptions about observed phenomena – namely that decision makers
will allocate resources under their control in such a manner that no alternative arrangement
would be better. Individuals always do the best they can given their situation. And then we
extrapolate from that to the system level that any arrangement so achieved, if it survives,
must – by definition – be the best arrangement in the feasibility set.
42
There is no doubt that this understanding of the Chicago price theory tradition
proved to be extremely productive, as evidenced especially in the work of George Stigler and
Gary Becker. Look at whatever practice one finds in the world of human affairs – be it in
the ordinary business of life, or the most exotic practice from disparate cultures ancient as
well as modern – and apply the “Tight Prior Equilibrium” assumption in a consistent and
persistent manner and you generate digestible explanations that are easily translated into
testable hypotheses. Science, under a particular definition, moves forward. The economic
approach to human behavior --- maximizing behavior, stable preferences, and market
equilibrium (Becker 2013 [1976], Vol. I, p. 294) --- comes across as the natural development
of the logic of economic reasoning from first principles. We live in a world of scarcity, and
as such we must choose, in making those choices we must weight alternatives, and in
weighing those alternatives we do the best we can with the information we have. How can
anyone object to such a basic formulation of human purposiveness in striving to better their
condition in the face of given constraints?
However, for our present purpose the more relevant question is whether the
application of the Tight Prior Equilibrium, besides being a logical exercise, is the more
effective prophylactic against popular fallacies concerning the weaknesses of will and a
palsied invisible hand. Analogous to the earlier discussion of Knight’s critique of Pigou, we
also find the logic of the “Tight Prior Equilibrium” to be completely valid. Yet the weakness
with this argumentative strategy against market failure, harking back to Knight, is that it lacks
logical soundness. For the formal conditions of equilibrium to prevail, the “Tight Prior
Equilibrium” must assume that market situations are already in equilibrium and that
prevailing prices are sufficient for the solution to allocative problems. In his review of Abba
Lerner’s The Economics of Control (1944), Friedman makes the same argument against Lerner
43
that Knight made against Pigou. 18 By focusing on the formal conditions for an optimum,
Lerner neglected the institutions and context within which economic decision-making was
made. It expressed economics as if economic decision-making occurred in a vacuum. Thus,
it could not appraise the administrative problems of the policies Lerner proposed or their
social and political ramifications. As Friedman states:
Lerner’s acceptance of the price mechanism does not, however, mean
acceptance of the particular institutional arrangements with which the price
system is historically associated, namely, a free-enterprise exchange economy
characterized by private ownership of the means of production (1947, p.
407).
For Friedman, “the formal analysis is almost entirely irrelevant to the institutional problem”
(1947, p. 405), which for the academic economist is understanding what are the appropriate
institutional conditions to generate the optimal allocation of resources, such that marginal
social benefit equals marginal social cost. Friedman’s main criticism is that “Lerner writes as
if it were possible to base conclusions about appropriate institutional arrangements almost
exclusively on analysis of the formal conditions for an optimum” (1947, p. 415).
Lerner’s preoccupation with the optimality conditions of competitive equilibrium
leads him to reject that prices will be sufficient for the optimal allocation in those cases when
private and social costs diverge, such as when monopoly power is present. Therefore, Lerner
It could be argued, however, that Friedman is guilty of similar methodological problems as Lerner in his
“The Methodology of Positive Economics” (2013 [1953], Vol. I). The central argument that Friedman makes in
this paper is to refute two claims about methodology in economics: 1) A hypothesis or theory in economics is
acceptable only if its assumptions are realistic; 2) The realism of the assumptions of an economic hypothesis or
theory is distinct from the truth of its predictions (2013 [1953], Vol. I, p. 262). In other words, a theory can be
tested by the realism of its assumptions independently of the accuracy of its predictions. He opposes these
claims not only because they are “fundamentally wrong and productive of much mischief,” but also because
they impede the attainment of consensus on tentative hypotheses in positive economics. For Friedman, “the
ultimate goal of a positive science is the development of a theory or a hypothesis that yields valid and
meaningful predictions about phenomena not yet observed.” In other words, Friedman has an instrumental
view of theory in economics, such that “a theory is to be judged by its predictive power for the class of
phenomena which it is intended to explain.” The validity of a hypothesis is determined in comparison of its
predictions with experience. Therefore, a theory is simpler the less the initial knowledge needed to make the
prediction and more fruitful the more precise its predictions. The difference in methodology that Friedman
employs here and in his 1947 review of Lerner’s The Economics of Control reveals that he is a transitional figure
between the Knight/Viner/Simons generation and Stigler/Becker generation of the Chicago School.
18
44
concludes that the market is inefficient and requires government intervention as the deus ex
machina to generate a convergence of marginal and social costs. Central planners would
eliminate such market failures by following a rule of pricing according to marginal cost, such
that “Lerner would instruct the managers to pretend that they are operating under the
conditions of perfect competition and to play at private enterprise” (1947, p. 408).
However, Lerner misses the point that prices are a necessary, though not a sufficient
condition for generating a tendency towards equilibrium. Such optimality conditions do not
emerge in an institutional vacuum. Without the institutional prerequisite of private property,
central planners are precluded from access to the knowledge that market prices
communicate and the coordinative effect such prices have on individuals in generating the
conditions of equilibrium as an unintended outcome of their buying and selling through the
market process. Implicit to Lerner’s argument, and to general idea that prices are sufficient
solutions to allocative problems, is the implication that the valuation of the factors of
production necessarily follows from the valuation of consumer goods. However,
“implication is a logical relationship which can be meaningfully asserted only of propositions
simultaneously present to one and the same mind” (Hayek 2013 [1945], Vol. I, p. 250).
Our point here is not to assert that all assumptions must be completely realistic.
Economic theory would be impossible under such an intellectual restriction. But the policy
relevance of assumptions independent of the predictive power of a theory also matters. In
other words, if positive economics is to advance and make fruitful contributions to public
policy, they must have a bearing on the appropriate institutional arrangements in which
individuals can strive to ameliorate social conflict and achieve greater social cooperation
under the division of labor.
45
Friedman’s arguments against Lerner are particularly relevant in another respect for
discerning the proper prophylactic against popular fallacies about the market economy, one
that was paramount to Knight/Viner/Simons generation of Chicago price theory and
alluded to by Buchanan in describing the mission of the Thomas Jefferson Center.
Institutional arrangements must also be judged by their “noneconomic implications, of
which the political implications – the implications for individual liberty – are probably of the
most interest and the ethical implications the most fundamental” (1947, p. 416).
The irony is that the economist who wishes to defend the efficiency of the market by
utilizing the “Tight Prior Equilibrium”, namely by hermetically sealing any market situation
from the presence of market failure, is also trapped under the same logical straightjacket
from making any public policy recommendations or proposals of institutional reform. The
logical implications of the “Tight Prior Equilibrium” for welfare economics and public
policy is best stated by Stigler in his “Law or Economics?”:
[E]very durable social institution or practice is efficient, or it would not
persist over time. New and experimental institutions or practices will rise to
challenge the existing systems. Often the new challenges will prove to be
inefficient or even counterproductive, but occasionally they will succeed in
replacing the older system. Tested institutions and practices found wanting
will not survive in a world of rational people. To believe the opposite is to
assume that the goals are not desirable (1992, p. 459).
By this logic, Stigler argues, the presence of interest groups lobbying for import tariffs of
sugar are efficient because they have stood the test of time. Although consumers incur
deadweight losses from such tariffs, “lacking a cheaper way of achieving this domestic
subsidy, our sugar program is efficient,” meaning that any attempt at changing the rules of
the game (i.e. removing the tariffs) by the economic reformer would only generate greater
rent-seeking by less efficient lobby groups and further deadweight losses than had not the
economic reform attempted any change.
46
Becker’s argument in “A Theory of Competition of Pressure Groups for Political
Influence” (1983) best exemplifies this idea that efficient institutions would survive the test
of the marketplace. Becker combines the concept of political rent-seeking with the notion
that governments correct for market failure. In equilibrium, competition among pressure
groups for the political distribution of resources, both by those groups being subsidized and
by those groups being taxed, will be such that deadweight losses will be eliminated. The
implication of Becker’s argument are that those interest groups that are being subsidized are
efficient presumably because they have managed to minimize the costs of lobbying for
increasing subsidies and monitoring potential free riding within the interest group. As Becker
states “Politically successful programs are ‘cheap’ relative to the millions of programs that
are too costly to muster enough political support, where ‘cheap’ and ‘expensive’ refer to
marginal deadweight costs, not to the size of taxes and subsidies” (1983, p. 381).
Competition among interest groups will also generate an efficient method of taxation
because replacement of a less efficient by a more efficient tax reduces the optimal pressure
by taxpayers because the marginal deadweight loss decreases. This reduction in pressure
raises the subsidy to those subsidized interest groups as well as raising the net income of
taxpayers. Therefore, both subsidized interest groups as well as taxpayers will exert political
pressure in favor of the most efficient method of taxation because both parties are made
better off. It is the rendition of the political process in terms of the “Tight Prior
Equilibrium” that leads Becker to state the following: “Consequently, public enterprise may
only appear to be less efficient than private enterprises because intentional subsidies are not
included in the definition of ‘output.’” (italics original, Becker 1983, p. 387).
The Chicago Price theory tradition shared by Knight, Simons, and Viner to
Friedman, Stigler and Becker has provided a bulwark for understanding the role of price
47
system in coordinating the activities of millions of individuals and undermining the case for
extensive government intervention into the market economy. However, as Frédéric Bastiat
argued, “The worst thing that can happen to a good cause is, not to be skillfully attacked, but
to be ineptly defended” (1996 [1845], p. 107). Chicago price theory has indeed explained the
role of the market economy in a free society, but once the baton was passed to the postWWII generation of economists at the University of Chicago, the multifaceted way that
individuals continually adjust and adapt to realize the gains from trade was transformed into
an intellectual framework that put aside the reasons for adjustment and adaptation and
focused instead on conceptual clarity that denied efficiencies and market failures.
Outside of the University of Chicago, a “neglected” branch of Chicago price theory
emerged among economists Armen Alchian, James Buchanan, and Ronald Coase, who
provided an understanding of the market economy not by assuming the conditions the
equilibrium, but by focusing their analysis on the dynamic adjustments required in the
presence of market failures. By drawing attention to institutional solutions and the role of
entrepreneurial action in discovering such solutions, they illustrated how market processes
ameliorate social conflict and open up the possibility of realizing the gains from productive
specialization and peaceful cooperation through voluntary exchange. It is this argument we
contend that fulfills Simons’ plea for academic economics, and proves to be a better
prophylactic against popular fallacies.
IV. Conclusion
What Chicago Price Theory does for the reader is provide a detailed documentary record of the
construction of this tradition from its origins with Knight to its modern presentation in
Becker. All the classic papers are covered in the three volumes, but for the discerning reader
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the critical issue is to see not only what unites the generations in the evolution, but also what
sets each generation apart. There is evidence in these volumes of “a tale of two Knights” –
the Knight that leads logically to Stigler and thus Becker, but also a Knight that leads to the
institutional economics of Coase and Buchanan. In his book The Demand and Supply of Public
Goods, Buchanan argued that “The economist should not be content with postulating models
and then working within such models. His task includes the derivation of the institutional
order itself from the set of elementary behavioral hypotheses with which he commences. In
this manner, genuine institutional economics becomes a significant and an important part of
fundamental economic theory” (1999 [1968], p. 5). Friedman, ironically, stands somewhere
in-between both – with his scientific work leaning more in the Stigler-Becker direction, but
his more popular writings leaning more in the Buchanan-Coase direction (see Boettke and
Candela 2016).
This interpretive puzzle about Chicago Price Theory matters because it either raises
or suppresses as a scientific and scholarly project the sort of concerns that Knight was trying
to get at with his discussions in The Ethics of Competition (1935), Freedom and Reform (1947), and
ultimately in Intelligence and Democratic Action (1960). Either the knowledge of price theory is
an essential component to a theory of reform (as Buchanan and Coase thought) or it is
limited to its role in explanation and prediction (as Stigler and Becker thought). The editors
of these volumes do not push the conversation in this direction, but the reader will be lead in
this direction as they work through the three volumes of classic articles if they allow
themselves to see the subtle differences in argument between Knight/Viner/Simons and
Friedman/Stigler/Becker.
Those subtle differences result, ultimately, in shifting Chicago Price Theory from a
theory about the power of the price system (within the institutional regime of private
49
property and freedom of contract) in guiding individuals in their consumption and
production decisions so that they are accommodating the constantly changing conditions of
tastes and technology to a statement of the equimarginal principle when all the efficient
adjustments have in fact been accomplished. The Chicago “Tight Prior Equilibrium”
imposes a logical discipline on the world of human affairs, but it does not invite an inquiry
into the diversity of institutions that arise to ameliorate our human imperfections and
potentially turn situations of conflict into opportunities for social cooperation. As a result,
the “fresh water” economics of Chicago still leaves us thirsty, and the “saltwater” economics
of MIT/Harvard cannot serve to quench our thirst, so we must look to those alternative
streams of thought for satisfaction in our quest to understand the dynamics of the market
process. These three volumes of Chicago Price Theory provide a partial map to find those
alternative streams, but it requires the discerning reader to look not for continuity, but
discontinuity and discord. What an exciting intellectual resource our editors have provided
us with.
50
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55
Appendix: Table of Contents
Volume I
Introduction Steven G. Medema, J. Daniel Hammond and John D. Singleton
PART I TEACHING AND DOING PRICE THEORY AT CHICAGO
1. Arthur I. Bloomfield (1992), ‘On the Centenary of Jacob Viner’s Birth: A Retrospective View of the
Man and His Work’, Journal of Economic Literature, XXX (4), December, 2052-85.
2. Don Patinkin (1973), ‘Frank Knight as Teacher’, American Economic Review, 63 (5), December, 787810.
3. George J. Stigler (1973), ‘Frank Knight as Teacher’, Journal of Political Economy, 81(3), May-June, 518520.
4. David I. Fand (1999), ‘Friedman’s Price Theory: Economics 300 at the University of Chicago in
1947–1951’, in J. Daniel Hammond (ed.), The Legacy of Milton Friedman as Teacher, Volume I, Chapter 2,
Cheltenham, UK and Northampton, MA, USA: Edward Elgar Publishing Ltd, 309-321.
5. Gary S. Becker (1999), ‘Milton Friedman, 1912-‘, in J. Daniel Hammond (ed.), The Legacy of Milton
Friedman as Teacher, Volume I, Chapter 4, Cheltenham, UK and Northampton, MA, USA: Edward
Elgar Publishing Ltd, 138, 140-146.
6. Thomas Sowell (1993), ‘A Student’s Eye View of George Stigler’, Journal of Political Economy, 101 (5),
October, 784-92.
7. Harold Demsetz (1993), ‘George J. Stigler: Midcentury Neoclassicalist with a Passion to Quantify’,
Journal of Political Economy, 101 (5), October, 793-808.
8. Victor R. Fuchs (1994), ‘Nobel Laureate: Gary S. Becker: Ideas About Facts’, Journal of Economic
Perspectives, 8 (2), Spring, 183-92.
9. Sherwin Rosen (1993), ‘Risks and Rewards: Gary Becker’s Contributions to Economics’,
Scandinavian Journal of Economics, 95 (1), March, 25-36.
10. Melvin W. Reder (1982), ‘Chicago Economics: Permanence and Change’, Journal of Economic
Literature, XX (1), March, 1-38.
PART II METHODOLOGY AND ECONOMIC SYSTEMS
11. Frank H. Knight ([1933] 1951), ‘Social Economic Organization’, in The Economic Organization,
Chapter 1, New York, NY: August M. Kelley, Inc., 3-30.
12. Frank H. Knight ([1935] 1951), ‘Statics and Dynamics’, in The Ethics of Competition and Other Essays,
Chapter VI, New York, NY: August M. Kelley, Inc., 161-185.
13. Jacob Viner (1941), ‘Marshall’s Economics, in Relation to the Man and to His Times’, American
Economic Review, XXXI (2), June, 223-35.
14. F.A. Hayek (1945), ‘The Use of Knowledge in Society’, American Economic Review XXXV (4),
September, 519-30.
15. Milton Friedman (1953), ‘The Methodology of Positive Economics’, in Essays in Positive Economics,
Part 1, Chicago, IL and London, UK: Chicago University Press, 3-43.
56
16. Gary S. Becker (1976), ‘The Economic Approach to Human Behavior’, in The Economic Approach to
Human Behavior, Chapter 1, Chicago, IL and London, UK: Chicago University Press, 3-14, references.
17. George J. Stigler and Gary S. Becker (1977), ‘De Gustibus Non Est Disputandum’, American
Economic Review, 67 (2), March, 76-90.
PART III THE THEORY OF DEMAND AND CONSUMER BEHAVIOUR
18. Alfred Marshall ([1890] 1920), ‘Gradations of Consumer Demand’, in Principles of Economics, Book
III, Chapter III, London, UK and New York, NY: Macmillan and Co., 92-101.
19. Frank H. Knight (1921), ‘The Theory of Choice and of Exchange’, in Risk, Uncertainty, and Profit,
Chapter 3, Boston, MA and New York, NY: Houghton Mifflin Company, 51-93.
20. Jacob Viner (1925), ‘The Utility Concept in Value Theory and its Critics’, Journal of Political
Economy, 33 (4), August, 369-87.
21. Jacob Viner (1925), ‘The Utility Concept in Value Theory and its Critics: II. The Volatility
Concept in Welfare Economics’, Journal of Political Economy, 33 (6), December, 638-59.
22. Frank H. Knight (1925), ‘Economic Psychology and the Value Problem’, Quarterly Journal of
Economics, 39 (3), May, 372-409.
23. Henry Schultz (1930), ‘Development of the Demand Concept’, in The Meaning of Statistical Demand
Curves, Chapter 1, Chicago, IL: University of Chicago Press, 1-10, reset.
24. W. Allan Wallis and Milton Friedman (1942), ‘The Empirical Derivation of Indifference
Functions’, in Oscar Lange, Francis McIntyre and Theodore O. Yntema (eds), Studies in Mathematical
Economics and Econometrics: In Memory of Henry Schultz, Chicago, IL: University of Chicago Press, 175-89.
25. Milton Friedman and L.J. Savage (1948), ‘The Utility Analysis of Choices Involving Risk’, Journal of
Political Economy, LVI (4), August, 279-304.
26. Milton Friedman (1949), ‘The Marshallian Demand Curve’, Journal of Political Economy, LVII (6),
December, 463-95.
27. Milton Friedman and L.J. Savage (1952), ‘The Expected-Utility Hypothesis and the Measurability
of Utility’, Journal of Political Economy, LX (6), December, 463-74.
28. Armen A. Alchian (1953), ‘The Meaning of Utility Measurement’, American Economic Review, 43 (1),
March, 26-50.
29. Milton Friedman (1957), ‘Consistency of the Permanent Income Hypothesis with Existing
Evidence on the Relation between Consumption and Income: Budget Studies’, A Theory of the
Consumption Function, Chapter IV, Princeton, NJ: Princeton University Press, 38-114.
30. George J. Stigler (1961), ‘The Economics of Information’, Journal of Political Economy, LXIX (3),
June, 213-25.
31. Zvi Griliches (1961), ‘Hedonic Price Indexes for Automobiles: An Econometric Analysis of
Quality Change’, in The Price Statistics of the Federal Government: Review, Appraisal, and Recommendations,
Washington, DC: National Bureau of Economic Research, Inc., 173-96.
32. Gary S. Becker (1962), ‘Irrational Behavior and Economic Theory’, Journal of Political Economy, LXX
(1), February, 1-13.
57
33. Lester G. Telser (1962), ‘The Demand for Branded Goods as Estimated from Consumer Panal
Data’, Review of Economics and Statistics, 44 (3), August, 300-324.
34. Margaret G. Reid (1963), ‘Consumer Response to the Relative Price of Store versus Delivered
Milk’, Journal of Political Economy, 71 (2), April, 180-86.
35. Gary S. Becker (1965), ‘A Theory of the Allocation of Time’, Economic Journal, LXXV (299),
September, 493-517.
36. Robert T. Michael and Gary S. Becker (1973), ‘On the New Theory of Consumer Behavior’,
Swedish Journal of Economics, 75 (4), December, 378-96.
37. Gary S. Becker (1974), ‘A Theory of Social Interactions’, Journal of Political Economy, 82 (6),
November – December, 1063-93.
38. Sherwin Rosen (1974), ‘Hedonic Prices and Implicit Markets: Product Differentiation in Pure
Competition’, Journal of Political Economy, 82 (1), January – February, 34-55.
39. Gary S. Becker (1976), ‘Altruism, Egoism, and Genetic Fitness: Economics and Sociobiology’,
Journal of Economic Literature, 14 (3), September, 817-26.
Volume II
PART I PRODUCTION, COSTS AND SUPPLY
1. F.H. Knight (1917), ‘The Concept of Normal Price in Value and Distribution’, Quarterly Journal of
Economics, 32 (1), November, 66-100.
2. F.H. Knight (1921), ‘Cost of Production and Price over Long and Short Periods’, Journal of Political
Economy, 29 (4), April, 304-35.
3. J. Maurice Clark (1923), ‘Different Costs for Different Purposes: An Illustrative Problem’, Studies in
the Economics of Overhead Costs, Chapter IX, Chicago, IL: Chicago University Press, 175-203.
4. Frank H. Knight (1923), ‘The Ethics of Competition’, Quarterly Journal of Economics, 37 (4), August,
579-624.
5. Jacob Viner (1925), ‘Objective Tests of Competitive Price Applied to the Cement Industry’, Journal
of Political Economy, 33 (1), February, 107-11.
6. Frank H. Knight (1925), ‘On Decreasing Cost and Comparative Cost’, Quarterly Journal of Economics,
39 (2), February, 331-33.
7. Charles W. Cobb and Paul H. Douglas (1928), ‘A Theory of Production’, American Economic Review,
18 (1), March, 139-65.
8. Jacob Viner (1931), ‘Cost Curves and Supply Curves’, Zeitschrift fur Nationalokonomie, 3 (1),
September, 23-46.
9. Jacob L. Mosak (1938), ‘Interrelations of Production, Price, and Derived Demand’, Journal of Political
Economy, 46 (6), December, 761-87.
10. George Stigler (1939), ‘Production and Distribution in the Short Run’, Journal of Political Economy,
47 (3), June, 305-27.
58
11. George J. Stigler (1940), ‘A Note on Discontinuous Cost Curves’, American Economic Review, 30 (4),
December, 832-35.
12. Paul H. Douglas (1948), ‘Are there Laws of Production?’, American Economic Review, XXXVIII (1),
March, 1-41.
13. George J. Stigler (1951), ‘The Division of Labor is Limited by the Extent of the Market’, Journal of
Political Economy, LIX (3), June, 185-93.
14. George J. Stigler (1958), ‘The Economies of Scale’, Journal of Law and Economics, 1, October, 54-71.
15. Armen Alchian (1959), ‘Costs and Outputs’, in Moses Abramovitz (ed.), The Allocation of Economic
Resources: Essays in Honor of Barnard Francis Haley, Stanford, CA: Stanford University Press, 23-40.
16. Zvi Griliches (1960), ‘Hybrid Corn and the Economics of Innovation’, Science, 132 (3422), July,
275-280.
17. Jack Hirschleifer (1962), ‘The Firm’s Cost Functions: A Successful Reconstruction?’, Journal of
Business, XXXV (3), July, 235-55.
18. Lester G. Telser (1964), ‘Advertising and Competition’, Journal of Political Economy, LXXII (6),
December, 537-62.
19. George J. Stigler (1968), ‘Price and Non-Price Competition’, Journal of Political Economy, 76 (1),
January – February, 149-154.
20. Richard Thaler and Sherwin Rosen (1976), ‘The Value of Saving a Life: Evidence from the Labor
Market’, in Nestor E. Terleckyj (ed.), Household Production and Consumption, New York, NY and
London, UK: Columbia University Press, 265-97.
PART II MONOPOLY AND ANTITRUST
21. Jacob Viner (1922), ‘The Prevalence of Dumping in International Trade. I’ Journal of Political
Economy, 30 (5), October, 655-80.
22. George J. Stigler (1942), ‘The Extent and Bases of Monopoly’, American Economic Review, 32 (2),
Part 2, June 1-22.
23. George J. Stigler (1950), ‘Monopoly and Oligopoly by Merger’, American Economic Review, 40 (2),
May, 23-34.
24. G. Warren Nutter (1951), ‘The Growth of Monopoly, 1899–1939’ and ‘Appendix B: Basic Data
on the Growth of Monopoly 1899–1939’, in The Extent of Enterprise Monopoly in the United States, 1899–
1939: A Quantitative Study of Some Aspects of Monopoly, Chapter III, Chicago, IL: Chicago University
Press, 25-43, 112-55, notes.
25. Aaron Director and Edward H. Levi (1957), ‘Law and the Future: Trade Regulation’, Northwestern
University Law Review, 51, 281-96.
26. Arnold C. Harberger (1954), ‘Monopoly and Resource Allocation’, American Economic Review, 44
(2), May, 77-87.
27. Ward S. Bowman, Jr. (1957), ‘Tying Arrangements and the Leverage Problem’, Yale Law Journal, 67
(1), November, 19-36.
59
28. John S. McGee (1958), ‘Predatory Price Cutting: The Standard Oil (N.J.) Case’, Journal of Law and
Economics, 1, October, 137-69.
29. M.L. Burstein (1960), ‘The Economics of Tie-In Sales’, Review of Economics and Statistics, 42 (1),
February, 68-73.
30. Lester G. Telser (1960), ‘Why Should Manufacturers Want Fair Trade?’, Journal of Law and
Economics, 3, October, 86-105.
31. Robert H. Bork and Ward S. Bowman, Jr. (1965), ‘The Crisis in Antitrust’, Columbia Law Review, 65
(3), March, 363-76.
32. George J. Stigler (1966), ‘The Economic Effects of the Antitrust Laws’, Journal of Law and
Economics, 9, October, 225-58.
33. Richard A. Posner (1970), ‘A Statistical Study of Antitrust Enforcement’, Journal of Law and
Economics, 13 (2), October, 365-419.
34. Richard A. Posner (1975), ‘The Social Costs of Monopoly and Regulation’, Journal of Political
Economy, 83 (4), August, 807-27.
35. Michael Mussa and Shewin Rosen (1978), ‘Monopoly and Product Quality’, Journal of Economic
Theory, 18 (2), August, 301-317.
PART III MONOPOLISTIC COMPETITION AND OLIGOPOLY
36. George J. Stigler (1940), ‘Notes on the Theory of Duopoly’, Journal of Political Economy, 48 (4),
August, 521-41.
37. Don Patinkin (1947), ‘Multi-Plant Firms, Cartels, and Imperfect Competition’, Quarterly Journal of
Economics, 61 (2), February, 173-205.
38. George J. Stigler (1949), ‘Monopolistic Competition in Retrospect’, in Five Lectures on Economic
Problems, Chapter 2, London, UK: London School of Economics and Political Sciene and Longmans,
Green and Co., 12-24.
39. George J. Stigler (1949), ‘A Theory of Delivered Price Systems’, American Economic Review, XXXIX
(6), December, 1143-59.
40. George J. Stigler (1964), ‘A Theory of Oligopoly’, Journal of Political Economy, 72 (1), February, 4461
Volume III
PART I DISTRIBUTION THEORY
1. Milton Friedman and Simon Kuznets (1954), ‘Incomes in the Professions and in Other Pursuits’
and ‘Incomes in the Five Professions’, in Income from Independent Professional Practice, Chapters 3 and 4,
New York, NY: National Bureau of Economic Research, Inc., 62-172.
2. Milton Friedman (1953), ‘Choice, Chance, and the Personal Distribution of Income’, Journal of
Political Economy, LXI (4), August, 277-90.
3. Melvin W. Reder (1969), ‘A Partial Survey of the Theory of Income Size Distribution’, in Lee
Soltow (ed.), Six Papers on the Size and Distribution of Wealth and Income, Studies in Income and Wealth
Volume 33, New York, NY and London, UK: Columbia University Press for the National Bureau of
Economic Research, 205-53.
60
PART II CAPITAL AND PROFIT
4. Frank Hyneman Knight ([1932] 1935), ‘Interest’, in The Ethics of Competition and Other Essays, Chapter
X, New York, NY: Augustus M. Kelley Inc., 251-276.
5. Frank H. Knight (1934), ‘Capital, Time, and the Interest Rate’, Economica, 1 (3), August, 257-86.
6. Frank H. Knight (1944), ‘Diminishing Returns from Investment’, Journal of Political Economy, 52 (1),
March, 26-47.
7. Don Patinkin (1948), ‘Price Flexibility and Full Employment’, American Economic Review, 38 (4),
September, 543-64.
8. J. Fred Weston (1950), ‘A Generalized Uncertainty Theory of Profit’, American Economic Review, 40
(1), March, 40-60.
9. J. Hirshleifer (1965), ‘Investment Decision Under Uncertainty: Choice – Theoretic Approaches’,
Quarterly Journal of Economics, LXXIX (4), November, 509-36.
PART III LABOUR ECONOMICS AND THE THEORY OF HUMAN CAPTIAL
10. Erika H. Schoenberg and Paul H. Douglas (1937), ‘Studies in the Supply Curve of Labor: The
Relation in 1929 Between Average Earnings in American Cities and the Proportions Seeking
Employment’, Journal of Political Economy, 45 (1), February, 45-79.
11. M. Bronfenbrenner (1939), ‘The Economics of Collective Bargaining’, Quarterly Journal of Economics,
53 (4), August, 535-61.
12. Henry C. Simons (1944), ‘Some Reflections on Syndicalism’, Journal of Political Economy, LII (1),
March, 1-25.
13. George J. Stigler (1946), ‘The Economics of Minimum Wage Legislation’, American Economic
Review, 36 (3), June, 358-65.
14. Simon Rottenberg (1956), ‘The Baseball Players’ Labor Market’, Journal of Political Economy, 64 (3),
June, 242-58.
15. Gary S. Becker (1960), ‘An Economic Analysis of Fertility’, in Demographic and Economic Change in
Developed Countries, Princeton, NJ: Princeton University Press, 209-40.
16. M. Bronfenbrenner (1961), ‘Notes on the Elasticity of Derived Demand’, Oxford Economic Papers,
13 (3), October, 254-61.
17. Theodore W. Schultz (1961), ‘Investment in Human Capital’, American Economic Review, LI (1),
March, 1-17.
18. Armen A. Alchian and Reuben A. Kessel (1962), ‘Competition, Monopoly, and the Pursuit of
Money’, in Aspects of Labor Economics, Princeton, NJ: Princeton University Press, 157-83.
19. Gary S. Becker (1962), ‘Investment in Human Capital: A Theoretical Analysis’, Journal of Political
Economy, 70 (5), October, 9-49.
20. George J. Stigler (1962), ‘Information in the Labor Market’, Journal of Political Economy, 70 (5),
October, 94-105.
21. Abert Rees (1966), ‘Information Networks in Labor Markets’, American Economic Review, 56 (1/2),
March, 559-66.
61
PART IV PUBLIC ECONOMICS AND WELFARE ANALYSIS
22. F.H. Knight (1924), ‘Some Fallacies in the Interpretation of Social Cost’, Quarterly Journal of
Economics, 38 (4), August, 582-606.
23. M.W. Reder (1942), ‘Welfare Economics and Rationing’, Quarterly Journal of Economics, 57 (1),
November, 153-59.
24. George J. Stigler (1943), ‘The New Welfare Economics’, American Economic Review, 33 (2), June,
355-59.
25. James M. Buchanan (1949), ‘The Pure Theory of Government Finance: A Suggested Approach’,
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26. Milton Friedman (1952), ‘The “Welfare” Effects of an Income Tax and an Excise Tax’, Journal of
Political Economy, 60 (1), February, 25-33.
27. Gary S. Becker (1958), ‘Competition and Democracy’, Journal of Law and Economics, I, October,
105-109.
28. R.H. Coase (1960), ‘The Problem of Social Cost’, Journal of Law and Economics, III, October, 1-44.
29. Arnold C. Harberger (1964), ‘The Measurement of Waste’, American Economic Review, 54 (3), May,
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30. Arnold C. Harberger (1971), ‘Three Basic Postulates for Applied Welfare Economics: An
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31. George J. Stigler (1970), ‘Director’s Law of Public Income Redistribution’, Journal of Law and
Economics, 13 (1), April, 1-10.
32. George J. Stigler (1972), ‘Economic Competition and Political Competition’, Public Choice, XIII,
Fall, 91-106.
PART V REGULATION
33. George J. Stigler and Claire Friedland (1962), ‘What Can Regulators Regulate? The Case of
Electricity’, Journal of Law and Economics, V, October, 1-16.
34. George J. Stigler (1971), ‘The Theory of Economic Regulation’, Bell Journal of Economics and
Management Science, 2 (1), Spring, 3-21.
35. Richard A. Posner (1974), ‘Theories of Economic Regulation’, Bell Journal of Economics and
Management Science, 5 (2), Autumn, 335-58.
36. Sam Peltzman (1976), ‘Toward a More General Theory of Regulation’, Journal of Law and Economics,
19 (2), August, 211-40.
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