Uncertainty, Evolution, and Economic Theory
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''Uncertainty, Evolution, and Economic Theory'' is an article published in 1950 which was written by economist
Armen Alchian Armen Albert Alchian (; April 12, 1914February 19, 2013) was an American economist. He spent almost his entire career at the University of California, Los Angeles (UCLA). A major microeconomic theorist, he is known as one of the founders of new in ...
. In this article, Alchian delineates an evolutionary approach to describe firms’ behavior. His theory embodies principles of biological evolution and
natural selection Natural selection is the differential survival and reproduction of individuals due to differences in phenotype. It is a key mechanism of evolution, the change in the heritable traits characteristic of a population over generations. Charle ...
. This article is among the first in the economics literature to analogize between success and survival in the market with the mechanism of variation and natural selection postulated in evolutionary biology. Alchian postulated that the survival of a few firms from a large number of firms that entered the market may be due to random entrepreneurial decisions rather than by brilliance or cunning. Success and survival rests upon the market’s response to the firms' products. Entrepreneurial decision-making cannot be tied to an explicit maximizing objective because the future is not known, and, at best, is a mishmash of probabilistic outcomes.


Evolutionary approach to firm survival

The evolutionary approach to firm survival and behavior proposes that firms do not have to consciously strive to maximize profits and that is because scarcity and competition will ensure the firms' survival and will behave as if they are maximizing profits. Much like the survival of heliophiliac plants, only those plants that do get sunshine will survive. The plants that have survived is understood to have acquired more sunlight than the non-surviving plants. This explanation contrasts starkly with the mainstream picture of accurate foresight and perfect rationality often ascribed to economic actors. Alchian dismisses
profit maximization In economics, profit maximization is the short run or long run process by which a firm may determine the price, input and output levels that will lead to the highest possible total profit (or just profit in short). In neoclassical economics, w ...
and
utility As a topic of economics, utility is used to model worth or value. Its usage has evolved significantly over time. The term was introduced initially as a measure of pleasure or happiness as part of the theory of utilitarianism by moral philosopher ...
maximization as meaningful attributes of firms’ survival. He argues that uncertainty and probabilistic outcomes make the maximization of any objective function meaningless. Alchian states that uncertainty arises from two sources: imperfect foresight and human inability to solve complex problems with a host of variables. Uncertainty and a combination of random behavior and foresight lead to probability distributions of outcomes (profits/losses) rather than a unique outcome. Consequently any objective function has to incorporate both returns AND attitudes towards risk, but an objective function cannot incorporate a non-objective function (which is what preferences for risk are) and still be an objective function. Success and viability depend on implementing strategies that yield positive profits; similar to natural selection firms realizing negative profits are more likely to be culled from the population regardless of managerial aspirations. In the long run this leads to a population of firms appearing to share discernible criteria ascribable to successful firms. Competing firms that mimic the behavior of successful/surviving firms will appear to be consciously maximizing profits even though their strategies were developed in the absence of the aforementioned criteria. Alchian notes that the successful firms may not consciously maximize profits but act as if they do because market forces cull firms that fail to yield positive returns. What the goals of the entrepreneurs of successful firms are is not relevant. Market forces affect firm profitability, and in retrospect the historical record will show surviving firms behaving as if the firms had information and foresight. Firms which quickly emulate successful firms (by definition survivors of the market forces) will increase their chances of survival. Whereas firms that fail to adapt, or do so slowly, risk a greater likelihood of failure. Surviving firms evolve in the direction of the more economically profitable firms. Evolution and competition for scarce resources ensure that, in practice, firms do not have to consciously maximize an objective function. Alchian concludes that, despite uncertainty and the lack of knowledge by market participants, economists can still analyze the behavior of firms using the assumptions of profit maximization. The prerequisites for survival in the long run are returns greater than costs, profits in other words. In retrospect economists can compare alternatives and predict which behaviors were more conducive for survival even though such knowledge was unavailable to contemporaneous firms.


Inspiration

"Uncertainty, Evolution, and Economic Theory" was heavily influenced by Armen Alchian’s education and background in statistical analysis. Alchian studied statistics at
Stanford University Stanford University, officially Leland Stanford Junior University, is a private research university in Stanford, California. The campus occupies , among the largest in the United States, and enrolls over 17,000 students. Stanford is consider ...
under
W. Allen Wallis Wilson Allen Wallis (November 5, 1912 – October 12, 1998) was an American economist and statistician who served as president of the University of Rochester. He is best known for the Kruskal–Wallis one-way analysis of variance, which is named ...
who introduced Alchian to the statistical work of Ronald Fisher. Fisher was one of the founders of the Neo-Darwinian Synthesis and influenced Alchian’s approach on statistics. Alchian’s early studies at the
Rand Corporation The RAND Corporation (from the phrase "research and development") is an American nonprofit global policy think tank created in 1948 by Douglas Aircraft Company to offer research and analysis to the United States Armed Forces. It is financed ...
dealt with system analysis convinced Alchian that uncertainty was a central challenge threatening assumptions of
Marginal analysis Marginalism is a theory of economics that attempts to explain the discrepancy in the value of goods and services by reference to their secondary, or marginal, utility. It states that the reason why the price of diamonds is higher than that of wa ...
.


Impact

“Uncertainty, Evolution, and Economic Theory” was Alchian’s first major article. It is hailed by most evolutionary economists as an important and seminal contribution to economic theory. Economists who consider the article a powerful defense of the assumption of profit maximization include Arthur S. De Vany, Harold Demsetz, and Benjamin Klein.


Criticisms

"Uncertainty, Evolution, and Economic Theory" drew criticism from
Sidney G. Winter Sidney Graham Winter (born 1935, in Iowa City, Iowa) is an American economist and Professor Emeritus of Management at the Wharton School, University of Pennsylvania. He is recognized as a leading figures in the revival of evolutionary economics. ...
; he argued that Alchian failed to consider the transmission mechanisms that determine successful behaviors, and how they can be maintained and copied over time. According to Winter if maximizing profits is not a result of conscious action, then those particular actions cannot be learned by other firms. Winter further argued that in the case of weak competition selective pressure will be limited.


See also

* Evolutionary economics


References

* * * * * {{DEFAULTSORT:Uncertainty, Evolution, and Economic Theory Economics articles 1950 documents