Ten years after her passing, Ostrom's work remains vital.
An Economic Journey
Economics textbooks today are full of colorful pictures and graphs and are often accompanied by supplemental interactive online activities and videos. Armen A. Alchian’s and William R. Allen’s book, Universal Economics looks nothing like modern economics textbooks, yet it brings economics to life in a way that no video or online graphing feature ever could. This work reads like a cross between a classical economics textbook and a Malcolm Gladwell book. While reading it, you feel like you are going on a journey where you explore the world you are intimately familiar with through a whole new framework of thinking. Alchian and Allen use a plethora of everyday examples and scenarios and introduce you to them in a brand new light. From sitting in church pews to assessing meteorite damage, this book challenges the reader to think beyond the seemingly “obvious” explanations for things and analyze them using the methodology of economics.
This book has been in the works since the 1980s. It has been described by his colleagues as Alchian’s “magnum opus.” Universal Economics is the product of decades of collaboration and conversation with fellow academics, graduate students, and friends. Alchian would often pop into a colleague’s office and ask “have you got any new ideas?” It is in this spirit of inquiry that this book came to be. Alchian and Allen think before they model, something that is becoming increasingly rare in the field of economics. They stress that their economic insights are planted firmly on solid economic theory. The book’s predecessor, University Economics, was famous, or notorious perhaps, for its end-of-chapter questions, which oftentimes puzzled even the professors. Universal Economics keeps the tradition of fun and challenging end-of-chapter questions alive and includes brief answers.
The book starts out by stating its quite cheeky intent. The authors admit that the reader will become brainwashed, but it is in the “desirable” sense. By “desirable” brainwashing they mean that the reader will begin to see their erroneous beliefs about the world for what they are—wrong. Some commonly held beliefs that the economic way of thinking illuminates are “property rights commonly conflict with human rights” and “rent control improves and expands housing.” The authors pose economic challenges to these widespread economically unsound beliefs in an intellectually stimulating and an enjoyable way. The first thirteen chapters lay the foundation for the economic way of thinking and basic price theory. These chapters cover the concepts of costs, marginal thinking, efficiency, and property rights, among many other basic principles. Chapters 14 through 29 use the foundational concepts in the previous chapters to build the economic framework for decision making in organizations like firms. Chapters 30 through 42 apply economic thinking and price theory in the realms of labor markets and money.
Private property rights lay the foundation for how many societies are organized. The key to understanding societal phenomena is knowing the “rules of the game,” of which rights are a part. Knowing who has what type of rights, for example property rights or the right to free speech, allows one to understand the behavior of people in a society. Private property rights are some of the most foundational and basic rights because they protect people from having their rights infringed upon. The authors describe private property rights as “rights of people over uses of goods they own”. It is these rights that allow human beings to align their incentives in order to increase prosperity and flourish. The authors introduce the concept of cost in a novel way by discussing the interplay between cost and rights. One’s right to make a choice is available without payment, yet the choice itself has an opportunity cost and is not free.
The economic conditions afforded by property rights allow positive-sum exchange to take place. Individuals who engage in voluntary transactions are afforded a situation they would not be able to attain on their own, trade leads to more satisfaction. Alchian and Allen offer an explanation for why economists are so concerned with marginal thinking rather than thinking in terms of totals and/or averages. Economics, they stress, focuses on human decision making and thinking on the margin is how individuals approach a decision. One person does not make decisions for themselves based on totals in society or even averages. They ask themselves should I purchase something or not? And how much should I buy? These decision making questions encapsulate marginal thinking.
Higher prices are often laid at the feet of the producers, and it is commonly thought that higher prices are a result of greedy producers who pass their higher costs onto their customers. Consumers, the authors point out, are actually the culprit. Higher prices are a result of increased consumer demand. Consumers compete with each other to drive prices up.
The authors end this section of their book by connecting property rights with markets. Pollution and misuse of public property are oftentimes referred to as “market failures” and serve as a justification for government intervention. These incidents, however, are not a result of the failure of the market but an absence of clear private property rights. Not only do private property rights allow individuals to invest and have control over their goods, they internalize externalities which mitigates pollution and the abuse of property.
Decision Making in Organizations
Why do we have increasingly specialized labor and production? Today we see companies providing extremely niche and a very narrow array of products. The answer to this global trend is specialization. Prosperity increases when individuals specialize in the production of a good or service then trade with each other. This results in a situation where all individuals involved in the exchange are better off and they are able to attain a level of consumption with trade that they would have never had access to if they were producing goods and services alone.
A large part of the second section of the book explores the economic consequences of public policy. Something seemingly as small as a 1 cent tax on a pound of peanuts has economic ramifications. The output of peanuts will decrease. Immediately, if output stays the same and the taxes are paid, the peanut growers will lose wealth. This results in higher marginal cost for the growers which will lead to a decrease in output. Farmers who were breaking even before the tax will now be forced out of the market or will have to reduce their production. This reduction in supply will lead to a higher price for consumers. Not only that, but the value of land will fall because it is less profitable to own. The tax will also result in a reduction of value of peanut-producing equipment and will impact that market.
The third section of the book covers wealth, rates of return, and risk. The author’s treatment of present values is particularly novel, along with the examples they provide. The text includes tables that illustrate the present value of various payments after each year (1–50 years out) which demonstrate the impact and importance of time and interest. Interest is explained as a “package of several components” that is made up of the pure rate of interest, loan-negotiation costs, inflation, and default risk. This concept explains that everyone pays the same rate of interest even though various groups appear to pay either higher or lower rates because what is typically referred to as the interest rate is actually a package of prices.
Alchian and Allen provide a unique treatment of earnings. They invite the reader to think about their own earnings and various life events that will impact their ability to acquire earnings such as earning an income or marriage. They make a distinction between age-related annual earnings and total lifetime earnings, emphasizing that “the capital value of lifetime earnings permits a more complete comparison of earnings of people with different lifetime patterns of investment and consumption.” This perspective equips the reader to be able to fully analyze earnings comparisons and income factors as well as apply these concepts to their own current and future earnings plans. The applications in this section analyze timely topics such as the concepts of a “living wage” and “equal pay for equal work.” The authors analyze these concepts in the broader contexts of wage controls and the more traditional minimum wage. This section also focuses on mechanisms of capitalization that many textbooks have ignored.
Universal Economics is truly a classic economic text that offers timeless insight into the methodology of economics and applications of economic theory. Arguably the most novel contribution of this book is its ability to make sense of social, political, and economic phenomena in logical and coherent ways. Alchian and Allen search for and find satisfactory answers to puzzling questions and then find ways to generalize them. This text is not only a defense of the methodology of economics but an exploration of how this methodology can be applied and what it can do to illuminate important questions in our world.