Showing papers by "Kenneth J. Arrow published in 1974"

Environmental Preservation, Uncertainty, and Irreversibility

Abstract: A number of recent contributions by economists have provided a clear insight into the causes of the varied forms of environmental deterioration, and have also suggested, implicitly or explicitly, policies for more efficient management of environmental as well as other resources.1 Yet, as Allen Kneese has pointed out in a review of empirical studies of pollution damages, “a general shortcoming of [these studies] has been that they have treated a stochastic or probabilistic phenomenon as being deterministic.”2 The purpose of this paper is to explore the implications of uncertainty surrounding estimates of the environmental costs of some economic activities. It is shown in particular that the existence of uncertainty will, in certain important cases, lead to a reduction in net benefits from an activity with environmental costs. In such cases the implication for an efficient control policy will generally involve some restriction of the activity.

Uncertainty and the Evaluation of Public Investment Decisions

Abstract: The implications of uncertainty for public investment decisions remain controversial. The essence of the controversy is as follows. It is widely accepted that individuals are not indifferent to uncertainty and will not, in general, value assets with uncertain returns at their expected values. Depending upon an individual’s initial asset holdings and utility function, he will value an asset at more or less than its expected value. Therefore, in private capital markets, investors do not choose investments to maximize the present value of expected returns, but to maximize the present value of returns properly adjusted for risk. The issue is whether it is appropriate to discount public investments in the same way as private investments.

Limited Knowledge and Economic Analysis

Abstract: Considers the idea that the uncertainties about economics stem from the need to understand the economics of uncertainty. Also argues that the lack of economic knowledge is largely due to the difficulty in modeling the economic agent's ignorance. The neoclassical model, founded on concepts regarding the individual economic agent and the market, is the starting point for the discussion. It is suggested that a market system is informationally economical and that the individual agent need not know very much about the economic system as a whole because there is far more in it than any one individual can learn. What the individual must know is the motivation and production conditions that define him or her. In addition, the simplification of an individual's decision making processes is possible because the markets have supplied the needed economic information in the form of prices. Also examined is the nonexistence of markets for future goods. This is done by considering the implications for the rest of the system and the reasons for the market's nonexistence. Finally, it is proposed that when uncertainty exists, risk aversion implies that steps will be taken to reduce risks. (SFL)

Limited Knowledge and Economic Analysis

Abstract: Considers the idea that the uncertainties about economics stem from the need to understand the economics of uncertainty. Also argues that the lack of economic knowledge is largely due to the difficulty in modeling the economic agent's ignorance. The neoclassical model, founded on concepts regarding the individual economic agent and the market, is the starting point for the discussion. It is suggested that a market system is informationally economical and that the individual agent need not know very much about the economic system as a whole because there is far more in it than any one individual can learn. What the individual must know is the motivation and production conditions that define him or her. In addition, the simplification of an individual's decision making processes is possible because the markets have supplied the needed economic information in the form of prices. Also examined is the nonexistence of markets for future goods. This is done by considering the implications for the rest of the system and the reasons for the market's nonexistence. Finally, it is proposed that when uncertainty exists, risk aversion implies that steps will be taken to reduce risks. (SFL)

Optimal Insurance and Generalized Deductibles

Abstract: This report is intended as a contribution to the theory of demand for insurance. In many circumstances, it appears that, given a range of alternative possible insurance policies, the insured would prefer a policy offering complete coverage beyond a deductible. In an earlier paper (Arrow [1]; reprinted in Arrow [3], pp. 212-216), this argument was developed for the case where the risk being insured against was, effectively, loss of income. Recently, Ehrlich and Becker [4] have extended these results considerably, as well as analyzing other responses of the insured to the price of insurance, responses beyond the scope of this study. For some other related work, see Pashigian, Schkade, and Menefee [8], Smith [12], and Gould [6]. However, income is not the only uncertainty, especially in the context of health insurance, and only under special and unrealistic circumstances can it be held that the other uncertainties have income equivalents. Put loosely, the marginal utility of income will in general d...

The Measurement of Real Value Added

Abstract: Publisher Summary The concept of value added has played an essential role in both private and national income accounting as a device for allocating the origins of income to the various points in the productive sector of the economy at which primary factors are brought to bear on the creation of the total value of final products. It provides an accounting that exactly exhausts total product. It is, however, a monetary magnitude and as such subject to all the vicissitudes that have made economists engage in the unavailing search for an invariable standard of value. To assess more deeply the relative merits of alternative measures of real value added, it is necessary to ask what its economic meaning is. This chapter discusses the most natural meaning of real value added that arises from the estimation of production functions. The output of any commodity is determined by the inputs of a number of commodities of which some are primary factors and others are produced goods, which is refer to as materials. The attribution of a special role to primary factors, capital and labor, and the construction of an aggregate for them can be justified only for the usual reasons, that is, their use in production is separable from that of the materials.

Stability independent of adjustment speed

Abstract: Publisher Summary This chapter discusses stability independent of adjustment speed. Hicks, in his classic work, introduced for serious consideration by economists the problem of analyzing stability in multiple markets. He defined a concept of perfect stability in which one market was singled out and the remaining markets were divided into two sets: in the first set, all prices were held fixed at their equilibrium values, while, as the singled-out price varied, all prices in the second set were continuously adjusted to keep supply and demand on all the markets in that set constant. Under these conditions, excess demand was defined as a function of the singled-out price. If the resulting function was downward sloping for all ways of singling out a price and all ways of dividing the remaining markets into two sets as indicated, then the economy was said to be perfectly stable. A necessary and sufficient condition for perfect stability was that the Jacobian matrix of the excess demand functions have the property that the principal minors of odd order have negative determinants and those of even order have positive determinants.

On the Agenda of Organizations

Abstract: In classical maximizing theory, it is implicit that the values of all relevant variables are at all moments under consideration. All variables are therefore agenda of the organization, that is, their values have always to be chosen. On the other hand, it is a commonplace of everyday observation and of studies of organization that the difficulty of arranging that a potential decision variable be recognized as such may be much greater than that of choosing a value for it. What the Federal Government regards as appropriate agenda has changed rapidly; nor can it be maintained that the new agenda necessarily correspond to changes in demand or supply, i.e., the emergence of new problems in the world or of new techniques for their solution. Unemployment insurance is an old idea, and the need for it did not emerge only in the Great Depression; but it suddenly changed from a non-agendum to an agendum. (I shall occasionally make use of this singular form, though the dictionaries label it obsolete.) Similar examples can be cited for all sorts of organization; innovation by firms is in many cases simply a question of putting an item on its agenda before other firms do. We can also see some items now in the process of becoming agenda. In the case of the Federal Government, the possibility of flexible exchange rates is at least on the horizon.