Uncertainty, Evolution, and Behavioral Economic Theory

Geoffrey A. Manne

International Center for Law & Economics

Todd J. Zywicki

George Mason University School of Law; PERC - Property and Environment Research Center

March 7, 2014

Journal of Law, Economics and Policy, Forthcoming
George Mason Law & Economics Research Paper No. 14-04

Armen Alchian was one of the great economists of the twentieth century, and his 1950 paper, Uncertainty, Evolution, and Economic Theory, one of the most important contributions to the economic literature. Anticipating modern behavioral economics, Alchian explains that firms most decidedly do not – cannot – actually operate as rational profit maximizers. Nevertheless, economists can make useful predictions even in a world of uncertainty and incomplete information because market environments “adopt” those firms that best fit their environments, permitting them to be modeled as if they behave rationally. This insight has important and under-appreciated implications for the debate today over the usefulness of behavioral economics.

Alchian’s explanation of the role of market forces in shaping outcomes poses a serious challenge to behavioralists’ claims. While Alchian’s (and our) conclusions are born out of the same realization that uncertainty pervades economic decision making that preoccupies the behavioralists, his work suggests a very different conclusion: The evolutionary pressures identified by Alchian may have led to seemingly inefficient firms and other institutions that, in actuality, constrain the effects of bias by market participants. In other words, the very “defects” of profitable firms – from conservatism to excessive bureaucracy to agency costs – may actually support their relative efficiency and effectiveness, even if they appear problematic, costly or inefficient. In fact, their very persistence argues strongly for that conclusion.

In Part I, we offer a short summary of Uncertainty, Evolution, and Economic Theory. In Part II, we explain the implications of Alchian’s paper for behavioral economics. Part III looks at some findings from experimental economics, and the banking industry in particular, to demonstrate how biases are constrained by firms and other institutions – in ways often misunderstood by behavioral economists. In Part IV, we consider what Alchian’s model means for government regulation (with special emphasis on antitrust and consumer protection regulation).

Number of Pages in PDF File: 27

Keywords: antitrust, Alchian, bank lending, behavioral economics, bias, consumer protection, efficiency, endowment effect, experimental economics, fee shrouding, government intervention, irrationality, law and economics, over-optimism, Rasmussen, rational actors, regulators, self-interest, uncertainty

JEL Classification: D61, D80, G21, G28, K21

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Date posted: March 9, 2014 ; Last revised: March 24, 2014

Suggested Citation

Manne, Geoffrey A. and Zywicki, Todd J., Uncertainty, Evolution, and Behavioral Economic Theory (March 7, 2014). Journal of Law, Economics and Policy, Forthcoming; George Mason Law & Economics Research Paper No. 14-04. Available at SSRN: http://ssrn.com/abstract=2406175

Contact Information

Geoffrey A. Manne
International Center for Law & Economics ( email )
3333 NE Sandy Blvd
Suite 207
Portland, OR Oregon 97232
United States
503-770-0076 (Phone)
HOME PAGE: http://www.laweconcenter.org
Todd J. Zywicki (Contact Author)
George Mason University School of Law ( email )
3301 Fairfax Drive
Arlington, VA 22201
United States
703-993-8091 (Phone)
703-993-8088 (Fax)

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PERC - Property and Environment Research Center
2048 Analysis Drive
Suite A
Bozeman, MT 59718
United States

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