Presentation Speech by Professor Ragnar
Bentzel of the Royal Academy of Sciences
Translation from the Swedish text
Your Royal Highnesses, Ladies and
In a couple of years, we shall be able to celebrate the centenary of a remarkable event in the history of economic science. In 1874, the French economist Leon Walras made an extremely important contribution to economic thought by constructing a theory to explain the basic features in the economic mechanism which determine what quantities of different commodities will be produced in a country, what prices will prevail and how the incomes will be distributed between different groups in the community. This theory was presented in the form of a large system of equations, which was intended to illustrate the extensive network of relationships linking together different parts of the economy and creating a mutual interdependence between all the different prices, quantities of commodities and incomes. This theory laid the foundations of one of the most important structure in economic science-the general equilibrium theory. Its purpose is precisely to elucidate the mutual relations between different phenomena in an economy, in order thereby to create a basis for conclusions concerning prices, production structure, income distribution etc.
Walras' theory was later developed by many economists, including the Swede Gustav Cassel. However, up to the 1930s, the equations of the system were formulated in such general terms that the analytical possibilities were strongly limited. The analysis was focused on formal conditions of consistency.
When in 1939 John Hicks published his book Value and Capital, he breathed fresh life into general equilibrium theory. He constructed a complete equilibrium model, which was systematically built up, to a much greater extent than previous efforts in this field, on assumptions about the behaviour of consumers and producers. This gave greater concreteness to the equations included in the system and made it possible to study the effects produced within the system by impulses coming from outside it. For example, the model could show how changes in phenomena such as the harvest yield, the consumers' taste and the price expectations of business enterprises had consequences which spread throughout the whole economic system and affected prices, production, employment, interest rates etc. However, Hicks could not have got as far as this if he had not, on several points, himself created the necessary foundations for his model construction, amongst other things, by developing earlier theories of consumption and production and by constructing a theory of capital on the basis of assumptions about profit maximization.
Hicks used traditional differential analysis as a mathematical tool. When later more modern mathematical methods began to be introduced into economics, Arrow used them to study the properties of general equilibrium systems. He thereby formed the basis for a radical re-formulation of previous theory. Together with Gerhard Debreu, he produced in 1954 a very abstract model, based on mathematical set theory, which opened up fresh possibilities of making interesting analyses. For example, he and Debreu were the first to be able to demonstrate, in a mathematically stringent manner, the conditions which must be fulfilled if a neoclassical general equilibrium system is to have a unique and economically meaningful solution. By introducing a new technique for dealing with the theory of decision-making under conditions of uncertainty and risk, and by incorporating this theory in the general equilibrium theory, Arrow has also achieved results of great theoretical and practical interest.
While economic theory in general may be defined as the theory of how an economic condition or an economic development is determined within an institutional framework, the welfare theory deals with how to judge whether one condition can be said to be better in some way than another and whether it is possible, by altering the institutional framework, to achieve a better condition than the present one. Among Hicks' contributions in this field, attention may be called in particular to this elucidation of the index problems and his re-statement of the concept of consumer surplus. This concept may be defined as the difference between the highest price that a person would be willing to pay for a commodity, if he were pressed, and the price that he would need to pay for this commodity on the market. Hicks' definition of this concept has come to be of great importance, above all, in the evaluation of the social rate of return on public investments.
In his doctoral thesis, which was published in 1951, Arrow put the following question. Let us assume that in a society one has a number of alternative conditions to choose between and that each individual in the society can rank all these alternatives in order of desirability. Is it, in this case, possible to find ethically acceptable, democratic rules, for making a collective (or social) ranking of the different alternatives in order of desirability? Arrow showed that that question must be answered in the negative. It is in principle impossible to find such rules. This conclusion; which is a rather discouraging one, as regards the dream of a perfect democracy, conflicted with the previously established welfare theory, which had long employed the concept of a social-welfare function. However, this concept is nothing but an expression of a social ranking in order of desirability such as Arrow had shown that it was in principle impossible to make.
Drs. Arrow and Hicks,
I ask you to receive your prizes from the hands of His Royal Highness the Crown Prince.
From Nobel Lectures, Economics 1969-1980, Editor Assar Lindbeck, World Scientific Publishing Co., Singapore, 1992
Copyright © The Nobel Foundation 1972