Arrow, Kenneth (1921–)

Born August 23, 1921, in New York City, Kenneth J. Arrow was awarded the Royal Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel (widely known as the Nobel Memorial Prize) in 1972 with Sir John R. Hicks for their contributions to general economic equilibrium theory and welfare theory. Arrow is one of the major representatives of the neoclassical school of economics. His main contributions were devoted to the fields of social choice theory—which includes his famous Arrow impossibility theorem—general equilibrium theory, growth theory, and economics of information and organization.

He graduated in 1940 with a B.S. in social science with a major in mathematics at City College of New York. He received an M.A. in mathematics in 1941 from Columbia University. During World War II, he served as an officer in the Weather Division of the Army Air Corps, conducting research. After the war he returned to graduate study at Columbia. In 1947, he joined Jacob Marschak as a research associate at the Cowles Commission, University of Chicago, where he became Assistant Professor of Economics during 1948 to 1949. His work on social choice dates from this period. In 1949, he was appointed Acting Assistant Professor of Economics and Statistics at Stanford University where he has been working ever since, except for the period 1968 to 1979. In 1968, he moved to Harvard University as Professor of Economics, becoming the James Bryant Conant University Professor in 1974. In 1979, he returned to Stanford as Joan Kenney Professor of Economics and Professor of Operations Research. He retired in 1991 when he was designated Emeritus Professor. Among other high honors, he received the John Bates Clark Medal of the American Economics Association in 1957.

A desired objective of economists is to formulate a “social welfare function.” This function—the relationship between the well-being of the society at large and the utility of the individuals comprising that society—would determine the best possible social situation stemming from individual rankings of alternatives. Is it possible to achieve a social situation that satisfies all individuals? What does this achievement entail? Arrow endeavored to achieve this objective under minimal ethical conditions: the function should include all the possible orderings, decisions should be coherent, and no individual would have a privileged position in determining the solution. Arrow's conclusion was that this social ordering was logically impossible. The result, called Arrow impossibility theorem, was part of his doctoral dissertation at Columbia—published in 1951 as Social Choice and Individual Values—which states that it is impossible to formulate a social preference order corresponding to individual rankings satisfying a set of minimal acceptable conditions. Instead, it seems plausible for Arrow that a “dictator” imposing an order of preferences is required. This conclusion gave rise to a lot of academic work on welfare economics. Amartya Sen's “Paradox of Impossibility of a Liberal Paretian,” which states that it is impossible to obtain an acceptable distribution on the basis of liberal minimal conditions, constitutes an example of this line of inquiry.

As stated above, Arrow also contributes to the economics of information. Although neoclassical economic theory is based on the presupposition of complete information for every economic agent, actually different individuals have often unequal knowledge of relevant [Page 114]information. This situation of “asymmetric information” engenders a number of problems to economics: misguiding incentives and decisions and the generation of unnecessary or avoidable costs—for example, the setting of wages in labor markets and employer's preferences for the existing employees (productivity levels of potential employees is unknown to the employer). Asymmetric information before a contract is signed is called “adverse selection,” and after contracts, “moral hazard.” A typical example of moral hazard is the negligible behavior of insured car drivers. The insurance company ends up with an adverse selection of people and rising the premium for all kind of consumers. A nonoptimal allocation of resources results from this divergence between the private marginal cost of an action and the social marginal cost of the same action. This notion of moral hazard was developed by Arrow in a 1963 paper about medical insurance.

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