Department of Economics
Jack Hirshleifer was an economic theorist with broad-ranging interests. Two areas in economics have especially felt the impact of his work. Early in his career, he was instrumental in the information economics revolution; late in his career, he expanded the domain of economic discourse with his work on evolutionary economics and conflict resolution.
Hirshleifer spanned a broad range of issues in his early work as one of the founding fathers of information economics. He made the abstract ideas of contingent claims concrete through his examples and applications. In the process, he helped develop fundamental tools, such as the covariance of risks, the analysis of gambling and insurance, the Modigliani-Miller Theorem, and the analysis of public investment. He also expanded the range of information economics with two fundamental contributions. His work on the private and social value of information clearly shows that competitive markets need not reflect the social value of information. His example of an inventor who can invest based on the knowledge of the impact of his invention shows that there can be an oversupply of inventive activity. This "race to be first" has its reflection in the current literature on patent races, and represents a fundamental problem in intellectual property law that the profession is only now coming to grips with. His second fundamental contribution showed that differences in taste are not enough to explain speculation. He was the first to analyze speculation in a full general-equilibrium model, with different structures of market completeness carefully considered. Although not generally recognized as such, this is also the first paper to point out the indeterminacy of equilibrium when markets are incomplete.
In addition to his founding contributions in information economics, Hirshleifer had a lifelong interest in conflict, beginning with his earliest work on war damages. Late in his career this area became the focus of his contributions, and he was a leader in extending economic methods to problems more traditionally studied in political science. He wrote broadly on expanding the domain of economic discourse to include the "rational" evolutionary analysis of altruism and spite. His work on conflict showed how "Peace is more likely to the extent that the decisiveness of conflict is low, or ... if the stakes are small or the technology favors the defense. More surprisingly, perhaps, increased productive complementarity between the parties does not systematically favor peace...the poorer side is generally motivated to invest more heavily in fighting effort. So conflict can become an income-equalizing process." Finally, his weakest link/best shot experiment (with Glenn Harrison) demonstrates that economic incentives play a key role in determining how much people will contribute to a public good.
"War Damage Insurance," The Review of Economics and Statistics, Vol. 35, No. 2. (May 1953), pp. 144-153. Argues that vulnerability rated war damage insurance would create private incentives to make property less vulnerable to enemy bombing, and that this would be superior to administrative fiat.
"On the Theory of Optimal Investment Decision," The Journal of Political Economy, Vol. 66, No. 4. (Aug 1958), pp. 329-352. Examines different internal rate of return and present value rules when there is a divergence between borrowing and lending rates, and shows that while the problem can be solved by careful consideration of the budget constraint, neither of these rules gives the correct answer all the time.
"Risk, The Discount Rate, and Investment Decisions," The American Economic Review, Vol. 51, No. 2(May 1961), pp. 112-120. Discusses how covariance of new risks with the existing portfolio makes it desirable to diversify by adding new risks.
"Investment Decision Under Uncertainty: Choice-Theoretic Approaches," The Quarterly Journal of Economics, Vol. 79, No. 4. (Nov 1965), pp. 509-536; and "Investment Decision under Uncertainty: Applications of the State-Preference Approach," The Quarterly Journal of Economics, Vol. 80, No. 2. (May 1966), pp. 252-277. These two paper develop the time-state-preference approach (what we now call the state-contingent model) applied to traditional problems in economics: gambling and insurance; Modigliani-Miller Theorem and evaluation of public projects.
"Urban Water Supply: A Second Look," (with J. W. Milliman) The American Economic Review, Vol. 57, No. 2 (May 1967), pp. 169-178. In a famous earlier work with J.C. DeHaven Water Supply: Economics, Technology and Policy (University of Chicago Press, 1960) alternative methods of supplying water to Southern California were subject to cost-benefit analysis. This paper review what actually happened: policy makers ignored the advice, and chose what both prospectively and retrospectively was the worst economic choice. They conclude: "It appears that the agenda for economists, at this point, should place lower priority upon the further refinement of advice for those efficient and selfless administrators who may exist in never-never land. Rather, it should focus on devising institutions whereby fallible and imperfect administrators may be forced to learn from error."
"The Private and Social Value of Information and the Reward to Inventive Activity," The American Economic Review, Vol. 61, No. 4. (Sep 1971), pp. 561-574. Makes the simple yet crucial point that the benefit of receiving information first bears no necessary relationship to the social value of the information. For example, inventive activity may be oversupplied because the inventor can make investments based upon knowledge of the invention. This paper also makes careful use of an infinitesimal deviant individual in a representative individual world.
"Speculation and Equilibrium: Information, Risk, and Markets," The Quarterly Journal of Economics, Vol. 89, No. 4. (Nov 1975), pp. 519-542. This paper shows that differences in taste are not enough to explain speculation - differences in beliefs are required. Unlike earlier work on speculation that ignores the endogeneity of prices, the setup here is a full general equilibrium model, with different structures of market completeness carefully considered. In particular, market incompleteness alone cannot explain speculation. Although not generally recognized as such, this is the first paper to point out the indeterminacy of equilibrium in an incomplete market setting.
"Competition, Cooperation, and Conflict in Economics and Biology," The American Economic Review, Vol. 68, No. 2 (May 1978), pp. 238-243. This paper draws connections between the economics and sociobiology literature, and marks the beginning of Hirshleifer's interest in sociobiology and conflict.
"The Expanding Domain of Economics," The American Economic Review, Vol. 75, No. 6. (Dec 1985), pp. 53-68. This paper is a broad overview of the application of economic logic to a variety of "non-economic" problems. Hirshleifer begins by examining endogeneity of preferences. He identifies the different between altruistic preferences, and what would now be called the "warm-glow" effect of participation. He reviews Becker's "rotten kid" theorem, which says that an altruistic parent can actually gain from altruism. As an alternative theory of preferences, models of status, such as the rat-race are examined. The underlying point of view is that of "as-if" rationality - altruism must provide some benefit to the altruist. From this perspective, Hirshleifer examines models such as the psychological model of "anger, gratitude, response" and argues that seemingly irrational behavior does indeed benefit the individual. The final topic is once again that of conflict. A narrow range of possible settlements it is argued increases the potential for conflict. Increasing returns followed by diminishing returns explains the monopoly on military force within the state, while also explaining the multiplicity of states.
"An Experimental Evaluation of Weakest Link/Best Shot Models of Public Goods," (with Glenn W. Harrison) The Journal of Political Economy, Vol. 97, No. 1. (Feb 1989), pp. 201-225. This experimental contribution to the public goods literature explores how the increasing incentives to free ride lead to greater free riding. This paper also introduces the "best-shot" game, a public goods contribution game in which only the largest contribution to the public good matters. In this type of game it is socially and individually optimal for only one player to contribute, and unlike many other types of public goods games, this theoretical prediction is exactly what happens in the laboratory.
"The Technology of Conflict as an Economic Activity," The American Economic Review, Vol. 81, No. 2 (May 1991), pp. 130-134. "Peace is more likely to the extent that the decisiveness of conflict is low, or ... if the stakes are small or the technology favors the defense. More surprisingly, perhaps, increased productive complementarity between the parties does not systematically favor peace...the poorer side is generally motivated to invest more heavily in fighting effort. So conflict can become an income-equalizing process."