At the time this was published in 1960, Professor Alchian and Associate Professor Allen taught economics at the University of California, Los Angeles. Armen Alchian passed on February 19, 2013.
Economics sometimes has been described (and condemned) as the study of selfish behavior. The conception of the "economic man" has been ridiculed as a bloodless abstraction which constitutes a calumny on real people who are warm in spirit and generous in heart. For (most) real people are not wholly self-centered creatures, coldly calculating only how best to aid themselves even at the cost of injuring others, if need be.
This is but a parody of the "economic man" notion specifically and of the concern of economic study generally. Economics, accurately conceived, is directed to the analysis not of selfish behavior as such, but of efficient behavior. The basic question asked by the economist is not, "In light of the egocentric avariciousness of people, how can one best skin one’s neighbor?" Rather, he asks, "In light of the scarcity of resources, how can one squeeze the greatest return—which can take myriad forms, e.g., goods, power, utility, inner glow of contentment—from given productive services, talents, and environment? Or, alternatively, how can one achieve his desired goals with the minimum cost?" His goals can involve not only his own immediate welfare, but also that of other people.
Giving with Efficiency
We can usefully illustrate the matter by considering the granting of a subsidy or gift. The motivation of the giver may be as humanitarian and philanthropically pure as can be, but what of the efficiency with which the aid is given?
Suppose that a university—call it U.C.L.A.—wishes, for reasons good or bad which we shall not consider here, to subsidize the veterans in the student body by providing campus housing. U.C.L.A., it can be imagined, possesses a substantial amount of land on which are placed a number of war-surplus barracks. The barracks are renovated into a total of 1,000 apartments. The rent is set at $30 per month, which exactly clears the veterans’ market, i.e., at $30, the veterans, of whom there are more than 1,000, wish to take 1,000 apartments. (If the price is set at less than $30, there is at the outset a messy problem of administrative rationing, for at such a low price, more than 1,000 veterans will demand apartments.) The U.C.L.A. administrators decree that no non-veterans are allowed to occupy apartments, so non-veterans do not apply.
The land being devoted to veterans’ housing has some alternative valuable uses, e.g., as parking space, playing fields, or simply scenic lawn; so there is a cost involved in the housing program. The major question is now in order: for the given cost borne by U.C.L.A., are maximum benefits being bestowed, or, stated differently, could benefits equivalent to those actually bestowed be attained at smaller cost to U.C.L.A.?
Maximizing the Benefits
For the moment, concentrate on maximizing benefits. Are the beneficiaries of the subsidy as well off as possible with the resources being made available to them? As things stand, the veterans must take their assistance in a specified form, i.e., a barracks apartment, or not receive aid at all. And with more veterans than apartments, some veterans receive nothing. Now, if the apartments were to be opened to the whole student body, the market-clearing rent presumably would be higher than $30; suppose it to be $40. Some veteran might feel that, instead of living in the barracks at $30, it would be preferable to sublease his barracks apartment for $40 and apply the excess proceeds to the renting of a more desirable apartment in town at, say, $60. In this fashion, the veteran would in effect obtain a gift in the form of money ($10) which he then expends as he pleases.
Who gains and who loses by this subleasing procedure?
Before subleasing was allowed, the veteran had the alternatives of (a) a barracks apartment at $30 or (b) a town apartment at $60. But now the veteran is presented with an additional alternative, viz., (c) rent and sublease a barracks apartment, gaining a $10 profit, and live in a town apartment. Although the town apartment may be more conducive than a barracks apartment to gracious living, the veteran might prefer alternative (a) over (b); i.e., he might prefer the inferior apartment plus an extra $30 to spend on other things over the more expensive apartment. But in comparing alternative (a) to (c), staying in the barracks apartment would provide only an extra $20 for other things, and this extra $20 might or might not be sufficient to compensate for the poorer apartment. Finally, we certainly can say that if he prefers alternative (b) over (a), he will prefer (c) over (a), for a town apartment plus an extra $10 (i.e., alternative c) is preferable to a town apartment without an extra $10 (i.e., alternative b). In any event, the subleasing alternative cannot hurt the veteran, and it may help him.
Non-Veterans Also Gain
Has the non-veteran student who is subleasing from the veteran at $40 been helped or hurt? He may feel envious that he is not a member of the privileged group eligible for the barracks at $30, but this is true whether or not subleasing is permitted. Prior to subleasing, his only alternative was a town apartment at $60, but with subleasing he can now rent a barracks apartment at $40. He may prefer the latter. The subleasing offer has given him, too, an additional alternative, and his accepting the new alternative is evidence that he is better off by moving into the barracks.
U.C.L.A. also is involved. The university is financially indifferent, for it receives $30 per apartment whether or not the apartment is subleased.
It appears that no one is hurt by the subleasing practice, and the veteran and the other student are both better off. Why, then, are administrators generally loath thus to widen the alternatives of those they are intending to aid? If the university wants to put valuable resources at the disposal of veterans, why does it prevent the full potential benefits being realized by restricting the use to which the veterans can put the subsidy? Perhaps administrators would consider it "untidy" and "inappropriate" to provide veterans’ housing which is occupied by non-veterans. Or perhaps the administrators feel that they know what is best for the veterans, and barracks-living at $30 is deemed by them to be preferable for veterans to town-living at $60 and a $10 profit.
The moral is plain. A free price system enables men to use their resources in the ways they consider best. If it is felt that welfare is enhanced by broadening the alternatives available, a free price system enlarges welfare.
Alternative Land Use
Consider another possibility, which presents some additional complications. Suppose that the land now occupied by the barracks could be rented by U.C.L.A. at a rate equivalent to $50 per month for each apartment—or the land could be sold and the proceeds invested in acceptable fashion at a rate of interest equivalent to $50. With 1,000 apartments, this alternative income, as rent or interest, is $50,000 per month, compared to $30,000 when the land is used as barracks apartments for veterans.
In this "no barracks" case, U.C.L.A. could keep $30,000, so that the university would be equally well off under the two schemes, and allocate the remaining $20,000 among all veterans, of whom there are, let us say, 2,500. Each veteran receives $8 per month. How would the veterans fare now compared to the other schemes?
When subleasing of the barracks was not allowed, 1,000 veterans chose to live in the barracks at a rent of $30, and the remaining 1,500 received nothing from the university. Now, under the "no barracks" plan, with $20,000 being distributed among all veterans, clearly the 1,500 who would not have been in the barracks are better off: $8 is better than nothing. However, we cannot generalize about the other 1,000, for some of them will prefer $8-and-no-barracks-apartment, while some would have preferred the barracksapartment-and-no-$8.
When subleasing is allowed, it is again the case that 1,500 veterans do not benefit, for they cannot obtain an apartment. But the 1,000 with apartments can either keep the apartment at $30 or sublease at $40 and net $10 cash. In the "no barracks" case, with each veteran receiving $8 from U.C.L.A., those 1,000 who would have had a barracks apartment are worse off. However, if there were only 1,600 veterans, so that each receives $12.50 from the university, those who were willing to sublease (and perhaps even some of those who preferred to keep a barracks apartment when the alternative was to gain only $10 through subleasing) are better off.
And, of course, the greater the amount of money to split among a given number of veterans, the greater the share of each. If the market value of the land is $80,000, then $50,000 could be divided among the 2,500 veterans, giving each $20. That is, the better the alternative use U.C.L.A. has for its land, the greater and more widespread will be the benefits of utilizing the alternative and disbursing cash.
The Market Maximizes Alternatives for All Concerned
Let us summarize the conclusions from this array of possibilities. We began with veterans obtaining barracks apartments at the market-clearing rent of $30, without the right of subleasing. The university is discriminating not only in favor of veterans, but also in favor of those particular veterans who prefer a $30 barracks apartment to a $60 town apartment.
Now, if subleasing is allowed, another alternative is made available to both veterans and non-veterans. Those veterans who prefer to stay in the barracks have not lost, and those who prefer to sublease have gained. Similarly, some non-veteran students will not be interested in subleasing, but others are. Financially, U.C.L.A. is not affected. The introduction of subleasing rights has not hurt anyone, and some are benefited.
However, if subleasing is allowed, the apartments become more valuable. Even though a particular veteran might not demand an apartment at $30 for his own use, he is happy to rent at the pegged price of $30 in order to sublease at $40. The veterans’ market is no longer cleared: all 2,500 veterans seek an apartment, and there are only 1,000 apartments. With a pegged rent of $30 and no prohibition on subleasing, the university is discriminating among veterans in a new way, viz., in favor of those 1,000 veterans who happen to acquire apartments when all 2,500 want apartments.
Suppose that U.C.L.A. decides to get out of the veteran-housing business and sell the land or lease it in its most profitable use. Then receipts are available to disburse among all veterans. It may well be that some of the veterans who would have acquired barracks apartments will not be pleased by giving up the apartment and receiving cash. However, the more the cash, i.e., the better is the alternative use to which the land is now devoted, the fewer and the less insistent will be the complaints. In any case, those veterans who did not have apartments will be benefited by distribution of the cash. No longer is there discrimination among the veterans, for the resources made available to the favored group are evenly disbursed among all members of the group.