The Analytical Relevance of Price Theory
Viner, the Knight circle and other members of Chicago’s prewar department did provide members of the Chicago School with an appreciation for the socially efficacious regulation of human behavior in free markets through the price mechanism (Reder 1982: 13).
In the 1930s and 1940s, Knight’s clear explanation of the operation of the price system in a free market introduced many Chicago students to an argument that was uncommon among American economists at the time (Knight 1951, originally published for classroom use in 1933), and Viner’s price theory course reinforced the message. Yet the Marshallian perspective was actually strengthened when Milton Friedman took over teaching the course in the late 1940s (Hammond 2010). Remarkably, from the 1930s to the 1980s, Chicago’s core price theory course, required of all graduate students in their first year, was primarily taught by a sequence of Viner or Knight (until the late 1940s), Friedman (until the 1970s), Arnold Harberger (until the early 1980s), and Gary Becker (1970s and 1980s; he continued teaching a section of the course into the twenty-first century). Consistency in content and quality across five decades in the core price theory course helped establish the school.However, teaching price theory was one thing, making it an analytical policy tool was another. While the rest of the economics discipline sought greater “descriptive accuracy” in the underlying assumptions of their models, members of the Chicago School continued, and in fact extended, the earlier Chicago emphasis on the “analytical relevance” of basic economic principles to policy analysis (Friedman 1953). Henry C. Simons, who had joined his former teacher Knight at Chicago in the late 1920s and moved to the university’s law school in the 1930s, had advocated a “positive program” for economic reform (Simons 1934) that many point to as the first formulation of a Chicago School policy agenda.
Knight (1944) himself directly defended analytical relevance over realism in his criticism of Hicksian demand theory, although he refused to acknowledge the predictive power of economics as an applied policy science in the same manner that Friedman and company did shortly thereafter. Friedman’s (1953) essay called for the “analytical relevance” of Marshallian price theory to be tested against the empirical evidence provided by existing policies. It quickly became the locus classicus of the Chicago School’s methodology.A good example of the difference that the Chicago approach made can be found in the early postwar debate between Stigler and Richard Lester over the effect of minimum wage legislation. Lester argued, as had many American institutionalist labor economists, that price theory was irrelevant to the evaluation of minimum wage legislation because (1) labor markets were not competitive; and (2) neither employers nor workers were profit maximizers in labor market transactions (Lester 1946). Stigler’s (1946) response re-affirmed the analytical relevance of Marshallian price theory to considerations of applied policy, even in labor markets. Despite the standoff between Stigler and Lester in the late 1940s, the increasing acceptance of the Chicago approach meant that, by the 1970s, Stigler’s conclusions had become the disciplinary standard. Similar controversies over other applied price theory topics solidified the Chicago approach. Stigler’s role was crucial in debates over imperfect or monopolistic competition (Stigler 1949) and kinked demand curves in oligopolistic industries (Stigler 1947), both of which started as challenges to the descriptive accuracy of competitive models. But other Chicago economists were also involved. Aaron Director led the battle in re-evaluating monopoly as the basis for trust busting; Eugene Fama extended price theory to financial market activity in the efficient market hypothesis; and Lester Telser led the critical appraisal of anticompetitive measures such as re-sale price maintenance agreements.
The predictive power of the Chicago approach, however, required the specification of a second methodological assumption to accompany Friedman’s principle. The necessary assumption, which came to be known by the name Stigler and Becker used as the title of the article in which they articulated it - “De gustibus non est disputandum” (Stigler and Becker 1977) - was implicit in Friedman’s essay when he “ventured the judgment” that disagreements about policies depend on different predictions of the policies’ outcomes rather than “fundamental differences in basic values” and, hence, that the progress of positive economic science could solve policy disagreements (Friedman 1953: 5). Essentially, price theory taught Friedman, Stigler and the rest of the Chicago School to focus on changes in the measurable cost structures surrounding market participants for scientific explanation, rather than changes in tastes, preferences and values. It was this lesson that Stigler and Becker codified for methodological purposes: assume that tastes and values are stable over time and among people. De gustibus non est disputandum joined Friedman’s “analytical relevance” as the methodological principles upon which the Chicago School was built, and became particularly important as the School broadened its reach across the entire breadth of human behavior (Becker 1976).