CONTRIBUTIONS OF

KENNETH ARROW
PRESENTED BY

ARUN MS (36004)

SANTHOSH KUMAR RAO C (36040)

SIVASANKARAN NE (36047)

SRINATH SARAVANAN P (36048)

VIGNESH K (36056)
ABOUT KENNETH ARROW
• Kenneth Joseph Arrow (23 August 1921 – 21 February 2017) was an
American economist, mathematician, writer, and political theorist.
• He is youngest Nobel winner in the economics at the age of 51 his work
on general equilibrium analysis.
• He was the joint winner of the Nobel Memorial Prize in Economic
Sciences with John Hicks in 1972.
• In economics, he was a major figure in post-World War II neo-classical
economic theory.
• Many of his former graduate students have gone on to win the Nobel
Memorial Prize themselves.
• His most significant works are his contributions to social choice theory,
notably "Arrow's impossibility theorem“.
• He has also provided foundational work in many other areas of economics,
including endogenous growth theory and the economics of information.
GENERAL EQUILIBRIUM THEORY
( ARROW-DEBREU MODEL )
WORKING WITH THE FRENCH ECONOMIST GÉRARD DEBREU, ARROW DEMONSTRATED THAT THE
INTUITIONS FROM A SINGLE MARKET COULD BE GENERALISED.
FIRST, THERE WAS A GENERAL EQUILIBRIUM AT WHICH PRICES EQUALISED SUPPLY AND DEMAND IN
EVERY MARKET AT ONCE.
SECOND, THIS EQUILIBRIUM WAS EFFICIENT.
THIRD, ANY EFFICIENT ALLOCATION OF RESOURCES COULD BE REACHED BY REDISTRIBUTING WEALTH
AND THEN LETTING COMPETITIVE MARKETS TAKE OVER. MARKETS COULD STILL FAIL, BUT ARROW’S
ANALYSIS EXPLAINED THE CIRCUMSTANCES UNDER WHICH THEY WOULD SUCCEED.
THE ARROW DEBREU MODEL WAS SIMPLE ENOUGH TO BE UNDERSTOOD IMMEDIATELY BY
MATHEMATICIANS WITH NO TRAINING IN ECONOMICS, YET GENERAL ENOUGH, GIVEN EVER SUBTLER
INTERPRETATIONS OF THE NOTION OF COMMODITY, TO ENCOMPASS A LARGE FRACTION OF ECONOMICS
KNOWN UP UNTIL THAT TIME, AS SPECIAL CASES.
IN HIS WORK, HE CONTRIBUTES TO TWO IMPORTANT PROOFS. FIRST, HE AND GERARD DEBREU PROVED
THE EXISTENCE OF A GENERAL EQUILIBRIUM ACROSS ALL GOODS MARKETS, WHICH ACCOUNTS FOR
FEEDBACK EFFECTS BETWEEN MARKETS. PREVIOUSLY, FORMAL ECONOMICS FOCUSED ON PARTIAL
EQUILIBRIUM MODELS, IGNORING THE INTERACTIONS BETWEEN NOMINALLY-SEPARATE MARKETS.
ALTHOUGH THE PROOF OF GENERAL EQUILIBRIUM IS BASED IN ABSTRACT MATHEMATICS, THE SHIFT
FROM PARTIAL TO GENERAL EQUILIBRIUM HAS IMMENSE CONSEQUENCES FOR POLITICAL THINKING.
OFTEN, POLITICIANS RELY ON SIMPLISTIC ECONOMIC THINKING TO JUSTIFY THEIR POLITICAL PRIORS, A
TENDENCY SOMETIMES SATIRIZED AS ‘101-ISM’ FOR ITS INABILITY TO MOVE BEYOND CONCEPTS FROM
INTRODUCTORY ECONOMICS COURSES.
FOR EXAMPLE, OPPONENTS OF MINIMUM WAGE LAWS DECLARE THAT MINIMUM WAGES ALWAYS
REDUCE EMPLOYMENT AND RAISE PRICES BY INCREASING THE COST OF LABOUR. UNDER A PARTIAL
EQUILIBRIUM MODEL, THIS THINKING WOULD BE CORRECT: A PRICE FLOOR SET ABOVE THE
EQUILIBRIUM WAGE RATE LEADS TO LOWER EQUILIBRIUM EMPLOYMENT.
HOWEVER, UNDER GENERAL EQUILIBRIUM, THE HIGHER WAGES ALSO TRANSLATE TO GREATER DEMAND
FOR PRODUCTS AND SERVICES BY THOSE EMPLOYEES, INCREASING DEMAND FOR LABOUR. THUS, THE
CERTAINTY OF THE SIMPLE PARTIAL EQUILIBRIUM MODEL MASKS THE INHERENT FEEDBACK EFFECTS IN
AN ECONOMY. IT ALSO SHOWS THE NECESSITY OF CAREFUL EMPIRICAL STUDY OVER SELF-ASSURED
PROCLAMATIONS (FOR MINIMUM WAGES, STUDIES REVEAL A SMALL, BUT STILL NEGATIVE IMPACT ON
AGGREGATE EMPLOYMENT.)
WELFARE ECONOMICS
ARROW’S PROOF OF GENERAL EQUILIBRIUM ALSO CHARACTERIZED THE WELFARE EFFECTS OF GENERAL EQUILIBRIUM IN THE TWO FUNDAMENTAL
THEOREMS OF WELFARE ECONOMICS. THE FIRST THEOREM STATES THAT UNDER PERFECT COMPETITION, THE COMPETITIVE EQUILIBRIUM WILL
BE PARETO OPTIMAL, AND THE SECOND THEOREM STATES THAT ANY POSSIBLE PARETO OPTIMAL OUTCOME CAN BE ACHIEVED THROUGH DIRECT
INCOME TRANSFERS AND MARKET COMPETITION.

THE TWO THEOREMS HAVE SOMEWHAT CONTRADICTORY POLITICAL IMPLICATIONS. CONSERVATIVES TEND TO LEAP ON THE FIRST THEOREM TO
PROMOTE UNRESTRICTED MARKETS. THEY ARGUE THAT IF COMPETITIVE MARKETS PRODUCE A PARETO OPTIMAL OUTCOME, AND BY
IMPLICATION UNCOMPETITIVE MARKETS MAY FAIL TO DO SO, THEN SOCIETY SHOULD EMBRACE COMPETITION AS THE CURE FOR ALL ILLS.

HOWEVER, ARROW HIMSELF DISMISSED THIS THINKING. HE NOTED THAT THE ASSUMPTIONS NECESSARY FOR THE FIRST THEOREM TO HOLD ARE
RESTRICTIVE, SO THE GOVERNMENT HAS A POTENTIALLY-EXPANSIVE ROLE TO PLAY IN ENSURING FAIR COMPETITION IN THE MARKET. THESE
RESTRICTIONS ALSO LED TO AN IMMENSE LITERATURE ON MARKET IMPERFECTIONS, EXPLORING THE MYRIAD WAYS THAT MARKETS CAN
PRODUCE INEFFICIENT OUTCOMES.

THIS THINKING ALSO DISREGARDS THE SECOND THEOREM, WHICH FELLOW NOBEL-WINNER AMARTYA SEN ONCE DESCRIBED AS “A
REVOLUTIONARY’S HANDBOOK.” WHEN THIS THEOREM HOLDS, THE GOVERNMENT COULD ENGAGE IN RADICAL INCOME REDISTRIBUTION
WITHOUT UPENDING THE EFFICIENCY OF THE MARKET. FOR EXAMPLE, THEY COULD CREATE A TRULY MERITOCRATIC SYSTEM BY REDISTRIBUTING
INCOME TO FULLY NEUTRALIZE ANY EFFECT OF INHERITANCE OR UPBRINGING ON ONE’S PROSPECTS, THEN LETTING MARKET COMPETITION
PROCEED.
WELFARE ECONOMICS:
This thinking also disregards the Second Theorem, which fellow Nobel-winner Amartya
Sen once described as “a revolutionary’s handbook.” When this theorem holds, the
government could engage in radical income redistribution without upending the efficiency
of the market.

For example, they could create a truly meritocratic system by redistributing income to fully
neutralize any effect of inheritance or upbringing on one’s prospects, then letting market
competition proceed.
In this theorem, redistribution is not a sin against the market system, but an intrinsic
feature of it. In Arrow’s words, “The freedom to make choices in a market economy
demands the ability to choose jobs and goods. I therefore have a built-in belief that
reducing income inequality is not in contradiction to economic freedom but part of it.”
SOCIAL CHOICE THEORY
• ARROW’S OTHER LANDMARK CONTRIBUTION WAS HIS EPONYMOUS IMPOSSIBILITY
THEOREM. HIS THEOREM DEMONSTRATED THAT NO POSSIBLE ORDINAL VOTING
MECHANISM CAN CONVERT INDIVIDUAL PREFERENCES INTO A COLLECTIVE RANKING
WITHOUT EITHER VIOLATING CERTAIN FAIRNESS CRITERIA, SUCH AS ‘IF EVERY VOTER
PREFERS X TO Y, THEN THE COLLECTIVE RANKING MUST PREFER X TO Y,’ OR MAKING ONE
VOTER INTO A DICTATOR WHOSE PREFERENCES ALONE DETERMINE THE OUTCOME.
• TODAY, MANY POLITICIANS CLAIM TO SPEAK FOR ‘THE WILL OF THE PEOPLE,’ IMPLICITLY
ASSUMING THAT THE COLLECTIVE WILL OF THEIR CONSTITUENTS IS CLEAR AND
COHERENT. YET THE ARROW IMPOSSIBILITY THEOREM DEMONSTRATES THAT NO SUCH
COLLECTIVE WILL COULD EXIST. ELECTORAL RESULTS DON’T NECESSARILY REPRESENT THE
WILL OF THE PEOPLE; THEY REPRESENT THE WILL OF THE SYSTEM’S CREATORS,
EMBODIED IN THE ELECTORAL RULES.
SOCIAL CHOICE THEORY
IN THE UNITED STATES, TRUMP WON THE ELECTION WHILE LOSING THE POPULAR VOTE.
THE COMBINATION OF THE ELECTORAL COLLEGE AND SENATE PRIVILEGES SMALL STATES
AND NARROWLY-DIVIDED STATES OVER LARGE, POLITICALLY-HOMOGENOUS ONES.
CLINTON WON CALIFORNIA BY AROUND 4.3 MILLION VOTES, A GAP GREATER THAN THE
POPULATION OF 24 STATES AND APPROXIMATELY EQUAL TO THE POPULATION OF THE 6
SMALLEST STATES COMBINED. YET THIS VICTORY WAS WORTH EXACTLY THE SAME AS IF SHE
HAD WON THE STATE BY ONE VOTE.
IN CANADA, THE LIBERAL GOVERNMENT RENEGED ON A CAMPAIGN PROMISE TO REPLACE
FIRST-PAST-THE-POST VOTING WITH ANOTHER SYSTEM, CREATING AN UPROAR AMONG
THOSE WHO HOPED FOR A CHANGE TO ELECTORAL RULES. YET ARROW’S THEOREM SHOWS
THAT THE PROPOSED REPLACEMENTS, DESPITE THEIR POTENTIAL ADVANTAGES OVER FPTP,
WOULD ALSO HAVE INHERENT FLAWS.
ENDOGENOUS GROWTH
WHEN STUDYING THE SOURCES OF ECONOMIC GROWTH, ARROW PROPOSED A MODEL
OF LEARNING-BY-DOING TO EXPLAIN PRODUCTIVITY GROWTH. HE THEORIZED THAT
PRODUCTIVITY IN THE PRODUCTION OF GOODS AND SERVICES COMES FROM PRACTICE. AS
A FIRM PRODUCES MORE GOODS OVER TIME, IT GENERATES KNOWLEDGE ABOUT THE
PRODUCTION PROCESS. SOME OF THIS KNOWLEDGE LEADS TO INTERNAL GAINS, REDUCING
COSTS AND INCREASING OUTPUT, WHILE SOME LEAKS OUT FROM THE FIRM, BOOSTING
ECONOMY-WIDE PRODUCTIVITY.
WITH THIS THEOREM, ARROW SLIGHTLY PREDATES BCG’S CREATION OF THE EXPERIENCE
CURVE IN THE MID-1960S AND PROVIDES A FOUNDATION FOR THE 10,000 HOURS OF
PRACTICE RULE DECADES BEFORE MALCOLM GLADWELL POPULARIZED IT. IT ALSO EXPLAINS
THE EXISTENCE OF INDUSTRY CLUSTERS, SUCH AS SILICON VALLEY, SINCE THESE BENEFICIAL
‘LEAKS’ ARE MORE LIKELY IN CLOSE GEOGRAPHIC PROXIMITY.
ENDOGENOUS GROWTH
MORE CONTENTIOUSLY, LEARNING-BY-DOING ALSO JUSTIFIES THE ‘INFANT INDUSTRY’ ARGUMENT FOR
ECONOMIC PROTECTIONISM. THE IDEA IS THAT IMMEDIATELY EXPOSING DOMESTIC MANUFACTURING
TO FOREIGN COMPETITION WOULD DEPRIVE IT OF THE OPPORTUNITY TO IMPROVE THROUGH PRACTICE.
THUS, THE GOVERNMENT SHOULD SHELTER SO-CALLED INFANT INDUSTRIES UNTIL THEY REACH A
SUFFICIENT SCALE TO COMPETE ON THE GLOBAL MARKET.
THIS ARGUMENT IS BOLSTERED BY ITS EMPIRICAL RECORD. MANY INDUSTRIALIZED COUNTRIES
DEVELOPED WHILE RESTRICTING INTERNATIONAL TRADE. FOR EXAMPLE, SOUTH KOREA LIMITED TRADE
WHILE ITS CHAEBOL GREW AND DEVELOPED THE SKILLS NECESSARY TO COMPETE IN ELECTRONICS AND
OTHER HIGH-VALUE MANUFACTURING. CHINA DIRECTLY ENCOURAGED THESE LEAKS BY MANDATING
KNOWLEDGE SHARING AS A CONDITION OF MARKET ACCESS AND OFTEN CHOSE TO LOOK AWAY WHEN
DOMESTIC COMPANIES STOLE THEIR INTERNATIONAL PARTNERS’ IP.
INFORMATION ECONOMICS
SEVERAL YEARS BEFORE AKERLOF AND OTHERS FORMALIZED THE ANALYSIS OF
ASYMMETRIC INFORMATION, ARROW NOTED THE IMPLICATIONS OF IT FOR HEALTH
CARE. HE ARGUED THAT HEALTHCARE SERVICES, SUCH AS PRIMARY CARE BY A
DOCTOR, HAD VAST INFORMATIONAL CHALLENGES AND THAT THESE CHALLENGES
WOULD MAKE FREE COMPETITION IN HEALTH MARKETS IMPOSSIBLE.
HE ALSO NOTED THE TENSION INHERENT IN HEALTH INSURANCE, WHERE
ELIMINATING THE COST TO CONSUMERS WOULD LEAD THEM TO OVER-CONSUME
HEALTH SERVICES, STRAINING THE SYSTEM, BUT THAT CHARGING FOR SERVICES
WOULD CREATE PRICE-BASED RATIONING, HARMING THE POOR AND VULNERABLE.
INFORMATION ECONOMICS
HIS INSIGHTS ECHO IN TODAY’S DEBATE IN AMERICA OVER HEALTH INSURANCE AND
HEALTH CARE. CONTRARY TO REPUBLICANS’ CLAIMS, HEALTH SERVICES CANNOT BE
EASILY COMPARED AS ONE MIGHT DO WITH BOXES OF CEREAL. THESE SERVICES RELY
ON THE TRUST BETWEEN A PATIENT AND THEIR DOCTOR, LIMITING COMPETITION IN
THE HEALTH MARKET. THUS, PURE COMPETITION WILL NEITHER DRIVE PRICES DOWN,
NOR LEAD TO SUPERIOR PATIENT CHOICE.
ADDITIONALLY, THE TENSION BETWEEN MORAL HAZARD AND INSURANCE REMAINS IN
THE OPPOSING POSITIONS OF REPUBLICANS AND DEMOCRATS. REPUBLICANS ARGUE
THAT PRICE SIGNALS ARE NECESSARY TO FORCE PATIENTS TO BE CAREFUL CONSUMERS
OF HEALTH SERVICES, WHILE DEMOCRATS RETORT THAT FORCING INDIVIDUALS TO
FOREGO MEDICAL TREATMENT DUE TO THEIR INCOME IS INHUMANE.