Sunday, May 5, 2013

What picture of economics is emerging?


I'm not going to answer this definitively; I'm just going to give some preliminary thoughts in bullet point form:

  • The "invisible hand" is a result of the dynamics of an information transfer process from something identified in economics as the "demand" (which is a nebulous concept based on consumer desires and abilities) to the supply (which is a fairly well-defined concept based on physical widgets or services). The price is what detects a demand signal being sent to the demand.
  • In particular, these dynamics arise without any particular description of the micro theory: the reason the supply curve is upward sloping and the demand curve is downward sloping is a result of the price detecting information being transferred from the demand to the supply. Marginal utility may help explain a micro theory, but it is unnecessary to derive the basic results.
  • Additionally, the information transfer model does not require equilibrium and therefore can operate when the system is not in equilibrium (as long as $I_{Q^d} \sim I_{Q^s}$).
  • Since the information source is the demand, the idea that "supply creates its own demand" is on the whole false since the information destination cannot create the information so destined. Supply can uncover demand (i.e. information that used to be transmitted from the source into "empty space" can suddenly have a place to go).
  • The price is a way of "detecting" the process of transmitting information from the demand to the supply, so in a sense, money is a unit of information that at a basic level only has meaning in what demand it can be used to transmit information to what supply.
  • As a corollary to the previous point, anything that behaves like supply and demand with something functioning as a price can be put in this framework. For example, the IS-LM model behaves like supply (LM) and demand (IS) curves with the interest rate functioning as the "price". So does the AD/AS model with the "price level" functioning as the price.
  • Prices can be sticky if information transfer is non-ideal. Again, this is based on non-ideal information transfer and does not depend on a particular micro theory (menu costs, money illusion, signalling) -- a micro theory is unnecessary.
  • If $I_{Q^d} \gg I_{Q^s}$ or the price becomes undefined, then the information transfer mechanism breaks down and there might not be any kind of market at all
  • One could take this further and make the argument that $I_{Q^d} \sim I_{Q^s}$ represents a condition for a well defined concept of "economics" to exist, and that studying things where little information is transferred by a ill-defined price is actually something else ... like sociology. Does market failure represent a boundary of applicability in a similar way that nonequilibrium systems can lack a well defined concept of temperature? 

2 comments:

  1. On that last bullet, it seems the efficient markets hypothesis is empty ... markets are efficient when $I_{Q^d} \sim I_{Q^s}$, or basically the price contains most of the information when the price contains most of the information.

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  2. Typos: First bullet: last demand should be supply. I occasionally say the price "transfers" information ... it should say that it detects information being transferred. The price is a coordinating signal used by the market to optimize the allocation of supply.

    ReplyDelete

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