Friday, August 15, 2014

Rationality and entropic forces

An anonymous commenter hit upon what may be a key point in a unifying picture of human behavior and market forces. Entropic forces would be indistinguishable from some plausible set of human decisions. You could say that atoms experience an entropic force to diffuse into a volume or you could say that the atoms want to diffuse into the volume (they derive utility from expanding into the volume, but it is a diminishing marginal utility that reaches equilibrium when the atoms are uniformly distributed across it).

For atoms, that seems silly. For humans, it doesn't. It gives us a sense of agency when we are being led (individually) by forces beyond our control, at least in the information theory picture.

Scott Sumner says that people underestimate rationality of economic agents:
Economists and non-economists also underestimate just how rational people really are, at least in aggregate. How much they understand about the world. And how efficiently markets aggregate information. And they do so because people don't seem very smart, or very rational. As always in economics, appearances can be deceiving.
However, we can interpret this as people's irrationality being irrelevant (the core common sense is right -- people don't seem hyper-rational), and their apparent rationality with respect to economic theory as being the result of information-theoretic entropic forces beyond their control.

We appear rational in economic theory only because we are adrift and carried along by the rational invisible hand.

6 comments:

  1. Since one of the results of your analysis is the unimportance of microfoundations to macroeconomics (I may be overstating your result, if so I apologize). Isn't the rationality or irrationality of the individual agents in the economy Irrelevant to the analysis of the entire price system? If I understand your model correctly, you could have completely rational individuals or completely irrational individuals or some mix and your analysis would be unaffected. Since this allows for a more or less agnostic stance about individual rationality, I view this as a feature not a bug.

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    1. I agree! I am just trying to see both sides of the argument ... Where traditional economics sees rational expectations, I see entropic forces.

      The entropic force view is much more useful in my view but it wasn't at all clear to me what kinds of things economists were trying to describe with their behavior models. It appears to be a combination of entropic forces and correlated human behavior.

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  2. Since I've always wondered how most micro-founded macro models don't run afoul of Arrow's Impossibility Theorem or the implications of the fallacy of composition, I tend to view rational expectations as a property of the market rather than the individuals involved. Would it be reasonable to say that rational expectations is equivalent to assuming that price does it consistently deviate from the maximum information solution?

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    1. Using the economics definition of "rational expectations", then rational expectations are the model-consistent expectations -- they don't consistently deviate from whichever model you are using.

      So, yes, assuming rational expectations in the information transfer model is equivalent to assuming the prices don't consistently deviate from the maximum information solution. But prices do deviate! (in recessions, for example). In that sense, the information transfer model as a theory of the trend that allows for potential deviations due to deviations from peak information transfer is also part of a model that doesn't require rational expectations.

      That probably came out as a word salad, but I've looked at the distribution of deviations from the trend and found that they are random except for periods of "non-rationality" (or periods of strongly correlated human behavior) that coincide with recessions:

      http://informationtransfereconomics.blogspot.com/2013/12/plucking-rgdp-growth.html

      The random distribution around the maximum information solution is what is exactly required for rational expectations ... see the first equation here:

      http://en.wikipedia.org/wiki/Rational_expectations#Theory

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  3. hmm.. in your back and forth with mike freimuth, he mentioned (I'm paraphrasing) that perhaps alien species could have completely different utility functions which would perhaps manifest in totally different output. But if I'm understanding correctly, if the entropic force view is correct, then it wouldn't matter whether it was aliens or dogs and whatever their utility was - you'd end up with the same "rational" structure?

    I think I/we need to nail down the definitions a bit more precisely, because I think my confusion is probably more semantic than anything.

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    1. Sorry for the delay ... On a short vacation.

      To answer your question, I'd say that different utility functions might lead to different coefficients in the model as it does for other countries but the generic model would have the same "rational" structure imposed by information theory.

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