Monday, September 18, 2017

Ideal and non-ideal information transfer and demand curves

I created an animation to show how important the assumption of fully exploring the state space (ideal information transfer i.e. information equilibrium) is to "emergent" supply and demand. In the first case, we satisfy the ideal information transfer requirement that agent samples from the state space accurately reproduce that state space as the number of samples becomes large:

This is essentially what I described in this post, but now with an animation. However, if agents "bunch up" in one part of state space (non-ideal information transfer), then you don't get a demand curve:

1. The interesting economic/policy question is to then consider what causes some markets to have ideal information transfer (agents fully exploring the state space), and why many do not.
What do you have in mind here? On the micro-level there may be coordination issues (firms rely on suppliers who rely on predictable order volumes etc), and at the macro level, I'm not sure - why do agents suddenly all sell stocks at the same time every 20 years or so and cause a market crash? Do you think that agents are a little more than random, but interact or rely on the choices of others in some way so that they occasionally cluster together in the state space, but mostly appear random?

1. It's definitely an interesting question.

My intuition is that agents generally explore the state space due to their complexity that is only approximated by randomness. However because they are complex, they can occasionally interact in ways that can cause them to make correlated actions.

I think there's something to information cascades as well as the general psychology of fear. Feedbacks are probably very important.

The only way the idea of "occasionally clustering" can be a useful model, however, is if most of the time they don't cluster -- i.e. enough time so that we can understand what "equilibrium" is. I can imagine some markets where it isn't "occasionally", but rather "all the time". In that case, that specific market might be incomprehensible as an economic system.

My working hypothesis for macro is that we have complex agents fully exploring the state space most of the time, interrupted by discrete events of correlation (caused by some cascading information event such as an unexpected central bank decision, or even a statistically random bad run of poor earnings reports) that we call recessions.