Economic System Dynamics

Standard textbook economic theory quite generally assumes the neoclassical economic model, which is a static model of unregulated free markets. Every western government in our era believes implicitly in a free market with “springs,” where imbalances are only of short-term nature. The model postulates the nonempirical idea of utility and assumes stable equilibrium, a notion that goes back over two hundred years to Adam Smith’s famous “Invisible Hand.” The standard, reigning theory of free markets asserts that individually selfish behavior can lead collectively to the greatest benefit of society. Modern dynamic approaches, in stark contrast, understandmarkets as far from equilibrium systems [6, 12]. How did such fundamentally opposing viewpoints in teaching arise? We first define the basic elements of market dynamics independently of any particular model and then, after surveying the neoclassical model [27, 28] critically, we discuss in the other three sections of this paper the empirical basis and implications of market disequilibrium. To model a market, consider N agents who buy and sell n assets. By agents we mean consumers, producers, traders, and so forth. At any given time t each agent holds quantities x(t) = (x1, . . . ,xn) of the n different assets. The price of the assets is denoted by p(t) = (p1, . . . , pn). The basis for modelling the dynamics of a market of n assets and N traders is the differential equation (or a discrete iterated equation) dp/dt = ε(p, t) where ε(p, t) = D(p, t)− S(p, t) is the excess demand calculated for all N agents. Here, D is the total demand and S is the total supply for a given asset “at price p” (in reality there is always a bid/ask spread, so by “p” we mean the price of the last trade). Equilibrium is defined by vanishing excess demand, ε = 0. Static models of markets assume a