March 1, 2013

The Illusion of Equilibrium

From the dawn of our economic education – sometimes beginning when we were in middle school – we were taught about the concepts of supply and demand. At the center of those supply and demand curves lies an equilibrium; an equilibrium which can be accurately calculated by QD = QS or  [m(x) + b]Demand = [m(x) + b]Supply. Most of us learned such simple algebraic equations in seventh grade. The context of a ”equilibrium” excels far beyond what the average person may think. This equilibrium continues as an overly complex and highly ambiguously understood concept.

The history of economics revolve around the idea of equilibrium and done so since the early theories of Leon Walras and Stanley Jevons. Leon Walras (in 1874) conceptually founded the ideas of marginal utility when he drafted a hypothetical economy using a series of equations that equaled the number of unknowns. Equilibrium prices and quantities solve this system of complexity and demonstrate prices and quantities drive the economy towards equilibrium. Stanley Jevons was the first to formulate economics as a mathematical science in the early 1860s by formulating the ideas of economic utility.

Economics has since then improved upon these concepts and added more equations to the pool of useful calculations.  Economics has since been referred to as a science, in relation to that of physics, more so today than ever before. Conventional economics, or orthodox economics, deals with the concept of equilibrium, and other mathematical concepts, as objective facts–absolute certainties. From this perspective we can better identify the mainstream economic profession as a static representation of a dynamic and changing field of study. In other words, the orthodox view of economics, or the dominant school of thought, may place itself in a limited bubble of knowledge and exploration.

To further explain the concept of equilibrium, we turn to what is referred to as the “evenly rotating economy.” The concept of an evenly rotating economy dates back to Ludwig Von Mises who used such a phrase to describe a static economy. The “evenly rotating economy” analogously creates a situation in which all persons stop deliberating the many factors within a situation and proceed to perform an action in a general way.  To simplify, all economic functions perform themselves in a robotic process with all other things equal.

As we know, however, the economy is not a machine and it certainly isn’t a chessboard with people being manipulated. Instead, one should view the economy as an ecosystem—a community of living and dynamic organisms. The people involved in an economy—which includes everyone—interact and interconnect with each other in more than one way every second of everyday.

We know that economics studies what it means to be human: to make choices based upon a set of preferences. These preferences are selected upon how they themselves interpret them because humans interact differently from day to day. Value is subjective and individual desire changes for every circumstance. Actions occur in individual’s minds and any attempt to subjectively measure such decisions is inaccurate.

Equilibrium can only exist when there remains perfect information. The decision maker must have perfect knowledge regarding the choice he or she made. The knowledge one has acquired must become more and more concrete as time passes. This equilibrium will only last as long as anticipations and expectations prove correct. Executions of plans are as a result of relevant knowledge and any change in that knowledge disrupts the equilibrium.

“All propositions of equilibrium analysis, such as the proposition that relative values will correspond to relative costs, or that a person will equalize the marginal returns of anyone factor in its different uses, are propositions about the relations between actions. Actions of a person can be said to be in equilibrium in so far as they can be understood as part of one plan” (F.A. Hayek 36, Individualism and Economic Order).
Equilibrium is impossible to achieve because individuals are constantly changing wants, desires and actions. Dissatisfaction in expectations always occurs for many every day. Macro fluctuations in micro foundations interrupt ecological processes that may lead to a complex equilibrium. Stability and complexity lay the foundation for a mixed economy; however, it may appear that such stability is difficult to achieve given the ecological differences in human desires.

In the end, economics is not physics. Economics, if anything, is an art; an art of future predictions based upon hypothetical models and calculations. To think otherwise is an insult to the physics profession and the knowledge we have gained through actual experimentation.

As Mises says, “What they are doing is vain playing with mathematical symbols, a pastime not suited to convey any knowledge.”

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