Probabilistic Economic Theory

Anatoly Kondratenko, 2022

The monograph offered to the attention of readers is the second in the series devoted to the development of probabilistic economic theory. This book presents principles of physical economics, new economic discipline primarily concerned in the book with the agent-based physical modeling of the market economic systems and eventually with the elaborating of probabilistic economic theory. At the heart of physical economics and probabilistic economic theory are the well-known cornerstone concepts of classical economics, in particular the subjective theory of value, such as regularity in the sequence of market phenomena and an interdependence of those, as well as key roles of individuals’ actions and social cooperation in the many-agent market processes. This monograph may seem interesting to everyone who is engaged in research in economics, finance, econophysics or physical economics, as well as to professional investors and stock traders.

INTRODUCTION. Probabilistic Economic Theory

“The market economy is the social system of the division of labor under private ownership of the means of production. Everybody acts on his own behalf; but everybody’s actions aim at the satisfaction of other people’s needs as well as at the satisfaction of his own. Everybody in acting serves his fellow citizens. Everybody, on the other hand, is served by his fellow citizens. Everybody is both a means and an end in himself, an ultimate end for himself and a means to other people in their endeavors to attain their own ends.

This system is steered by the market. The market directs the individual's activities into those channels in which he best serves the wants of his fellow men. There is in the operation of the market no compulsion and coercion. The state, the social apparatus of coercion and compulsion, does not interfere with the market and with the citizens’ activities directed by the market. It employs its power to beat people into submission solely for the prevention of actions destructive to the preservation and the smooth operation of the market economy. It protects the individual's life, health, and property against violent or fraudulent aggression on the part of domestic gangsters and external foes. Thus the state creates and preserves the environment in which the market economy can safely operate… Each man is free; nobody is subject to a despot. Of his own accord the individual integrates himself into the cooperative system. The market directs him and reveals to him in what way he can best promote his own welfare as well as that of other people. The market is supreme. The market alone puts the whole social system in order and provides it with sense and meaning”.

Ludwig von Mises. Human Action. A Treatise on Economics. Page 243

Exactly how is our economic market world arranged at the deepest micro level, at the level of individuals and businesses, buyers and sellers on markets? How does the market economy function? According to what laws and rules do people make decisions about price and quantity of bought and sold goods? How does a market price eventually become established, and how can one and the same volume of goods be sold regularly each year at this price on the market? How and why does this regularity change over the course of time, and how and why do markets grow or fall? We attempt to answer these and many other similar questions in this book within the framework of a new economic discipline, namely, physical economics.

In general terms, at the conceptual or descriptive level, the answers to these questions are known from classical economic theory. They are obtained with the aid of the logical method of economic theory and they are given in this book in epigraph form to the parts and the chapters. These answers represent by themselves extensive quotations from the fundamental work of Ludwig von Mises [1]. But other questions agitate us more. Where can we search for the answers in this book, and how can all these answers of classical economic theory be expressed in terms of the natural exact sciences, i.e., in mathematical language? Therefore, in the book we attempt to develop quantitative methods of calculation for economic systems, as well as their structure and dynamics, which would make it possible to speak about the further development of quantitative economic theory.

Contemporary, real, economy is a complex dynamic system. It is therefore possible and necessary to attack the problem of studying its structure and dynamics in different ways and from different points of view. Our point of view is such that we look at the economy primarily as a collection of an enormous number of reasonably thinking and actively acting people, each of them “is not only homo sapiens, but no less homo agents” [1] simultaneously. To solve their problems and achieve their goals, these people are forced to constantly make important decisions for themselves about production, purchase and sale of goods, organization of logistics and marketing, control of other people, etc. As reasonable people, they attempt to make specific decisions that would bring more benefit and a large return for their efforts. Such rational decisions can be made only on the basis of having sufficient information regarding factors that concern their interests Therefore, people are constantly searching for and processing new, relevant market information. But we never possess completely adequate information about the things interesting us in view of the time constraints at our disposal, or in view of our obviously finite mental and technical abilities. It is our deep belief that human nature, and also the nature of market economic systems, is such that all our market decisions can only be approximate. In more technical terms, they can only be of a probabilistic nature. Furthermore, according to our vision of the market economy, all economic processes and phenomena are nothing more than the result of the actions of all players in the economy. There seems to be no escaping the conclusion that all economic processes and phenomena in the market economy are, to some extent, also probabilistic by their nature. Hence, there is only one step prior to obtaining the fundamental conclusion that the market economy is not simply a complex dynamic, but that it is still probabilistic [2–5]. Therefore, in order to be able to give a sufficiently complete description of such complex probabilistic systems, adequate economic theory must also be probabilistic to a considerable extent. For this, it is necessary to incorporate into the classical economic theory the uncertainty, as well as probability at the appropriate mathematical level, i.e., to develop probabilistic economic theory adequately in relation to the contemporary economic reality. Specifically, the present study is devoted mainly to this purpose.

In this book we have limited ourselves to the study of the probabilistic aspects of functioning markets in a sufficiently free market economy. More accurately, we study the details of supply and demand, as well as the mechanisms of the formation of prices and the establishment of equilibrium in the markets. Emphasis is given to the description of probabilistic nature of these fundamental market categories and notions. All these market concepts have been the subject of intensive investigations and critical rethinking in the book within the framework of the main paradigm of physical economics, which can be briefly formulated as follows.

All markets consist of people, buyers of some goods and sellers of other goods, simultaneously. Everything that the markets do, these people do, and it is precisely the action of all these people in the market that determine all results of the work of that market [1]. We have defined five fundamental or general principles of physical economics (and probabilistic economic theory naturally): the cooperation-oriented agent principle, the institutional and environmental principle, the dynamic and evolutionary principle, the market-based trade maximization principle, and, finally, the uncertainty and probability principle. These determine, in essence, the work of markets in our physical economic models. The cooperation-oriented agent principle speaks about the unique moving role of the market agents and significant role of social cooperation in modern market economy. The institutional and environmental principle expresses the fact that the interaction of agents with the various institutions and external environment must be taken into account simultaneously with the interaction of the agents with each other. The dynamic and evolutionary principle reflects the fact that the market behavior has, to certain extent, a deterministic character and consequently can be described with the aid of the equations of motion. The market-based trade maximization principle determines the direction of the motion of the free market as a whole under the influence of internal market forces. The uncertainty and probability principle tell us that all market phenomena are probabilistic in nature and thus help us to understand what a mathematical apparatus must do in order to adequately describe market behavior under uncertain conditions. We refer to the appropriate approach to as probabilistic economic theory, and since this theory is built by analogy with the “probabilistic physical theory” (quantum mechanics) of many-particle systems, we designated it more precisely as quantum economy [4]. Since the picture of the market economic world is built in physical economics at the micro level in approximately the same way as in physics, there is, in principle, a possibility of developing the quantitative methods of calculating the market economies by analogy with the calculation methods in physics. Consequently, it becomes possible to fruitfully use natural science concepts and speak natural science language to describe and analyze market structures and dynamics. In this book, we widely explore these great possibilities that help us to look at economic reality from the natural science points of view and discover new perspectives of economic theory for investigation and development.

In conclusion, it is natural that the direct mechanical transfer of methods and concepts of physics into the economic theory would be impossible. We only can accurately borrow and transfer general concepts and formal methods, since economic and physical phenomena are principally different in their essence and content. In this book and within the framework of this approach, the basic concepts and general principles of physical economics are developed and described. On this basis, we have developed the complex of the principally new quantitative methods of calculation and analysis of many-good, many-agent market economies that we named probabilistic economic theory.

References

1. Ludwig von Mises. Human Action. A Treatise on Economics. Yale University, 1949.

2. Emmanual Farjoun and Moshé Machover. Laws of Chaos: a Probabilistic Approach to Political Economy. Verso, London, 1983).

3. Philip Ball. Physical Modelling of Human Social Systems. Complexus 2003; 1:190–206.

4. A.V. Kondratenko. Physical Modeling of Economic Systems. Classical and Quantum Economies. Nauka (Science): Novosibirsk, 2005.

5. K.K. Val’tukh. Development of a Probabilistic Economic Theory. Herald of the Russian Academy of Sciences, 2008, Vol. 98, N 1, p. 51–63.