Abstract
Many important regularities observed in the economy are feedback processes, including stability, fluctuations, crises, lock-in/network effects and growth. Each type has its endogenous causal structure, driven by its specific incentive structure and agents’ behavioural responses. The price mechanism is a balancing feedback system. Fluctuations, probably including the business cycle, are due to balancing feedback with delay. Reinforcing feedback also occurs. The interrelation of real-world economic phenomena, e.g. prices, with perceptions and/or expectations can lead to self-fulfilling prophecies, including crises. Complementarity between a product and corresponding expertise, e.g. a QWERTY keyboard and its skilled users, leads to technological lock-in—especially important nowadays, with “network effects” when an app is widely used, thereby excluding competitors. Interaction between competitors is an arms race, where each participant tries to stay ahead of rivals, e.g. in reducing unit costs; the possible advantage of each is constantly eroded, but the aggregate result is a long-term fall in costs, and hence also in prices; growth occurs because more is produced with the same resource inputs. Other systems phenomena also occur, e.g. the prevalence of power laws. All these systems phenomena provide microfoundations that causally connect the micro- and macro-levels.
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Notes
- 1.
- 2.
The outcome of competition between potential buyers tends to favour richer consumers, who have more buying power (Joffe, 2017a); however, this is not readily expressed using standard feedback analysis.
- 3.
The textbook (Marshallian) approach to the price mechanism involves the implicit assumption that the regression coefficient for the situation where a supply shock affects demand is the inverse of that for when a demand shock affects supply. This has been called into question empirically by Beaudry et al. (2018) for the labour market: they note that studies of minimum wage legislation tend to observe small wage elasticities of employment demand, yet studies of labour supply shocks tend to find elastic labour demand. Similarly, the textbook description of the price mechanism states that in competitive markets, prices are formed to equate marginal revenue (given by the demand curve) with marginal cost (given by the supply curve). However, it has long been known that the causal process used by businesspeople is quite different from this account (Hall & Hitch, 1939; Lee, 1998).
- 4.
The emphasis on actual causal processes, depicted in a causal loop diagram that is easy to understand, is not only methodologically superior to the conventional static diagram involving supply and demand curves. It has also been shown to produce better results in the context of teaching (Mashayekhi et al., 2006; Wheat, 2008).
- 5.
The term “business cycle” is here used in the conventional sense, and does not include Kitchin, Juglar, Kuznetz or Kondratieff cycles.
- 6.
Other important examples of free-floating markets, in which prices lack a major input from unit costs, are the financial sector, primary products – minerals and agricultural produce (“commodities”), and collectibles e.g. valuable works of art.
- 7.
See, for example, the list of 70 historical “manias, panics and crashes” in Kindleberger (1978, 45–46), which are virtually confined to the financial sector, company shares, commodities (including gold) and real estate. This picture is confirmed by a further 20 examples since 1978 (Aliber & Kindleberger, 2015, 18). The exceptions to this pattern are new products, as previously argued, from the Dutch tulip bulb craze of 1636 to the dot-com bubble. Note that emotions such as “irrational exuberance” (Shiller, 2005) do not play a causal role in this process, which operates in the same manner irrespective of whether a house buyer is worried that she will be priced out of her desired home if she does not buy quickly, or excited by the prospect of capital gains.
- 8.
This situation refers to preindustrial times. Since the industrial revolution, countries have undergone demographic transitions, after which prosperity tends to reduce the rate of population growth.
- 9.
This explains why modern economic growth has only occurred since the advent of firms able to purchase all their inputs. It was an institutional change that started with the factory system, leading to legal changes that facilitated the expansion of the new type of firm into all areas of the economy (Joffe, 2011). It also explains catch-up growth, e.g. in East Asia, which is a puzzle for the conventional view that modern economic growth is due to inventiveness, seen as external to the economic system. In addition, it can account for the relative lack of success in some economies with a capitalist structure, such as Latin America during the twentieth century, because the dynamism of the national economy depends on the degree of competitiveness of its constituent firms.
- 10.
A similar model has been constructed in the system dynamics software package Vensim (Joffe, 2012). Simulations showed that the price charged by both firms steadily declined, apparently indefinitely, but only if they were both able to alter their unit costs. The findings were robust to other changes in the firms (efficiency of investment) or in the market (price elasticity of demand). The model did not include economies of scale or scope.
- 11.
Arms races also occur elsewhere in the economy, e.g. workers who work longer hours than they would wish, to try and achieve a better relative position over other workers—especially important in relation to positional goods, e.g. access to good schools (Frank, 2011). Again, relative positions are constantly eroded as the success of one participant is matched by that of others, but the aggregate effect is that more hours are worked than would occur without this relative/positional aspect.
- 12.
This situation is characteristic of homeostatic processes in biology, such as temperature regulation in humans, which increase “inclusive fitness”, i.e. the probability of surviving and passing on one’s genes (Joffe, 2013b).
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Joffe, M. (2021). Equilibrium, Instability, Growth and Feedback in Economics. In: Cavana, R.Y., Dangerfield, B.C., Pavlov, O.V., Radzicki, M.J., Wheat, I.D. (eds) Feedback Economics. Contemporary Systems Thinking. Springer, Cham. https://doi.org/10.1007/978-3-030-67190-7_3
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