1. Advanced Theoretical Economics (3 Credits) Spring 2005 Prof. Chen Ping China Center for Economic Research, Peking University

2. Complex Economics: A General Framework of Micro Behavior, Industry Competition, Macro Dynamics, and Organizational Evolution March 4, 2005 Introduction: Why we need a new general theory of complex economics?

3. A Strange Puzzle in History of Science Most of people would agree that economic phenomena are more complicated than biology, chemistry, or physics, But ……, if you look at theoretical models in mainstream economics, it is much simpler than the simplest model in physics: the ideal gas model, which has 6N degree of freedom with N particles In contrast, the famous rational-expectations Lucas model of island economy with N agents, only 3 degree of freedom No variety of species as biology, no structure as chemistry, no vector as physics (only price – a single scalar)

4. The Limitation of Methodological Individualism The Robinson Crusoe economy > against basic observation in sociobiology: human nature is social animal (family, community, state, division of labor, fashion, group warfare,...) The representative agent model in macro analysis > ignore conflicting interests in market economy (rich/poor, lender/borrower,...) Assumption of greed/selfishness (maximizing personal utility/profit) > ignore rich human behavior (parent-care and love, kin and group solidarity, non- profit organizations,....)

5. Conflicting with Basic Observations in All Other Disciplines in Natural & Social Sciences Microfoundations of macroeconomics > against the Principle of large numbers in probability theory Noise-driven model in econometrics > against the second law of thermodynamics in physics Convexity of utility function > against biological constraints with lower and upper boundaries Universal rationality > ignore varieties in personality, culture, and society

6. Conflicting with Common Experiences in Industrial Society Market stability condition excludes increasing return to scale > no room for scale and scope economy Perfect/complete market has no room for strategic pricing, product innovation, product cycle, business cycles, market crisis, even profit opportunities … Long-run equilibrium and rational expectations > average people are always right > no room for learning, leadership, power, inequality, wars, scientific discovery, technology revolution, social change, social conflicts, even environment change....

7. Roots of Limits in Economic Theory Mathematical difficulties in analyzing complex economic systems: non-stationary time series, many variables, short time windows, non-controllable events, participants/observers, … Narrow Anglo-Saxon experience (UK, US) with small army and limited war > Fantasy with free trade and invisible hand (Not experience from continental countries as France, Germany, Russia, or China) Mathematical decoration for ideological war: Subjective utility theory against objective labor value theory > polarized economic assumptions: classical vs. Marxism, “free market” vs. socialism/nationalism, …

8. Historical Failures and New Economic Thinking British power based on navy and commerce > Adam Smith and classical economics Increasing inequality and rise of socialism > Marxism and rise of labor union World wars and the Great Depression > Emergence of socialist countries and Keynesian revolution (macroeconomics & welfare state) Stagflation and limits of big governments > Lucas counter-revolution, new classical & supply-side economics Financial crisis and stock market crash > rise of chaos theory and complexity science

9. Misguidance of Equilibrium Economics Perfect competition theory > irrelevance with industrial society and organizational innovations Efficient market hypothesis > financial liberalization Solow’s neo-classical growth model > ignore of industrial & education policy Lucas revolution of rational expectations and microfoundations deny the governments role and wealth effect of macro policy Coase Theory of transaction cost > firm theory without firm, institutional theory without history and conflicts > failure of shock therapy in Eastern Europe

10. Mean vs. Foresight Economics Blind investment (efficient market hypotheses) vs. value-creative investment (entrepreneurship) Risk diversification (portfolio theory) without industry information vs. strategic investment (Warren Buffet, Jim Rogers) with in-depth industry analysis Short-term opportunity cost analysis (static optimization approach) vs. time-window strategic timing (product cycle & business strategy) Greed (self-interest) vs. co-development of self & social interest.

11. Knowledge Accumulation and Theory Sophistication Nonlinear supply-demand curve and nonlinear business cycles (Hicks, Goodwin, …) Bounded rationality and behavioral psychology (Simon, Tversky & Kahneman, …) Game theory, multi-equilibrium, and evolutionary game theory Information asymmetry and incomplete market HP filter, nonlinear trends, filter, and testing deterministic chaos Laboratory experiments and computer simulation

12. Course Plan I. Re-examining existing economic theories: micro, macro, finance, econometrics, institutional economics II. Introducing new methodology: empirical, historical, and theoretical III. Interdisciplinary dialogue and knowledge integration IV. New development