Economic Complexity and Econometric Simplicity Prof. Ping Chen Spring /20/2004

Basic Elements in Research Ability Observation (case study, empirical analysis) Question (conflicting theories and possible alternatives, hidden assumptions) Educated Quess (historical analysis, polar cases, qualitative evaluation, quantitative modeling Empirical Tests (natural & lab experiments)

Alfred Marshall Principles of Economics (1920) The Mecca of the economist lies in economic biology rather than in economic dynamics. But biological conceptions are more complex than those of mechanics; a volume on Foundations must therefore give a relatively large place to mechanical analogies; and frequency use is made of the term “equilibrium,” which suggests something of statical analogy. This fact.... has suggested the notion that its central idea is “statical,” rather than “dynamical.” But in fact it is concerned throughout with the forces that cause movement: and its key-note is that of dynamics, rather than statics.

Eugene P. Wigner "Events, Laws of Nature, and Invariance Principles" Nobel Lecture, Dec. 10, 1963, Science, 145 (3636), ,1964. It is clear that physics does not endeavor to explain nature. In fact, the great success of physics is due to a restriction of its objectives: it only endeavors to explain the regularities in the behavior of objects. The specification of the explainable may have been the greatest of discovery of physics so far.

Evolving Methodology in Science Pre-science: mythology and historical story Theory of elements Theory of atoms Theory of geometry Dynamic theory: trajectory Probability theory Statistical mechanics: collective behavior Thermodynamics: macro behavior and impossibility Evolutionary theory

From Simplicity (Convergence) to Complexity (Diversity) Static to dynamic theory Linear to nonlinear theory One-body to many-body problem Integrable to non-integrable problem Stationary to non-stationary problem Equilibrium (stable) to non-equilibrium (unstable) problem Homogeneous to inhomogeneous (hierarchical) structure

Critical Thinking: Discovering Hidden Hypothesis Moving ruler with fixed length (Newton’s absolute time and space) Changing ruler and clock in moving (Einstein) Fair game in probability theory Ergotic theory: time averaging = ensemble averaging Non-ergotic movements and chaotic behavior

Questioning Supply-Demand Curve Puzzling cases: Why health cost rises so rapidly? Why stock prices so volatile? How to price a product in practice? Question: if supply-demand model is universal, what kind of phenomena would not appear?

Hidden Hypothesis of SS-DD Model Stability of equilibrium? Why single cross-section? Interdependence of SS and DD Linear regime of SS or DD curve Non-observable variable

Modify SS-DD Curve From linear to non-linear curve Implications of non-linear SS-DD curve Biological and ecological constraints in addition to budget constraints Social interaction vs. individual rationality Macro environment of individual choice Fashion and social trend Multiple time scales

From Statics to Dynamics: Business Cycle Effect Missing business cycle effect in micro and finance theory: IS-LM curve and business cycle effect Conflicting interests for demand and supply side in financial market