Economic Complexity and Econometric Simplicity Prof. Ping Chen Spring /27/2004

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 (supply induced demand: doctors and patients) 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

What is the source of persistent business cycles? Conflicting beliefs in market stability: Marx (explosive oscillation) Schumpeter (persistent oscillation=biological clock) Frisch (demped oscillation maintained by external shocks) Nelson and Granger (marginal: unit root and persistent shocks) Who is right? Mathematical modeling Natural experiments Universal (physics) theory

What is the rational foundation of efficient market? Friedman’s argument for efficient market: Perfect competition would eliminate speculator? Hidden assumptions: Infinite arbitrage resource Winner’s strategy can be replicate (zero- information cost, predictable pattern of trajectory)

Where is the microfoundations of macro fluctuations Lucas model of inter-temporal substitution Degree of freedom and arbitrage opportunity Relative price movements in time and space The principle of large numbers: Relative deviation =

China Puzzle, Economic Chaos, and Evolutionary Dynamics Needham’s question, scale economy, and diversified evolution under open and close systems > evolutionary culture dynamics and the origin of division of labor (1968 – 1979 – 1987) Discovery of economic chaos > endogenous nature of persistent business cycles (1984 – 1987 – 1996) Law of large numbers in statistical economic mechanics > social animal and meso economics (1999 – 2002) Toward a Unified Evolutionary Theory of Bioeconomic Dynamics (Economic Complexity and Bioeconomic Physics) (2002 – 2004) Economy scale and culture diversity: historical interactions among resource, technology, and war in shaping division of labor and social evolution

New Ideas in Economic Thinking and Modeling Ecological constraints and physiological basis of economic behavior: Nonlinear boundaries against convex utility & production > population dynamics is a better alternative of optimization approach Emerging technologies are the driving force of “creative destruction” and PERSISTENT business cycles > open evolution against close Arrow-Debreu model Social psychology + conflicting interests > collective behavior out-weights individual rationality (Friedman- Lucas model of methodological individualism) Path-dependence (history & culture matters) + economic metabolism > raise serious doubt to transaction cost (property right) school