Scale Economy and Path Dependence Prof. Ping Chen Spring /5/2004

Scale Economy and Market Competition Adam Smith dilemma: “Invisible hand” vs. “Division of labor is limited by market extent” Implications of scale economy: Market power of monopolistic competition Path-dependence and the fattest survivals Multiple equilibrium and uncertainty in institutional selection Critical role of market-share competition and strategic behavior

Switching Pendulum in Economic Policy From Keynesian fiscal policy to Friedman monetary policy From welfare state to tax cut From increasing regulation to deregulation and liberalization From state enterprises to privatization From industrial policy to commercialization From price control to market mechanism

New Challenges Rise and fall of regions and nations Economic bubbles and financial crises Increasing uneven distribution Aging, breakdown of families and communities, guns and drugs Illegal immigration and industry sourcing out Accelerating tech advancement and business competition

Rethinking Fundamentals of Market Economy Big vs. small governments Free vs. regulated market Free trade vs. market protection Arm race vs. export-led growth Demand side vs. supply side policy Moral vs. amoral economy The third force: NGO and civil society The role of regional governments and regional cooperation

China Experience and New Thinking in Economics Competitive edge under mixed economy and small welfare state Over-expansion of governments and regulating system Challenge in job-creating and tech advancement Individualism and social interaction Tech trends and market bubbles Development strategy and social policy

Government Limitation and Market Failure Government limitations in dealing innovation uncertainty and management complexity > simplicity and rigidity Information technology, biotech, Market failures Pricing difficulty for pollution, arts, science, health, and education Fads and bubbles: short vs. long-run efficiency Non-equilibrium growth and uneven distribution Welfare state and industry sourcing out

Land Policy Debate Property right and free exchange > market efficiency and fairness Control of total land acreage Compensation price: market price or output of last three years, price trend and fluctuation How to share increasing land value? To farmer, village, or government? Plus social welfare? Fiscal burden and investment barrier

Third Way? Development strategy Nonlinear pricing Shared community Social capital and non-profit organization Standard and rule of game Adaptive evolution of institution and economy Balanced arrangement of cooperation, community, and law ( 情, 理, 法 ) Optimal levels and sizes of governments and economic unit Micro, meso, and macro economies

New Economic Methodology Nonlinear dynamical behavior Macro environment of micro decision Individual preference and social interaction Trend and cyclic fluctuations Moving equilibrium and strategic behavior Multiple equilibriums and dynamic instability Bifurcation tree and evolutionary history Middle ground between polar models Interactions among governments, market, and society

Basic Models of Economic Dynamics Noise-driven fluctuation: AR(1) and unit root, AR(2) pseudo cycles Deterministic cycles: Multiplier-accelerator model (Samuelson) Limit cycle model (Goodwin: nonlinear oscillator, Lotka-Volterra model) White chaos model (logistic map) Color chaos model (Lorenz, Rossler, Chen)

Advanced Stochastic Models Random walk (representative agent model of endogenous fluctuations) Brownian motion and diffusion process (representative agent model of exogenous fluctuations) Birth-death process (probability population model of endogenous fluctuations)

Reference Sources Economic dynamics Linear and nonlinear dynamics Stochastic processes Time series analysis Mathematical biology Difference and differential equation Partial differential equation Fourier transform

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

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 =

Commanding Height: Battle of Ideas Keynes vs. Hayek, Socialism vs. capitalism From Roosevelt to Mrs.Thatcher End of Cold War Transition economy and shock therapy