Thursday, May 03, 2012

Bipolar Feedback Prices

According to mainstream (neoclassical) economics, price is determined by the negative feedback of  both supply and demand interacting with one another. As the supply of a good goes up relative to demand, the price goes down; as demand for it goes up relative to supply, the price goes down.

Underlying the supply of a given good, there are producer costs affecting how much will be produced. The law of diminishing returns (negative feedback) says that you will get less and less value out of something over time. You can only get so much work out of people, at incrementally lower levels. You can only get so much work out of a machine. Crops can only be grown at a certain 2-D density.

Underlying the demand for a given good, we have the law of diminishing marginal utility (negative feedback), which affects how much demand one has for a given good at a given time. I will likely pay more for the first apple than for the second. I will probably not buy more apples than I can eat before they rot. Thus, my demand for a given good decreases the more of that good I have.

Again, this is traditional, neoclassical economics. From this we get our supply and demand curves, and from their intersection, we get the market clearing price. This is the equilibrium price.

But this is wrong. This is not how prices come about.

The problem is that with only negative feedback, we have only half the equation. What if there is positive feedback? Let us look at what would happen in a positive feedback-only economy.

The positive feedback version of the law of diminishing returns is the law of increasing returns. How can we have increasing returns? If the marginal cost of producing something decreases with each unit created, we would have increasing returns. Software is a good example of this. So would be e-books (paper books abide by the law of diminishing returns). However, there is another example of this outside of knowledge/information-based products, and that is the agglomeration economies of cities. The existence of spillover effects and mass production creates increasing returns (at least for a while, in the latter case). Thus, increasing urbanization and increasing virtualization result in increased positive feedback.

The positive feedback version of the law of diminishing marginal utility is the law of increasing marginal utility. While it is true that individual consumers must necessarily abide by the law of diminishing marginal utility, groups do not. Fads cause more and more product to get purchased. Of course, there are various mechanisms that can drive a fad, from those that drive fashion fads to those that drive things like housing bubbles. The former may be accurately described by things like Keynes' "animal spirits," but the latter likely have underlying mechanisms more accurately described by Austrian Business Cycle Theory. Whatever the case, if you can get a lot of people buying something, you can get positive feedback.

As pointed out above, negative feedback results in equilibrium. Positive feedback, however, results in boom-bust cycles and multiple equilibria. If you had a positive feedback fire, it would get hotter and hotter over time, until it suddenly became too hot and burned itself out. This is the description of a bubble, be it a housing bubble or a fad.

But note that negative feedback models, which give us the equilibrium theory of prices, is based on viewing people as individuals. The individual producer has diminishing returns; the individual consumer has diminishing marginal utility. However, if we view the economy as being a group of people, producers can have increasing returns and consumers have increasing marginal utility. This can cause one to come to the conclusion that a future of abundance is possible (and if an abundance economy is possible, socialism is possible). Such people would have to ignore the fact that increasing returns are not infinite, and in fact result in not just boom, but bust as well. But one can nevertheless see why they would make such an error.

However, if we understand people as being what they in fact are, both individuals and social, we have to consider both negative and positive feedback processes simultaneously.

With both kinds of feedback, supply is determined by both diminishing and increasing returns, demand is determined by both diminishing and increasing marginal utility. Both interact. Thus, the supply of a good cannot reach an equilibrium point, but must always fluctuate in ways that are incalculable and unpredictable. For the same reason, demand cannot reach an equilibrium, but must always fluctuate in ways that are incalculable and unpredictable. Thus, we would not have the smooth curves we see when we draw supply and demand curves, but lines that would instead look more like the graph for a given stock over time. Worse, these two complex processes then have to interact to create the price of that good. Thus, price is inherently incalculable and unpredictable. Without the ability to calculate what the price "should" be, if there is not any such thing as a market clearing price, dreams of even market socialism must fall away.

Bipolar feedback drives a large number of complex, creative processes. The economy is but one kind of such a process. As we can see, we have bipolar feedback (increasing vs. diminishing returns/marginal utility) underlying both supply and demand, which are themselves bipolar feedback processes. This is complex, creative process on top of complex, creative process. The economy thus becomes increasingly incalculable, the more such processes we realize are part of the economy.
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