Advanced Theoretical Economics 3 Credits Spring 2005

1
Advanced Theoretical Economics (3 Credits)Spring
2005 

• Prof. Chen Ping
• China Center for Economic Research, Peking
  University

2
Complex EconomicsA 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 gt 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
  gt ignore conflicting interests in market economy
  (rich/poor, lender/borrower, ...)
• Assumption of greed/selfishness (maximizing
  personal utility/profit) gt 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 gt against the
  Principle of large numbers in probability theory
• Noise-driven model in econometrics gt against the
  second law of thermodynamics in physics
• Convexity of utility function gt against
  biological constraints with lower and upper
  boundaries
• Universal rationality gt ignore varieties in
  personality, culture, and society

6
Conflicting with Common Experiences in Industrial
Society

• Market stability condition excludes increasing
  return to scale gt 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 gt
  average people are always right gt 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 gt 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 gt 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 gt Adam
  Smith and classical economics
• Increasing inequality and rise of socialism gt
  Marxism and rise of labor union
• World wars and the Great Depression gt Emergence
  of socialist countries and Keynesian revolution
  (macroeconomics welfare state)
• Stagflation and limits of big governments gt Lucas
  counter-revolution, new classical supply-side
  economics
• Financial crisis and stock market crash gt rise of
  chaos theory and complexity science

9
Misguidance of Equilibrium Economics

• Perfect competition theory gt irrelevance with
  industrial society and organizational innovations
• Efficient market hypothesis gt financial
  liberalization
• Solows neo-classical growth model gt 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 gt firm theory
  without firm, institutional theory without
  history and conflicts gt 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