Is Economic Equilibrium a Flawed Concept?
Trading and Investing
Economic equilibrium is reached when households optimize their utility, firms maximize their profits and markets for all goods clear (i.e. everything that is produced finds a buyer, no surplus or inventories).
Let’s assume for a while that these (somewhat dubious) axiomatic conditions make sense and that such an equilibrium indeed exists. A most problematic quandary is to show that reasonable dynamical rules — whereby agents struggle to learn how much to produce, at what price to sell, how much to save, etc. – indeed lead to equilibrium fast enough, before shocks of all kinds move the goal post and define a new equilibrium. If convergence is too slow, the system will rather be perpetually *out-of-equilibrium*.
Alas, a suite of recent models suggest that this is the case. In many instances, economic equilibrium does indeed exist. However, cannot become reached unless a benevolent central planner tells everybody what they should do for their best interest. When agents rather follow their own selfish interest, Adam Smith’s “invisible hand” is just unable to ensure enough coordination. Equilibrium is dynamically unstable. As a result, means that the system becomes repelled far away and behaves completely differently from what equilibrium would predict.
Often, endogenous excess volatility ensues: the system spontaneously oscillates or becomes chaotic, without any “fundamental” shock at all. The concept of economic equilibrium is, in such cases, irrelevant or, worse, misleading. In the context of financial markets, it is safe to bet that prices are never in equilibrium and decouple from fundamental value (see my previous post).
One such model was studied by Theo Dessertaine, José Morán et al. in the context of firm networks and supply chains. Depending on how strongly agents react to observed imbalances, the economy can either converge to equilibrium, oscillate (like in the “beer game”) or go haywire. See:
Out-of-equilibrium dynamics and excess volatility in firm networks – ScienceDirect
More recently, my PhD student Nirbhay Patil has proposed a primitive good-exchange model where agents buy and sell from one another, and adapt their prices in the face of supply-demand imbalance, see:
2405.18116 (arxiv.org)
When production is low enough such that each agent is left with goods they cannot afford, economic equilibrium is reached, with a small level of wealth inequalities. But beyond a certain production threshold, such equilibrium becomes still perfectly well defined but becomes dynamically unstable. And leads to the spontaneous appearance of a rich class and a poor class. Rich agents are not necessarily those who produce the most coveted goods: the instability is a non-trivial, collective phenomena, described by the beautiful mathematics of Random Matrix Theory.
