[From Bill Powers (930917.1600 MDT)]
Marcos Rodrigues (930915.1600 BST) --
The economics project sounds wonderful. Economics has been in the
back of my mind since a CSG member and economist, Bill Williams,
enlisted me eight or ten years ago in tackling the "Giffen
Paradox" as a control-system problem, and since my father started
writing, in his extreme old age, about economics.
The Giffen Paradox is so-called because it concerns a situation
(quite common) in which the "law" of supply and demand works
backward. In this situation there is a budgetary constraint
limiting the total amount of money that can be spent on a given
set of goods. The representative goods Williams used were "bread"
and "meat." Meat is more costly per pound than bread, but
contains more calories per pound than bread. Also, eating meat is
more "prestigious" than eating bread (i.e., there is a preference
for eating meat on some grounds other than calories).
We set this situation up as three control systems operating in
parallel:
Calorie system: perceives total calories represented by meat and
bread purchases, acts by raising meat and bread purchases equally
to bring calories to reference level. Purchases = consumption.
Prestige system: perceives positive prestige from meat purchases
and zero or negative prestige from bread purchases. Acts to raise
total perceived prestige toward reference level by increasing
meat purchases.
Budget system: perceives total cost of meat and bread; if cost
exceeds reference level (one-way control system), reduces
purchases of meat.
When relative loop gains were properly adjusted, this set of
control systems reproduced the Giffen Paradox, to wit: WHEN THE
PRICE OF BREAD IS INCREASED THE SYSTEM PURCHASES MORE BREAD.
That is the "paradoxical" violation of the law of supply and
demand, easily explained with a PCT model. So the Giffen Paradox
should now really be called the Williams Effect.
I think this solution of the Giffen Paradox has enormous
implications concerning poverty, in fact providing a clear
definition of what constitutes poverty. You are in poverty if
your income is so low that when the price on the cheapest goods
you buy is raised, you are forced to buy more of the cheapest
goods and less of the more expensive and higher-quality goods.
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My father, a retired scientist, has been interested in
macroeconomic theory for about 15 years (he is now 93), and has
been writing about it. The main point of his study is that he has
been comparing existing economic theories with the historical
record in the Statistical Abstracts (the record of what has
happened in the US economy). He finds that the predictions of
economic theory have almost nothing to do with the facts. In
place of standard economic assumptions, he has come up with a set
of relationships that DO fit the facts, and some rather startling
conclusions about what makes the US economy run, and fail.
One interesting fact is that for the past 100 years, the
expenditures by the "composite producer" on capital costs --
i.e., investment -- has remained constant at 20 +/- 2 percent of
total income, this range not been exceeded in any year. There is
no relationship between amount of investment expressed as a
fraction of total income and the Gross National Product: the same
ratio appears in good years, bad years, and all other years.
There is a fixed market for investment: the economy can't be made
to grow faster by increasing investment. And it never has been
made to grow faster in that way.
Another interesting fact. In the US, the Federal Reserve has
tried to reduce inflation by tightening the money supply.
Tightening the money supply has had three main effects: it slows
growth; it increases unemployment, and it either has no effect on
inflation or it INCREASES inflation. The only clear effects of
tightening the money supply have been to make the economy worse.
And now the biggest shocker. It is standard economic practice to
calculate savings (consumer and producer) by subtracting total
expenditures from total income (NOT by adding up actual savings).
This simple approach was suggested by Keynes' analogy of the
whole economy to a single family, scaled up. To Keynes, it was
obvious that a family does not spend all it earns, saving the
difference for future needs. It was equally obvious that this was
how the whole nation works: the difference between earnings and
expenditures must represent the savings of the whole nation.
What Keynes overlooked, and my father saw, was that this analogy
is invalid. At any given time, the nation represents individuals
or familities in ALL stages of the economic cycle. Some are
spending all they earn; others a little farther along are putting
money aside; still others are withdrawing their money, because
their future has arrived. So the net savings rate of the whole
nation must be very much less than the savings rate for a family.
The apparent savings rate calculated from income and
expenditures, which averages about 7 % of yearly income, can't
possibly be the real savings rate, for the real savings rate must
average around zero.
So what IS this observed difference between total income and
total expenditures? It is a leakage of buying power out of the
economy. There are many sources of leakage, including bad foreign
loans and investments, imbalance of trade, and the use of
overseas labor in place of domestic labor. One of the main
reasons for leakage is the fact that some people or institutions
have such huge incomes that they can't possibly spend them all on
goods and services within the economy. Because they do not spend
all of what they earn inside the economy, they do not return to
the composite producer enough to pay for producing the whole
economic product. This creates an automatic annual markup of
prices: one of the main contributors to inflation. The leakage
rate also directly subtracts from the exponent in the expression
for growth rate of the economy.
Finally, inflation itself. It turns out that the primary culprit,
other than leakage, is industry-wide collective bargaining. The
historical record shows that increases in wages due to collective
barganing have, for 100 years, been completely offset by
increases in prices. Organized labor has not gained one cent in
purchasing power through wage increases. There may have been
other kinds of gains, but wage negotiations have not produced any
increase in real wages. They have produced, instead, inflation.
When leakage is added to wage increases, inflation is almost
entirely accounted for.
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I haven't been able to talk my father into merging his analysis
with a PCT analysis ("What individuals want has nothing to do
with economics!!!"). However, PCT naturally enters into
macroeconomics by providing the missing explanation for what
keeps the circular counterflows of goods and money going. What
keeps them going is the difference between what people want and
what they get.
I think it would be possible to derive a macroeconomic demand
curve from the composite behavior of individuals who want
specific amounts of specific goods, neither less nor more. Over a
population, for any particular good, there would be a range of
amount wanted, with very few people wanting none at all, and very
few people wanting enormous amounts (for example, of oatmeal or
movie videos). The result would be that as the available amount
of a good increases, there would be less and less effort on the
part of the population to obtain it, producing a concave demand
curve that is high at low supply and low or zero at high supply.
This amounts to a new definition of economic man: not as a
maximizer who can be driven to indefinitely large outputs of
labor when given indefinitely increasing rewards, but as a
controller aiming to obtain specific amounts of goods and
services. This change of assumptions, it seems to me, would lend
itself to surveys of people's actual economic behavior. If you
simply asked people to list how much or how many of a wide
variety of goods and services they would like to consume, I will
bet that for most of them the number would be quite finite and
reasonable. How many pencils would you like to have? How many
cars? How much food would you like to eat? How many clothes would
you like to have in your closet? And so forth.
In your proposal for modeling how managers work, you could try
out the same idea. Do managers really try to maximize profits?
According to Newell (or was it Simon), they do not: they pick
what seems a reasonable goal and adjust their efforts
accordingly, a process he called "satisficing." He got a Nobel
prize in economics for that. While he didn't advertise this idea
as following from PCT, it most certainly does.
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You can use any of my writings that will do you any good: feel
free.
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Best,
Bill P.