Probabilistic Economic Theory

CHAPTER I. Fundamentals of the Method of Agent-Based Physical Modeling

“For a social collective has no existence and reality outside of the individual members’ actions. The life of a collective is lived in the actions of the individuals constituting its body. There is no social collective conceivable which is not operative in the actions of some individuals. The reality of a social integer consists in its directing and releasing definite actions on the part of individuals. Thus the way to a cognition of collective wholes is through an analysis of the individuals’ actions”.

“The whole market economy is a big exchange or market place, as it were. At any instant all those transactions take place which the parties are ready to enter into at the realizable price. New sales can be effected only when the valuations of at least one of the parties have changed”.

PREVIEW. What is the Main Point of the Concept of Agent-Based Physical Modeling?

The concept of agent-based physical modeling is based on taking the known, fundamental concepts of classical economic theory, and uniting and eventually converting them into probabilistic economic theory. It is described with the help of formal approaches and methods borrowed from theoretical physics, begi

1. The Concept of Agent-Based Physical Modeling

It is well-known that the method of conceptual modeling of economic systems has long and widely been used in economic theory. According to the new physical economic mode of thought, the main requirement for such economic models, which determines their basic predestination, is skill, with which several important basic concepts and principles must harmoniously, competently and simultaneously be incorporated into the theory. The latter is very important since, by the definition of the problem, all concepts and principles play roles that compare their significance in the economy under study.

Despite their simplicity, the first and most well-known conceptual theories of neoclassical economics, such as supply and demand (S&D below), contributed significantly to economic science. They helped economists to better understand the basic elements of the economic world, and they gave rise to graphic conceptualizations that aided the transfer of this knowledge to others, especially students. Early on, conceptual modeling had, and continues to have, great significance. This is also the case in Austrian economics, where it bears the name method of imaginable constructions and it is considered as the basic method in economic inquires. In theoretical physics, it is not acceptable to accentuate attention on the use of models, since theoretical physics itself can rightfully be considered as the conceptual mathematical modeling of physical systems. Specifically, in theoretical physics, the most advanced methods of theoretical modeling of complex systems have been developed. Moreover, there is the required inclination towards conducting the quantitative numerical, and, as precisely as possible, calculations of structure and properties of these models. The deep structural and dynamic analogies between the many-particle physical systems and the many-agent economic systems are exploited in this book to transfer concepts and analytical methods from theoretical physics to economics.

2. The Main Paradigm of Physical Economics

For the achievement of larger clarity, let us again mention the main idea in physical economics regarding the use of analogies with physics. For this purpose, we once more express the thought of the main paradigm of physical economics as follows: physical systems consist of atoms. As was well known long ago, all that the physical systems do, atoms do. Market systems consist of market agents, buyers and sellers. And it is also known that all that the markets do, the market agents do. Both the physical and market economic systems are the complex dynamic systems, whose dynamics are determined by interaction between the elements of the system and their interaction with the environment in the widest sense of this notion. In our view, the very existence of such structural and dynamic similarity gives rise to the possibility, in principle, of building formal, many-agent physical economic models by analogy with the theoretical models of the many-particle physical systems, for example, of polyatomic molecules. It is here that the physical economic model could include all basic concepts and principles which define the work of the economy. As a result, it could sufficiently, simply, and adequately describe both the main structural features and principal dynamic characteristics of the economy being modeled, a target at which this study is precisely aimed, since no model can immediately describe everything completely. The study of economic systems by means of physical modeling must be carried out gradually, step by step, incorporating into the model ever finer effects and properties in the way that theoretical physics has done over the course of theoretical studies of complex physical systems. Thus, physical economics borrows formal approaches and model structures from theoretical physics. In other words, physical economics uses the very body or framework of the theoretical models of the many-particle systems, but not the results of theoretical studies of the concrete real physical systems. Namely this is the essence of physical modeling of economic systems. In conclusion, the obvious structural and dynamic analogy of the many-agent economic systems with the many-particle physical systems is basic to the formulation of fundamentals of the method of the agent-based physical modeling of the many-agent market economic systems in the formal economic space, and eventually, of the five general principles of physical economics as well as probabilistic economic theory.

3. The Axioms and Principles of Physical Economics

Generally speaking, our attitude towards the problem of adequate quantitative description of the agent behavior in the market as well as market S&D and price formation is based on the two rather simple axioms of a very general character.

1. The Agent Identity Axiom.

All market agents are the same, only the supplies and demands they have different. The axiom says that all market agents share common properties, depending primarily on agent revenues and expenses, or more strictly, on supply and demand (S&D below) for traded goods and services. It is these agents’ S&D that mainly determine the rational economic behavior of agents on the markets, and eventually the behavior of the whole markets. It shows a possibility of building rather common and accurate models of behavior of agents in the market, and hence the total market as a whole. It sets us on the right track for the identification and examination of the common properties in the behavior of market agents that ensure appearance of the common patterns and regularities in the course of market processes. It gives us the ability to build theoretical economic models on a fairly high scientific level by using physical and mathematical methods, which is the primary goal of physical economics and economic theory in general. We are certain that only these types of common market phenomena and processes are rightly a matter for exact scientific economic enquiry. In other words, it focuses us on building economics as an exact science in the image and after the likeness of the natural sciences.