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On Learning and Adaptation in the Economy

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  • W. Brian Arthur
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    Abstract

    The standard mode of theorizing assumed in economics deductive--it assumes that human agents derive their conclusions by logical processes from complete, consistent and well-defined premises in a given problem. This works well in simple problems, but it breaks down beyond a "problem complexity boundary" where human computational abilities are exceeded or the assumptions of deductive rationality cannot be relied upon to hold. The paper draws upon what is known in psychology to argue that beyond this problem complexity boundary humans continue to reason well, but by using induction rather than deduction. That is, difficult or complex decision problems, humans transfer experience from other, similar problems they have faced before; they look for patterns and analogies that help them construct internal models of and hypotheses about the situation they are in; and they act more or less deductively on the basis of these. In doing so they constantly update these models and hypotheses by importing feedback--new observations--from their environment. Thus, in dealing with problems of high complexity humans live in a world of learning and adaptation. I illustrate these ideas by showing that the processes of pattern recognition, hypothesis formation and refutation over time are perfectly amenable to analysis; and by using them to explain supposedly "anomalous" behavior in financial markets

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    File URL: http://qed.econ.queensu.ca/working_papers/papers/qed_wp_854.pdf
    File Function: First version 1992
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    Paper provided by Queen's University, Department of Economics in its series Working Papers with number 854.

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    Date of creation: May 1992
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    Handle: RePEc:qed:wpaper:854

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    Cited by:
    1. repec:att:wimass:9625 is not listed on IDEAS
    2. Carl Chiarella & Mauro Gallegati & Roberto Leombruni & Antonio Palestrini, 2003. "Asset Price Dynamics among Heterogeneous Interacting Agents," Computational Economics, Society for Computational Economics, vol. 22(2), pages 213-223, October.
    3. Nagel, Rosemarie & Nicolaas J. Vriend, 1997. "An Experimental Study of Adaptive Behavior in an Oligopolistic Market Game," Discussion Paper Serie B 408, University of Bonn, Germany.
    4. Tay, Nicholas S. P. & Linn, Scott C., 2001. "Fuzzy inductive reasoning, expectation formation and the behavior of security prices," Journal of Economic Dynamics and Control, Elsevier, vol. 25(3-4), pages 321-361, March.
    5. Shareen Joshi & Mark A. Bedau, 1998. "An Explanation of Generic Behavior in an Evolving Financial Market," Research in Economics 98-12-114e, Santa Fe Institute.
    6. Spyros Skouras, 1998. "Financial Returns and Efficiency as seen by an Artificial Technical Analyst," Finance 9808001, EconWPA, revised 24 Aug 1998.
    7. Beltrametti, Luca & Fiorentini, Riccardo & Marengo, Luigi & Tamborini, Roberto, 1997. "A learning-to-forecast experiment on the foreign exchange market with a classifier system," Journal of Economic Dynamics and Control, Elsevier, vol. 21(8-9), pages 1543-1575, June.
    8. Guse, Eran A., 2010. "Heterogeneous expectations, adaptive learning, and evolutionary dynamics," Journal of Economic Behavior & Organization, Elsevier, vol. 74(1-2), pages 42-57, May.
    9. Nicolaas J. Vriend, 2002. "Was Hayek an Ace?," Southern Economic Journal, Southern Economic Association, vol. 68(4), pages 811-840, April.
    10. Charles Perrings, 1998. "Resilience in the Dynamics of Economy-Environment Systems," Environmental & Resource Economics, European Association of Environmental and Resource Economists, vol. 11(3), pages 503-520, April.
    11. Vriend, Nicolaas J., 1996. "Rational behavior and economic theory," Journal of Economic Behavior & Organization, Elsevier, vol. 29(2), pages 263-285, March.
    12. W. Brian Arthur & John H. Holland & Blake LeBaron & Richard Palmer & Paul Taylor, 1996. "Asset Pricing Under Endogenous Expectation in an Artificial Stock Market," Working Papers 96-12-093, Santa Fe Institute.
    13. Gans, Joshua S., 1995. "Evolutionary selection of beliefs," Economics Letters, Elsevier, vol. 49(1), pages 13-17, July.

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