General Constrained Dynamic Models in Economics - General Dynamic Theory of Economic Variables - Beyond Walras and Keynes

For more than 100 years economists have tried to describe economics in analogy to physics, more precisely to classical Newtonian mechanics. The development of the Neoclassical General Equilibrium Theory has to be understood as the result of these efforts. But there are many reasons why General Equilibrium Theory is inadequate: 1. No genuine dynamics. 2. The assumption of the existence of utility functions and the possibility to aggregate them to one “master” utility function. 3. The impossibility to describe situations as in “Prisoners Dilemma”, where individual optimization does not lead to a collective optimum. This book aims at overcoming these problems. It illustrates how not only equilibria of economic systems, but also the general dynamics of these systems can be described in close analogy to classical mechanics. To this end, this book makes the case for an approach based on the concept of constrained dynamics, analyzing the economy from the perspective of “economic forces” and “economic power” based on the concept of physical forces and the reciprocal value of mass. Realizing that accounting identities constitute constraints in the economy, the concept of constrained dynamics, which is part of the standard models of classical mechanics, can be applied to economics. Therefore, it is reasonable to denote such models as General Constraint Dynamic Models (GCD-Models) Such a framework allows understanding both Keynesian and neoclassical models as special cases of GCD-Models in which the power relationships with respect to certain variables are one-sided. As mixed power relationships occur more frequently in reality than purely one-sided power constellations, GCD-models are better suited to describe the economy than standard Keynesian or Neoclassic models. A GCD-model can be understood as “Continuous Time”, “Stock Flow Consistent”, “Microfounded”, where the behaviour of the agents is described with a general differential equation for every agent. In the special case where the differential equations can be described with utility functions, the behaviour of every agent can be understood as an individual optimization strategy. He thus seeks to maximize his utility. However, while the core assumption of neoclassical models is that due to the “invisible hand” such egoistic individual behaviour leads to an optimal result for all agents, reality is often defined by “Prisoners Dilemma” situations, in which individual optimization leads to the worst outcome for all. One advantage of GCD-models over standard models is that they are able to describe also such situations, where an individual optimization strategy does not lead to an optimum result for all agents. In conclusion, the big merit and effort of Newton was, to formalize the right terms (physical force, inertial mass, change of velocity) and to set them into the right relation. Analogously the appropriate terms of economics are economic force, economic power and change of variables. GCD-Models allow formalizing them and setting them into the right relation to each other.