279
Small variations in velocity will
shoot a pinball in totally different
directions. Like a pinball player,
economists cannot always predict
which way stocks will go.See also: Economic man 52–53 ■ Economic bubbles 98–99 ■
Testing economic theories 170 ■ Behavioral economics 266–69
CONTEMPORARY ECONOMICS
directly interact with each
other; they just respond to prices,
constantly changing their
behavior and prices to achieve
the best outcome. In a complex
system such as an economy,
individuals interact directly with
each other using simple “rules of
thumb” rather than rational
calculations, a little like bees in
a hive. This can lead to complex
patterns of behavior in the economy
as a whole.
Chaotic economies
Ideas related to Grandmont and
Kirman’s arguments are found in
chaos theory, first developed in the
1950s by US mathematician and
meteorologist Edward Lorenz.
Economists assume that
individuals act rationally
and that all events are
determined by cause
and effect.This means that the economy
should be predictable.But economies are
complex systems, and
individuals may each act
slightly differently to
any given event.These small differences
can lead to a myriad of
different outcomes.Wild randomness
In the 1960s and 70s French-
American mathematician
Benoît Mandelbrot argued
that economists are wrong
to try to smooth out
economic figures by looking
for averages and ignoring
extremes. He argued that
it is the extremes that give
the true picture.
Mandelbrot’s criticism
was aimed at those who
model prices for shares
and commodities on the
assumption that one price
leads directly to another and
things average out in the long
run. He believed that the
mild elements of randomness
built into these models are
misleading. Models should
be based on the assumption
of “wild randomness”—the
idea that individual freak
occurrences matter as a
change takes place. For
Mandelbrot markets are far
more volatile than economists
suggest, and the mistake they
continually make is to try to
come up with laws that work
in the same way as the laws
of classical physics.The economy is
chaotic even when
individuals are not.Lorenz was trying to discover
why the weather could not be
predicted far into the future. His
computer analyses revealed that
minute changes in the atmosphere
might multiply to produce dramatic
changes in the weather.
To analyze chaotic movements,
theorists have developed a form
of “non-linear” mathematics.
Much like the weather, they argue
that a minute change in starting
conditions can produce such a
different outcome that the process
appears chaotic, whether for stock
market movements or economic
growth. If they are right, then the
predictable equilibriums that are
the bedrock of most economic
theories are very far off the mark. ■