Monday, November 18, 2013

The fundamental equation of economics

It is every physicist's dream to find a formula so powerful that it can explain everything (and carry the inventor's name). Such hopes are not as prevalent in Economics, first as we realize that we cannot find such a fundamental equation (we are just not smart enough), second because an economy is so complex that it defies any attempts to reduce it to one equation.

This does not stop James Wayne, who as a physicist is still pursuing his dream. And he claims to have found the Fundamental Equation Of Economics (FEOE), thereby finally proving that Economics is truly part of Physics. What a relief. And what is this equation that can, as the author forcefully argues, explain all observed economic phenomena and solve all economic problems, without exception? What is this formula that shows that equilibrium, the laws of supply and demand, DSGE and SL/ML (whatever that is) models are all deeply flawed? Here it is: The change in time of the joint probability distribution of future valuation of assets and liabilities is a function of its current distribution. We do not know yet what this function is, because it is currently too difficult to figure it out at the atomic level, but we know it exists. Now we can go revolutionize Economics and solve the world's problems.

Long live the Wayne Equation!


Anonymous said...

The author has responded, but put his comment in the wrong post. read it here

a jjwinterpretation said...

Bob Shiller joined the debate "Is Economics a science"
according to an article on Project Syndicate on 11/6/2013.

It is refreshing to see Shiller's candid admission that existing economics is more
like an engineering rather than a science. That is much better than pretending, or
unwillfully/willfully ingorance.

However, it is very wrong for Shiller to say that "economic phenomena do not have the same
intrinsic fascination for us as the internal resonances of the atom or the functioning
of the vesicles and other organcelles of a living cell."

No! No! No! Professor Shiller, almost everyone including almost every physicist and biologist
in the world are much more interested in learning how to predict the financial markets
than learning the works of atoms or organcelles. The REAL PROBLEM is that economists so far
have almost nothing useful to teach us! THAT IS THE PROBLEM. No economist WAS able
to answer question whether the financial is predictable and let alone how to predict it.

Everything in the physics world is predictable. Physicists just found Higgs boson predicted
50 years ago! Amazing. Yet all of sudden, in the most approachable length and time scale
of everyday life, there is a black hole of knowledge and we are still wondering whether
the financial market is predictable and how to predict it. Something is very wrong here.

BTW, Professor Shiller and others, whether economics is a science should be considered as a settled issue.

There is no doubt that economics is a science. It is a branch of quantum physics!

Economics does have immutable laws: physics laws of social science. Please check out

Economics does have a universal mathematical framework like Maxwell’s Equations for
electromagnetism: a fundamental equation of economics. Please check out

a jjwinterpretation said...

There is true that Fundamental Equation of Economics (FEOE) is
a strange equation. That is because the human behavior is
very different from other physical objects.

It will take a while for people to get used to it. It should be no
doubt this FEOE is REAL AND USEFUL. Here are several examples:

FEOE works for personal finance. I have met many very intelligent people
including many economists who refuse to play lottery. Yet nearly all of them are
dreaming to be millionaires one day. With FEOE, it is very easy to see why you
should play lottery with a limited amount of money because it increases
your probability to become a millionaire in your lifetime. However, it does
not mean you should spend a lot of money on lottery. The amount should NOT
be a significant total sum over your lifetime. The same logic applies to your
other economic activities like being a MD/lawyer/trader/investment banker/CEO, saving,
investing, or starting a new business. With FEOE, you actually can have a
realistic scientific sound way to become a millionaire. It is all in
probabilities. Even better this is physics!

FEOE works for game theory. Take rock paper scissors game. FEOE gives you
scientific guidance: 1) People have free wills. Don’t be so sure you can
guess how others will move. That is laws of physics. 2) On average, you
cannot lose if you could use or become a quantum random number generator.
3) FEOE assures you that the probability how others moves is
precisely predictable. Therefore, the key is to think in terms of probabilities.
The same logic applies to other games. Essentially FEOE uses the probability
theory to study game theory and equilibrium. Nothing wrong with that.

(To be continued in next post)

a jjwinterpretation said...

(Continuing from previous post)

FEOE works for financial markets. One most difficult problem in modern finance is
how to price a CDO with mortgage, corporate, or muni bonds. Despite the bad reputation
of copula models, FEOE confirms usefulness of copula functions because they are
the same as JPDFs (skip this section if you don’t know what that is). However, FEOE
advises not to use Gaussian copula in general. There are hundreds other copula and
there are many ways to build your own copula functions. This approach works before during
and after the great recession of 2008. FEOE works well with option pricing theories.
FEOE is more general approach than the Black-Sholes formulation. FEOE is not compatible with many other financial theories.

FEOE works for microeconomics. The paper uses the US housing market as an example.
However, FEOE is not compatible with Marshall's supply and demand, and market
equilibrium framework. The paper provides a new and universal framework. In the
economic logician web site, there are comments on a recent paper on the price of diamonds.
some arguments are about the defination of supply and demand. It is SAD to see
that people are taught about Marshall's framework in the day one of economic class.
Yet after decades' professional training under Marshall's framework, people are
still arguing about how to define the supply and demand. I am sure these are fine
people. The real problem is that Marshall's framework is not a science.

FEOE works for macroeconomics. Could aggregated supply and demand works for
macroeconomics if Marshall’s framework does not even work for microeconomics.
Very unlikely. FEOE model works for US and Chinese economy, of course!

If FEOE works for personal finance, game theory, financial markets, macroeconomics,
and macroeconomics, other fields of social science, biology, and physics. This
cannot be accidental! Therefore, FEOE is a REAL DEAL, whether you like it or not.

Economic Logician said...

I suggest you take a deep breath, then look up some literature in Economics. Any literature will do. Use this, for example.

Iowa said...

Economic systems are driven by chaos. Small initial conditions can have huge impacts sometime in the future the problem is new small initial conditions are cropping up all the time and most fizzle. Looking back you can see correlation. Yet, by the time you see correlation new initial conditions have cropped up. Economic systems are deterministic systems but they are not predictable. Look up computational irreducibility. Or plant a tree and predict where the branches are going to come out 40 years from now.

Kansan said...

Yet, from a distance, all trees have a similar from. What matters in economics is not every single transaction, but the big picture. And that, you do not need this kind of complexity.

Anonymous said...


What you said about chaos is fine in math and physics.. In economics, what phenomenum can be described by a deterministic equation precisely? None I can think of.

Wayne's FEoE could be right because people behave more like a particle than a planet or a rock.

Economic Logician said...

Attempts at finding chaos in economic systems have been largely unsuccessful. And something that appears to be random is not chaotic. In fact chaos can be deterministic.

Anonymous said...

EL, chaos can only be deterministic for a group of hard core academic purists. These are not useful concepts outside planet systems or something similar.