The Unity of Science and Economics: A New Foundation of Economic Theory

Abstract

The level of complexity of a system often depends on how the system is described. Currently, the standard economic theory is the general equilibrium theory. However, in science, it is generally accepted that biological systems, which include human societies, are non-equilibrium systems. In this book, we will show that when human societies are described as non-equilibrium systems, economic activities become much simpler to understand. Furthermore, we will derive simple mathematical theories about major factors in economic activities and about human mind, all from the combination of physical and economic principles. Biological and social systems are indeed very complex. But beneath this complexity lies two common properties. First, all life systems need to obtain resources from the environment to compensate for the continuous dissipation to maintain life. Second, for any life form to be viable, its cost to obtain resources cannot exceed the value of the resources over its life cycle. Similarly, for a business to be viable, its average cost of operation cannot exceed its revenue. Costs include fixed cost and variable cost. In short, all organisms and organizations need to satisfy a physical principle and an economic principle. From these two principles, we develop a mathematical theory of the relations among the main factors in economic activities, such as fixed cost, variable cost, duration of operation or lifespan of organisms, uncertainty, discount rate, and level of output. This theory enables us to systematically analyze the return and profit of biological and social entities with specific structures and policies. The results are highly consistent with empirical observation and common sense. The new theory greatly simplifies our descriptions of the structures and functions of human societies. It enables us to perceive clearly about the long term consequences of personal choices, economic policies and social structures. Human mind, as part of the human body, is evolved under the same economic principle that its average cost has to be less than its average value. How to measure the cost and value of information processing by humans and other living systems? More than one hundred years ago, Maxwell linked the cost and value of information to entropy. In 1948, Shannon formally defined information as entropy mathematically. From the thermodynamic theory, entropy flow drives most directional movements, including movements in human societies. Hence entropy provides a universal measure of value. We developed an entropy theory of human mind. It provides a simple description about basic patterns of learning and human psychology. It also provides a quantitative link between our judgment and decision making, such as trading activities by investors. The theory offers simple and consistent descriptions of many patterns of asset market and investor behaviors that have puzzled the researchers.