New model shows how our social networks could contribute to generating economic phenomena

Credit: Pixabay/CC0 Public Domain

Many standard economic models assume that people make fully rational individual decisions. But new research suggests that economic phenomena such as inequality and business cycles are best explained by models that recognize that people’s decisions are influenced by the decisions and behaviors of the people around them.

To demonstrate this, the researchers built a model in which families are integrated into a social network that strongly influences their saving decisions. This rather simple model has led to cyclical fluctuations similar to business cycles, as well as to the emergence of inequality – for example, many poor households with low savings rates and a few rich households with high savings rates.

Replace utility maximization in economic modeling with behavioral decision making

These results reflect behavior that can be observed in the real world, but which standard economic models often fail to capture or explain, demonstrating that this more realistic approach is an important alternative to classical economic modeling.

“We are replacing utility maximization in economic modeling with behavior-based decision making to offer a different perspective on problems such as economic growth,” says Jacob Kolb, a former Ph.D. A student at the Potsdam Institute for Climate Impact Research (PIK) and one of the authors of the study now published in Proceedings of the US National Academy of Sciences (PNAS). “Although the model we use is very simple, it shows how we lose key insights into important economic phenomena if we model humans as rational decision-making machines rather than as deeply social beings.”

In fact, the model predicts that during recessions, saving rates increase before production rises—which fits observations of private savings in 19 OECD countries. “Hence, our approach appears to be quite realistic in this regard,” says co-author Jobst Heitzig of PIK. “Next, we will use the social dynamics we analyzed here to model the reallocation of capital from unsustainable CO22 Intensive economic activities for more sustainable investments.

The researchers note that when social dynamics get faster in their model, inequality between families can suddenly disappear, but if families copy their friends too quickly, they may learn the wrong thing and stop saving altogether.

Picture of a man balancing a column on his hand

The authors used the image of a man balancing a pole on his hand to illustrate the difference between their new, older, and traditional model. “A standard macroeconomic model might assume that man is a perfect pole equilibrium, and any angle deviations must be driven by external shocks, such as sharp gusts of wind,” says co-author J. Duane Farmer, director of the economics of complexity. at the Institute for New Economic Thinking, University of Oxford. From this point of view, after each shock the man moves his hand perfectly to make the shaft vertical again, but before he can achieve this, another shock hits him, causing the shaft to wobble. This interpretation is clearly wrong; theories assuming some of the due The shaft oscillation to the man’s imperfect ability to balance the shaft provides a much better explanation.”

The study is also an example of the successful promotion of young talents. Its first author, Yuki Asano, developed the model and found the main results during his undergraduate thesis at PIK, under the supervision of Jakob Kolb and Jobst Heitzig. Asano then moved on to earn his Ph.D. At the University of Oxford where the writing of the paper had the support of Doyne Farmer, a pioneer of chaos theory who also spent a few years at PIK in 2010.

Knowing the Model You Can Trust: The Key to Better Decision Making

more information:
Yuki M. Asano et al., Emerging Inequality and Business Cycles in a Simple Behavioral Macroeconomic Model, Proceedings of the National Academy of Sciences (2021). DOI: 10.1073/pnas.2025721118

Submitted by the Potsdam Institute for Climate Impact Research

the quote: A new paradigm showing how our social networks can contribute to the generation of economic phenomena (2021, July 6) Retrieved on November 30, 2021 from .html

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