WEBVTT NOTE A Model of Austrian Economics 1 00:00:00.000 --> 00:00:11.000 I'm going to present a model of Austrian economics and I also like to call this project, sometimes I like to call it dynamic, stochastic, general disequilibrium. 2 00:00:11.000 --> 00:00:26.000 And this title suggests that the goal of this project is to come up with a framework which is probably just as general as the models that are used in mainstream economics. 3 00:00:26.000 --> 00:00:32.000 But in addition we would like to incorporate some of the Austrian insights into such a framework. 4 00:00:32.000 --> 00:00:40.000 In order to do so we have to leave the concept of equilibrium, as I will argue in a second. 5 00:00:40.000 --> 00:00:49.000 And then the idea is to have such a model and to actually track the patterns that we expect over the business cycle 6 00:00:49.000 --> 00:00:55.000 into the system of national accounts, that is GDP and all its sub-components. 7 00:00:55.000 --> 00:00:59.000 Now, how could such a model possibly work? 8 00:00:59.000 --> 00:01:02.000 No, that's not it. 9 00:01:02.000 --> 00:01:07.000 First of all, the model is agent-based and accounting-based. 10 00:01:07.000 --> 00:01:14.000 That is to say, there are many types of agents that act in a completely decentralized fashion on virtual markets, 11 00:01:14.000 --> 00:01:17.000 where they exchange money against goods and services. 12 00:01:17.000 --> 00:01:24.000 And every agent has a balance sheet, and this balance sheet records its economic status at all times. 13 00:01:24.000 --> 00:01:32.000 And then we can simply aggregate those balance sheets and reach some macroeconomic status 14 00:01:32.000 --> 00:01:38.000 where we can then basically read out what would this mean to GDP. 15 00:01:38.000 --> 00:01:44.000 The model is also behavioral in the sense that these agents, they have certain goals. 16 00:01:44.000 --> 00:01:53.000 That is, they satisfy preferences or they maximize profits and they use algorithms to do this. 17 00:01:53.000 --> 00:01:58.000 They're not maximizing utility or something like that because that doesn't exist here. 18 00:01:58.000 --> 00:02:05.000 But they use some kind of procedural rationality and very simple algorithms to achieve their goals. 19 00:02:05.000 --> 00:02:08.000 And all of this is implemented in a Java language. 20 00:02:08.000 --> 00:02:19.000 It's like an object-oriented language where we can simulate the outcomes of such a model. 21 00:02:19.000 --> 00:02:25.000 I talked about markets, and this is the core, or the key, to understanding this model. 22 00:02:25.000 --> 00:02:30.000 The markets, the way I've designed them is as follows. 23 00:02:30.000 --> 00:02:40.000 A market can be populated by many, many firms, and each of those firms would have a certain quantity on offer, and it sets a price. 24 00:02:40.000 --> 00:02:45.000 So the individual supply curve of each firm would be simply a horizontal line. 25 00:02:45.000 --> 00:02:51.000 And if we then add them up or aggregate them, we would get something like an upward sloping supply curve. 26 00:02:51.000 --> 00:03:00.000 But this is not a Marshallian supply curve. It's simply something which shows us the price spectrum at which some total quantity would be available in a market. 27 00:03:00.000 --> 00:03:08.000 And then, on the demand side of the market, there would be some demanders. They enter the market and they have limited information. 28 00:03:08.000 --> 00:03:12.960 Information. They don't know this entire supply curve, but they randomly select three 29 00:03:12.960 --> 00:03:16.920 offers, then they choose the one with the cheapest price, and then they compare this 30 00:03:16.920 --> 00:03:21.520 price with their reservation demand or their reservation price. The reservation price again 31 00:03:21.520 --> 00:03:27.400 is behavioral, I'll get to that in a second, but this is what they do. They compare their 32 00:03:27.400 --> 00:03:32.040 willingness to pay with what they have in the market, and if this is okay, then they 33 00:03:32.040 --> 00:03:40.620 they make a purchase and then what happens is that the market is updated because one 34 00:03:40.620 --> 00:03:46.260 unit of the good has been sold now, the supply curve is actually shortened and the system 35 00:03:46.260 --> 00:03:54.280 reaches a new plain state of rest to put it in Misesian terms and this step by step the 36 00:03:54.280 --> 00:04:00.440 model goes into the future and there are markets for basically everything that circulates in 37 00:04:00.440 --> 00:04:01.320 in this economy. 38 00:04:02.320 --> 00:04:04.720 First of all, in every market transaction, 39 00:04:04.720 --> 00:04:08.360 money is exchanged against a good or service. 40 00:04:08.360 --> 00:04:11.520 And so we strictly separate between the monetary level 41 00:04:11.520 --> 00:04:13.460 and the real level of the economy. 42 00:04:13.460 --> 00:04:15.120 And then we can see simply there's a market 43 00:04:15.120 --> 00:04:17.840 for consumer goods and for labor and for capital goods 44 00:04:17.840 --> 00:04:20.440 and for equity shares and for credit, 45 00:04:20.440 --> 00:04:22.160 that is future money. 46 00:04:22.160 --> 00:04:26.420 And these are the balance sheets of the agents, 47 00:04:26.420 --> 00:04:29.720 like in a representative way. 48 00:04:29.720 --> 00:04:32.560 and yeah, we can see here that all the money 49 00:04:32.560 --> 00:04:33.840 is basically held by the banks, 50 00:04:33.840 --> 00:04:35.480 so this is like a gold standard basically 51 00:04:35.480 --> 00:04:38.900 and then they have like the firms and the households 52 00:04:38.900 --> 00:04:41.560 they have checking accounts and whenever they buy something 53 00:04:41.560 --> 00:04:44.840 they transfer money from one checking account to another. 54 00:04:44.840 --> 00:04:48.600 So it's like they act with money substitutes basically. 55 00:04:48.600 --> 00:04:50.520 And then they're envisioning their time deposits 56 00:04:50.520 --> 00:04:53.680 which can be converted into loans 57 00:04:53.680 --> 00:04:58.320 and then they can be used to purchase capital. 58 00:04:58.320 --> 00:05:03.320 and all of this is follows like basic accounting standards 59 00:05:04.440 --> 00:05:07.080 and so at each point in time, 60 00:05:07.080 --> 00:05:09.440 we have like a full-fledged accounting system. 61 00:05:13.380 --> 00:05:15.580 Now, what about the real side of the economy? 62 00:05:17.260 --> 00:05:19.480 It's modeled as follows. 63 00:05:20.800 --> 00:05:22.220 Here we have a grid 64 00:05:22.220 --> 00:05:25.680 and there are different stages of production, right? 65 00:05:25.680 --> 00:05:27.920 And then we also have different lines of production 66 00:05:27.920 --> 00:05:30.240 in the horizontal direction. 67 00:05:30.240 --> 00:05:34.480 And this is like a playground for the firms. 68 00:05:34.480 --> 00:05:36.680 The firms can still be settled at one of those nodes. 69 00:05:36.680 --> 00:05:38.560 And whenever a firm is settling here, 70 00:05:38.560 --> 00:05:40.760 then it can start to produce this good, which is here. 71 00:05:40.760 --> 00:05:42.720 This would be like F3. 72 00:05:42.720 --> 00:05:44.520 And another firm would settle here 73 00:05:44.520 --> 00:05:46.600 and then would produce the good D2. 74 00:05:46.600 --> 00:05:49.000 So they're just different goods in the economy. 75 00:05:49.000 --> 00:05:50.680 And if there's no firm, then the good 76 00:05:50.680 --> 00:05:51.920 is not going to be produced. 77 00:05:54.400 --> 00:05:57.640 And now say a firm is here at C2. 78 00:05:57.640 --> 00:06:01.480 then it can only use certain production factors as inputs. 79 00:06:02.400 --> 00:06:05.160 That is to say, it can use intermediate goods 80 00:06:05.160 --> 00:06:07.800 of the next higher stage and it can use machines, 81 00:06:07.800 --> 00:06:09.760 oh, I forgot to mention that here we have machines 82 00:06:09.760 --> 00:06:11.580 which are like fixed capital goods 83 00:06:11.580 --> 00:06:14.220 and it can use fixed capital goods from its own stage 84 00:06:14.220 --> 00:06:15.880 and it has to use labor. 85 00:06:15.880 --> 00:06:18.900 Labor needs to be used in any type of production process. 86 00:06:18.900 --> 00:06:23.320 So that is just to say that production factors 87 00:06:23.320 --> 00:06:25.380 are complementary, you cannot assemble products 88 00:06:25.380 --> 00:06:27.080 in a completely arbitrary fashion. 89 00:06:27.640 --> 00:06:35.640 Furthermore, there's a production function, which is basically a Leontief type production function. 90 00:06:35.640 --> 00:06:38.640 This simply describes a numerical relationship between inputs and outputs. 91 00:06:38.640 --> 00:06:43.640 I use one worker to produce one good, for example, or something like that. 92 00:06:43.640 --> 00:06:47.640 It's a bit more complicated than that, but I'll spare you the details. 93 00:06:47.640 --> 00:06:53.640 There's a processing capacity, like how many intermediate goods can a firm actually process per time period, 94 00:06:53.640 --> 00:06:59.640 and that depends on how much labor and how much capital has it accumulated and all that. 95 00:06:59.640 --> 00:07:08.480 In essence, it is a production function which rewards the accumulation of capital, the division 96 00:07:08.480 --> 00:07:14.640 of labor, and which most importantly follows the law of returns as stated by Mises. 97 00:07:14.640 --> 00:07:18.920 And it has constant returns to scale, just as in other mainstream economics. 98 00:07:18.920 --> 00:07:30.920 Okay, let's get to the behavioral section of it. These are the household preferences and I model them simply as sequences of intended actions. 99 00:07:30.920 --> 00:07:42.920 That is to say, a household might go about and say, okay, each household has an order in which he desires to purchase goods. 100 00:07:42.920 --> 00:07:46.420 So he starts out and say, I want to buy one unit of good B. 101 00:07:46.420 --> 00:07:48.660 And then he starts out, he wants another unit of good B 102 00:07:48.660 --> 00:07:52.020 and maybe a unit of good A, and later a savings contract. 103 00:07:52.880 --> 00:07:55.560 And in each of these actions, 104 00:07:55.560 --> 00:07:59.300 he has a reservation expenditure. 105 00:07:59.300 --> 00:08:02.840 And this reservation expenditure, or a reservation price, 106 00:08:03.780 --> 00:08:08.780 is, or describes the law of diminishing marginal utility. 107 00:08:08.780 --> 00:08:11.780 You could say that the reservation expenditure 108 00:08:11.780 --> 00:08:16.780 of each household is defined by his money holdings 109 00:08:17.280 --> 00:08:20.400 minus his money demand in each transaction. 110 00:08:20.400 --> 00:08:23.080 And the money demand in turn is a function 111 00:08:23.080 --> 00:08:25.700 of the numbers of the units of the good 112 00:08:25.700 --> 00:08:28.000 in question that he already owns. 113 00:08:28.000 --> 00:08:30.320 And the higher, this is monotonically increasing, 114 00:08:30.320 --> 00:08:35.040 so the higher this number, the lower is his willingness 115 00:08:35.040 --> 00:08:36.980 to pay for another unit of that good. 116 00:08:36.980 --> 00:08:40.960 And that's it, that's basically the law 117 00:08:40.960 --> 00:08:42.960 of Diminishing Marginal Utility. 118 00:08:45.960 --> 00:08:49.960 In addition, they also have pre-income preferences, so they have to decide, 119 00:08:49.960 --> 00:08:53.960 am I going to work in this time period or not? 120 00:08:53.960 --> 00:08:58.960 This decision reflects the trade-off that they face between leisure time and real consumption. 121 00:08:58.960 --> 00:09:02.960 In order to estimate the real consumption that they will have in the next time period, 122 00:09:02.960 --> 00:09:05.960 they first need to estimate the purchasing power of money, 123 00:09:05.960 --> 00:09:09.960 because they only know the money that they have in their pockets. 124 00:09:09.960 --> 00:09:16.320 And how do they do that? Well, they look at what they spent, what they consumed in the last time period. 125 00:09:16.320 --> 00:09:18.480 This is the real consumption in the last time period. 126 00:09:18.480 --> 00:09:24.880 And divide this by what they spent on this consumption, and then this gets them an estimate of the purchasing power of money. 127 00:09:24.880 --> 00:09:32.280 And then they multiply this with their current money holdings, and this is what they get as their expected real consumption, if abstaining from work. 128 00:09:32.280 --> 00:09:35.640 And then this enters the reservation wage function. 129 00:09:35.640 --> 00:09:43.640 And again, this is monotonically increasing, so the higher the expected real consumption, the less they're inclined to work. 130 00:09:43.640 --> 00:09:53.640 And as a side note, this is obviously an adaption of the regression theorem that I've just shown here. 131 00:09:53.640 --> 00:10:01.640 Now the firms, what do they do? I'm not going into all algorithms that I've developed, but how do the firms determine price and quantity? 132 00:10:01.640 --> 00:10:11.880 What they do is, first of all, the sales strategy of firms is only about revenue maximization. 133 00:10:11.880 --> 00:10:16.720 Because investment always precedes sales and so all these costs are sunk costs, doesn't 134 00:10:16.720 --> 00:10:17.720 matter. 135 00:10:17.720 --> 00:10:20.240 So it's only about revenue. 136 00:10:20.240 --> 00:10:25.520 But they don't know the revenue maximizing combination of quantity and price and they 137 00:10:25.520 --> 00:10:29.520 use therefore a process of try and error. 138 00:10:29.520 --> 00:10:34.080 And what they do, they have limited information there, it's an environment of radical uncertainty, 139 00:10:34.080 --> 00:10:38.800 so they only monitor their own balance sheet, their inventories, what they did not sell, 140 00:10:38.800 --> 00:10:42.360 and they always try to withhold a certain quantity from the market. 141 00:10:42.360 --> 00:10:50.160 So if, in particular, they have a target range of inventories, which is proportional to the 142 00:10:50.160 --> 00:10:59.160 quantity that they offer, and whenever they sell too much, then they raise the price. 143 00:10:59.160 --> 00:11:05.520 When they sell too little, then they lower the price, and that's sheer like this. 144 00:11:05.520 --> 00:11:14.760 In addition, if they sell too much with respect to their target and they were able to produce 145 00:11:14.760 --> 00:11:22.800 as much as they wanted, so they're not investment-constrained, then they also raise the offering target. 146 00:11:22.800 --> 00:11:27.840 And if the sales are low and they were still also investment-constrained, then they lower 147 00:11:27.840 --> 00:11:29.840 and the security offering target. 148 00:11:29.840 --> 00:11:31.840 So this is like a process of trial and error, 149 00:11:31.840 --> 00:11:33.840 like where do I end up in the market? 150 00:11:33.840 --> 00:11:35.840 And there are many firms who do this 151 00:11:35.840 --> 00:11:37.840 and they're competing with each other. 152 00:11:39.840 --> 00:11:41.840 Finally, investment, 153 00:11:41.840 --> 00:11:43.840 well that's actually quite easy. 154 00:11:43.840 --> 00:11:45.840 What they do is they go to the market, 155 00:11:45.840 --> 00:11:49.840 they look at all possible capital combinations 156 00:11:49.840 --> 00:11:51.840 that they could use and they calculate the unit costs. 157 00:11:51.840 --> 00:11:53.840 And they know the unit costs 158 00:11:53.840 --> 00:11:55.840 because they know the production function 159 00:11:55.840 --> 00:12:05.840 These are the prices that they find in the markets, and that's the unit cost, and whenever this is sufficiently low, below their sales price, then they make the investment because they expect to earn a profit. 160 00:12:08.840 --> 00:12:22.840 Finally, there's bankruptcy, I'm not going into the details of that, but this simply means that if they cannot pay that, then they go bankrupt, and then new firms are being created, and this gives the system some flexibility to changing conditions. 161 00:12:25.840 --> 00:12:51.840 Here is like simply how can we imagine this and we can imagine the demand by some kind of imaginary demand curve which is probably a bit more complex than that and here is the unit cost curve and what happens now in the system when it's interdependent is that the prices they will converge in some way. 162 00:12:51.840 --> 00:12:59.840 If there's monopoly, okay, then okay, it can always withhold quantity from the market and it will raise prices above unit costs. 163 00:12:59.840 --> 00:13:05.840 But say there's competition, then there can be two situations. 164 00:13:05.840 --> 00:13:14.840 Either the prices are competed down to the cost level, and that will be the case whenever the production factors are abundant, 165 00:13:14.840 --> 00:13:21.960 or the prices of the production factors actually bid up some to where the price 166 00:13:21.960 --> 00:13:27.280 level is and that will be the case when the production factors are scarce. And so 167 00:13:27.280 --> 00:13:35.480 here we have some interdependency and this is how it works. These are two 168 00:13:35.480 --> 00:13:44.360 possible capital combinations of a or capital resource allocations of an 169 00:13:44.360 --> 00:13:53.640 in Economy. So here we have a line of production, and this economy works with 14 workers. We 170 00:13:53.640 --> 00:14:01.280 have nine here, three here, one, one. And the goods that they produce are indicated 171 00:14:01.280 --> 00:14:04.960 in red, they go in this direction, and the money goes in the other direction. And then 172 00:14:04.960 --> 00:14:11.920 we have dividends and wages going back to the households. 173 00:14:11.920 --> 00:14:19.480 And here we have a different capital configuration, which is more capital intensive, we have more 174 00:14:19.480 --> 00:14:22.080 workers at the higher stages of production. 175 00:14:22.080 --> 00:14:30.080 Now how can this, is this possible, yes it is, but in order to become more capital intensive 176 00:14:30.080 --> 00:14:34.060 they need machines up here because otherwise they could not process all the goods that 177 00:14:34.060 --> 00:14:38.200 now arrive up here, much more goods arriving here now. 178 00:14:38.200 --> 00:14:43.360 And so we have, all together, we have a more roundabout production structure here, which 179 00:14:43.360 --> 00:14:50.120 is characterized by higher capital intensity, higher division of labor, a more complex assembling 180 00:14:50.120 --> 00:14:52.760 of goods. 181 00:14:52.760 --> 00:14:54.720 And how can we get from A to B? 182 00:14:54.720 --> 00:14:57.020 I mean, that's a critical question. 183 00:14:57.020 --> 00:15:00.880 And the answer is only by savings. 184 00:15:00.880 --> 00:15:07.760 Because these companies down here, they have very little revenue, yeah? 185 00:15:07.760 --> 00:15:13.920 They only get 24 monetary units as revenue, and they could never even afford an additional 186 00:15:13.920 --> 00:15:14.920 worker. 187 00:15:14.920 --> 00:15:19.360 So they can only expend if they have credit. 188 00:15:19.360 --> 00:15:23.280 So from A to B, we only get by savings. 189 00:15:23.280 --> 00:15:25.680 And the question is, can we show that? 190 00:15:25.680 --> 00:15:28.680 Yes, we can. 191 00:15:28.680 --> 00:15:34.600 I'll show you this, and this is how the model then will end. 192 00:15:34.600 --> 00:15:42.840 This is just a very simple version of it, but this is how it looks. 193 00:15:42.840 --> 00:15:48.600 You can run this and it will be running on our website, so it's possible to illustrate 194 00:15:48.600 --> 00:15:52.960 this and to track all the components of an economy. 195 00:15:52.960 --> 00:15:57.480 We can look at nominal consumption, real consumption, we can look at the labor market, at the price 196 00:15:57.480 --> 00:15:59.920 levels and so on and so on. 197 00:15:59.920 --> 00:16:05.920 We can look here at the allocation, and now this is a very simple economy, right? 198 00:16:05.920 --> 00:16:12.920 There's only one consumer good, this is here B1, there's one intermediate good and one machine, very simple. 199 00:16:12.920 --> 00:16:20.920 But we see that firms, okay, this computer is a bit slow so I have to pause it so that we can see the full picture. 200 00:16:20.920 --> 00:16:28.920 The firms are settling here at these nodes and they're trading in these goods and then they produce goods and so on. 201 00:16:28.920 --> 00:16:41.920 Converges quite slowly, that is caveat, but you can track over time what happens with 202 00:16:41.920 --> 00:16:52.440 these quantities and in 2000, well it's a bit slow, in 2040 there will be a shock and 203 00:16:52.440 --> 00:16:55.840 and then the production structure is expanded 204 00:16:55.840 --> 00:17:00.840 and we will see that then real consumption 205 00:17:01.720 --> 00:17:03.320 will actually rise. 206 00:17:03.320 --> 00:17:04.480 Let's go back to the topics 207 00:17:04.480 --> 00:17:05.480 because I'm running out of time. 208 00:17:05.480 --> 00:17:07.800 I'll show you how the result of this later. 209 00:17:08.720 --> 00:17:11.480 Now in essence, every spending pattern by the household 210 00:17:11.480 --> 00:17:13.580 sustains a certain production structure. 211 00:17:14.800 --> 00:17:18.560 And when this spending pattern changes, 212 00:17:18.560 --> 00:17:20.680 the preferences change for instance, 213 00:17:20.680 --> 00:17:25.680 Then we can show how the capital structure follows. 214 00:17:25.720 --> 00:17:28.080 So we have the principle of consumer sovereignty 215 00:17:28.080 --> 00:17:29.880 implemented here. 216 00:17:29.880 --> 00:17:34.880 And when there's an increase in savings, 217 00:17:37.320 --> 00:17:38.920 we have a lengthening of the production structure, 218 00:17:38.920 --> 00:17:41.280 which will eventually lead to higher output. 219 00:17:42.360 --> 00:17:47.360 And if there's credit expansion, then we don't have, 220 00:17:47.360 --> 00:18:17.360 We don't have, we have basically the same consumption pattern, but we have more money coming from the side basically, like being simply provided to firms, and then this will also lengthen the production structure, and it will raise output for a while, but as we know it will all come to an end, and finally when this credit expansion ceases, or when the money is being more equally distributed, then we have a breakdown. 221 00:18:17.360 --> 00:18:30.360 That's it. And the good thing is that we can track this, we can see how the macroeconomic magnitudes are actually reflect such a cycle. 222 00:18:30.360 --> 00:18:39.360 And we can look at the patterns, the macroeconomic patterns that would show up in such a cycle. 223 00:18:39.360 --> 00:19:09.360 To close this, this is just a comparison between what other economists do and what we have in this model here and I think this list could even be extended and I'm just saying that, as I said, we break with many of the metaphors that are actually usually being put forward and we replace this by some new metaphors but I think they are more realistic and they are more in line with Austrian economics. 224 00:19:09.360 --> 00:19:17.360 and Economics. 225 00:19:17.360 --> 00:19:26.360 So, I pause this here, yeah, and you can see there was a shock in 2040, the structure is 226 00:19:26.360 --> 00:19:31.360 now lengthened, and real consumption has gone up, thank you.