A new Economics Theory
© March 2011, Tienzen (Jeh-Tween) Gong
Economics is a well-established discipline and well-defined with some
sub-fields, such as, microeconomics, macroeconomics, political
economics, comparative economic systems, etc.. The basic laws of a
market were almost wholly developed by Adam Smith. The recent
advancements on utilizing the mathematics and game theory have
transformed it into a physics-like natural science. However, this new
economics theory will be developed by putting all those traditional
economics theories aside and to construct a new theory from a set of
principles outlined in
"Linguistics Manifesto" (ISBN 978-3-8383-9722-1). Then this new theory
will be checked with those old theories item by item (the theorems,
laws, phenomena, etc.). If this new theory does not encompass the
entirety of the old theories, then it is not a complete theory. If it
does not give out some new insights in comparison to those old theories,
then it is a wasting of the time. Fortunately, this new theory is,
indeed, a complete theory.
I. A brief introduction of the old theories.
a. Adam Smith's theory
The modern economics theory after Adam Smith can be encapsuled with the five laws below.
- Law 1 -- the price of a product is determined by its supply and its demand.
- Law 2 -- the preference for products is moved by an "invisible hand" which is the collective subconsciousness of a market.
Note: this invisible hand can be expressed as the "Nash attractor" (also called Nash Equilibrium).
- Law 3 -- the higher productivity for a product will lower its price.
- Law 4 -- the price of products are also determined by the amount of money available.
Lemma -- the monetary and the fiscal policies are ways of manipulating the money supply.
Theorem -- the easier the money, the higher the prices.
- Law 5 -- the "free" market will allow the interactions of the
above four laws resonating at the highest point (the optimal point).
Theorem -- free competitions will lower the prices.
b. The recent advancements on Economics
The following concepts or statements are the brief summary of the most advanced
economics theory of today. They are utilized or authored by Nobel Laureates from
2007 to 2010.
- Pareto optimal -- an outcome of a game is Pareto optimal if
there is no other outcome that makes every player at least as well off
and at least one player strictly better off. That is, a Pareto optimal
outcome cannot be improved upon without hurting at least one player.
- Nash equilibrium (NE) -- for a given set of rules (or
strategies) of a large complex system (or a game), if no member (player)
of the system can do better by unilaterally deviating from those rules,
it is a Nash equilibrium. And, it has the following attributes.
- A Nash equilibrium of a system is, in general, not a Pareto optimal.
- If a system has a Nash equilibrium, it is a stable (well-defined) system.
- In a strong Nash equilibrium, no coalition (a group
members of the system) can cooperatively deviate (from the set rules or
strategies) in a way that benefits all its members.
- Any large complex stable system (or game) has, at least, one Nash equilibrium.
- About setting up the rules for a (any) large complex system:
- Question -- Can we implement a set of rules in which all equilibrium outcomes are optimal for a given goal function?
- Weak implementation -- every equilibrium is optimal.
- Strong implementation -- every optimum is an equilibrium.
- Answer -- Yes. We can always implement a set rules for a
system (having more than 3 members) and make all Nash equilibria of
that system to be Pareto optimal if the following two conditions are
- There is no veto rule -- if a system has veto rule, it becomes a monopoly or a dictatorship system.
- It has a condition of Maskin monotonicity (MM) -- that
is, if a rule is selected, it cannot be replaced by a new rule even
though the new rule becomes more prominent in the system.
- Revelation principle -- any equilibrium outcome of a set of
arbitrary rules of a system can always be replicated by a set of
incentive-compatible rules. A set of rules is incentive-compatible if
there is no hidden rules in it.
- Gibbard-Satterthwaite's indeterminacy (GSI) theorem -- For a
(any) given large complex system (game) with a given set of rules, there
are always more than one Nash equilibrium if the dictatorship (the
hegemony or the veto power) is absent.
- Laffont-Maskin's Mismatch theorem -- if a system has a
none-zero intrinsic friction (none-zero viscosity), the strongest power
might not be the winner in that system.
- Diamond-Mortensen-Pissarides (DMP) model -- for a system
having none-zero intrinsic friction, it has, at least, three attributes.
- It always has sub-Nash equilibria (more than one NE), similar to the GSI theorem.
- A leader (who initiates an act) is always more efficient
than a follower in an equilibrium, a consequence of the Maskin
- It will always takes some additional "efforts" (moving
from one bad equilibrium to a good equilibrium) for a follower to catch
up with the leader.
II. The New Theory:
a. Rules of a Market
In fact, the essence of Economics is just one point, "How are prices set for
products?". In traditional theories, it is described with the following mechanism.
If p >> 0 and b >> 0, then a trade can be made at s (the price of a product)
- A seller is willing to sell if F >= p > > 0
P = the minimum profit expected = s (selling price) - c (cost)
Cost = production cost (material, labor, over head, etc.) +
transaction cost ( advertisement, market friction, etc.) + tax
(taxation, common resource cost, etc.).
F is the desirable profit for a seller.
- A buyer is willing to buy if E >= b >> 0
b (buyer's profit) = Bp (the value for the product in buyer's view) - s (the selling price).
E is the enjoyment value from the product for the buyer.
However, in "Linguistics Manifesto", every mechanism is a part of a
self-referential loop. So, when the price of a product (p1) is initially
set with the above mechanism (M1), a self-referential loop will kick
Thus, prices of products are not static but move on dynamic equilibriums, (m1, p1), (m2, p2) , (m3, p3), ...etc..
- Selling side -- new sellers are joining in; new technologies are developed; upgraded products are designed, etc..
- Buying side -- new buyers are coming in, new tastes are developed, etc..
b. The Inner Dynamics of Economy
For any Nash equilibrium, there have two key points in "Linguistics Manifesto."
- All (each and everyone) large complex systems are governed by the "same" set of principles and laws.
- All (each and everyone) large complex systems are composed of in tiers.
Thus, in the physical universe, there is a hyperspace in addition to the
ordinary space. In mathematics, there are imaginary numbers in addition
to the real numbers. In linguistics, all languages are sharing the same
metalanguage. Then, there must be a hyperspace for economics.
As the hyperspace is also a part of the self-referential loop, the laws
in it are similar to its ordinary (base) space. Yet, particles in a
hyperspace do not obey the laws of its base space. However, the dynamics
of the hyperspace does affect the dynamics of the base space via the
self-referential links. With these understanding, a "new" economics
theory can be discussed with three new concepts (ghost, tail and flag).
For an item (a product, such as oil), it has many attributes (its functions, its
substances, its value, etc.). All those attributes roam in the base
space. As soon as one attribute ascends into its hyperspace, it is no
longer bound by the laws of base space. For the convenience, I will call
this flying attribute a ghost of that item (which is in the base
space). At this moment, the only attribute of a product of our interest
is its value. That is, the price of an item is its ghost, roaming in
its hyperspace. Now, we can define two new concepts.
- Tail -- in biology, the function of a tail is for
balancing the entire body. In economy, a tail can carry the weight of
the entire body. For example, the value of the entire stocks of a
company is determined by a very small tail (often less than 1% of the
whole) which is traded in a market.
- Flag -- in warfare, the movement of the flag directs the
movement of the entire army. In economy, the market movements can be
directed by flags.
In traditional Economics, there are types of sub-fields while they are
not analyzed in a tier-structure. For example, oil is a product, and it
obeys the five laws of Adam Smith in a market. However, oil has some
derivatives, the oil options, future, etc.. In traditional theories,
these are simply derivatives or leverages and viewed as new products
which roam (be traded) in the same market and obey the same economic
laws. In this new theory, these new derivatives are viewed as its (oil)
ghosts, tails or flags which roam in a hyperspace and obey a set laws
which have the same forms as the basic laws but are not the same laws as
their dominions are completely different.
Thus, the ghost, tail and flag have much, much more freedom than
counter parts in the base space while they can change the dynamics of
the base space.
In fact, a product (such as oil can have "different" values (prices) at
any instant point in the same market simultaneously. This is why the
attribute of value (price) becomes a ghost which is not bound by the law
The prices of a product are determined by the
interaction between the base space and its hyperspace via a
self-referential loop. Only with this ghost-tail- flag concept, the true
dynamics of economy can be described.
c. The Absolute Principle
In the traditional Nash theories, they are, in fact, pointing out the followings.
- For every single system (or game), it actually has
two or more subgames. For example, the rule book of the chess game is
one game. Yet, the psychological plays in a player's mind is another
game on a chess game.
- While by definition that no player or a group of players are
able to gain with any unilaterally changed action in a NE, everyone is
able to gain by moving from a bad NE to a good NE in a given system.
These are, seemingly, contradictions. Yet, in "Linguistics Manifesto", there are two key points.
- Every large complex system must encompass all contradictions.
- An absoluteness will always emerge from those contradictions with a process of renormalization.
The absoluteness which must emerge from the above Nobel economics is a
"Cheating Principle" -- No one can make any gain by cheating in a (any)
large complex system (game). Any act which violates or ignores the rules
(one or more) of the system is a cheat. The most often cheat is that
someone ignores a part of the system (game) by playing only the part he
knows about. In the case of chess game, a computer with a brute
computation power can win the game without concerning the psychological
strategies as the chess game universe is relatively small. For a "Go"
game, the computation power alone will never count for anything.
In the 1750s, China's power has reached a zenith point. Its GDP was
about half of the world total. Its land territory increased more than 4
fold (400%) in comparison to the Ming dynasty. The Emperor told the
Ambassador of British, "China has everything and needs nothing from the
outside world." That is, China ignored a big part of the game, the
advancement of the Western world. By playing only half the game
(system), China's demise did come just a few years later in 1842. In
1960s, Mao had mobilized China to a boiling point in a "closed" China.
Yet, China remained poor and backward. After 1979, China began to play
the "whole" game by learning and participating in the Western games. In a
short 30 years, China is now the second largest economy in the world.
The fact is that one (regardless of who he is) will not win the game if
he is only playing the partial game, especially if the size of two parts
has no huge difference (less than 10 to 1). When two economies meet,
every single game has two subgames. Instead of learning Chinese game, we
call it an unfair play, an uneven playing field. By only playing the
half-game, the US-China trade imbalance has reached a point of damaging
America's national security.
Of course, if we can eradicate the Chinese game completely, then we will
be okay. Yet, there is no chance of annihilating Chinese culture (which
is a major part of her game) in a foreseeable future. Perhaps, we
should try to understand the true essence of the makeup of Chinese game.
An article at http://www.chinese-word-roots.org/cwr017.htm can be of a help on this.
III. Applications of this New Theory
a. Jobs and Unemployment
Job is a very special product. By knowing the dynamics of the job
market, the laws of the economics can be wholly understood.
The job market is controlled by the following laws and variables.
The above facts are known by any economist. However, there are a few key
points which are the direct consequences of the principles of
"Linguistics Manifesto" (LM).
- Law of demand / supply
- Demand is decided by
- Creativity and technology
- Business cycle
- Supply is decided by
- external force -- unemployment insurance, welfare, etc.
- international trade
- Market (field) friction
- information friction
- location friction
- Business cycle
- creativity and technology
- market failures
- International trade
- opportunity cost
- comparative advantage
- size of the economies
- External force
- unemployment insurance
- welfare programs
- Market failure
- traditional failure -- monopoly, incomplete markets, too high of social costs, ...
- breakage of the self-referential loop
- Mis-march -- the supply is not needed by the demand
The traditional economics is viewed as an empirical phenomenology which
studies the broad observational data instead of doing controlled
experimentation. Thus, the theories of economics are viewed more
tentative than physical sciences. Yet, in LM, the above difference is
not the key point of separating the two sciences. The major point is
about the language being used.
While the traditional economics theories do use the mathematics tools,
such as, variables, functions and equations, they do not use the concept
of "Charge" and others which are used in physics. However, in this LM
economics, those concepts are the major part of the theory. Please visit
the following page for details,
- They are not just interlocked but are parts of the self-referential loop.
- In LM, there is an Antidote principle -- the substance X is an
antidote for substance Y, Z. etc., but it can never be an antidote for
itself. Thus, the unemployment insurance and welfare programs can never
improve the job market.
- In addition to the intrinsic market friction, the mis-march is
the major factor to prevent any market mechanism to produce the full
employment. This is, again, the consequence of LM. In physics, there are
two types of elementary particles, boson and fermion. In any "Hole
(job) and Particle (applicant) model," there is no mis-march issue for
boson. That is, any boson (un-skilled labor) can fit into any kind of
hole (non-technical job). However, for fermions, they can only fit into
holes which accept their spin charge. Thus, even in job market, the
concept of "Charge" must be introduced.
b. The Market Failure
Traditionally, market failure is about the monopoly, the incomplete
market and over-regulations, etc.. Yet, the recent financial crisis of
2008 can be analyzed easily with this new theory.
Ricardo pointed out that Adam Smith gave out two conflicting definitions of the relative value of a product;
- the price of a product is the toil and the trouble of acquiring it,
- the price of a product is that it can impose upon other people.
For Smith, the difference between these two definitions are not too great;
- one is the cost of production,
- the other is the utility value to a consumer.
In this new theory, a product can have many different prices simultaneously in the same market;
- one is the cost of production -- the base value,
- the others are determined by tails and flags, and these prices can be much higher or lower than the base value.
Those tails and flags are self-referential parts of their base products.
As they are roaming in a hyperspace, they have much, much more freedom
than their base particles. However, these two spaces are linked via the
self-referential loops. If such a link is broken, the hyperspace
collapses. The financial crisis of 2008 was simply caused by a too high of a
housing price which was no longer able to be supported by the base
For a house X, it has an original price Opx. While it is not in the market itself, a tail (about 1%) of the market was traded, and this tail action pushes the opx to a higher level Tpx (tail price of house X). That is, there is a net profit of pfy for house X, and this net profit is not a result of any effort nor any toil done on the house X; it comes out of the blue, the action of a tail. Thus, a tail of a market can either create or destroy wealth for the entire body of that market. Obviously, this tail action is quite different from the concept of leverage. A tail is a ghostly force which can create or destroy out of the blue, without any real change of a market in its base space.
Although this ghostly force has much more freedom than the particles in the base space, it is still linked to the base space via the self-referential loops. If that linkage is broken, this ghostly force must change its direction to regain the linkage. Its destructive force is just as huge as its creative force.
This concept of economic hyperspace and ghostly force of tail and flag was never addressed by any traditional economics theory in such terms but is new from this new Economics Theory which is, again, the direct consequence of the "Linguistics Manifesto."
c. The Currency Exchange rate and the International Trade
Pushing the value of RMB (Renminbi) higher is, now, a joint effort among
Whitehouse, Capitol Hill and the entire American intelligentsia (the
academic and the media) with two major reasons.
- The claimed reason -- the artificially undervalued RMB is the
major cause for the trade imbalance for America with the grave
consequence of losing millions of American jobs.
- The unstated reason -- by pushing up the value of RMB, America
will get an instant debt reduction as the value of T-bill in China's
hand will lose significantly instantly.
Yet, the higher value of RMB will definitely have the following consequences.
The following principles are direct consequences of LM.
- All (each and everyone) Chinese people will instantly
become richer. Then, even some poor Chinese with this godsend gift of
wealth from America are, now, able to scoop up some great America assets
(such as, real estate) dirt cheap. Yet, we are so thankful for their
investing in America.
- The trustworthiness and the prestigiousness of RMB was
instantly enhanced by our action of proving that it has undervalued
repeatedly. A few years ago, RMB had a zero chance to become a
creditable international currency, let alone to be the foundation for
Asian dollar. Again, with our repeated guarantee that RMB is a very
trustworthy currency, in a few more years, the financial institutions of
East Asia will simply become branch offices of China's banks. That is,
we have dug our own grave to end American dollars as the only world
- The entanglement principle:
- Definition -- If variable B is a compound function of (x, y), then B is entangled with (x. y).
- Principle -- The effect of B can be adjusted by
manipulating either x or y.
Thus, for the claimed reason -- the artificially undervalued RMB is the
major cause for the trade imbalance for America with the grave
consequence of losing millions of American jobs, the (adverse) effect of
higher RMB value on China can be easily canceled out by some entangled
variables, such as,
- the material cost will be significantly reduced for China's exporters,
- the enriched Chinese poor people can become new buyers for those better quality export items,
- the overhead cost in the America will be reduced for those Chinese exporters.
The net effect is that the higher RMB will not have much adverse effect
on China's exporters. About three years ago, the RMB was 8.27 to 1 with
US dollars, yet, US- China trade imbalance widened today while the ratio
is now 6.6 to 1.
- The mutual immanence principle:
While the opposites or
the contradictions are viewed as demons in mathematics, they are
permanently confined and mutually immanent between each other in the
"Linguistics Manifesto". That is, if variable B has power X in the field
F, then -B has the same power in that field. Thus, for the unstated
reason (by pushing up the value of RMB, America will get an instant debt
reduction as the value of T-bill in China's hand will lose
significantly instantly), China can scoop up much more T-bill dirt cheap
from then on, which has unbound profit in comparison to a fixed amount
- The richness principle -- no side effect of any kind of
richness cannot be remedied by the richness itself.
The "Linguistics Manifesto" is not just about languages. Its principles
are universal, applicable to all fields. While we can ignore the above
facts, we cannot escape from the omnipotence of the above principles.
Paul Krugman (Nobel Laureate) wrote, "A government is trying to maintain
a fixed exchange rate despite some fundamental imbalance that makes
such a peg impossible to maintain in the long run." Thus, if China has
artificially undervalued its RMB, she will definitely face a dire
consequence sooner or later from the omnipotent force of the economic
According to this new theory, the issue of US-China trade imbalance
rises solely from the "Cheating Principle." We are simply cheating
ourselves by playing only the half-game. If we continue to play only a
partial game (my way or the highway), our chance of winning is not very good.
Furthermore, for any economy, the most important flag is its currency,
according to this new theory. If that flag falls, that economy
collapses. For winning the competition of any trade game, there are
many ways to do it. Yet, to strengthen the competitor's flag can never
be a smart move regardless of the fact of how many immediate spoils
which we can scoop up.
Yet, someone might say that we have done Japan in with the exact such a strategy, pushing the Japanese Yen from 400 to 1 to the current ratio. And, the Japanese economy has been in a dungeon ever since, for almost 20 years now. But, it is because that the Japanese yen was and still is genetically handicapped with the following reasons.
- Japan is simply a too small of a country on both her population and her landmass.
- The most of the Asia countries (China, Korea, and South-East Asia countries) will never accept the leadership of Japanese Yen because of the nightmare memory of the World War II.
- The Western countries do not give too much care for Yen in one way or the other.
On the contrary, China is an entirely different species with a completely different genetic makeup. President Clinton once said, "in terms of the experience on hegemony, China-US ratio is two millenniums over half a century" (in paraphrase). To strengthen the Chinese flag has only one outcome, to do American dollar in.
The traditional economics is defined by many sub-fields:
Although there are links or interlocks among those sub-fields, no
definite tier-structure nor self-referential loops are identified in the
- Managerial economics
- Financial economics
- Monetary and fiscal policies
- National accounts
- Positive vs normative economics
- Orthodox vs heterodox economics
- National vs international economics
On the contrary, this new Economics Theory is based wholly on the principles from "Linguistics Manifesto;"
The "Large Complex System Principle" (LCSP) -- there is a set
principles which govern all large complex systems regardless of whatever
those systems are, a number set, a physics set, a life set or a
Corollary of LCSP (CLCSP) -- the laws or principles of a
"large complex system x" will have their correspondent laws and
principles in a "large complex system y."
- Every large complex system is constructed by self-referential loops, and it forms tier-structure. And, it is;
- Every large complex system must encompass all
contradictions, and an absoluteness will always emerge from those
contradictions with a process of renormalization.
Furthermore, the governing principles;
- Cheating principle,
- Antidote principle,
- Entanglement principle,
- Mutual immanence principle,
are not economic specific principles. They are general principles,
applicable on any large complex system. Thus, economy is no different
from any other large complex systems, physical universe, the number
system, the linguistic systems, etc.. Indeed, this new Economics Theory
is the direct consequence of the "Linguistics Manifesto".
Note: The book "Linguistics Manifesto" is, now, published (115 pages, ISBN 978-3-8383-9722-1) and is available at
many university libraries.
- Barnes & Noble