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Tuesday, July 27, 2010

The Economy: A Closed or Open System...

The first law of thermodynamics (aka the conservation of energy principle) says that energy is neither created nor destroyed.  This central principle of physics featured prominently in the texts used by Leon Walras and William Jevons when they were developing the mathematical economics that underlie general equilibrium.  There is also a second law of thermodynamics that states that entropy (a measure of disorder/randomness) is always increasing.  Coincidentally the second law of thermodynamics was not well understood at the time that Walras and Jevons were developing their ideas on general equilibrium.

Thermodynamics also recognizes two types of systems: closed systems and open systems.  Closed systems are those systems that do not react, interact, or communicate with any other system (i.e., there is no energy, matter, information, etc flowing out of a closed system).   Within a closed system energy may be converted from one form to another, but it is neither created nor destroyed (via the first law of thermodynamics) and (via the second law of thermodynamics) the system will tend to a state of maximum disorder or entropy where it will come to a rest.  Open systems, on the other hand, are different.  Energy, matter, and information flow into and out of an open system.  Open systems can harness the energy flowing in to create structure and order temporarily, but over time via the second law of thermodynamics disorder reigns supreme.  In open systems there is a constant tension between energy fed order creation, and entropy driven order destruction.

Closed systems always have a predicable maximum entropy equilibrium (although the dynamics by which the system reaches this equilibrium can be quite complicated).  Open systems on the other hand may display equilibrium behavior...or they may display sustained disequilibrium behavior, wild oscillations, exponential growth, punctuated equilibrium dynamics, chaotic behavior, etc.  Closed systems will tend toward an equilibrium state of maximum disorder and do not have the ability to self-organize the way open disequilibrium systems do...

So...is the economy best characterized as a closed equilibrium system or an open disequilibrium system?  I urge you to answer this question for yourself, as it has fairly profound implications as to the type of economics (particularly macroeconomics) that you should spend time studying.  But before you spend a great deal of time pondering...take 30 seconds and look out the nearest window.

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