Saturday, May 19, 2018

371. Entropy of markets

Concerning entropy in markets, economics is ambivalent. For the economist the essence of the market is competition, and in what the economist calls ‘perfect competition’ there are many alternative products with the same function, that can ‘substitute’, replace each other, and thus compete. That restricts profits and presses for efficiency, as a public good. Here, entropy is high, because there are many similar products.

On the other hand, there is innovation: novel products that sharply distinguish themselves from established ones. If the innovation is successful, it will push out established products, so that the total number decreases. For that reason, and because of its distinction, its ‘sticking out’, innovation decreases entropy. It is, so to speak, the life of the economy, as poetry is the life of language. And then, in due course, competitors appear who imitate the novelty, and entropy rises again.

When the market is ‘imperfect’, as in monopoly, competition stalls and entropy is low, here, not from yielding a unique new product, but from restricting the number of alternatives. It is the task of public ‘competition authorities’ to prevent that.

Now, will one still say that low entropy is the ‘life’ of the system? Or should one distinguish between the number of alternatives, in competition, as ‘good entropy’, and the unicity of one of them, in innovation, as ‘good negentropy’, and call only the latter the life of the system?

In my work, and in this blog, I presented a ‘cycle of discovery’. At one point of the cycle we have the situation of ‘consolidation’: a previous innovation has settled down, in its diffusion and imitation in the economy, yielding high entropy. To decrease entropy again, towards a new innovation, practice has to move to a new ‘selection environment’, in evolutionay terms, with different practices that the existing product is faced with. The crux of that is that it yields novel challenges of survival, pressure to change (necessity being ‘the mother of invention’). Also, the new environment, precisely where the old product fails, yields indications in what directions to change. This illustrates the need for variety for innovation to occur: novel information to expose inadequacies and new opportunities.
This initiates a set of further steps towards new negative entropy, in a new innovation, which then, after a while, moves on to a erosion of negative entropy, in diffusion, where entropy creeps in again. I discussed this in more detail in item 138 in this blog.  

In this way, the cycle becomes a cycle of high to low entropy, feeding on novelty from a new environment, and back again to high entropy, in the diffusion of novelty. It becomes a cycle of life, found also in natural life and death.

This cyclical process is an alternation of stability and change. Only stability would stifle life, but only flux would break it up. 

In a famous debate, in the 1950s, between Popper, Kuhn, Lakatos and Feyerabend, Popper, the champion of falsification as a criterion of science, had to admit that under empirical contradictions of a theory one should not instantly consider it falsified, because a certain conservatism, in ‘milking the theory for all it is worth’, even under an accumulation of anomalies, shows up ‘where the real limits of its validity lie’, and, I would add, gives indications of possible new contents and directions to develop a new theory.

So perhaps this is how the economy should also be seen: as an alternation of increase and decrease of entropy.