What is a price??? People use them every day, but they seldom think about what it is. It is, of course, a measurement. But a measurement of what? It is a measurement of value. But this just leads us to another question—what determines the value?
For a long time, the answer was thought to be the amount of labor, perhaps combined with materials. As Adam Smith put it, “The real price of every thing, what every thing costs to the man who wants to acquire it, is the toil and trouble of acquiring it.” (p. 101) Most classical economists followed suit. But it turned out that labor was not so easy to measure:
…unlike something like mass, labour isn’t easily measurable. For example, Smith equated the cost of gold with the labour required to extract it – but how did that square with the fact that most of the gold in circulation had been mined by slaves? for more sophisticated goods – say, an iPhone – it is even less clear how to add up the various sources of labour. Obviously there are the company’s employees, its suppliers, and so on, but where do you draw the line? Many of its technologies (such as internet capability, GPS, touchscreens, cryptography) were based on government-funded military technologies, so how do you factor that in? What about the basic science behind those technologies? What about the free websites such as Wikipedia, or open-source software, or digital information in general, which add value to the iPhone? And so on.
Labour is also subjective in other ways. How do you compare the labour value provided by a CEO who has just received a multi-million-dollar payoff in return for leaving a money-losing company (there is no shortage of examples) with the hard graft provided by an undocumented farm worker, or for that matter someone assembling iPhones?…Because labour is not directly measurable, one consequence is that the theory as a whole, including the invisible hand mechanism, is unfalsifiable in the sense that it can never be disproved by experiment. A broader point is that…there is no direct mapping between numbers and value…pp. 102-103
And so economists invented the concept of utility—how much use value someone derives from an item.
The concept of utility was first proposed in the late eighteenth century by Jeremy Bentham, the English philosopher and social reformer, who defined it as that which appears to ‘augment or diminish the happiness of the party whose interest is in question.’ Society’s purpose, Bentham argued, was to satisfy the ‘greatest happiness principle’ – i.e. provide the greatest happiness to the most people. The goodness of an action could be assessed by adding together its positive and negative effects on the people involved.
Bentham’s aim was to put social policy on a rational, enlightened basis. Neoclassical economics promised a way to do this, by expressing utility in terms of mathematical laws. Of course, utility was completely subjective, and even harder to measure than labour – but again that didn’t matter. The aim of utility theory was not to incorporate subjectivity; it was to replace it with numbers, which is not quite the same thing. p. 104
But even this did not explain everything. This was exemplified by the diamond/water paradox proposed by Adam Smith. Water is not only useful, but essential–we need it every single day or we will die. And yet it is relatively cheap, even free. Diamonds are utterly useless (except for things like industrial drills). Yet they sell for a fortune in jewelry stores.
We know prices to be connected to value, but how does it work? Why are the cookies made by your grandmother free, but the ones in the store cost money? Or put another way: if money is measuring something, what is it measuring?
So, exasperated economists threw up their hands and finally settled on the theory of marginal utility and called it a day. Marginal utility brings in the concept of the margin—a small increase in the quantity of something. The marginal utility of a the first slice of pizza is quite different from the tenth slice (the tenth slice being at the margin). If we just crawled out of a desert we would pay almost anything for a tall glass of water (assuming we had the misfortune to crawl into a libertarian compound), but probably nothing for a diamond ring at that moment. As Britannica summarizes, “[W]ater in total is much more valuable than diamonds in total because the first few units of water are necessary for life itself. But, because water is plentiful and diamonds are scarce, the marginal value of a pound of diamonds exceeds the marginal value of a pound of water.”
One of the founders of what was termed the “marginal revolution” was William Stanley Jevons (of Jevons’ Paradox fame).
As Jevons argued, if utility is equated with value, then it can be measured through price. He wrote: ‘I hesitate to say that men will ever have the means of measuring directly the feelings of the human heart. A unit of pleasure or of pain is difficult even to conceive; but it is the amount of these feelings which is continually prompting us to buying and selling, borrowing and lending, labouring and resting, producing and consuming; and it is from the quantitative effects of the feelings that we must estimate their comparative amounts. We can no more know nor measure gravity its own nature than we can measure a feeling; but, just as we measure gravity by its effects in the motion of a pendulum, so we may estimate the equality or inequality of feelings by the decisions of the human mind. The will is our pendulum, and its oscillations are minutely registered in the price lists of the markets.’
The economy could therefore be modeled using what Jevons called ‘a mechanics of utility and self-interest,’ similar to Newtonian mechanics. More precisely, exchange prices were determined by marginal utility, which took into account a person’s current state – you will pay less for a loaf of bread if you already have as much as you can eat. When the transaction is complete, both parties ‘rest in satisfaction and equilibrium, and the degrees of utility have come to their level, as it were.’…Today, economists often prefer to work instead with preferences, which simply rank things or desires in order, but utility is still seen as a mysterious, unmeasurable, subjective quantity which individuals aim to maximise (a word invented by Bentham) through economic exchange, subject only to budgetary constraints. Perhaps the most famous description of this process is supplied by what Jevons called ‘the ordinary laws of supply and demand.’pp. 104-105
The law (or laws, as it is sometimes called to distinguish the two components) of supply and demand is…a graphical representation of [Adam] Smith’s invisible hand. If the price of some commodity is too high for whatever reason, then more suppliers will enter the market, while at the same time demand will fall. The result will be a surplus of supply, which will bring the price down. Conversely, if prices are too low then the combined response of and demand will push them back up again.
In fact, the only real difference is that utility has been substituted for labour as the presumed source of value. Since neither can be measured directly – only inferred from prices – this has no effect on the equations. Money has no role, other than as a book-keeping device for things like prices or budgetary constraints, so has dropped out of the calculations altogether, with any increase in budget leading only to increased consumption,” Genuine subjectivity has also been removed; individuals are treated as a black box, in the sense that the reasons for their motivations are left alone, but at the same time their actions are reduced to the maximisation of an equation. p. 106
This, then, represents the mathematical foundations underpinning modern economic “science” (hence my oft-used scare quotes). It is (still) based on Newtonian classical physics. It assumes people are “particles”: highly rational actors constantly attempting to maximize their ‘utility’ (an invented phantom quantity). It argues that prices are fixed entities that are “naturally” headed towards equilibrium (a magic number where supply = demand), assuming no “interference,” of course. And it assumes money is just a neutral medium of exchange with no effects on the underlying economy.
To make people as regular and predictable as elementary particles in physics, economists invented the concept of Homo economicus—rational economic man. Rational economic man makes rational decisions based on perfect knowledge according to his or her utility—utility being defined as above. Rational economic man is also purely selfish, looking out for only his own satisfaction and no one else’s. The rational economic man consistently asks only one question: “What’s in it for me?”:
When neoclassical economics was first developed in the late nineteenth century, the idea was to literally translate concepts from Newtonian physics into economics, to produce what the French philosopher – and founder of sociology – Auguste Comte had called a social physics: A property of Newtonian dynamics is that it can be expressed mathematically as a kind of optimisation problem: objects moving in a field take the path of least action, where action represents a form of energy expenditure.
For example, the diffraction of light through a glass prism can be viewed as light waves (or individual photons) taking the most efficient path. Newton’s contemporary, Gottfried Wilhelm Leibniz, explained the idea by comparing God to an architect who ‘utilizes his location and the funds destined for the building in the most advantageous manner.’ Following the same script, neoclassical economists assumed that in the economy, individuals act to optimise their own utility by spending their limited resources. Economists could then make Newtonian calculations about how prices would be set in a market economy, to arrive at what William Stanley Jevons called a ‘mechanics of self-interest and utility’. p. 176
The equating of mechanics with economics was illustrated in the 1892 book Mathematical Investigations in the Theory of Value and Prices by Irving Fisher, which was based on his Yale thesis (he was awarded that university’s first PhD in economics)…Economic agents were viewed as particles, while the marginal utility or disutility for a particular commodity (defined as the satisfaction gained from consuming one more unit of it) was viewed as a force acting in a kind of commodity space...
But the idea of people acting rationally has been substantially undermined by modern psychology. People are hardly rational. They are full of various ‘cognitive biases’ and errors. They use rules of thumb and simplification. They do not have perfect knowledge or judgement. They are often highly irrational. They are sometimes selfish, and sometimes altruistic. They are social animals, and therefore vulnerable to social pressures and herd behavior. While there is a branch of economics that theoretically studies this (behavioral economics), none of its conclusions have been incorporated into fundamental economic concepts or models.
Now, if physicists’ fundamental model of the particle were to be somehow disproved, then how could the entire field not be called into question? Yet this never, ever happens in economics. Instead, it’s just swept under the rug as “necessary simplifications” with a few minor exceptions that can safely be ignored. This wouldn’t be a big deal, except for the fact that economics is supposedly the principal determinant of the social order according to politicians. We exist for the health of the economy, not the reverse.
Indeed, the libertarian’s entire philosophy and world view is dependent upon this idealized clockwork mechanism operating as smoothly as the orbit of planets around the sun or the falling of objects in a vacuum.
One big idea in the book is that prices are actually a quantum phenomenon. Prices have no objective, independent existence apart from our observations; prices can only decisively determined at the time of sale. Before said sale, it is an ‘indeterminate’ quantity—existing in theory, but impossible to be pinpointed with 100% accuracy. Only once the transaction is completed does the price becomes reified and measurable in various currencies.
Orrell makes an analogy with quantum physics, where a particle’s speed and position are unknown and indeterminate until it is observed and measured. We can, for example, assign a position or direction to a particle (but not both). It only exists in a range of potential; once a transaction is completed the potential ‘collapses’, into a fixed number we call ‘price’, but before that it’s properties are indeterminate, not fixed.
The diffuse nature of the wave equation meant that the true state of a particle could never be completely nailed down. The German physicist Werner Heisenberg argued that it therefore made no sense to speculate about what was going on inside the atom. The true state of a particle was unknowable, and all we had were observations, which were subject to inherent uncertainty because of the wave equation. He quantified this with his uncertainty principle, which stated that the more accurately a particles position was measured, the more uncertain was its momentum, and vice versa. p. 34
Think of items at a yard sale or an estate sale. Having conducted a number of these this past year, I can tell you that there is no set value—and hence no absolute price—for any item. An item is only “worth” what someone agrees to pay for it; before that it is just an indeterminate idea or concept, and one that is often quite wrong.
Of course, when we go to a store, we see prices on everything. This tricks us into thinking that prices are some sort of absolute value measurement like temperature or distance. But even these “set” numbers are only theoretical until someone actually purchases the item—that is, the money exchange takes place. Until that event takes place, prices are imaginary. Think of stores selling highly inflated prices for bottled water just before a hurricane, or slashing the prices of items like turkeys after Thanksgiving.
For example, what is modern art really worth? Why are the paintings of Van Gogh, which were literally worth noting in his lifetime, now auctioned for millions of dollars? What some people see as random splotches on canvas, others are willing to pay top dollar for. While this may be an extreme example, even a casual glance at Craigslist or eBay will confirm that value is not so easily mapped to prices, even at the margin.
I would argue that value is inherently a subjective quality, and thus impossible to determine! In that sense, it is analogous to beauty, which is also inherently subjective. While some things can be classified as objectively beautiful with a high degree of certainty (say, Renaissance paintings or Classical sculpture); others are much more de gustibus (i.e. ‘in the eye of the beholder’). However, we do not profess to measure beauty by an absolute, numerical scale. Nor do we claim that it is regular and predictable, or that it can be modeled accurately.
But the key point is, if price is an indeterminate quantity, then the smooth supply and demand curves used by Neoclassical economists (which treat prices as stable and heading towards equilibrium) are not valid. Instead, prices are better described by the principles of quantum physics:
The transaction is rather like the measurement process in physics, where we measure – put a number on – the position of a particle, or record how far it moves in a certain time. Even there, we know from quantum physics that position and time are not simple, linear, external quantities. They warp and connect and break into small parts. In other words, they are not like number. Measurement is a far more complex procedure than appearances suggest – hence the uncertainty principle.
Money therefore acts in markets as a measurement device: a means to collapse the estimate of an assets value down to a single point, akin to the process of wave function collapse which occurs during quantum measurement. Rather than measuring labour, or utility, it is measuring money, which in quantum economics is treated as a fundamental quantity (it might be made-up, but so is the economy, and money at least has well-defined units). Like a photon, a money object is not an inert particle, but a quantum entity in its own right which affects what is being measured.
…The economy as a whole can be viewed as a giant market where producers’ asks are being reconciled with consumers’ offers. As individuals we may usually feel like pricetakers, paying whatever our budget can afford, but as a group we act so as price-makers. Our bids are constrained and channelled by price lists and conventions, but nothing is set in stone, and there is always an element of uncertainty…supply and demand cannot be neatly separated, but are two aspects of a coupled system. pp. 116-117
This view of prices demolishes the whole idea of supply and demand curves which stand at the heart of Neoclassical economics. Rather than markets “naturally” heading towards equilibrium, Quantum Economics argues that the economy is inherently unstable, using examples from unorthodox thinkers like Frederick Soddy and Hyman Minsky. That’s why, he argues, “the most appropriate models for economics tend to be based on mathematical techniques such as complexity and network theory that have proved useful for the study of complex organic systems in general.” (p. 49)
[An economics] textbook…explains that ‘A good way to think about the market equilibrium is to imagine that the demand curve is blue, that the supply curve is yellow, and that the only color we can see in the real world is green.’ The market equilibrium comes at the point where the two curves intersect, and the punch line – yellow and blue makes green! – carries an important lesson: the green dot has no independent existence of its own, and it doesn’t move unless either the yellow line or the blue line moves.
…Even though textbooks routinely claim that these lines have been empirically measured, (and people have certainly tried) it is in fact impossible to properly measure a ‘supply curve’ or a ‘demand curve’ – all we can do is measure transactions at a particular price (the green dots) and the result we obtain will include the effects of both supply and demand, is. We are therefore trying to tease out the values of two variables – supply and demand- from a single number, which doesn’t work (in mathematics this is known as the identifiability problem). And in fact there are plenty of reasons to believe that it makes no sense to view supply and demand as stable (for a time) and separate entities, rather than as parts of a coupled dynamic system.
As Orrell sums up in an online article for Aeon:
To sum up, the key tenets of mainstream or neoclassical economics – including such things as ‘utility’ or ‘demand curves’ or ‘rational economic man’ – are just made-up inventions, no more real than the crystalline spheres that Medieval astronomers thought suspended the planets. But real things like money are to a remarkable extent ignored.
Economics is quantum (Aeon)
Indeed, real things like money are indeed ignored in economics, to the surprise of most laypeople (i.e. outside of the “priesthood”). Economic “science” considers money to be nothing more than a neutral medium of exchange—just a convenient item to facilitate transactions. The total amount of this intermediate item in existence may effect prices to some degree, but the fundamental nature of the item itself (precious metals, paper, cowrie shells, iron nails, Newfoundland cod)—and how it is brought into existence—does not matter; only the exchanges do.
This grows out of the orthodox origin story of money as merely an intermediate item that can exchanged for all other items in an economy to facilitate barter transactions. So economists study only the transactions and ignore the role of money; it is just a “veil” over what is essentially a barter economy at heart.
…what does money do?…Most economists, the answer has long been very simple – nothing special. Money is just an inert chip with no special properties of its own. To understand the economy, economists should not focus on money – in fact, they should do the opposite, and ignore its bewitching and distracting activities…This attitude was born in part from the Aristotelian creation myth that money evolved as a substitute for barter, so it was just another commodity that could be exchanged like any other. As Paul Samuelson wrote in Economics, ‘if we strip exchange down to its barest essentials and peel off the obscuring layer of money, we find that trade between individuals and nations largely boils down to barter.’ But it also reflected a Newtonian view of the economy as a mechanistic system, in which the two sides of money were collapsed down to a single point, and money became no more than another inert particle to be held or exchanged. pp. 99-100
Quantum Economics argues that money should be a fundamental element of economic analysis. Furthermore, it embodies multiple, simultaneous qualities, just like light can be described and modeled as both a wave and a particle—both/and as opposed to either/or. Both of these “mental models” can be used to understand light. Similarly, money embodies multiple qualities at the same time. We can choose which model or aspect to examine for our purposes—medium of exchange, store of value, or means of denominating debts, etc.
Throughout its history, money has alternated between these two sides, presenting either as a virtual system for accounting (clay cuneiforms in ancient Mesopotamia, wooden tally sticks in early Medieval England, electronic money today), or as a treasured thing (Ancient Greece and Rome, the gold standard), while retaining the essential characteristics of each. The dichotomy is also reflected in our two main theories of money: chartalism, which says that money represents a virtual debt to the state; and bullionism, which says it boils down to metal. Most economists ignore the debate and treat money as an inert medium of exchange with no special properties of its own. The situation therefore resembles the old debate about whether light was a virtual wave (Aristotle) or a real particle (Isaac Newton). Eventually, quantum physicists came to the conclusion that light isn’t a particle or a wave, it is both at the same time. Most people didn’t care, and just worried about keeping the lights on, and so it is with money.
Economics is quantum (Aeon)
There is a good section on the history of money. Quantum Economics examines what’s sometimes called the Endogenous Theory of Money. That is, banks do not lend money that’s already in existence that has been deposited with them. Rather, new money is brought into existence anytime the bank initiates a new loan.
Mainstream economists, remarkably, do not believe that this is true (despite the banks admitting to it). They instead argue that it is fractional reserve banking which increases the money supply. That is, banks can loan in excess of what they have on deposits (holding, say, only 10 percent of a loan amount on deposit). When that “new” money is subsequently deposited elsewhere, it can be used as a deposit for further loans.
But in reality, the banks are not constrained by the amount of money on deposit in their vaults and on their spreadsheets at any given point in time. Instead, they first make the loans, and then secure enough deposits to cover their reserve requirements. Where do these new deposits come from? From the central bank, of course! They simply ask for it.
So that means that the amount of money circulating in an economy is inherently connected to the amount of overall debt. As debts grow, so too does the amount of money in circulation. If there is too much money circulating for proper investment, it can lead to bubbles—particularly asset bubbles. People buy assets which are increasing in value not because they derive any utility from it at all (for example, an empty flat in London), but because they can use the appreciation of the asset’s value to get more money.
…Since money is created by private banks when they issue debts, a flip side is that when the debts are repaid, the money just disappears back into the void, like a particle annihilating with its anti-particle. As noted by the Bank of England, Just as taking out a new loan creates money, the repayment of bank loans destroys money… Banks making loans and consumers repaying them are the most significant ways in which bank deposits are created and destroyed in the modern economy. So unless new loans are constantly created to replace these funds, the money supply will shrink, further exacerbating a downturn. p. 133
…The most obvious reason for omitting the pivotal role of banks…was because economists wanted to keep money out of the equation. Only by doing so could they maintain the pretense that the economy is some kind of barter system based on rational exchange. Just as subjectivity is considered taboo in sociology, so the emotion-laden topic of money creation is taboo in economics. More troubling, perhaps, are indications that attempts were made to obfuscate, as if authors were at times willfully trying to confuse their audience and lead them away from the important insight that each individual bank creates new money when it extends credit…p. 134
Consequently, a capitalist market economy is a highly complex, interconnected, dynamic, stochastic system. Thus, it cannot be modeled by the tools of classical physics with its Classical pretensions of exact measurements and deterministic, interacting particles. With this flawed conception of market economies, it’s no wonder economic models have failed to make accurate predictions. Having documented the problems with the concepts and worldview of orthodox economics, much of the latter half of the book is devoted to analyzing the failures of economists to predict recurrent financial panics and crashes.
Economics is often compared to meteorology, and even sometimes models itself after that field. William Stanley Jevons wrote in 1871 that economics would become ‘a science as exact as many of the physical sciences; as exact, for instance, as Meteorology is likely to be for a very long time to come.’… p. 229
The most obvious difference between the weather and the economy, from a forecasting perspective, is that we create, and have some direct control over, the latter. Recessions are not random storms that come out of nowhere, as economists like to portray them, but are things that we take part in and can take steps to actively prevent. Economists are also entangled financially with the system they are studying. Viewed this way, it is true that it is not completely fair to compare economics with weather forecasting. Economists’ responsibility is far greater, and is more like that of engineers or doctors – instead of predicting exactly when the system will crash, they should warn of risks, incorporate design features to help avoid failure, know how to address problems when they occur, and be alert for conflicts of interest, ethical violations, and other forms of professional negligence.
Its failings in these areas, rather than any particular forecast, are the real reason so many are calling for a genuinely new paradigm in economics, as opposed to a rehashed version of the old one. And the danger is not pluralism (doctors don’t always agree either), but a monoculture based on flawed ideas. Macroeconomic forecasting might be a relatively small part of economics, but its missed predictions and mis-analysis, with their dramatic real-world consequences, are just the most visible and concerning symptom of a deeper problem which starts with the basic assumptions, and affects other branches of mainstream economics. pp.257-258
What this means, Orrell ultimately concludes, is that the concepts derived from quantum physics have much to contribute in fixing the conceptual errors in the conventional Neoclassical economic framework. But while physics is actively incorporating quantum models into its framework, economics remains resistant to any change or development. Perhaps this is because the tenets of the current economic pseudo-science is so very amenable for protecting and promoting the interests of the already rich and powerful around the world.
If quantum economics has a central principle, though, it is that it is not possible to take this kind of detached, impersonal view of the economy. We are entangled with each other and with the economy as a whole, and our subjective judgements about value both define the economy, and are shaped by the economy. The quantum T has an independent, localised, ‘particle aspect’, but also a diffuse and entangled ‘wave aspect’ – in a very real sense, we are not just influenced by, but are actually formed by our relationships, especially when money is involved. This quantum objectivism, if we call it that, might sound a bit mystical, but really it is a more realistic version of Randian objectivism: reality has a quantum nature that is dependent on consciousness; one cannot always attain knowledge about this reality through the use of inductive logic; the purpose of life is more than the pursuit of one’s own happiness; individuals are entangled. And as we have already seen, it has a number of practical implications for the field of economics… p.301
Quantum Economics Paper at Real World Economics Review (PDF)