Agent-based modeling, a new approach favored by computer science types, is much more likely to prove useful than the general equilibrium modeling of traditional economics precisely because markets are nothing like the models economists traditionally use.
Though computationally intensive at a minimal level, agent models scale much better than the conventional equilibrium models. Conventional models yield publishable results with three or four variables, but become totally intractable at about thirty degrees of freedom. Agent models scale linearly with the number of modeled agents and linearly with the comutational load of each agent’s decisions. Thus, they present a vastly more promising application of computation to economics.
So perhaps a reasonably useful theory of economics may emerge just in time to do us some good! Or perhaps, just barely too late…
A story to this effect appears in today’s New York Times.
It seems clear that no one really knows what is coming next. Why?
Well, part of the reason is that economists still try to understand markets by using ideas from traditional economics, especially so-called equilibrium theory. This theory views markets as reflecting a balance of forces, and says that market values change only in response to new information — the sudden revelation of problems about a company, for example, or a real change in the housing supply. Markets are otherwise supposed to have no real internal dynamics of their own. Too bad for the theory, things don’t seem to work that way.
As an aside it’s nice to see Doyne Farmer’s name for the first time in a while in that article. Anyone besides me remember reading The Eudaemonic Pie? A very interesting read to say the least; Farmer is perhaps the most memorable character in the memorable story.