A key assumption of economic theory may be wrong

The concept of equilibrium, one of the most central ideas in economics and one of the core assumptions in the vast majority of economic models, may have serious problems, concludes a study from the Institute for New Economic Thinking at the Oxford Martin School.

The concept of equilibrium is the basis of many economic models, including models used by policymakers on issues like monetary policy, climate change, trade policy and the minimum wage. In a paper published today in Science Advances, Marco Pangallo, Dr Torsten Heinrich and Professor Doyne Farmer investigate this question in the simple framework of normal form games and show that when the game gets complicated this assumption is problematic. If these results carry over from games to economics, this raises deep questions about economic models and when they are useful to understand the real world.

Professor Doyne Farmer, Director of Complexity Economics at the Institute for New Economic Thinking at the Oxford Martin School explains, “This study shows that even in the fairly simple behavioural models of normal form games, complexity and competition change whether players will use a rational strategy and reach equilibrium. We find that if player incentives aren’t aligned they are unlikely to find equilibrium when the game gets complicated.

Source: Study suggests a key assumption of economic theory may be wrong