What are the Economic Lagrange Equations?
Based on the belief that the dynamics of the many-agent market economies has to some extent a deterministic character, we derived the economic equations of motion by formal analogy with classical mechanics of the many-particle systems. As a result, we naturally obtained the economic Lagrange equations of motion describing dynamics of economic systems in time. It is fascinating that we can interpret Lagrangian as the mathematical classical representation of the market invisible hand concept.
1. Foundations of Classical Economy
The logic of the present Section is the following. With the understanding that, pursuing own various well-defined goals, the market agents behave to some extent in a deterministic way, in this Chapter we are going to outline the adequate and approximate equations of motion for the economy. In order to design a physical model and derive classical equations of motion for economic systems in the price space ab initio, that is with the five general principles of physical economics in mind, we first make similar approximations and assumptions needed to derive the equations of motion for physical systems. This can be found in the course of theoretical physics by Landau and Lifshitz [1, 2]. In this way we derive equations of motion for economic systems, which are similar to equations for physical systems in form, and are considered by us as an initial approximation for a physical economic model of the modelled economic system.
According to the above-stated plan of actions we could confine ourselves in this Chapter to just writing equations of motion analogous to those obtained in classical mechanics. However, we consider it useful to derive a full row of equations and to make additional comments on our actions. As we have indicated before, according to our approach to classical modeling of economic systems, every economic agent, homo negotians, acts not only rationally in his or her own interests, but also reasonably. They negotiate to reach a minimum price for the buyer and a maximum price for the seller, but also leave their counteragent a chance to gain profit from transactions or to achieve some other goals, economic or noneconomic in nature. Otherwise, transactions would take place only once, while all agents would prefer the continuation and stability of their business.
Besides, we presume that external forces are usually inclined to influence market operations positively, establishing common rules of play that favor gaining maximum profit, utility, trade volume, or something else for the whole economic system. Based on these assumptions, we have a firm belief that there are certain principles of optimization, and their effects on market agents result in certain rules of market behavior and certain equations of motion that are followed by all rational or reasonable players spontaneously or voluntarily. In our opinion, it is they who have the leading role in the market.
Concluding, let us repeat that we will derive below the economic Lagrange equations of motion by recognizing inexplicitly the following five general principles of physical economics:
1. The Cooperation-Oriented Agent Principle.
2. The Institutional and Environmental Principle.
3. The Dynamic and Evolutionary Principle.
4. The Market-Based Trade Maximization Principle.
5. The Uncertainty and Probability Principle.
It is evident that the uncertainty and probability effects begin to play significant role in classical economies only for the markets with huge numbers of agents. We do not concern ourselves with these effects within the framework of classical economy because it is much easier to study these problems within the framework of quantum economy (see next two chapters).
2. The Economic Lagrange Equations
Let us proceed to deriving equations of motion for the classical economy shown schematically in Fig. 1. We follow the same procedure as in classical mechanics [1]. To make calculations easier, we will consider here the one-good market economy, that is, only movement in one-dimensional price space with one coordinate P. Transition to a multi-dimensional case does not cause principal complications. We will consider that by the analogy with classical mechanics [1], a state of economy comprising of N buyers and M sellers and being under the influence of the environment is fully described by establishing all prices pi and their first time t derivatives (price changing rate or velocity of movement)
By analogy with classical mechanics we assume that these equations result from the following principle of maximization (the principle of least action or the principle of stationary action in mechanics). Namely, the action S must have the least possible value:
Fig. 1. Graphical model of an economy in the multi-dimensional PQ-space. It is displayed schematically in the conventional rectangular multi-dimensional coordinate system [P, Q] where P and Q designate all the agent price and quantity coordinate axes, respectively. Our model economy consists of the market and the external environment. The market consists of buyers (small dots) and sellers (big dots) covered by the conventional sphere. Very many people, institutions, as well as natural and other factors can represent the external environment (cross – hatched area behind the sphere) of the market which exerts perturbations on market agents, pictured here by arrows pointing from environment to market.
The obtained (1) and (2) lead to equations of motion or Lagrange equations [1]:
Equations of motion represent a system of second-order N + M differential equations of time t for N + M unknown required trajectories pi(t).
These equations employ as yet an unknown Lagrange function or Lagrangian L (p, ṗ, t) which is to be found on the basis of research or experimental data. We will note that Lagrange functions were used in literature to solve a number of optimization problems of management science [3]. Let us emphasize that determination of the Lagrange function is the key problem that can only be solved in practice by making the data of theoretical calculation fit the experiment. It can not be done using theoretical methods only. But what we can do quickly is to make the first obvious trial step. Here we assume that to a certain degree of approximation, the Lagrange function resembles (in appearance only!) the Lagrange function of its physical prototype, a system of N+M point material particles with certain potentials. All assumptions made here can be thoroughly analyzed later at the second stage of investigation and left unchanged or made more accurate after comparison with the experimental data. Accomplishment of this stage will naturally require great effort and expense. For now, we will accept these assumptions and consider that Lagrange functions have the same form as those of their physical prototype, but all parameters and potentials of the economic system will be chosen on the basis of economic experience, not taken from the physical prototype. We consider that by adjusting parameters and potentials to the experiment we can smooth out the negative influence of assumptions made for solutions of equations of motion obtained in this particular way.
So, according to our approach, equations of motion in classical economy are nominally identical to those in the corresponding mechanical system. However, their constants and potentials will have another essence, other dimensions and