Supply and Demand from a Phase Transition View

June 29, 2011

During my time in school, the ideas that were transferred to me were at the time seem impervious to error, handed from the all knowing teacher whose mercy I beg to impart with when it came time for me to be graded. As it is always said and deemed to be common sense for quite some time, demand and supply balances out resulting in an economic equilibrium of quantity and price. That’s however never apparent for most of everyday commodities.

Examining the concept of demand from what others have stated, it has always been assumed that the actors in the economic system are rational beings where in fact demand is the result of human actions which can never be predicted. That in effect adds to this economic model a stochastic variable which, in turns, confronts one to see the economic model of supply and demand in a probabilistic way. If demand and supply were to be balanced, on average, the probability of you finding your coffee and sugar in a store shelf would be just 1/2. That is to say that half of the shelves in a store would be empty. However, we all know that this isn’t the case. In the western world, shelves in supermarkets are always stocked with our favorite commodities. We can infer that supply is very much in excess of demand in such stores – or half of the population is in starvation.

This observation logically tells me that such properties of supply and demand can be described using a phase transition view; there exists two phases: excess supply and excess demand. From what we can observe from physical systems, phase transitions become exceedingly volatile at their phase transitional points in a continuous system. This, in economics, has counterparts that similarly resembles that of the open stock markets or foreign currency exchange markets.

Indeed, one can observe from past data of these markets and see the fluctuations that occurs at the critical points of the underlying continuous phase transition. It is due to current intrinsic market properties that markets remain almost always around the critical point. i.e. when there are more buyers than sellers, the market price goes up causing decrease in the number of buyers and increase in sellers. As actors in markets only care about the relative price of a market – up or down – the absolute price of the trading good becomes meaningless as it cannot be used to determine the market price.

The fluctuations around the critical point does not stabilize the absolute value of the market price but merely stabilize the statistics of market price fluctuations to follow and stick to the critical point. The amplitude of these fluctuations can theoretically reach infinite and thus no determination of market price projections can ever be made nor settled upon.

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