New model shows how our social networks could contribute to generating economic phenomena

Most economic models assume that people make rational individual decisions. New research shows that economic phenomena such as inequality and business cycles can be better explained by models that recognize that decisions made by people are affected by those around them.Researchers created a model where households are embedded in a network that strongly influences their savings decisions to show this. This model was very simple and produced cyclical fluctuations that resemble business cycles as well emergent inequality. For example, there were many poor households with low savings rates, while a few wealthy households have high savings rates.+++Substituting utility minimization in economic modeling with behaviorally-based decision making+++These results reflect behavior observed in the real world but which traditional economic models fail to capture or explain. This makes this realistic economic modeling an attractive alternative to classic economic modeling.Jakob Kolb is a former student at the Potsdam Institute for Climate Impact Research and one of the researchers of the study published in the Proceedings of the US National Academy of Sciences. Although the model is simple, it shows that we can miss important insights into economic phenomena if humans are viewed as rational decision-making machines and not as deeply social beings.The model predicts that private savings will increase in recessions when output falls. This is consistent with observations made by 19 OECD countries. Jobst Heitzig, co-author of the model, from PIK says that "our approach seems to be quite realistic" in this regard. "Next, we will use social dynamics that we have analyzed here to model capital re-allocation from non-sustainable and CO2-intensive economic activities to more sustainable investment.Researchers found that households may become more ineligible if their social dynamics becomes faster. However, households might start to copy their friends too fast and end up saving all together.+++ The picture shows a man holding a pole in his hand.To illustrate the differences between their model and other older models, the authors used the image of a man holding a pole in his hand. J. Doyne Farmer (Director of Complexity Economics, Institute for New Economic Thinking at Oxford University) says that a standard macroeconomic model would assume that the man can balance a pole perfectly. Any deviations in the angle must result from external shocks such as strong gusts of wind. "This view shows that after each shock, the man moves his hand perfectly to turn the pole vertically again, but before he can do this, another shock strikes and causes the pole to wobble. This explanation is clearly incorrect. Theories that the pole wobbles because of man's inability to balance it provide a better explanation.This study also shows how young talent can be promoted. Yuki Asano, the first author of the model, discovered the main results in his Bachelor thesis at PIK. He was supervised by Jakob Kolb & Jobst Heitzig. Asano went on to Oxford University to complete his PhD. Doyne Farmers, a pioneer in chaos theory and who spent a few more years at PIK during the 2010s, supported the paper's writing.###Article by Yuki M. Asano and Jakob J. Kolb. Jobst Heitzig, J. Doyne Farmer (2021). Emergent inequality, business cycles, and a simple behavioral macroeconomic model. Proceedings of the National Academy of Sciences [DOI:0.1073/pnas.2025721118]