25 Pages Posted: 5 May 2002
Date Written: April 2002
Economic and biological systems, as open dissipative systems, need to extract low entropy from the environment to compensate for continuous dissipation. This process can be represented by lognormal processes, which in turn can be mapped into a thermodynamic equation. From here, we develop an analytic thermodynamic theory of economics. Since a thermodynamic equation is of first order in temporal dimension, economic and biological systems as thermodynamic systems are intrinsically evolutionary. Most people agree that thermodynamic theory is a sounder foundation to describe living systems than Newtonian mechanics, which is the physical foundation of general equilibrium theory. As it is often the case, an analytical framework that is built on sounder physical foundation delivers more intuitive and simpler results. This theory, for the first time in economic literature, provides an analytic framework that explicitly represents the relation among fixed costs, variable costs, uncertainty of the environment and duration of a project, which is the core concern inmost economic decisions. Since all economic and biological activities represent the extraction and transformation of low entropy from the environment, this analytic thermodynamic theory offers a unified framework to understand the general pattern in economic and biological evolution.
Keywords: analytical framework, thermodynamic foundation of economics, variable costs, fixed costs, tradeoff between competitiveness and flexibility, non-equilibrium
JEL Classification: A10, B41, N30
Suggested Citation: Suggested Citation