Market Complexity

In previous posts, I introduced the importance of consumers in a well-functioning market. I also introduced the fact that consumers consisted of a byproduct of production. Consumers can neither consume nor acquire things to consume without first producing. These facts might lead one to assume that some sort of centralized control might make a more efficient market. Before I continue and describe why this cannot work, I would like to explain a concept critical to understanding the fallacy of centralized planning — or market intervention. I will in this post explain the complexity of markets.

Butterfly Effect

Systems thinkers occasionally refer to the Butterfly Effect. The Butterfly Effect provides a hypothetical example of a highly complex system. Small changes in one part of a large system can cause significant changes later in another part of that system. A butterfly could flap its wings in Indonesia, and six months later, through a chain of events, it could cause a hurricane off the coast of Florida.

Such an effect seems highly improbable. But, whether it’s even possible, it provides a good model for understanding the incredible complexity of large systems. Think about the number of connections it would require for a tiny action like the flapping of a butterfly’s wings to multiply its effects over time and distance to result in a hurricane thousands of miles away. If you stretch your imagination, the Butterfly Effect can help you consider how small actions in a large system can create sizable effects.

To make this description of complex systems a bit more realistic, I will describe two types of large-scale systems: mechanical systems and living systems.

Mechanical Systems

Mechanical systems consist of those systems that follow the laws of physics. They behave in highly predictable ways. If we know the detailed structure of the system, we can predict with a high level of certainty the behavior of the system’s processes.

The flow of water provides an excellent example of a mechanical system. We can say with almost absolute certainty that water from a small rainstorm on the East slope of the Rocky Mountains will ultimately arrive in the Gulf of Mexico. Even with the mechanical system, however, we cannot predict all the behavior precisely simply because we don’t have the capability of knowing all the details of the system structure. No one has mapped out the exact location of every rock and stone in the streams from the Rockies to the Mississippi. It will require this level of detail to predict the behavior of the system in detail.

Complex living systems present an additional set of complications.

Living Systems

Living systems have two characteristics that make them far more unpredictable than mechanical systems: they self-reference and self-adjust. These characteristics mean that living systems can watch their own behavior and adjust that behavior to produce a different outcome.

To demonstrate the adaptive behavior of a living system, let me use an example that has some similarity to the flow of water. Think of a man (or any mammal) traveling a road that generally slopes downhill. Unlike water that will always seek a lower level, the man can follow the uphill path to reach his ultimate destination. With many forks in the road, an observer cannot possibly predict in advance the exact route of the man traveling to his destination.

Billions of Decisions

The many individual transactions make up a living system that we refer to as a market. Predicting the behavior of a single individual in the market can be difficult by itself. Even if you have the individual’s shopping list, you cannot predict impulse purchases nor product substitutions. As markets get larger and larger, they include more and more unpredictable, self-adaptive humans.

Markets consist of millions of actors — both buyers and sellers — making billions of decisions involving one-by-one transactions. No individual, or small group of individuals, can comprehend the structure of large markets. Because of the adaptive nature of the humans in that system, precisely predicting the behavior in markets becomes impossible.

Conclusion

Piece by piece, I have tried to demonstrate that symbiotic interactions between producers and consumers— which in the end are the same people — create markets. Markets require a process that does the best job, somehow or another, allocating resources to produce what consumers desire and have the capacity to acquire.

In my next post, I will discuss the most effective and efficient method for resource allocation.

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