Munich Personal RePEc Archive

Fundamental Equation of Economics

Wayne, James J. (2013): Fundamental Equation of Economics.

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Abstract

Recent experience of the great recession of 2008 has renewed one of the oldest debates in economics: whether economics could ever become a scientific discipline like physics. This paper proves that economics is truly a branch of physics by establishing for the first time a fundamental equation of economics (FEOE), which is similar to many fundamental equations governing other subfields of physics, for example, Maxwell’s Equations for electromagnetism. From recently established physics laws of social science, this paper derives a fundamental equation of economics, which is the one mathematic equation that governs all observed economic phenomena. The fundamental equation of economics establishes a common entry point to solve all economic problems without any exception. FEOE is a mathematical bridge connecting the current economic reality and all future possibilities. We show that establishing FEOE clarifies many open questions regarding the foundation of economics, for example, what can be forecasted and what cannot be forecasted in economics. FEOE is far more precise and universal mathematical abstraction of economic reality, than the framework of Marshall’s laws of supply and demand and market equilibrium, which has been traditionally assumed by most economists as the foundation of economics. With FEOE-based analysis, economics is an exact and precise science just like any other subfields of physics. With restrictive assumptions, FEOE can be reduced to the laws of supply and demand and market equilibrium as special cases of market behavior. FEOE clarifies the widespread confusions among economists regarding the concept of equilibrium and disequilibrium. Because one important conclusion from FEOE is that the conceptual framework of general equilibrium and laws of supply and demand are deeply flawed, those macroeconomic models like DSGE and SL/ML built upon this conceptual framework must be flawed as well, and these macro models are not likely going to work well against the real world economy. A good macroeconomic model should apply FEOE to describe the economic reality and the dynamics of how reality evolves with time. In conclusion, this paper shows that the fundamental equation of economics provides a solid physics foundation for both theoretical and practical economics. Therefore, after establishing the fundamental equation of economics in this paper, there should be no doubt that economics is simply a branch of quantum physics in parallel with chemistry and optics. Over last four hundred years, there are many schools of thought emerged in economics while there is only one school of thought by Newton-Einstein-Bohr survived in physics over the same period. The logic conclusion is that there must be only one school of thought allowed in economics as a subfield of physics.

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