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Len H. Wallast

Evolvodynamics –

The Mathematical

Theory of

Economic Evolution

A Coherent Way of Interpreting Time,

Scarceness, Value and Economic Growth

Lecture Notes in Economics

and Mathematical Systems 665

Founding Editors:

M. Beckmann

H.P. Künzi

Managing Editors:

Fachbereich Wirtschaftswissenschaften

Fernuniversität Hagen

Hagen, Germany

Murat Sertel Institute for Advanced Economic Research

Istanbul Bilgi University

Istanbul, Turkey

Universität Bielefeld

Bielefeld, Germany

Editorial Board:

R. Slowiński, W.H.M. Zijm

http://www.springer.com/series/300

.

Len H. Wallast

Evolvodynamics -

The Mathematical Theory of

Economic Evolution

A Coherent Way of Interpreting Time,

Scarceness, Value and Economic Growth

Len H. Wallast

Vlissingen

The Netherlands

ISSN 0075-8442

ISBN 978-3-642-34055-0 ISBN 978-3-642-34056-7 (eBook)

DOI 10.1007/978-3-642-34056-7

Springer Heidelberg New York Dordrecht London

Library of Congress Control Number: 2013934270

This work is subject to copyright. All rights are reserved by the Publisher, whether the whole or part

of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations,

recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or

information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar

methodology now known or hereafter developed. Exempted from this legal reservation are brief excerpts

in connection with reviews or scholarly analysis or material supplied specifically for the purpose of being

entered and executed on a computer system, for exclusive use by the purchaser of the work. Duplication

of this publication or parts thereof is permitted only under the provisions of the Copyright Law of the

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Violations are liable to prosecution under the respective Copyright Law.

The use of general descriptive names, registered names, trademarks, service marks, etc. in this

publication does not imply, even in the absence of a specific statement, that such names are exempt

from the relevant protective laws and regulations and therefore free for general use.

While the advice and information in this book are believed to be true and accurate at the date of

publication, neither the authors nor the editors nor the publisher can accept any legal responsibility for

any errors or omissions that may be made. The publisher makes no warranty, express or implied, with

respect to the material contained herein.

Contents

1.1 The Probabilistic Background of Observation and Behavior . . . . 2

1.2 Generalized Darwinism and Shannon . . . . . . . . . . . . . . . . . . . . . 3

1.3 The Prerequisite of Reliable Inflow and Outflow Data . . . . . . . . 6

1.4 The Method of Science . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

1.5 The Mathematical Requirements of Statistical Selection Processes . . . 10

1.6 The Three Principles of Evolutionary Selection, Boltzmann and

Shannon . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

1.7 The Time-Compression Transition from Shannon to Darwin:

Assembling and Reassembling . . . . . . . . . . . . . . . . . . . . . . . . . 15

1.8 The Unit of Selection and the Unit of Exchange . . . . . . . . . . . . . 19

1.9 Production Functions, Marginalism and the Interaction of Inflow

and Outflow . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21

2 Sets of Entropy, Selection, Venn Diagrams and Bitpulses . . . . . . . . 29

2.1 Non-differential and Differential Sets of Entropy, Venn Diagrams,

Sample Space, Capacity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30

2.2 Overall Selection, Transmission and Exchange, Conditional

Entropy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35

2.3 Selection in Non-differential Sample Space of the Multi-sector

Economy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40

2.4 Variation, Inheritance, Selection, Interactors/Agents, Replicators,

Selection Probabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44

2.5 Bitpulses and the Definition of the Unit of Selection . . . . . . . . . . 51

2.6 The Uniqueness of State of a Bitpulse . . . . . . . . . . . . . . . . . . . . 55

2.7 Elementary Probability, State Probability, Some Formulas of

Conditional Entropy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56

2.8 Transmission, “Pure” and Financial Value, Inflow and Outflow, the

Unit Price . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60

2.9 Capital and Liquidity Surplus . . . . . . . . . . . . . . . . . . . . . . . . . . 63

v

vi Contents

3.1 The Reduction of Uncertainty by Selection . . . . . . . . . . . . . . . . 66

3.2 Combinations, Variations, Uncertainty and Information . . . . . . . 69

3.3 Consumption Probability, Investment Probability and Labor Input

Probability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72

3.4 Generative Replication and the Definition of the Replicator . . . . 73

3.5 Habits, Traits, Customs, Routines and the Limits of Informational

Knowledge . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75

3.6 Multi-Level Selection and the Definition of the Replicator . . . . . 78

3.7 Reductionism, Emergentism and Homogeneity . . . . . . . . . . . . . . 79

4 Blind and Purposeful Selection . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85

4.1 The Significance of Shannon’s Information Concept . . . . . . . . . . 86

4.2 Blind Selection . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91

4.3 Purpose and Shannon’s Existence Theorem . . . . . . . . . . . . . . . . 94

4.4 Blind Selection, Purposeful Selection and Economic

Inheritance. Some More Calculations . . . . . . . . . . . . . . . . . . . . . 98

4.5 Selection in Overall Sample Space . . . . . . . . . . . . . . . . . . . . . . 106

4.6 The Three Degrees of Freedom of Evolution . . . . . . . . . . . . . . . 109

5 Exchange and the Circulation of Entropy . . . . . . . . . . . . . . . . . . . . 113

5.1 Current Lifetime and Excess Lifetime of Bitpulses . . . . . . . . . . . 113

5.2 The Different Sorts of Bitpulses: Outflux, Output, Influx, Input and

Transmission . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115

5.3 The Circulation of Bitpulses . . . . . . . . . . . . . . . . . . . . . . . . . . . 119

5.3.1 The Probability Distributions of Current Lifetime and

Excess Lifetime of Bitpulses . . . . . . . . . . . . . . . . . . . . . 119

5.3.2 The Probability Distribution of Current Lifetime of Outflux

Bitpulses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 120

5.3.3 A Conditional Distribution of Current Lifetime of Outflux

Bitpulses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 122

5.3.4 Unconditional and Conditional Distributions of Excess

Lifetime of Influx Bitpulses . . . . . . . . . . . . . . . . . . . . . . 123

5.3.5 The Inflationary Mode of Evolution and the Associated

Probability Distribution of Current Lifetime of Output

Bitpulses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 125

5.3.6 The Deflationary Mode of Evolution and the Associated

Probability Distribution of Excess Lifetime of Input

Bitpulses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 127

5.4 The Probability Distribution of Outflux and Influx and the Markov

Property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 129

5.5 The Circulation of Output in the Inflationary Mode of Evolution . . . 132

5.5.1 The Money Exchange of Outflow . . . . . . . . . . . . . . . . . . 132

5.5.2 Relationships Between Output and Outflux . . . . . . . . . . . 135

5.6 The Circulation of Input in the Deflationary Mode of Evolution . . . 139

5.6.1 The Money Exchange of Inflow . . . . . . . . . . . . . . . . . . . 139

5.6.2 Relationships Between Input and Influx . . . . . . . . . . . . . 142

Contents vii

6.1 Outflow and Inflow in the Inflationary Mode of Evolution . . . . . 148

6.2 Outflow and Inflow in the Deflationary Mode of Evolution . . . . . 151

6.3 The Impacts of the Inflationary and Deflationary Modes of

Evolution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 153

6.4 Some Further Relationships of Price and Circulation Rates . . . . . 156

6.5 The Two-Sector Economy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 158

6.6 The Growth of Capacity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 161

6.7 Economic Growth and the Surplus of Output Over Input . . . . . . 165

6.8 Economic Evolution and Biologic Evolution . . . . . . . . . . . . . . . 167

7 Money and Liquidity, Time, Work and Effectiveness . . . . . . . . . . . 171

7.1 The Role of Money and Transmission in Production . . . . . . . . . . 171

7.2 The Liquidity Flux and Money Flows and Stocks . . . . . . . . . . . . 174

7.3 Liquidity Flux, Capital and Capacity . . . . . . . . . . . . . . . . . . . . . 178

7.4 The Handling Rate of Inflow and Outflow Selection and the Net

Growth of Capacity and Capital . . . . . . . . . . . . . . . . . . . . . . . . 179

7.5 The Definition of Work and Effectiveness . . . . . . . . . . . . . . . . . 182

8 Calculation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 187

8.1 Divisia’s Index Formulas for Output Calculation . . . . . . . . . . . . 187

8.2 Compartmentalization and Influx Calculation . . . . . . . . . . . . . . . 193

8.3 Aggregation Properties of Capacity and Capital . . . . . . . . . . . . . 197

8.4 The Calculation of the Macro Variables of the Economy . . . . . . 199

8.5 An Alternative Route to Calculate the Macro-Variables of the

Economy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 203

8.6 Other Sources of Data Collection . . . . . . . . . . . . . . . . . . . . . . . 205

9 Theory and Confirmation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 207

9.1 Consistency, Yes or No? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 208

9.2 Evolvodynamics and Keynes . . . . . . . . . . . . . . . . . . . . . . . . . . . 211

9.3 Eurocrisis and Monetary Expansion . . . . . . . . . . . . . . . . . . . . . . 214

9.4 Evolvodynamics and Monetary Expansion . . . . . . . . . . . . . . . . . 218

9.5 Evolvodynamics and Orthodoxy . . . . . . . . . . . . . . . . . . . . . . . . 221

9.6 Science, Premise and Prejudice . . . . . . . . . . . . . . . . . . . . . . . . . 223

9.7 Theory and Measurements . . . . . . . . . . . . . . . . . . . . . . . . . . . . 226

Appendix A The Number of Samples and the Principle of

Evolutionary Homogeneity . . . . . . . . . . . . . . . . . . . . . . . . 229

Appendix B Selection-Probabilities and Entropy of the Multi-Sector

Economy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 233

Appendix C Mutual Exclusiveness and Statistical Independence . . . . . . 239

P

Appendix D Derivation of H ¼ oi logoi as the Measure of

i

Information Per Sample . . . . . . . . . . . . . . . . . . . . . . . . . . 243

viii Contents

Appendix F The Role of Statistical Dependence in Evolution . . . . . . . . 249

Appendix G The Turning Point of Evolution . . . . . . . . . . . . . . . . . . . . . 255

Appendix H Four Different Growth-Positions an Economy can be in . . . 259

Appendix I Conventions and Explanation of Notation . . . . . . . . . . . . . . 263

About the Author . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 271

Consulted Bibliography . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 273

Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 275

Chapter 1

Darwin- and Shannon-Inspired Dynamic

Economic Selection

years and it appears that the main stream proponents do not have the answers.

Orthodox economic theorizing is apparently in a methodological crisis. It must be

remarked here that economics is not an exception among the sciences. Any science

may get caught in a methodological crisis. Half-baked adjustments in theory

formulation will not help under those circumstances. Radical new ideas are needed

to overcome the failures, ideas like the one by which physics overcame one of her

great conceptual crises: i.e. to reconsider behavior as a collection of chance events

of selection between different microstates. To work this out the author shares the

idea of Hodgson & Knudsen that the economy must be analyzed as an evolutionary

system solely governed by the three principles of Darwinian selection: variation,

selection and inheritance (Generalized Darwinism).

This is only the very modest begin of the enterprise. We need applied mathe-

matical reasoning to resolve the matter thoroughly. It is here where we need the

mathematical tools by which Claude E. Shannon analyzed the transmittance of

entropy/information over the communication channel. However, it is not that easy.

The stand in the way is that Shannon’s signals are ergodic and stretch out over finite

time, whereas the economic process is nonergodic. To overcome the nonergodic

barrier, we must make a Shannon-Darwin transition in which Shannon’s finite

time-length communication signals are replaced by instantaneous economic

sequences of vanishing differential time-length that reflect the allocation/realloca-

tion preferences of the economic agents.

The shortcomings of the neoclassical production function theory are exposed to

emphasize the necessity of replacing the neoclassical system by the evolutionary

inflow/outflow system that results after the Shannon-Darwin transition.

Lecture Notes in Economics and Mathematical Systems 665,

DOI 10.1007/978-3-642-34056-7_1, # Springer-Verlag Berlin Heidelberg 2013

2 1 Darwin- and Shannon-Inspired Dynamic Economic Selection

beings is neither as determined as that of economic man nor

as simply random as the throw of a die or as the drawing of

balls from a mixture of black and white balls. It is clear

however, that a deterministic model will not get us far in the

consideration of human behavior, such as communication,

while a random or statistical model might.

John R. Pierce

E.T. Jaynes’ life-work on Probability Theory bears the subtitle “The Logic of

Science” (Jaynes 2004). The subtitle expresses the notion that probability theory

is at the core of a wide (perhaps almost the complete?) range of what we observe

and how everything behaves within our universe. Originally developed to provide

modestly for the mathematics of chance games, probability theory has meanwhile

succeeded to provide the basic explanation (the logic) of more and more scientific

domains of inquiry. Simultaneously there has been a growing awareness that

probability theory is the basic logic behind the many things we observe and behind

the many ways we interact, behave and take our decisions. Boltzmann’s derivation

of the connection between probability and entropy may be regarded as the first

manifest demonstration that the macro-effect of what we experience and observe in

the foreground as real, fixed, rational and concrete is anchored in a background of a

dynamic micro-world of abstract probabilistic events. The probabilistic logic of that

micro-world has already been shown to hold good for many physical phenomena,

but it is certainly not restricted to the explanation of physical phenomena only.

Boltzmann was the first to recognize the connection between probability and

entropy. He went even further by conjecturing—far ahead of his time—a still

more profound relationship between entropy and the non-physical biological

order of Darwinian evolutionary systems.

It has since set many to explore Boltzmann’s principle further. The way we must

understand information about our world and interpret observations and behavior

within this world—it does not really matter whether of physical or non-physical

nature—was most profoundly reconsidered by Claude E. Shannon in the midst of

the twentieth century. Shannon formulated his path breaking views within the

framework of the transmittance of information over a communication channel

(Shannon 1948). Originally communication engineers were inclined to adopt the

most simple determinist idea of what people thought information to be: something

like countable atoms shot forward through the pipeline of the communication

channel. Just raise the frequency and/or the power of shooting and you get the

best of it.

Shannon subverted that picture completely. The ultimate idea is that anything of

information we find out about the things we observe and interact with is closely

connected with uncertainty and based on probabilistic events. According to

1.2 Generalized Darwinism and Shannon 3

itself in the freedom of choice with respect to the different states that each particular

sample of that sequence can randomly assume. In this manner information is

dependent on the probabilities of the different states that each sample can assume.

And it is here that the fundamental axioms and rules of probability theory enter the

scene rather than restrictive anthropocentric models that maximize postulated

(however unproved) object functions and thereby forbid certain parameters of

those object functions to change. In fact it does not matter so much what the

particular samples are that we observe. In case of the communication channel it

may be the volt-level of signals transmitted over an electric wire or it may be the

field of an electromagnetic signal propagating in free space or the pressure level of

an acoustic signal in the air or under water. But it may just as well be the writings of

an author or, if our domain of study is economics, the spending of money by

economic agents. The thing is that the relationships and the dynamic events

underlying the micro-events of communication as well as of spending and eco-

nomic exchange must be analyzed probabilistic from the very beginning rather than

on the basis of postulated object functions with so-called constant behavioral

parameters that always ultimately turn out in the end not to behave as real constants.

associated with the Darwinian evolutionary selection schedule. But the notion

that economic and social phenomena are evolutionary has only slowly gained

acceptance among social scientists since the 1980s, although it had already been

stressed many years ago by several economists unfortunately without very concrete

quantitative elaboration. Evolutionary economics is still not the exclusive approach

on the agenda of economic and social research as I think it should be and the

progress with models that are claimed to be evolutionary is also not what it should

be. The difficulty has been to translate the Darwinian approach into a workable

system of universal equations that successfully competes with alternative main-

stream models of economic explanation.

Existing mainstream models of economic theory are well known to possess

major inconsistencies, flaws and shortcomings that do not particularly candidate

these models as ultimate universal descriptions of economic phenomena. In his

1991 but still timely paper titled “How should we use Entropy in Economics?” E.T.

Jaynes remarks that “both Keynesian and Monetarist economic theories have been

unsuccessful in accounting for recent economic behavior. Neither can point to

particularly great past successes from adoption of their policies by Government,

and—if we can believe the press—neither seems to have an idea of what Govern-

ment should be doing now”. He suggests therefore that “only new ideas can help us”

and that “the failure of Keynesian and Monetarist mechanisms to account for recent

economic behavior might be attributed, at least in part, to their failure to recognize

4 1 Darwin- and Shannon-Inspired Dynamic Economic Selection

the entropy factors that must ultimately control economic change and equilibrium,

just as they do in thermodynamics” (Jaynes 1991). That was 1991. The financial

crisis of 2008 is now going on for more than 4 years. That it was largely unforeseen

by the accepted models of economic analysis reveals that Jaynes’ remark of 1991 is

still applicable in 2012 and—if economists keep on cherishing their current models

and methods of analysis—it will remain so for many years to go.

Noticing the difficulties with progress in economic science the recent fundamen-

tal back-to-Darwin approach of Hodgson and Knudsen (2010) is therefore very

welcome because the progress of science must always first be sought in improving

our understanding, interpretation and application of the basic principles. H&K’s

agenda has been to disclose the basic principles of what they call “Generalized

Darwinism” with the yet unfulfilled purpose to work it out into a (more) complete

theory of evolution for the domain of social phenomena. Although there have

already been many attempts to formulate an evolutionary economics by other

economists, the strict and detailed emphasis on the three Darwinian principles of

evolution in which H&K state the basis of economic and social evolution stands

out. It is exactly what we need to work out in a general mathematical theory of

economic evolution. I shall therefore discuss their ideas extensively, comment on it

often where needed and use it to elaborate on it in a deductively based universal

theory of economic selection in the line of E.T. Jaynes suggestions and last but

not least Shannon’s ideas about information and entropy. More specifically, my

contribution is first and for all to be interpreted as a generalization of Shannon’s

stationary communication theory towards the non-stationary domain of economic

evolution.

H&K concentrate primarily on the descriptive Darwinian perspective of evolu-

tion, which—I think—is too restrictive to reach their goal. We need the purity of

deductive mathematical reasoning to make progress in the line of Shannon.

Hodgson and Knudsen mention Shannon’s mathematical conception of informa-

tion/entropy and its relationship with evolutionary selection only in passing,

although Shannon’s probabilistic contribution is a major building-brick of the

evolutionary edifice and can’t be missed to derive the quantitative relationships

between the economic variables.

Nevertheless there is considerable correspondence between my Shannon-

inspired approach and the main starting points of H&K with respect to evolutionary

selection. In fact I endorse much of their views. But there are certainly a number of

issues in which I take a slightly different and occasionally a diametrically opposed

stand. These issues concern reductionism, the acceptance/avoidance of parametric

models of explanation (because of their restricted capability to describe processes

of dynamic change), the necessity of a unit of selection that does not vary in the

course of time, the nature of group selection and the multi-level layers of social

evolution.

Throughout this treatment I adhere unconditionally to the method of applied

mathematics demanding deductive reasoning and inference upon the basis of the

postulate of selection on which the Darwinian model rests, as well as on the

principles of continuity and evolutionary homogeneity, and absolute exclusion of

1.2 Generalized Darwinism and Shannon 5

stant parameters. By evolutionary homogeneity I understand the conversion of the

scale of dimension in which entropy, money value or time is expressed into another

scale without affecting the content of entropy, money value or time. The principle of

evolutionary homogeneity is very much related to the principles of physical and

mathematical homogeneity.1 Deductive reasoning links up with Shannon’s scien-

tific method of analysis and adherence to it is the best warranty to avoid

inconsistencies while generalizing his theory. The logic of this edifice will be

seriously distorted if combined with parametric models of economic behavior.

I will pursue a gradual course in enunciating my account of a Darwin/Shannon-

inspired universal theory of evolutionary selection, often reverting to what has been

established before to illuminate it from another angle of incidence. On the way

towards its completion I shall spend ample attention to the common and different

views of opinion with Hodgson and Knudsen. To bridge the gap between the

different worlds of descriptive science and mathematically inspired deductive

logic of science, I will avoid dealing with the mathematical details in a rigorous

manner as much as possible. This has the disadvantage that every statement I make

might be considered by some rigor seeking mathematicians as failing higher

standards of precision. To prevent them from such discourteous interpretation the

following emancipation proclamation is applicable to the present work:

Every variable x that we introduce is understood to have some set X of possible values. Every

function f(x) that we introduce is understood to be sufficiently well-behaved so that what

we do with it makes sense. We undertake to make every proof general enough to cover the

application we make of it. It is an assigned homework problem for the reader who is interested

in the question to find the most general conditions under which the result would hold.2

My message is not that mathematical rigor should not be pursued but that

conceptual clarity and mathematical imagination is here more important than

utmost mathematical rigor. I am aiming at an economic audience that is unaccus-

tomed to the methods of analysis I apply. My emphasis is on explaining the very

close connection between the great ideas of two outstanding scientists: the non-

mathematical world of Darwin and the mathematical world of Claude E. Shannon.

However I cannot avoid putting concepts in a mathematical setting that involves the

application of some elementary principles of set theory and probability theory, but I

hope to do that in a way understandable to the majority of my audience.

The mathematical way of reasoning, to which I adhere, conforms to the basic

mathematical methods of probability theory and resembles the way of reasoning

practiced by Shannon in his mathematical exposition of communication theory. In a

sense Shannon-like mathematical reasoning will be somewhat demanding for most

economists, unfamiliar as they are with that world and accustomed as they are to

1

The principle of evolutionary homogeneity should not be confused with economic homogeneity,

involving several disputable principles necessary to explain the mainstream theories of economic

orthodoxy.

2

Cited from (Jaynes 2004, page 676).

6 1 Darwin- and Shannon-Inspired Dynamic Economic Selection

about the burden of orthodox economics while taking notice of the present work.

The present exposition is self-contained. It is not necessary to work first through a

bulky textbook dealing with probability theory, but some familiarity with the

axioms of probability theory will help. I expect that the intertwinement of the

text with the many passages dealing with the ideas of Hodgson and Knudsen will

enhance understanding considerably.

The ultimate emphasis of my exposition is on explaining a completely novel

universal theory of economics, which I call evolvodynamics and which draws its

inspiration both from the Darwinian principles of evolution as explained by H&K

and from Shannon’s theory of the communication channel.3 For economists there is

still a world to gain by concentrating on Shannon’s ideas and the way these ideas

have been initially expounded and further developed (Shannon 1948; Jaynes 2004;

Papoulis 1985).

Those readers who consider an impressive list of consulted economic literature

as a prerequisite to take notice of economic publications, I must disappoint to my

regret. I prefer to consult only sources of well-established science and to keep my

references very moderate in number. More would distract from the message I wish

to deliver.

A point that should be clarified first here is that my contribution has another angle

of incidence than H&K’s. Hodgson and Knudsen stress the general features of

Darwinian selection as providing a universal overarching description of biologic

and social evolution. They consider a different class of social phenomena in order to

clarify subsequently how these phenomena fit in the general Darwinian scheme of

selection. They discuss also at length the insufficiency of Lamarckism to explain

social phenomena, the properties of the unit of selection (the replicator), the role

and function of interactors. They criticize Dawkin’s concept of memes. The leading

line is that their contribution is primarily descriptive like Darwin’s original contri-

bution (Darwin 1859). It is only occasionally and fragmentarily that H&K consider

how a system of equations can be mathematically framed such that it will accord to

the basic Darwinian selection schedule and that it can be used to explain observed

and observable social phenomena quantitatively.

3

The contours of a very precursory version of this novel theory have been sketched by the author

in 2009 and in revised form in 2012 (Wallast 2009a, b, c).

4

The terminology of inflow and outflow is chosen deliberately for clarity of exposition. Inflow is

the collective term for input and influx, each exercising its own special form of inflow. Likewise

outflow is the collective term for output and outflux, each also exercising its own special form of

outflow. Accurate definitions of these terms will be given as we proceed.

1.3 The Prerequisite of Reliable Inflow and Outflow Data 7

Darwinian evolutionary selection, on scientific inference as universal as it can be

done. That fabric is too often a neglected, even forgotten, subject of research among

social scientists in spite of its extreme relevance. The critical research on the

mathematical consistency of the concepts (e.g. the unit of selection, inflows,

outflows, stocks of value and money) and their interactions will very much contrib-

ute to the understanding as well as to correct definitions of these concepts. Mathe-

matical deductive reasoning adds another dimension to science, a dimension of

accurate and more rigorous reasoning better than rhetoric reasoning alone can do.

A difficulty that H&K leave unmentioned and unconsidered in their publications

on generalized Darwinism is that—with the exception of economic phenomena—

essential quantitative data of social phenomena are often not available. Economics

is a quantitative science. Data of macro-economic inflows and outflows are contin-

uously collected in the course of time. However, as far as I can oversee, it is quite

difficult if not impossible to collect reliable inflow- and outflow-data of social

evolution other than economic. E.g. we can explain the evolution of language by

analyzing its origins and the correspondences between vocabularies of related

languages in the way Darwin and others described the evolution of the neck length

of the giraffe or of the length of the forelimb of mice. But there seems to be no way

to relate such observations quantitatively to the time-course of the different inflow

and outflow variables as they are available for economic evolution. Biologic

evolution faces the same problem, seemingly to a lesser extent. For several species

there are more or less reliable data about the variation of the numbers of a

population in the course of time (e.g. an insect colony or the number of orang-

outans on Borneo). In that case we may have some idea about the dynamic changes

of inflow and outflow of the population by which a selection theory can be tested.

However, the equations of evolution of plant-, insect- and animal species involve

also the inflow and outflow by which the environmental condition of the species

varies. And it is very difficult to collect reliable data about inflow and outflow of

phenomena other than economic. Usually we must make guesses about the role

of temperature, the availability of specific food supplies and/or the presence of

predator species to estimate the extent of the inflow and outflow variable of the

environment, but these data are often quite unreliable. For economics the situation

is fortunately much rosier. Much more reliable data of aggregate inflow and outflow

of both population and environmental condition of the money-economy can be

gathered. This offers a unique although far from easy opportunity to test the

principles of Darwinian selection by testing the quantitative predictions of a derived

economic system of equations against the corresponding observed aggregate

quantities of macro-economic processes.

In sum, H&K’s summoning for further (quantitatively based) development and

testing of social evolution is very difficult to achieve for specific social phenomena

other than economic. It appears that—in the absence of access to the required

quantitative data—the best thing one can do is to push the descriptive method

still further with respect to the observation of secondary results of evolution like the

adaptation of the dominating color of moths in industrial areas, the evolution of the

8 1 Darwin- and Shannon-Inspired Dynamic Economic Selection

length of the forelimbs of mice, the evolution of the usage of tools by hominids, etc.

Fortunately, the outlook for economic theory testing is better.

We shall concentrate on the mathematics of inflow and outflow selection. The

first thing to do is to discuss and develop the mathematical concepts. They need

to be consistent in all respects. After that has been achieved, the more appealing

challenge is to derive and justify the equations that govern the universal

relationships between inflows, outflows and stocks of value of the macro-economy

and their (relative and absolute) change in a logical deductive manner from the

Darwinian principles of selection.

Hodgson and Knudsen state that Darwinian evolution and hence economic

relationships cannot be stated fully in derivable universal equations akin to those

of physics (Hodgson and Knudsen 2010, page 3). They consider any scientific

description of Darwinian evolution as incomplete and quite different from physics

(Hodgson and Knudsen 2010, page 3 and 4). This opinion is shared by many

economists, but it lacks substance. A motivation for this point of view has never

been given. It is merely one of those common statements one is inclined to believe

as self-evident so that further amplification is judged unnecessary. However

economic theory is concerned with the relationships between non-stationary time-

dependent statistical averages like there are many: inflows and outflows with their

various propensities, circulation rates, inflation rates, growth-rates etcetera. These

variables are statistical averages of non-stationary stochastic outcomes of decisions

that reflect the micro-economic selective behavior of individual agents. Thus the

economy can only be studied correctly as a framework of interacting selection

processes while employing the advanced tools of probability theory. Chances

govern what happens at the micro-levels of individual selection. Orthodox eco-

nomic theory is often concerned with explaining why an individual economic agent

makes a particular selective decision. However why an agent makes an individual

selection is irrelevant, only the probabilities by which a particular class of agents

takes such decisions are relevant. The associated probabilities determine the state of

the economy and the statistical averages, i.e. the economic macro-variables. The

dynamic relationships between these macro-variables are all what can be derived

using the tools of probability theory. Together the derived equations reflect the

universal theory of economics we seek. In essence the approach is completely akin

to the methods applied in statistical physics. Indeed the resulting economic nonlin-

ear system of equations is quite complicated, but the universal method of scientific

analysis does not warrant that the derived system of equations is always simple.

Let us in this respect recall how E.T. Jaynes addresses the challenge of scientific

economic explanation (Jaynes 1991). Instead of excluding the application of the

analytical mathematical method of physics to the explanation of economic behav-

ior, he wonders first why it is that the orthodox methods of economic analysis fail

1.4 The Method of Science 9

and in the line of that he suggests the application of a physical analytical method

instead, i.e. to deal with the economic process as a derivable probabilistic process

that resides in a time-dependent macroeconomic state to which a probability and

entropy is to be assigned in a similar manner as in statistical physics.

Despite that many economists are still unconvinced by this argument because

they think that there is more in the individual micro-behavior of agents than a

statistical theory that discloses only the statistical averages and the mutual

relationships this offers. In fact this objection relies on the assumption that there

is more information in the details of the micro-economic selective decisions than

the entropies and mutual relationships of the macro-economic statistical averages

can disclose. This incorrect idea rests upon a misunderstanding of the concept of

information. To clarify that, we need to explain what information is. It is here where

the entire mathematically based philosophy of Shannon’s conception of informa-

tion comes to our rescue. The matter will become clear after the complete

subsequent exposition of Shannon-inspired analysis on economic phenomena. We

cannot deal with it here at the introductory level of the present chapter.

The distrust and even disbelief in the universality of the logical deductive

method of science is widespread among social scientists. It is due to unfamiliarity

with the method of analysis. Perhaps it is also a misinterpretation of the nature of

explanations that a statistical theory of selection is capable of offering. The dictum

that good science must ultimately offer complete and universally valid descriptions

of evolution is then misunderstood as an assertion that science must ultimately

exactly predict and explain the aggregates of the evolutionary process. However

statistical theories do not provide exact answers like Newtonian mechanics under

certain idealized conditions provides (Note there are also many statistical

applications of Newtonian mechanics where it is different). The forecasts of

statistical selection theories are theoretically complete but have nevertheless always

a limited range of accuracy. If they would give determinist answers, there would be

no room and opportunity for evolving populations to behave freely. Such restriction

of freedom would of course be an absurd consequence.

But there is perhaps another cause that helped to create the distrust of

practitioners of the social sciences with respect to the application of the exclusive

method of logical deductive reasoning. We have already mentioned that cause

before within another context. What we observe and measure in many biologic

processes of evolution and in social evolution other than economic are secondary

matters such as the color change of the moth in industrial areas, but it is not what a

derived system of equations of evolutionary selection describes. The latter system

presents us the relationships between the various aggregate inflows, outflows,

growth rates and average unit price. However, that is exactly what is immeasurable

in most other spheres of evolution than the economic so that the derived equations

cannot be tested within the context of the latter domains. Science is there in a

deadlock. It appears that social scientists have already anticipated this by losing

their faith in the exclusive role of the logical deductive method of science. Never-

theless and fortunately inflows, outflows, growth rates and average unit price are

measurable within the sphere of economic evolution. Once established (as will be

10 1 Darwin- and Shannon-Inspired Dynamic Economic Selection

achieved in this treatise) the relations between the various inflows, outflows and the

other aggregates can directly be tested against quantitatively based observations of

a money-economy in the course of time.

Processes

the origin and evolution of species was, Darwin was not a mathematically oriented

theorist. On the contrary, his inception of the evolutionary selection process,

although descriptively cautiously and well worded besides extremely well

documented, is in some respects incomplete and susceptible of improvement.

That inception can only be done in a consistent manner if we stick to mathemati-

cally accurately defined concepts and consequent deductive reasoning from a

minimum of elementary basic assumptions. According to these claims we must

realize that any statistical selection theory demands formally an accurate delimita-

tion of the statistical experiments of selection involved. In this respect it is required

that the sample space of selection is defined accurately and that selection is always

between entities in different states.5 Thus we need to distinguish cautiously what

the entities of selection (the samples) are and what the different states of selection

are within the statistical selection experiments of Darwinian evolution. Moreover

the only events that really matter in statistical selection are the outcomes of the

individual trials of the statistical experiments. If there are no such events, then there

is nothing to explain and nothing happens to provide for an explanation. We should

also be aware that theory cannot explain an individual outcome of a single trial/

drawing of a statistical experiment in a determinist way. Hence a statistical selec-

tion theory cannot tell what an individual outcome of selection should be. It knows

its probability of occurrence to get into a particular state. More concretely and

anticipating more explanation later, it is impossible to know exactly whether a Euro

spent in the economy is spent on consumer purposes or on investment. It is just a

matter of probabilities: a probability of spending the Euro on consumption and a

probability of spending the Euro on investment. On the other hand what statistical

selection theory can do is—given the availability of historic measurements and

future policy measures—to present the most accurate account of the statistical

averages of the processes of selection in the course of time. These averages include

at any particular time instant: the aggregate outflows and inflows of the economy

(consumption, investment, wages, depreciation), the growth rates of these inflows

and outflows, the average circulation periods of each of these inflows and outflows

5

To cite E.T. Jaynes: “In a probabilistic model of the economy, we ought to include in the

probability of any macroeconomic state an entropy factor to take its multiplicity into account”

(Jaynes 1991, page 2).

1.6 The Three Principles of Evolutionary Selection, Boltzmann and Shannon 11

and the relationships of all this with the average price-level of consumption and

investment and with the relative rates of change of this price-level, the liquidity

flows and the rates of circulation.

and Shannon

Hodgson and Knudsen assert that any theory of social development should at least

pay tribute to three Darwinian principles of evolutionary dynamic change: varia-

tion, selection and inheritance. I will come back to discuss these basic principles of

selection in subsequent chapters comprehensively because they are core issues of

Darwinian selection, but as said before there is more. There is also the physicist

Boltzmann and the communication engineer Claude E. Shannon without whose

contributions the formulation of an evolutionary selection theory is unthinkable.

The nineteenth century physicist Boltzmann was deeply impressed by Darwin’s

theory and immediately understood that a well formulated mathematical selection

theory was required to work it out coherently for quantitative testing. Well,

Boltzmann had been involved in contemporary mathematical physical research

that ultimately led to a complete theory of statistical mechanics and thermodynam-

ics in the dawn of the twentieth century founded on Newtonian principles of

mechanical motion and on statistical selection theory. He used his expertise to

derive a relation that connected the entropy H to its state probability π:

H ¼ –log(π).6

Boltzmann immediately realized that the entropy H—stripped off as it was from

its thermodynamic background with its sole relationship with state-probability—

was a measure for the order of an evolutionary system. The more order it had, the

less probable its state. Boltzmann hinted that Darwin’s selection theory was

6

One is free to choose the base of the logarithm. As a rule I shall use the base 2, so that the entropy

is given by H ¼ –2log(π). The original form in which Boltzmann stated his H-theorem is H ¼

k · log(π), i.e. without the minus sign. Herein k is Boltzmann’s constant, a positive constant which

can be set to 1 if we adjust the dimensional unit in which entropy is measured accordingly. The

difference of sign with the formula in the main text is a matter of entropy definition. If we adhere to

the Clausius/Boltzmann measure of entropy, entropy is always negative and the second law of

thermodynamics must be stated as the law that in thermodynamically isolated systems entropy

will always increase. This is the common way of physicists to deal with the entropy concept.

I adopt the much more preferable Shannon measure of entropy in which entropy is related to state

probability as in the main text. The Shannon measure of entropy will have it that the entropy of

thermodynamically isolated systems will always decrease. Don’t worry: social systems are not

thermodynamically isolated. Thus the Shannon entropy of a social system can increase, i.e. create

more order. We can formulate the latter statement of increasing Shannon entropy also in the

following manner: that as a rule the selection of an economy will become more and more

improbable in the course of time. (Note this is not a necessity. Sometimes an economy is recessive

and during the recession phase its selection becomes more probable in the course of time).

12 1 Darwin- and Shannon-Inspired Dynamic Economic Selection

responsible for creating more and more order in evolutionary systems in the course

of time.

In the decennia covering the period between 1920 and 1950 the transference of

messages by means of electric, electromagnetic and acoustic signals (telegraph,

telephone, radio, light, radar and sonar) gained rapidly terrain. Communication

engineers became increasingly involved in the design of methods by which the

messages had to be coded and decoded for optimal transference and optimal

reception of information. The Second World War accelerated the demand for

these techniques. It was this background that stimulated a young engineer, Claude

E. Shannon, to launch an exciting theory of information and communication

handling, not easy to grasp at first glance, but extremely illuminating in the way

it treated choice, uncertainty, information, complexity, emergentism under the

common heading of the concept of entropy (Shannon 1948).

Shannon realized that the coding and decoding of signals over a communication

channel was a typical problem of statistical selection, which involved the assign-

ment of a state inflow probability PrfX0 g to the transmitted inflow sequence hX0 i at

the transmitter side and a state outflow probability PrfY0 g to the received outflow

sequence hY0 i at the receiver side of the channel.7 He considered sequences

(signals) of individual samples to be of finite time-length T and statistically

stationary (or more accurately: ergodic). The stationarity condition did not really

seem to affect the generality of his approach with respect to the communication

channel although radar and sonar signals and echoes are all but stationary. For a

discrete signal that could only assume a discrete number of different states Shannon

defined and justified the information content H ðX0 Þ per trial/sample of the inflow

sequence and the information content H ðY0 Þ per trial/sample of the outflow

sequence to equal the respective entropies:

X X

H ð X0 Þ ¼ λi log λi and H ðY0 Þ ¼ μj log μj (1.1)

i j

experiment of inflow respectively outflow selection. λi is the probability of a sample

of the inflow signal to be in state i. μj is the probability of a sample of the outflow

signal to be in state j. The summations over i and j extend over all states. Entropies

like H ðX0 Þ and H ðY0 Þ play a central role in evolution as measure of information,

choice, value and uncertainty as they do in Shannon’s information and communi-

cation theory.

Shannon’s mathematical description of the communication channel is very

general (within the context of ergodic signals) and lends itself to study a class of

various applications of communication while respecting the elementary principles

of probability theory and applying its sophisticated tools and rules where necessary.

Within this context the level of uncertainty and quantity of information are not so

7

See for the notational conventions Appendix I.

1.6 The Three Principles of Evolutionary Selection, Boltzmann and Shannon 13

entropy. Shannon treats therefore these concepts interchangeably dependent on the

interpretation that is applicable.

I shall avoid entering too much further in a discussion of the theory of the

communication channel but concentrate on the significance of its main theorems for

economic evolution. One important aspect of it must however here be especially

mentioned because it is directly concerned with the problem of generalizing the

ideas of Shannon in order to apply it to Darwinian evolutionary systems of statisti-

cal selection. Shannon focused on applying his path-breaking ideas to the under-

standing of the communication channel in many different contexts (i.e. the discrete

and continuous channel, with and without noise). One may tacitly assume that

Shannon did never consider the possibility that his theory could be generalized to

describe statistical evolutionary selection. As noted before Shannon’s communica-

tion channel is stationary, i.e. the transmitted signals have constant statistical

averages in the course of time and the stationary signals have always a finite

time-length T. On the other hand macro-economic evolutionary systems of selec-

tion are non-stationary. They possess statistical averages (inflow, outflow, circula-

tion rates, unit price) that vary dynamically. In fact these dynamic variations are

exactly what we wish to relate to one another and that we desire to explain by

derivable equations of Darwinian selection. The difficulty is therefore: how to catch

the dynamic non-stationary character of evolution in a mathematically consistent

manner? Or how to generalize Shannon’s approach to the non-stationary character

of evolutionary development? The clue to achieve that is differential analysis. If we

restrict Darwinian selection to consecutive intervals of infinitesimally small length

dt we may assume inflow and outflow of Darwinian evolution to remain unaltered

during a time-interval of length dt (at least to first order of accuracy in dt). This

implies that we must apply a time-compression operation ðT ! dtÞ to bridge the

gap between the time consuming Shannon sphere of selection and the instantaneous

Darwinian sphere of evolutionary selection and so to lift Shannon’s prerequisite of

stationary variables (See Fig. 1.1 for a more visual picture). In sum, Darwinian

evolution is a differential statistical selection process. Inflows feed differentially on

available stocks of entropy in the course of time; outflows replenish these stocks of

entropy differentially in the course of time so that the stocks don’t become

exhausted. On the other hand Shannon’s communication channel is a non-differen-

tial selection process. Stocks of entropy cannot be maintained in the communica-

tion channel system because creation of entropy in the communication channel does

not and cannot occur. Instead entropy may be lost in the process of communication

due to the presence of noise and other disturbances on the channel.

Our time-compression operation in Fig. 1.1 focuses in the very first instance on a

Darwinian evolutionary system where only two alternative states of selection are

being discerned: state 1 (which by convention we will consider to represent the

population state or subject state) and the alternative state 2 (which by convention

we will consider to represent the environmental state or object state). Note that this

binary system of selection involves signals (or sequences) of inflow and outflow

samples that can only assume two different levels (states, e.g. –6 V and +6 V for the

14 1 Darwin- and Shannon-Inspired Dynamic Economic Selection

Transmitter Receiver

X0 Communication Y0

channel

state 1 communication

state 2 channel selection

occur within a time-

Shannon Finite time-length T of signal interval of finite

time-length T.

Required

time-interval

compression

inflow entropies H(X1), H(X2) outflow entropies H(Y1), H(Y2)

occur within an infinitesimally small

time-interval of time-length dt

Fig. 1.1 The transition from communication channel selection towards Darwinian evolutionary

selection.

Each sample of the inflow sequence hX0 i and outflow sequence hY0 i is either in state 1 or in state 2. For the communication channel the

distinction in states may be achieved by two different volt levels or two different levels of acoustic pressure. For two-sector economic

evolution the distinction in states is marked by having a sample to get selected either in the consumption sector (state 1) or in the investment

sector (state 2).

H(Xi) is the entropy inflow per sample in state i (i ¼ 0, 1 or 2). H(Yi) is the entropy outflow per sample in state i (i ¼ 0, 1 or 2). Sequences of

samples extend over (t,t + dt). Entropy flows emerge as outcomes of the selection of samples. The entropy inflow of all the Zdt samples of

hX0 i in state i is Xi ¼ Zdt · H(Xi) bits. The entropy outflow of all the Zdt samples of hY0 i in state i is Yi ¼ Zdt · H(Yi) bits:

H(X0) ¼ H(X1) + H(X2), H(Y0) ¼ H(Y1) + H(Y2)

omy with consumption sector (state 1) and investment sector (state 2). This is the

way we have presented the sequences of inflow and outflow in Fig. 1.1 but it is by

no means necessary. We may just as well present a multi-state system of evolution

with N different states (in economics the multi-sector economy) that each sample

can assume.

It is convenient to introduce state 0 as a pseudo-state in order to represent the

situation that the outcome of a trial (sample) is always in one of the N possible

states. Thus the assertion that a sample is in state 0 is the certain statement that

anything has happened.

1.7 The Time-Compression Transition from Shannon to Darwin: Assembling and. . . 15

alternative states of selection (in economics the two-sector economy with N ¼ 2)

in Fig. 1.1 and in subsequent analysis does not affect the generality of analysis. We

may just as well discern more than two alternative states of selection and we will

often do so. The notation is then a little more complicated and it will be more

demanding to oversee the whole. Let ðt; t þ dtÞ denote the time-interval of selection

and let Z ¼ ZðtÞ denote the time-dependent sampling rate of selection per unit of

time during ðt; t þ dtÞ. Clearly dt is the time-length of the time-interval ðt; t þ dtÞ of

selection. The product Zdt of the sampling rate Z and dt is the length (the number of

samples during the time-interval of selection) of the sequences.

Generally then Xi ¼ Zdt HðXi Þ is the entropy inflow of all the samples in state i

of the sequence hX0 i and Yi ¼ Zdt H ðYi Þ is the entropy outflow of the samples in

state i of the sequence hY0 i ði ¼ 0; 1, 2, , N Þ. Furthermore, hX0 i and hY0 i are the

inflow and outflow sequences whose samples are either in state 1, or in state 2, or in

state 3, ; or in state N.

to Darwin: Assembling and Reassembling

Let us next consider Fig. 1.2. This is the situation after the Shannon-Darwin time-

compression operation has been performed for the two-sector model of selection. In

this schedule we keep approaching Shannon’s communication channel from the

Darwinian perspective of evolutionary selection. After the transition, selection is no

longer on a finite time-interval of length T but on the infinitesimally small time-

interval (t,t þ dt) of length dt. Thus all the samples of the inflow signal in Fig. 1.1

will be parallel-like selected on (t,t þ dt) to form a vertical inflow sequence in

Fig. 1.2. This has been represented in Fig. 1.2 by rotation of the inflow sequence of

Fig. 1.1 over 90 on the drawing-paper.8 Likewise all the samples of the outflow

signal in Fig. 1.1 will be parallel-like selected on (t,t þ dt) to form a vertical

outflow sequence in Fig. 1.2.

Each sample of hX0 i selected to annihilate in state i during the time-interval

ðt; t þ dtÞ is in the same state i at time t with probability 1. Likewise each sample of

hY0 i selected to originate in state j during the time-interval ðt; t þ dtÞ is in the same

state j at time t þ dt with probability 1.

One trial of the selection experiment involves the selection of one sample of

inflow allocated to annihilate on ðt; t þ dtÞ together with another sample of outflow

allocated to originate on ðt; t þ dtÞ.

A count of the number of samples in the particular example of Figs. 1.1 and 1.2

delivers 21 samples. This is called the sequence-length. More generally, with the

8

Mark the inflow and outflow sequences in Fig. 1.2 should actually have a small inclination such

that all of the selection events of their trials occur between t and t þ dt.

16 1 Darwin- and Shannon-Inspired Dynamic Economic Selection

state 1 2 1 2

dt

t t+dt

continuous time

Since there is “no noise on the channel” in this particular context, the inflow reproduces on the outflow side. Thus H(Y1) ¼ H(X1),

H(Y2) ¼ H(X2) and H(Y1) + H(Y2) ¼ H(Y0) ¼ H(X0) ¼ H(X1) + H(X2).

Clearly, Shannon’s stationary channel can only produce zero net growth H(Y0) – H(X0) ¼ 0 per trial. The number of trials/samples is

Zdt ¼ 21 of which λ1Zdt ¼ 14 are in state 1 and λ2Zdt ¼ 7 are in state 2.

In accordance with the evolutionary selection schedule hX0 i and hY0 i are the inflow and outflow sequences on the time-interval (t,t + dt). To

have this model handle general evolutionary situations with positive net entropy growth H(Y0) – H(X0) per sample, we must drop the

stationarity condition. In that general evolutionary context stationarity will nevertheless be maintained to first order degree in dt on the

selection interval (t,t + dt).

The assembled and reassembled entropy flows are:

Assembled Reassembled

Zdt ¼ 21 Zdt · H(X0) ¼ Zdt · H(Y0) ¼ 19.2842

λ1Zdt ¼ μ1Zdt ¼ 14 Zdt · H(X1) ¼ Zdt · H(Y1) ¼ 12.8561

λ2Zdt ¼ μ2Zdt ¼ 7 Zdt · H(X2) ¼ Zdt · H(Y2) ¼ 6.4281

get that Zdt is the sequence length. A finite sequence-length of 21 samples is

appropriate for illustration purposes in Figs. 1.1 and 1.2. However theoretical

considerations demand the sequence length Zdt to tend to infinity together with

the Shannon-Darwin transition T ! dt ! 0. This implies that Z ! 1 as well. This

operation is supposed not to affect the content of entropy or the measure of time on

behalf of the principle of evolutionary homogeneity. Thus Z >> Zdt ! 1 and

dt ! 0 . The transference of a very large (infinite) number Zdt of samples will

nevertheless support an infinitesimally small time-length dt. This implies that the

time-length dt=Z of a sample must be chosen extraordinarily small. These

requirements can always be met. Darwin was well aware of that: “Natural selection

can act only by the preservation and accumulation of infinitesimally small inherited

modifications, each profitable to the preserved being” (Darwin 1859, page 142).

1.7 The Time-Compression Transition from Shannon to Darwin: Assembling and. . . 17

In the general evolutionary context hY0 i is another sample sequence of the same

sequence-length as of hX0 i. However for the noiseless communication channel hY0 i

¼ hX0 i. I have left the identity of hY0 i and hX0 i unaffected by the Shannon-Darwin

transition T ! dt ! 0 in Fig. 1.2. However this does not correspond with the

general evolutionary situation, which requires hY0 i to differ from hX0 i. We shall not

consider the details of hY0 i of the example of Fig. 1.2 further in this section. We

restrict the discussion here mainly to the inflow selection process of Fig. 1.2 but it is

not insuperable to imagine a quite related outflow selection process for which

generally hY0 i 6¼ hX0 i.

Preparing for selection requires—in the very first instance—the gathering of

samples (here Zdt ¼ 21 in number). The gathered samples happen to be in different

states (here 14 samples in state 1 and 7 samples in state 2). These are the outcomes

of 21 trials. For clarity we shall call the initial gathering phase of the selection

process assembling and the subsequent reordering phase of the selection process

into the sequences hX0 i and hY0 i reassembling.

Shannon claims that the inflowP sequence of length 21 must be given information

content Zdt HðX0 Þ ¼ Zdt i λi logλi in accordance with (1.1). Recall that λi is

the probability of a sample of the inflow signal to be in state i. Note that, in the

particular example of Figs. 1.1 and 1.2, hX0 i has only 14 samples in state 1 and 7

samples in state 2 so that actually λ1 ¼ 14=21 ¼ 0:6667 and λ2 ¼ 7=21 ¼ 0:3333 in

this particular binary case of selection. It follows that

¼ 0:9183 Zdt

entropy content of hX0 i. We will call it the entropy inflow. The scale of the unit

of value (u.o.v.) in which entropy inflow is expressed may be any scale on behalf of

the principle of evolutionary homogeneity. The choice of the unit of value does not

seem to matter. It does not affect the selection outcomes because all samples occur

on the infinitesimally small time-interval ðt; t þ dtÞ. As time remains fixed at any

time instant on the interval ðt; t þ dtÞ, there is a fixed rate of exchange between

different units of value in the course of selection to first order of accuracy in dt. Thus

the u.o.v. may be a dollar, a Euro-cent, a real unit of value, a shell, a cow or one

thousandth of a cow or even a bit of entropy or 1.3 bits of entropy etcetera. It does

not matter be it that actually the u.o.v. should have a very, very small value to

warrant that we can express all entities of value with sufficient accuracy relative to

one another.

It follows that we are assembling 21 inflow samples of 21 u.o.v. (i.e. the

assembled value is 21 u.o.v.) and it turns out that—reordered—19.2842 u.o.v.

emerge out of it (i.e. the reassembled value is 19.2842 u.o.v.). This is Shannon’s

way of looking at the process of selection. And very important: Shannon’s formula

satisfies the principle of evolutionary homogeneity because the reassembled value

is proportional to the sequence length Zdt.

18 1 Darwin- and Shannon-Inspired Dynamic Economic Selection

Well, this is not the complete story. The problem is that Shannon’s formula is

only applicable if the number Zdt of samples is very large and 21 samples is

unfortunately far from enough to apply the approximation on which Shannon’s

formula (1.1) is based. For 21 samples the right answer is that only 16.827 u.ov.

instead of the 19.284 u.o.v. calculated by Shannon’s formula are being

reassembled. Unfortunately, the correct outcome of 16.827 u.ov. is incompatible

with the principle of evolutionary homogeneity. Thus for small sequence-length Zdt

the principle of evolutionary homogeneity will not be preserved.

However, the calculation error in Shannon’s approximation formula (1.1) can be

easily avoided by choosing a much larger number of samples. Let us choose a new

unit of value (the milli-u.o.v.) that is 1,000 times as small together with 1,000 times

as many samples. Then there are 21,000 samples of which 14,000 will turn out to be

in state 1 and 7,000 in state 2. The correct answer is now that Zdt H ðX0 Þ ¼ 19; 277

milli-u.o.v. will be reassembled, which is the equivalent of 19.277 u.o.v. This is

very close to the outcome of 19.284 u.o.v. calculated by Shannon’s formula (1.1). If

we choose a still smaller unit of value, the error between the two outcomes gets

smaller and smaller. In fact, if the number of samples is chosen infinitely large, the

error vanishes completely. See Appendix A for a complete explanation. We must

thus adopt the rule that the number Zdt of samples is always very large. For

illustration and explanation purposes, it is however sometimes desirable to keep

the number of samples at a finite limit (as in Figs. 1.1 and 1.2).

At a much later stage of analysis we shall see why it is justified to look at

this process of selection in the Shannon way (See Chap. 4 and Sect. 4.1). We shall

here just accept it. It follows that the reassembled X0 ¼ Zdt H ðX0 Þ units of

value in state 0 consist of X1 ¼ Zdt H ðX1 Þ ¼ λ1 Zdt HðX0 Þ u.o.v. in state 1 and

X2 ¼ Zdt H ðX2 Þ ¼ λ2 Zdt H ðX0 Þ u.o.v. in state 2.

In the example of Figs. 1.1 and 1.2 with Zdt ¼ 21, λ1 ¼ 14=21 ¼ 0:6667 and

λ2 ¼ 7=21 ¼ 0:3333 the numerical answers we get are Zdt HðX1 Þ ¼ 12:8561

reassembled u.o.v. in state 1 and Zdt HðX2 Þ ¼ 6:4281 reassembled u.o.v. in state 2.

In the above we have restricted the discussion to the statistical experiment of

inflow selection. For the statistical experiment of outflow selection (the other part of

the selection process) the same considerations with respect to assembling and

reassembling apply.

Anticipating further explanation in the sequel, we remark here that economically

inflow selection is the activity of economic agents (entrepreneurs and laborers) by

which they sacrifice (assemble) production resources (financial, material as well as

labor) and form (reassemble) novel combinations of the sacrificed value thereof that

effectuates the reduction of the sacrificed value. Similarly, economically outflow

selection is the activity of economic agents (investors and consumers) by which

they spend (assemble) on investment opportunities and consumption and form

(reassemble) novel combinations of the spent value thereof that effectuates the

reduction of the spent value. It is another way of looking at economic activity, but it

is also the only consistent way that accords with a Shannon inspired approach of the

evolutionary process.

1.8 The Unit of Selection and the Unit of Exchange 19

still rather incomplete, but it is impossible to set out all aspects at once. We will

gradually provide for its completion in subsequent chapters.

In the previous section we have considered selection on the time interval ðt; t þ dtÞ.

Selection is a continuous dynamic process. Hence it is not restricted to just one

particular time interval ðt; t þ dtÞ, but it goes on for continuously increasing time t.

Thus selection on ðt; t þ dtÞ is prosecuted by subsequent selection on consecutive

time-intervals ðt þ dt; t þ 2dtÞ, ðt þ 2dt; t þ 3dtÞ, ðt þ 3dt; t þ 4dtÞ, , each of the

same infinitesimally small time-length dt. Each interval of this indefinite series of

contiguous differential time-intervals may have its own unit of value.

But there are some serious limitations with respect to these choices of the units

of value. Whereas we argued in the previous section that it did not matter in which

u.o.v. reassembled entropy was to be expressed because that choice could not affect

the outcomes of selection on a single time-interval ðt; t þ dtÞ, we must now admit

that it does affect the comparison of reassembled entropy over consecutively

infinitesimally small intervals of time. For instance if we choose the Euro to be

our common u.o.v. for the time-intervals ðt; t þ dtÞ and ðτ; τ þ dtÞ with τ t finite

and τ t > 0, we obtain for the joint entropy inflow at time t:

ZðtÞdt H ðX0 ðtÞÞ ¼ ZðtÞdt ½λ1 ðtÞ log λ1 ðtÞ þ λ2 ðtÞ log λ2 ðtÞ Euros

Z ðτÞdt H ðX0 ðτÞÞ ¼ ZðτÞdt ½λ1 ðτÞ log λ1 ðτÞ þ λ2 ðτÞ log λ2 ðτÞ Euros

However, one Euro at time τ has another real content than one Euro at time t so

that, to keep the real content of the two outcomes comparable, we are induced to

correct the expression at time τ for the loss of real value of the Euro over the time

interval ðt; τÞ.

Likewise, if we had chosen still another u.o.v., e.g. the US dollar, then the joint

entropy inflow at time t would have been:

ZðtÞdt H ðX0 ðtÞÞ ¼ ZðtÞdt ½λ1 ðtÞ log λ1 ðtÞ þ λ2 ðtÞ log λ2 ðtÞ dollars

ZðτÞdt H ðX0 ðτÞÞ ¼ Z ðτÞdt ½λ1 ðτÞ log λ1 ðτÞ þ λ2 ðτÞ log λ2 ðτÞ dollars

We are now also induced to correct the latter expression at time τ for the loss of

real value of the dollar over the time interval ðt; τÞ. Well this is no problem if the loss

20 1 Darwin- and Shannon-Inspired Dynamic Economic Selection

of real value of the dollar over the time-interval ðt; τÞ is exactly the same as the loss of

the real value of the Euro over ðt; τÞ. In that case we can always reduce the values in

dollars to Euros in a consistent manner. However, a dollar’s change of real value

differs from a Euro’s change of real value. The latter inconsistency can only be

avoided if we stick to the same u.o.v over the contiguous differential intervals of

selection. This is what actually happens in a particular money economy: the agents of

that economy stick to the same money unit for exchange in the course of time.

However, exchange is another process than the process of entropy selection. It

suffices to use a money unit (e.g. the Euro) as our unit of exchange in the course of

time, but to compare the inflow, respectively the outflow, of selection during the

infinitesimally small time-interval ðt; t þ dtÞ with the inflow, respectively the out-

flow, of selection during another small time-interval ðt þ τ; t þ τ þ dtÞ, it is necessary

that inflows and outflows are expressed in a unit of value that is evenly scarce at time

t and at time τ. The unit of money (like the Euro) is inappropriate for that purpose

because it does not remain evenly scarce in the course of time due to price inflation.

Instead selection demands that the units of selection to be allocated and reallocated

are evenly scarce in the time-course of the process of selection. That is, they must

share the same state probability. In consequence of Boltzmann’s theorem equivalent

portions of entropy share the same state probability. Thus the unit of selection must

be a unit of entropy and preferably a unit of entropy that is as small as possible.

A natural candidate is the unit of entropy, i.e. the bit, because it holds everywhere the

same state probability equal to 12 at any time of selection because log 12 ¼ 1 bit.

However any constant quantity of bits can serve equally well as a unit of

selection. We will leave the choice of that constant quantity open and tentatively

appoint as our unit of selection a sample, however now with the restriction that each

sample stocks the same constant quantity of entropy everywhere and always.

The conclusion is then that a sample is the common article of selection to

allocate and reallocate economic flows of entropy in the course of time. That is,

the unit of selection is a fixed quantity of bits named the sample.

On the other hand within an economy economic value is not exchanged for units

of entropy but for units of money. At first glance one may think that the choice of

the money unit in which to exchange two entities A and B of the same unit price

does not affect the economy. The argument behind this false impression is that the

two entities A and B will remain equally expensive irrespective of the unit of value

in which their price is stated. However, the choice of the unit of exchange does

affect the economy because, to facilitate exchange within an economy, money must

be issued by a monetary authority. This is in itself a source of creating additional

entropy. Dependent on the price inflation induced by monetary policy the effects on

the economy will be different and this is why the choice of the unit of exchange

matters9 in the course of time.

In summary, selection is a process concentrating on assembling and

reassembling quantities divided up in bits of entropy. Exchange is a process

9

We might perhaps also call this the unit of transmission.

1.9 Production Functions, Marginalism and the Interaction of Inflow and Outflow 21

processes are essential for evolution to occur as we will see. Exchange in order to

get everything at the right destination for assembly, selection in order to get

everything reassembled in another order of states.

Without exchange we don’t get the candidate quantities for exchange at the right

positions to interact so that the selection processes cannot be executed. Exchange is

conditional to selection.

of Inflow and Outflow

models of mainstream economic analysis and the Darwin/Shannon inspired approach

of economic explanation. However, in several respects analyzing economic behavior

in a particular manner in either way may be quite related with respect to common

points of departure. E.g. in accordance with a classical description economics is

concerned with the alternative allocation of scarce resources. In the Darwin/Shannon

selection model the scarceness of an economic entity is reflected by its selection

probability (state probability). The less probable its selection, the scarcer it is. Since

actual selection is between different states, the different states reflect the different

alternative allocation possibilities. Selection is merely the process of allocation.

Another line of analysis where there are initially common and overlapping

considerations between ultimately widely different views is the inflow/outflow

order of an economy. Clearly an economy is a circulating inflow/outflow device.

Inflow is permanently sacrificed to yield outflow. In turn outflow will, after

exchange, be sacrificed as inflow to yield evermore outflow during subsequent

production cycles. The surplus of outflow over inflow causes the economy to

grow. These notions may be regarded to belong to common understanding. The

difference between the Darwin/Shannon view and the mainstream line of analysis is

in the working-out. Mainstream has embraced the neoclassical interpretation in

which production functions are postulated with their marginal products to account

for the relationships with the relative costs of the factors of production.

Neoclassical theory has been convincingly criticized in many different ways.

The major shortcoming is the failure of orthodox theories of economic behavior to

account for a universal truly dynamic explanation of economic development. In the

end this is the common focus of all critical examinations, however diverse they

individually may be. It is in the general stochastic dynamics of Darwin/Shannon

selection theory that all orthodox theories find their master. More concretely,

orthodox economic theories fixate and so maltreat time wittingly by the manner

they deal with parameters as constants and perhaps unwittingly by the manner they

differentiate mathematically.

22 1 Darwin- and Shannon-Inspired Dynamic Economic Selection

I feel that it is worthwhile to introduce and explain the superior Shannon inspired

conception of inflow/outflow against the particular background of a neoclassical

model. Moreover, this discussion will also contribute to understand how Darwinian

evolutionary selection must be mathematically described in a general dynamic manner.

Marginalist interpreters of neoclassicism have a lot to explain. Is it permissible

to define marginal products in the manner as is actually done in neoclassicism? Let

me discuss the subject by restricting the analysis to the two-sector production

function to which neoclassicists often adhere to explain the basic idea behind

their theory: the production function F ðK,LÞ of capital K and labor L. In this, K

is a capital stock expressed in units of real value, L is the stock of employed labor

expressed in units of labor (often the number of employed laborers). Noteworthy is

that F ðK,LÞ is hypothesized to equal the (yearly) aggregate output Ye of the

economy, which is here a flow variable expressed in units of real value10:

Ye ¼ F ðK,LÞ (1.2)

net domestic product NDP, i.e. GDP after entrepreneurial depreciation has been

deducted.)

The first thing to notice here is that in essence Ye is a flow variable and that K and L

are stock variables. Thus we encounter a flow variable on the left side and stock

variables on the right side of the equation. In two respects this is weird. First of all

why not input Xe on the lead: Xe ¼ F ðK,LÞ in the stead of output Y? e Secondly, the

reciprocal of the number of times that a flow variable goes into its stock variable is

the circulation rate of that stock variable. Thus if the symbol ζ denotes the output

e then by definition11:

circulation rate of output Y,

Ye ¼ ζ K (1.3)

It is well known that the circulation rate ζ is changing remarkably in the course of

the business cycle. It is decreasing when the recession phase sets in and it will

increase when recovery sets in reaching its maximum during the booming phase of

the business cycle. Thus—like Y, e K and L—ζ is a dynamic function of time t:

ζ ¼ ζðtÞ

10

Mark that the definitions of the neoclassical Ye and the evolutionary Y0 ¼ Zdt H ðY0 Þ, in the

present treatise applied, differ markedly. The most conspicuous difference is that Ye is a real value

of output usually accumulating over one year, whereas Y0 is entropy outflow of the executed

statistical experiment over the time-interval (t,t þ dt).

11

In case Ye is NDP, ζ is a net circulation rate per year, which neoclassicists consider to represent the

marginal product of capital under perfect competition. The problems to explain the business cycle

fluctuations of a net circulation rate ζ are not less great than the problems facing the explanation of

the fluctuations of the gross circulation rate considered in the text.

1.9 Production Functions, Marginalism and the Interaction of Inflow and Outflow 23

It is also quite well known that the relative time-dependent fluctuations of ζ are of

the same order of magnitude as the relative variations of output. The problem then

arises how the business cycle fluctuations of ζ affect the change of output Ye and the

change of K . The possibility that Ye is not very much affected and hence that—in

accordance with (1.3)—a decrease of ζ is largely accompanied by an increase of K is

quite beside the mark since it is well known that K is also apt to decline in the

recession phase.

Thus on account of expression (1.3) we expect that—as the recession sets in—

the decrease of ζ will affect a relatively larger fall of Ye. However it is also well

known that the decrease of ζ will not immediately be followed by a decrease of L.

The decline of L will follow with a delay of half to 1 year. Furthermore, after that

delay the decline of Ye will usually diminish or even stop and then expression (1.2)

deprives L to fluctuate very much.

Expression (1.2) does not reflect and may even contradict these observations,

because—if Ye declines relatively much more than K does—it is necessary on behalf

of (1.2) that the decline of Ye is accompanied by a simultaneous decline of L of

comparable magnitude.

[In fact the explanatory deadlock is even worse if we take into account the

role of the parametric exponents a and 1 a with Ye ¼ F ðK,LÞ ¼ b K 1a La and

0 < a < 1]. Therefore expression (1.2) does not reflect an instantaneous dynamic

universal relationship.

To save the neoclassical paradigm, the neoclassical functional relationships are

sometimes advocated as describing economic behavior and trends in the long run.

But this is quite an inadequate manner to deal with the problems. Indeed within the

context of the parametric method of scientific investigation one can always put the

long run defense strategy on the stage to save a theory. If the long run is long run

enough, the differences between the fluctuations of the left side and the right side of

(1.2) level off, but unfortunately this will also immobilize the dynamic import of the

theory. The more the fluctuations are averaging out, the more linear correspondence

there is between the left side variable Ye and the right side variables K and L of the

equation, but—despite that—the less these long run relationships explain. Long run

averaging cannot save a theory.

(Another but related way to save the neoclassical paradigm is to assume that it

holds only under conditions of static growth or by assuming stable or nearly stable

net growth. In that case Y,e K and L are assumed to share the same or nearly the same

net rate of growth. Fluctuations about that rate are completely ignored. Clearly such

assumption is totally unrealistic. It is just as much objectionable as the idea that the

theory has only long run significance.)

That the neoclassical production theory can only be given (weak) economic

significance under the unrealistic condition of long run averaging and/or under the

rigid restriction of static growth, is very much connected with the parametric nature

in which production functions must be stated. For instance we need two parameters

a and b for the Cobb Douglas production function:

Ye ¼ F ðK,LÞ ¼ b K 1a La with 0 < a < 1

24 1 Darwin- and Shannon-Inspired Dynamic Economic Selection

function as long as the parameters are near constants. To save the neoclassical

paradigm for the shorter run, it is necessary for a and b to fluctuate in the course of

time as well. However this undermines the assumed equivalence of the marginal

product @ F=@ K of capital to the unit cost of capital as well as the assumed

equivalence of the marginal product @ F=@ L of labor to the unit cost of real labor

under conditions of perfect competition. The deplorable result is that the complete

neoclassicist theory is tripped up.

In summary expression (1.2) does not contribute anything to explaining the

business cycle of the economy dynamically and thus it is legitimate to pose the

question why mainstream economists attach so much significance to a theory that

cannot explain the most elementary properties of the economic business cycle.

Economic science must be concerned with explaining the instantaneous dynamic

fluctuations of the business cycle in their mutual context, not with smoothing out

those fluctuations.

It is necessary to reconsider the relationships between the inflows and outflows

of the economy in a much wider and much more general perspective than the

narrow long run perspective that the neoclassical theory is capable to give. The

neoclassical production functions give a single one-sided view of an output variable

in terms of stock input variables and fail to deal with the full essence of the

economic production process: the complete mutual interaction between inflows

and outflows.

Well, to keep matters straight, the above critique does not definitely settle the

dispute about the validity of the neoclassical paradigm. It is quite difficult to

accomplish that in this way considering the many disguises in which production

functions are dressed and pop up, each requiring another way of demonstrating that

the new metamorphosis cannot in the least deal with the full dynamics of economic

evolution. However, what the criticism does is to call neoclassicism seriously in

question. And no more is needed. It is not the scientific task of opponents of the

theory to refute the neoclassical dream rigorously. Throwing motivated serious

doubts upon it is sufficient. On the other hand it is the scientific task of its

proponents to demonstrate beyond doubt (by mathematical argumentation and by

experimental verification) that the neoclassical production functions behave

dynamically sound in the short run. Unfortunately, there has been no sign whatso-

ever of the latter. Claims of that sort fail for the same reason: they hold only in the

long run or under conditions of rigid stable growth.

Nevertheless the idea underlying neoclassical production theory has a certain

appeal. It expresses the awareness that both the application of labor and the use of

entrepreneurial capital have an impact on output in the course of production.

The production function theory acknowledges the output Ye as a result of two

factors (that is the good thing). However, that is not sufficient. By common consent

economists have accepted GDP, the sum of gross investment and consumption, as

the joint outflow of the two-sector economy. Clearly then gross investment and

consumption must represent an outflow of the investment sector and an outflow of

1.9 Production Functions, Marginalism and the Interaction of Inflow and Outflow 25

the consumption sector in respective order. As there are two types of outflow,

consumption and investment, a satisfactory theory of inflow/outflow must take into

account that also two types of inflow exist: one that uses up the stock of entropy that

consumption builds up and another that uses up the stock of entropy that investment

builds up. The first stock I shall call labor capacity, the second stock I shall call

entrepreneurial capacity. Thus consumption is labor outflow, the flow of entropy

that increments labor capacity and labor inflow is the flow of entropy that

decrements labor capacity. Similarly, investment is entrepreneurial outflow, the

flow of entropy that increments entrepreneurial capacity and entrepreneurial depre-

ciation is entrepreneurial inflow, the flow of entropy that decrements entrepreneur-

ial capacity.

I shall elaborate on this topic in the only possible manner it can be done (i.e., in

an evolutionary context of economic development) in Sect. 2.1 of Chap. 2 and in

increasingly more detail in subsequent sections and chapters to come.

Labor and entrepreneurial capacity are stock quantities. If outflow is considered

to represent a flow variable, consistent analysis demands that inflow is dealt with on

the same footing as outflow, i.e. as a flow variable as well. Hence a more accurate

understanding of inflow/outflow analysis involves to discern the two inflows of the

two-sector economy: labor inflow (which includes wages and other inflows of the

consumption sector as we will demonstrate in due time) and entrepreneurial inflow

(which includes entrepreneurial depreciation as a measure of the wear and tear of

production resources as well as other inflows of the investment sector as we will

also demonstrate in due time).

In summary then the neoclassical production function does not provide for a

correct and consistent theory of interaction between the two flows of labor inflow

and entrepreneurial inflow on the one hand and the two flows of entrepreneurial

outflow (investment) and labor outflow (consumption) on the other. Let me further

clarify this as follows with the help of the inflow/outflow scheme of Fig. 1.2.

I will hereby apply the following notational conventions in accordance with

what has already been stated in Sects. 1.6 and 1.7:

The respective entropy volumes (per sample) of labor inflow, entrepreneurial

inflow and joint inflow per trial of the two-sector economy, P selected during

(t,t þ dt), are denoted by H ðX1 Þ , H ðX2 Þ and H ðX0 Þ ¼ i H ðXi Þ in accordance

with the Shannon-inspired scheme of Fig. 1.2.

The respective entropy volumes per sample of labor outflow, entrepreneurial

outflow and joint outflow per trial of the two-sector economy, selected during

P

(t,t þ dt), are denoted by H ðY1 Þ, H ðY2 Þ and HðY0 Þ ¼ j H Yj .

Agents select by using up and decommissioning entropy/value and by spending

and commissioning entropy/value. Mark that the subscripts (0, 1 or 2) decide about

to which state (i.e. to which sector) the inflow, respectively the outflow, belongs.

To avoid conceptual vagueness hX0 i and hY0 i are sequences each of Zdt samples,

with each sample consecutively selected over the time-interval ðt; t þ dtÞ,resulting

in the reassembled entropies/real values Zdt H ðXi Þ, respectively Zdt H Yj over

ðt; t þ dtÞ . The time-length of these sequences is always dt. HðXi Þ and H Yj

26 1 Darwin- and Shannon-Inspired Dynamic Economic Selection

CONSUMPTION SECTOR

Net growth of

labor capacity

Production

Y1 = Zdt ⋅ H(Y1) X1 = Zdt ⋅ H(X1)

Outflow Inflow

sequence Y0 sequence X0

Net growth of

entrepreneurial

capacity

INVESTMENT SECTOR

Fig. 1.3 The universal two-sector (binary) model of evolutionary inflow/outflow selection.

The system of equations is non-parametric and derivable from first principles of evolutionary economics.

H(Yi) is the reassembled entropy per sample in state i of the outflow sequence hY0 i. H(Xi) is the reassembled entropy per sample in state i of

the inflow sequence hX0 i

entropy per trial/sample. H ðXi Þ is reassembled entropy

inflow. H Yj is reassembled entropy outflow. H ðXi Þ , respectively H Yj , are

properties of the sequence hX0 i, respectively of the sequence hY0 i.

The indices i and j are used to discern between the different inflows and outflows

per sector of the multi-sector economy. H ðXi Þ is the reassembled entropy inflow per

trial/sample of the i-th sector; H ðYi Þ the reassembled entropy outflow per trial/

sample of the i-th sector. The notational convention with indices has the advantage

of offering much more insight into the eventual symmetries of the economic flow

variables than the old notational conventions do: Y for GDP, I for investment, C for

consumption, W for wages and D for depreciation. Please forget the old notational

conventions.

It is common knowledge that outflow is produced by the sacrifice of inflow.

Hence for the two-sector economy H ðY1 Þ will be produced as a result of sacrificing a

portion of the inflow H ðX1 Þ and of sacrificing a portion of the inflow H ðX2 Þ. Further,

H ðY2 Þ will be produced by sacrificing the remaining portions of HðX1 Þ and H ðX2 Þ.

Thus we see that both inflows, H ðX1 Þ and HðX2 Þ, are involved in producing both

outflows H ðY1 Þ and H ðY2 Þ in accordance with the inflow/outflow diagram of

Fig. 1.3.

The system of equations that applies to Fig. 1.3 is explainable from first

principles of evolutionary economics (See also Fig. 1.2). That system is universal

and non-parametric. It does acknowledge for interaction between the inflow and

outflow variables as the scheme of Fig. 1.3 suggests: labor inflow H ðX1 Þ and

1.9 Production Functions, Marginalism and the Interaction of Inflow and Outflow 27

outflow H ðY1 Þ and brand-new outflow H ðY2 Þ. The various inflows interact with the

various outflows. The interaction process has some very special features. E.g., the

production process causes entrepreneurial capacity stocked in the investment sector

and labor capacity stocked in the consumption sector to change continually. With

the sampling-rate Z representing the number of samples (trials of the statistical

experiment) per unit of time, the reassembled entropy X2 ¼ Zdt H ðX2 Þ, a very small

portion of the remnant of what was net produced in bygone times, serves to be

sacrificed for current production during (t,t þ dt) and the surplus of Y2 ¼ Zdt H ðY2 Þ

over X2 ¼ Zdt H ðX2 Þ is the net flow by which the value stocked in the investment

sector will increase during (t,t þ dt).

The interaction between H ðX1 Þ, H ðY2 Þ, H ðX2 Þ and H ðY1 Þ is the cause that the

marginal products @F=@L and @ F=@ K of the neoclassical production function with

respect to labor and entrepreneurial capital cannot be associated with the respective

unit costs of labor and of entrepreneurial capital. If we should nevertheless assume

so, we ignore that the stocks of labor capacity and entrepreneurial capacity are

being fed by both outflows HðY1 Þ and H ðY2 Þ , and at the same time are being

exhausted by both inflows H ðX1 Þ and HðX2 Þ . That implies that the increase of

labor capacity per trial is equal to the surplus H ðY1 Þ HðX1 Þ of H ðY1 Þ over H ðX1 Þ

and that the increase of entrepreneurial capacity per trial is equal to the surplus

H ðY2 Þ H ðX2 Þ of H ðY2 Þ over H ðX2 Þ . These surpluses represent a net growth

of capacity per sample/trial. So we might follow the noteworthy neoclassical

reasoning by remarking that H ðY2 Þ H ðX2 Þ is the total net increase of

entrepreneurial þ labor capacity per sample if labor capacity remains constant.

And that HðY1 Þ H ðX1 Þ is the total net increase of entrepreneurial þ labor

capacity per sample if entrepreneurial capacity remains constant. However, there

is no connection whatsoever with the unit cost of labor respectively with the unit

cost of entrepreneurial capital within the dynamically changing context of

selection.

Chapter 2

Sets of Entropy, Selection, Venn Diagrams

and Bitpulses

tion: inflow selection, outflow selection and overall (or concurrent) selection. These

experiments return each another entropy content of a particular differential set.

Each sector of the economy represents a non-differential set that stocks entropy

in a given state. The entropy content is called the capacity of that state-sector.

Differential sets of outflow deposit the entropy content they created during the

selection interval (t,t + dt) into those sectors. Differential sets of inflow withdraw

the entropy content they use up during the selection interval (t,t + dt) from those

sectors.

Venn diagrams assist to illustrate the relationships between various differential

sets and to clarify the definitions of other differential sets deducible from the

former.

A fundamental point of attention is how the unit of selection (the core object of

selection) must be defined. Much attention is given to the ideas of Hodgson &

Knudsen in this respect. Weighty mathematical considerations lead to one and

only one conclusion in virtue of the basic Darwinian principles: the unit of

selection is a bitpulse. This is a dynamic rectangular pulse of constant entropy

residing in a particular selection state with a finite lifetime stretching out over

time from its initial time (the time it has originated and has acquired its entropy

content) until its final time (the time it will expire and will lose its entropy

content).

During the time-interval (t,t + dt) of selection, only a very small portion

(nevertheless an exceptional large number) of the bitpulses, stored in a sector, is

selected. The flows of bitpulses selected are either entropy outflow (the originating

bitpulses adding to the stock) or entropy inflow (the annihilating bitpulses

withdrawing from the stock) during the time-interval of selection.

Lecture Notes in Economics and Mathematical Systems 665,

DOI 10.1007/978-3-642-34056-7_2, # Springer-Verlag Berlin Heidelberg 2013

30 2 Sets of Entropy, Selection, Venn Diagrams and Bitpulses

It from bit:

Every it—every particle, every field of force, even the space-

time continuum itself—derives its function, its meaning, its

very existence entirely—even if in some contexts indirectly—

from the apparatus-elicited answers to yes-or-no questions,

binary choices, bits.

John A. Wheeler

Diagrams, Sample Space, Capacity

experiment of outflow selection executed by economic agents. It considers putting

economic resources into disuse as another (parallel and simultaneous) statistical

experiment of inflow selection executed by economic agents. Aggregate economic

outflow H ðY0 Þ per sample is selected during a time-interval ðt,t þ dtÞ of infinitesi-

mally small length dt. Aggregate economic inflow H ðX0 Þ per sample is selected

during the same time-interval ðt,t þ dtÞ.

To keep matters clear it is helpful to define some elementary sets of stocks of

entropy. Let us denote by Si the sector that stocks all the entropy that is in state i

ði ¼ 1; 2, 3, N Þ. Further let the set S0 denote the entire economy in which all

entropy of the economy is stocked irrespective of state. That is,

[

N

S0 ¼ Si ¼ S1 [ S2 [ S3 [ [ S N (2.1)

i¼1

For the two-sector economy ðN ¼ 2Þ:

S0 ¼ S1 [ S2 (2.2)

During the differential selection interval (t,t þ dt) let agents select outflow H ðY0 Þ

as being created in the various sectors Si ði ¼ 1; 2, 3, N Þ. Since the probability of

the joint occurrence of the event that a sample is created in state i on (t,t þ dt) and the

event that it afterwards will cease existence before time instant (t þ dt) is negligible

relative to its singular chance of being created in state i on (t,t þ dt), we may

conclude that—to first order of accuracy in dt—all the created outflow on (t,t þ dt)

is still existing in Si at time instant (t þ dt). This implies that the selected outflow

H ðYi Þ reassembles entropy in state i on (t,t þ dt) that is still in that same state i at time

(t þ dt). The reassembled entropy outflow so originating over all Zdt samples of the

statistical experiment executed during (t,t þ dt) is Zdt H ðYi Þ. The flow Zdt H ðYi Þ

2.1 Non-differential and Differential Sets of Entropy, Venn Diagrams, Sample. . . 31

contributes to the differential growth of the entropy stock of Si over (t,t þ dt). I have

called this process entropy outflow selection.

Likewise let economic agents select inflow HðX0 Þ as being used up in the various

sectors Si ði ¼ 1; 2, 3, N Þ. The probability of the joint occurrence of the event

that a sample is used up in state i on (t,t + dt) and the event that it has been called in

existence after time instant t but prior to its moment of annihilation on (t,t þ dt) is

negligible relative to its singular chance of being used up in state i on (t,t þ dt).

Therefore we may also conclude here that—to first order of accuracy in dt—all the

inflow that is used up on (t,t þ dt) already existed in Si at time instant t. This implies

that the selected inflow H ðXi Þ reassembles entropy in state i on (t,t þ dt) that was

already in that same state i at time t. The reassembled entropy inflow so annihilating

over all Zdt samples of the statistical experiment executed during (t,t + dt) is

Zdt H ðXi Þ. Zdt H ðXi Þ contributes to the differential decrease of the entropy

stock of Si over (t,t þ dt). I have called this process entropy inflow selection.

What is crucial with respect to these statistical experiments of selection is that

not the entire content of entropy of Si is assembled/selected during (t,t + dt). Only

the assembled portion Zdt of the total entropy stock of S0 at time (t + dt) is object/

subject in the course of the statistical experiment of outflow selection during

(t,t + dt). Further only the assembled portion Zdt of the total entropy stock of S0

at time t is object/subject in the course of the statistical experiment of inflow

selection during (t,t + dt).

For the entropy that is reassembled from the assembled entropy it is helpful to

introduce the formal concept of differential sets of entropy. We define the differen-

tial subset dSþj to represent the subset of entropy of Sj stocked at time (t + dt) that

has originated during the infinitesimally small time-interval (t,t + dt) of selection.

Further we define the differential subset dS i to represent the subset of entropy of Si

stocked at time t that will annihilate during the infinitesimally small time-interval

(t,t + dt). This motivates us to say that the entropy “stocked” in dSþ j is Zdt H Yj

and that the entropy “stocked” in dS i is Zdt H ðXi Þ.

With the concepts of differential sets of entropy well defined, inflow selection is

between N alternative outcomes S of a trial/sample: entropy is in dS1 , in dS2 , or

in dSN . In that case dS0 ¼ i dSi is the playground of all the subsets that can be

selected. We call that playground the differential sample space of inflow selection.

Likewise outflow selection is between N alternative outcomes of a trial/sample:

S þ

entropy is in dSþ þ þ þ

1 , in dS2 , or in dSN . In that case dS0 ¼ i dSi is the differential

sample space of outflow selection.

The use of a set S0 (or dSþ

0 or dS0 ) of entropy stock from which entropy is selected

may be clarified with the help of so-called Venn diagrams. This is a handsome tool

to get a more concrete idea of the relationships between the various sets and

variables of entropy and the various probabilities that govern the evolution of

economic systems.

The N sets Si of entropy stock may be presented in a so-called non-differential

Venn diagram. This has been done in Fig. 2.1 for the two-sector economy with

N ¼ 2. Each of the N subsets Si holds a finite entropy stock H ðSi Þ. We may regard

32 2 Sets of Entropy, Selection, Venn Diagrams and Bitpulses

S1 S2

The two-sector economy S0 consisting of consumption sector S1 and investment sector S2. S0 is the union of S1 and S2: S0 ¼ S1 [ S2 such that

S1 and S2 do not overlap: S1 \ S2 ¼ ;, i.e. the intersection of S1 and S2 is the null set

the surface area of the set Si to represent an entropy stock H ðSi Þ of Si. We shall call

H ðSi Þ the capacity Ci of Si :

C i ¼ H ð Si Þ (2.3)

Ci is all the entropy stocked in Si .1 The outflow Yi ¼ Zdt H ðYi Þ is all reass-

embled entropy that goes into Si during the time-interval (t,t + dt) and the inflow

Xi ¼ Zdt H ðXi Þ is all reassembled entropy that is withdrawn from Si during the

time-interval (t,t + dt). It follows that the increase dCi of capacity Ci is the

entropy of the accumulating surplus of Yi over Xi . That is,

Thus

ðt

Ci ðtÞ ¼ Z ðθÞ ½Hθ ðYi Þ Hθ ðXi Þdθ (2.5)

1

is the value of Z at time θ. Also, in the integrand of the integral of (2.5), HðYi Þ and

H ðXi Þ traverse the values they assume at time θ. I will usually refrain from explicitly

recording this time-dependency in the notation of H ðYi Þ and H ðXi Þ in order to keep

the notation surveyable, although we might acknowledge for this time-dependency

by choosing the notation Hθ ðYi Þ and Hθ ðXi Þ as in (2.5). We should always keep in

mind that every variable is time-dependent.

Note further that

X X

dC0 ¼ dCi and C0 ¼ Ci

i i

1

Money holds a content of entropy equal to the quotient of the number of money units it represents

and the price level P.

2.1 Non-differential and Differential Sets of Entropy, Venn Diagrams, Sample. . . 33

differential sample space.

þ

dS0 ¼ dS

0 [ dS0

dS0+ dS 0−

dSþ

0 and dS0 overlap.

Top configuration:

The joint surface is the union dS0 ¼ dS 0

[dSþ þ

0 of dS0 and dS0 . Shaded surface is the

þ þ

intersection dS0 \ dS0 of dS0 and dS0

Center configuration:

dSþ þ

1 and dS2 do not overlap.

dS1+

dSþ þ þ

1 [ dS2 ¼ dS0 dS0−

Bottom configuration:

dS

1 and dS2 do not overlap. dS2+

dS

1 [ dS2 ¼ dS0

dS1−

dS0+

dS2−

For the two-sector economy C1 is labor capacity, the measure of the labor force

expressed in bits of entropy. C2 is entrepreneurial capacity, the measure of the

productive potential of the investment sector expressed in bits of entropy. C0 is

overall capacity.

The differential sets dSþ

j and dSi may also be presented in a Venn diagram. This

has been done so in Fig. 2.2 by means of a differential Venn diagram for the two-

sector economy with N ¼ 2 . Here the different sub-areas denote the various

differential subsets. Each differential subset holds the entropy reassembled in it

by the execution of the associated statistical experiment of selection during

(t,t + dt). We may regard the surface area of the subset to represent the entropy

of it, which is Zdt times the entropy per sample of this subset. Note that these

differential sets contain portions of entropy that vanish completely relative to the

infinitesimally greater entropy stocked in S0 . To focus attention on the borders

between the various differential sets, the same diagram has been configured three

times in Fig. 2.2. Whereas the non-differential sets S1 and S2 do not overlap as in

Fig. 2.1 (entropy is here either in state 1 or in state 2 to first order of accuracy in dt),

we notice that this is not the general rule for the differential sets of Fig. 2.2. The

entropy that originates in state j on (t,t + dt) (See the sets dSþ j of the center

configuration) has emerged from entropy that has annihilated both in state 1 and

in state 2 on (t,t + dt). Likewise the entropy that annihilates in state i on (t,t + dt)

(See the sets dS i of the bottom configuration) is bringing forth entropy both

originating in state 1 and in state 2 on (t,t + dt). Thus generally dSþ j and dSi

þ

overlap. In set-theoretical notation: dSj \ dSi 6¼Ø. Herein the symbol \ denotes

the intersection operation and Ø is the null set, which does not contain entropy.

34 2 Sets of Entropy, Selection, Venn Diagrams and Bitpulses

The surface area of the left side ellipse is equal to the outflow Y0 ¼ Zdt HðY0 Þ.

The surface area of the right side ellipse is equal to the inflow X0 ¼ Zdt HðX0 Þ.

The intersection is the surface area that the two ellipses have in common. The surface area of the intersection is the transmission

Zdt HðX0 \ Y0 Þ.

The shaded surface area at the left is the conditional outflow Y0 ¼ Zdt H(Y0 |X0 ).

The shaded surface area at the right is the conditional inflow X0 ¼ Zdt H(X0 |Y0 ).

The entire surface area covered by both ellipses is called the union. It covers a total area of Zdt HðX0 [ Y0 Þ.

It follows that HðX0 [ Y0 Þ ¼ HðY0 j X0 Þ þ HðX0 j Y0 Þ þ HðX0 \ Y0 Þ

This raises an important question. In the preceding we have asserted that the

probability of the joint occurrence of the event of a sample to originate on (t,t + dt)

and the consecutive event that this sample ceases existence on (t,t + dt) is negligi-

ble relative to the probability of the separate singular events of origination or of

annihilation of that sample. Does that not imply that there is virtually no chance that

dSþ

j and dSi overlap?

Well it does not really imply that. On the contrary, the joint occurrence of an

event of a sample both to originate on (t,t + dt) and to annihilate on (t,t + dt) is

concerned with the same sample first originating on (t,t + dt) and then afterwards

annihilating on (t,t + dt) or in reversed order. However, in Fig. 2.2 we are dealing

with the concurrent occurrence of a sample originating and a different sample

annihilating.2 The content of the overlapping area of dSþ

0 and dS0 is composed of

þ

samples of assembled entropy of dS 0 and dS0 that are sacrificed on (t,t + dt) to

effectuate (i.e. to reassemble) new samples of entropy within the entire differential

sample space. The chances of that production selection process are not negligible.

The deeper cause of overlapping is the statistical dependence between the elemen-

tary selection events of inflow and outflow. We will explain that in due time. It is

here where Shannon’s selection probabilities enter the scene as we will clarify at a

later stage of this exposition. The situation has been visualized from a slightly

different perspective in the Venn diagram of Fig. 2.3. The total surface area is called

þ

the union. This is the differential set denoted by dS0 ¼ dS 0 [ dS0 . It is also called

the overall differential sample space of selection because all statistical experiments

of selection take place within this sample space.

2

Note that the two samples—despite they are different samples—hold each the same content of

entropy.

2.2 Overall Selection, Transmission and Exchange, Conditional Entropy 35

þ

The differential entropy stocked in overall sample space per trial is H dS 0 [ dS0 ,

but—for closer connection to Shannon’s notational conventions—I will also denote

this differential entropy by H ðX0 [ Y0 Þ.3 The operator [ is the mathematical symbol

for the union operation that we met before in (2.1) and (2.2). We will use the new

notational convention interchangeably with the one with arguments X and/or Y closely

resembling Shannon’s notational convention for entropy. Thus HðdS i Þ ¼ HðXi Þ is

þ

the entropy content of dS i per sample, HðdS j Þ ¼ HðYj Þ is the entropy content of dSþj

þ þ

per sample and HðdS 0 [ dS0 Þ ¼ HðX 0 [ Y 0 Þ is the entropy content of dS

0 [ dS0 per

þ

sample. The new convention with arguments dS i and/or dSj is the more systematic

one, the other one is closer to existing practice. Thus the notational convention of

expressing the entropy content of a set S by HðSÞ as in (2.3) will also be followed for

the entropy content of differential sets. To clarify the production and using up of (or

the feeding on) entropy within the subsets of the Venn diagram of differential

selection further, Fig. 2.4 may be of additional aid for the two-sector economy

and Fig. 2.5 for the three-sector economy. Venn diagrams for any multi-sector

economy (N > 3) can be drawn in a similar way. It does not matter whether the

borderlines between the various subsets are curved or straight or just whimsical.

To help interpreting the Venn diagram, a differential set with a smaller index

will be standard positioned vertically higher in the Venn diagram than a differential

set with a larger index. Thus in Fig. 2.4 the differential subsets of the consumption

sector S1 are at the top of the drawing and the differential subsets of the investment

sector are at the bottom.

More remarks about some conceptual notions of probability theory have been

listed in Appendix C. They may be helpful to understand Figs. 2.4 and 2.5 better.

Conditional Entropy

Thus far we have considered the experiments of inflow selection and outflow

selection. We ascertained that the playground of the inflow experiment is differen-

tial sample space dS 0 and that the playground of the outflow experiment is

differential sample space dSþ þ

0 . Since dS0 and dS0 overlap and together form

þ

differential sample space dS0 ¼ dS0 [ dS0 , the two separate statistical experiments

of selection seem together to reflect more events than the selection events going on

þ

in dS0 alone. To oversee the whole of events within dS 0 and dS0 we must take into

account all the events that occur in dS0 and consider dS0 as the playground of an

overall statistical experiment of selection.

þ

The applicable rule here is that any single trial in sample space dS0 ¼ dS 0 [ dS0

will always involve the concurrent (simultaneous) selection of a sample annihilating

in state i (i ¼ 1; 2) and another sample originating in state j (j ¼ 1; 2). Thus a trial of

3

Shannon uses the notation H(X,Y), which is H(X0 [ Y0) in the notation to which I adhere.

36 2 Sets of Entropy, Selection, Venn Diagrams and Bitpulses

dS 0

+

B G dS 0−

D

F

A U

Fig. 2.4 The Venn diagram of evolution of the two-sector economy S0 with the number N of

sectors equal to 2.

The non-differential sectors, S1 and S2 , have not been illustrated. The differential set dSþ

0 of outflow interacts with the differential set dS0 of

inflow.

As a standard convention a differential set with a smaller index will be positioned vertically higher in the Venn diagram than a differential

set with a larger index.

A, B, C, D, E, F, G and U are subsets of these differential sets. Their respective entropy contents per trial are H(A), H(B), H(C), H(D), H(E),

H(F), H(G) and H(U). Note that

þ þ þ

dS

0 ¼ dS1 [ dS2 ¼ E [ F [ G [ D [ C [ U, dS0 ¼ dS1 [ dS2 ¼ B [ D [ E [ A [ C [ F

þ þ

dS

1 ¼ E [ F [ G, dS2 ¼ D [ C [ U, dS1 ¼ B [ D [ E, dS2 ¼ A [ C [ F

þ

dS

0 \ dS0 ¼ D [ C [ E [ F

0 [ dS0 :

A ¼ dSþ dS , B ¼ dSþ dS , C ¼ dSþ \ dS , D ¼ dSþ \ dS , E ¼ dSþ \ dS

2 0 1

0 2

2 1 2 1 1

F ¼ dSþ \ dS , G ¼ dS dSþ , U ¼ dS dSþ

2 1 1 0 2 0

Further,

H ðY1 Þ ¼ H(B) + H(D) + H(E), H ðY2 Þ ¼ H(A) + H(C) + H(F), H ðY0 Þ ¼ H ðY1 Þ þ H ðY2 Þ

H ðX1 Þ ¼ H(E) + H(F) + H(G), HðX2 Þ ¼ H(D) + H(C) + H(U), H ðX0 Þ ¼ H ðX1 Þ þ H ðX2 Þ

H ðY2 jX0 Þ ¼ H(A), H ðY1 jX0 Þ ¼ H(B), HðX2 jY0 Þ ¼ H(U), H ðX1 jY0 Þ ¼ H(G)

annihilating in state i on (t,t + dt) and the other concurrently originating in state j

on (t,t + dt).

Let then qi j be the elementary probability that such a concurrent pair of samples is

þ

selected on (t,t + dt). Clearly dS i \ dSj is the differential subset of all the events

whereby a sample annihilating in state i on (t,t + dt) is concurrently selected

with another sample originating instate j on (t,t + dt). The total entropy “stocked”

þ

in dS i \ dS j is Zdt H X i \ Y j . Thus it follows that the probability qij of

concurrently selecting a sample in state i and another sample in state j on (t,t + dt)

is equal to

H X i \ Yj

qij ¼ for i; j ¼ 0; 1, 2, 3, , N (2.6)

H ðX0 \ Y0 Þ

[See also Appendix B, (B.9)].

2.2 Overall Selection, Transmission and Exchange, Conditional Entropy 37

M

L

C N

D

+

dS 0

K

O

P dS 0−

E

J

B F

H

A G

Fig. 2.5 The Venn diagram of evolution of the three-sector economy S0 with N ¼ 3 sectors. The

three non-differential sectors, S1, S2 and S3, have not been illustrated. The differential set dSþ

0 of

þ

outflow interacts with the differential set dS

0 of inflow . Notice that there are 3 subsets dSi \ dSj

2

dS

0 ¼ D[ E [F[ G [L [ K[ J[ H[ M[ N[ O[ P

dSþ

0 ¼ A[ F[ J[O [ B[ E [K [ N[C [D[ L [M

dS

1 ¼ M [ N [ O [ P, dS2 ¼ L [ K [ J [ H, dS3 ¼ D [ E [ F [ G

dSþ þ þ

1 ¼ C [ D [ L [ M, dS2 ¼ B [ E [ K [ N, dS3 ¼ A [ F [ J [ O

þ

dS

0 \ dS0 ¼ D [ E [ F [ L [ K [ J [ M [ N [ O

H ðY0 jX0 Þ ¼ H(A) + H(B) + H(C), H ðX0 jY0 Þ ¼ H(G) + H(H) + H(P)

H ðY1 Þ ¼ H(C) + H(D) + H(L) + H(M), H ðY2 Þ ¼ H(B) + H(E) + H(K) + H(N),

H ðY3 Þ ¼ H(A) + H(F) + H(J) + H(O), H ðX1 Þ ¼ H(M) + H(N) + H(O) + H(P),

H ðX2 Þ ¼ H(H) + H(J) + H(K) + H(L), H ðX3 Þ ¼ H(D) + H(E) + H(F) + H(G)

There are 15 subsets of differential sample space dS0 ¼ dSþ

0 [ dS0 . For the N-sector economy that number would be N ðN þ 2Þ

Each trial of the overall selection experiment may have therefore N 2 different

outcomes, each occurring with probability qi j ði; j ¼ 1, 2, 3, ,N Þ. On the analogy

of Shannon’s formula (1.1) it must follow that all entropy per trial “stocked” in

þ

overall differential sample space dS0 [ dS0 must be equal to

X

H ð X 0 [ Y0 Þ ¼ qi j log qij (2.7)

i;j

experiment on (t,t + dt).4 Equation (2.7) has been given by Shannon in his seminal

4

That formula (2.7) has a structure equivalent to that of formulas (1.1) need not surprise. Its

justification is based on the same argument that justifies (1.1). We will discuss that justification in

Chap. 4.

38 2 Sets of Entropy, Selection, Venn Diagrams and Bitpulses

paper (Shannon and Weaver 1963, page 21). Note that Zdt H ðX0 [ Y0 Þ is the

surface area (entropy) of differential sample space dS0 in the Venn diagrams of

Figs. 2.2, 2.3, 2.4 and 2.5.

The process of overall selection and reassembly of Zdt H ðX0 [ Y0 Þ is attended

by a concurrent portion Zdt H ðX0 \ Y0 Þ of assembled inflow and assembled outflow

þ þ

of dS

0 \ dS0 , the intersection of dS0 and dS0 . The assembly of Zdt H ðX0 \ Y0 Þ is

the intersection process by which the entropy of that common portion is transferred

from the past into the future. We shall call the latter process entropy transmission or

exchange. The area that dSþ

0 and dS0 have in common in Fig. 2.3 “stocks” an

entropy flow Zdt H ðX0 \ Y0 Þ. This common area is the intersection of the differ-

ential set of inflow events and the differential set of outflow events. The entropy

Zdt HðX0 \ Y0 Þ of this set is also called transmission (after Shannon). The termi-

nology clarifies exactly what it does: transferring information/entropy from the past

into the future. We shall define the rate of transmission γ as the quotient of

transmission per unit of time and per unit of joint capacity C0 :

Z H ðX0 \ Y0 Þ

γ¼ (2.8)

C0

by “borrowing, respectively lending” an equal amount of entropy in a particular

state simultaneously. Exchange is the creation/annihilation of entropy in exchange

for money. The counter emergence of money is like the annihilation/creation of a

virtual sample of entropy in a preliminary balancing state of existence.5 Entropy

and its simultaneous counterpart of virtual money form together an indissoluble

pair within the transmission domain. They reflect the “origination” of financial

revenue and the “annihilation” of financial cost, which is accompanied by the

exchange of money (financial entropy) for entropy. We shall be concerned with

that subject in Chaps. 5, 6 and 7. We shall further discuss overall selection and

transmission/exchange at a more detailed level in Sect. 4.5.

Inflow selection and outflow selection are restricted to events in limited sub-areas

of overall differential sample space, i.e. to events in dS 0 , respectively to events in

dSþ0 . However since dS 0 is the union of dS

0 and dS þ

0 and the latter two subsets

overlap, inflow and outflow selection result in double counts of entropy annihilating

þ

and entropy originating. Zdt HðdS 0 \ dS0 Þ is shared by the reassembled entropy

þ

Zdt HðX0 Þ of dS0 and by the reassembled entropy Zdt HðY0 Þ of dS0 . Note from

þ

Figs. 2.4 and 2.5 that overall sample space dS0 [ dS0 covers the area total of the

þ þ

separate areas of dS

0 and of dS0 minus the area of the intersection dS0 \ dS0 . Thus

þ

H dS þ þ

0 [ dS0 ¼ H dS0 þ H dS0 H dS0 \ dS0 (2.9)

5

The concept “virtual sample” has been deliberately chosen here as it appears to play a similar role

as a virtual particle in physics: it does not have an independent existence of itself.

2.2 Overall Selection, Transmission and Exchange, Conditional Entropy 39

þ

HðdS 0 [ dS 0 Þ can also be stated as the sum of the entropy þ transmission

þ

H dS0 \ dS0 per trial, the conditional entropy inflow HðdS

0 dS0 Þ ¼ HðX0 jY0 Þ

þ

per trial of X0 given Y0 and the conditional entropy outflow HðdS0 dS0 Þ ¼ HðY0 jX0 Þ

per trial of Y0 given X0 :

þ þ

H dS þ þ

0 [ dS0 ¼ H dS0 dS0 þ H dS0 dS0 þ H dS0 \ dS0 (2.10)

We will encounter other (conditional) forms of inflow and outflow. We list here

four different forms of inflow and outflow of an economic sector Si :

• Unconditional inflow of the sector Si : Xi ¼ Zdt H ðXi Þ with HðXi Þ ¼ H dS i

þ inflow of the sector Si : Xi ¼ Zdt H ðXi jY0 Þ with H ðXi jY0 Þ ¼

• Conditional

H dSi dS0

• Unconditional outflow of the sector Si : Yi ¼ Zdt H ðYi Þ with HðYi Þ ¼ H dSþ i

outflow of the sector Si : Y i ¼ Zdt HðYi jX0 Þ with H ðYi jX0 Þ ¼

• Conditional

H dSþ dS

i 0

þ

These conditional entropies are formally defined in Appendix B. dS i dSj is that

portion of the subset dSi in the Venn diagram that it does not have in common with

þ

dSþ

j . Likewise dS j dS þ

i is that portion of the subset dSj that it does not have in

þ þ þ

common with dS

i . Clearly dSi dSj , dSj dSi : and dSi \ dSj do not overlap one

another.

þ

The financial consequences of selection manifest themselves within dS0 \ dS0 .

þ

As an example of conditional differential subsets, consider dS1 dS2 in the Venn

diagram of Fig. 2.4. We claim that dSþ þ

1 dS2 ¼ B [ E. To see this, note that dS1 and

dS2 have the subset D in common. Hence since the condition is that dS2 is certain,

the probability of selecting any subset of dS2 is equal

to 1 implying that the subset D

þ

of dSþ contributes the entropy log 1 ¼ 0 to dS 1 dS2 . That is, D is a null subset of

1

þ

þ

dS1 dS2 . What rests is dS1 dS2 ¼ B [ E.□

We are dealing with economic activity as the process of executing statistical

experiments of selection.

Clearly, the probability of an inflow sample to annihilate in state i within sample

space dS 0 on ðt; t þ dtÞ is λi ¼ H ðXi Þ=H ðX0 Þ and the probability of an outflow

sample to originate in state j within sample space dS 0 on ðt; t þ dtÞ is

μj ¼ H ðYi Þ=HðY0 Þ. That is,

H ð Xi Þ H Yj

λi ðtÞ ¼ ; μj ðtÞ ¼ for i; j ¼ 0; 1, 2, 3, ; N (2.11)

H ð X0 Þ H ðY0 Þ

þ

With the introduction of conditional entropy inflows H dS dS and condi-

þ i 0

tional entropy outflows H dSi dS0 we must be aware that these flows offer a range

40 2 Sets of Entropy, Selection, Venn Diagrams and Bitpulses

þ

of candidates, additional to H dS

i and H dSi , for the definition of the economic

variables such as consumption, investment, wages and entrepreneurial depreciation.

Our task is to find out what the definitional assignments of these flows to the

considered conditional and unconditional entropy inflows and outflows should be.

We cannot solve this puzzle immediately. We need much more mathematical

reasoning to come to grips with it.

of the Multi-sector Economy

assembling) Zdt samples from non-differential sample space S0 randomly during

ðt; t þ dtÞ with the aim to rearrange and reorder (i.e. to reassemble) them for

purposeful reallocation of entropy into dS 0 . Let the assembled entropy of the Zdt

inflow-samples drawn from non-differential sample space S0 while selecting during

ðt; t þ dtÞ be Hm per sample. The reassembly of these samples

P in differential sample

space dS 0 effectuates the entropy inflow H ðX0 Þ ¼ i λi log λi per sample so that

agents exploit a surplus per sample of assembled entropy Hm over reassembled

entropy H ðX0 Þ on the selection

P interval (t,t + dt).

Zdt H ðX0 Þ ¼ Zdt i λi log λi is a measure of value of the inflow. It is also a

measure of the uncertainty that economic agents face as they decide

decommissioning economic equipment, P sources and resources. In this respect

greatest uncertainty is attained if i λi log λi is at its maximum. This maximum

is log N and it is easily seen that this maximum is attained for λi ¼ 1=N . That is,

X

H ð X0 Þ ¼ λ

i i

log λi log N

What exactly does it mean if uncertainty is at its maximum log N with λi ¼ 1=N?

Well, this reflects the situation that economic agents will not gather more than the

very minimum of knowledge from the selection decisions they take all the time on

the selection interval (t,t + dt). Such minimum reflects the complete lack of

knowledge of the selecting agents. With this in mind recall that inflow selection

is a process of selecting (i.e. assembling) Zdt samples from non-differential sample

space S0 randomly during ðt; t þ dtÞ with the aim to rearrange and reorder (i.e. to

reassemble) them for purposeful reallocation into differential sample space dS 0 . If

there is maximum uncertainty with respect to this achievement, this implies that the

surplus of assembled entropy Zdt P Hm of the Zdt unordered samples from S0 over

reassembled entropy Zdt i λi log λi of the reordered samples within dS 0

vanishes. That is, if there is maximum uncertainty,

X X

Hm þ λ log λi ¼ 0 resulting in Hm ¼

i i

1

iN

log N with λi ¼ N1

2.3 Selection in Non-differential Sample Space of the Multi-sector Economy 41

It follows that Hm ¼ log N. This implies that the assembled Zdt samples from S0

will always get selected each with equal probability 1=N during ðt; t þ dtÞ

irrespective of the state in which they reside. Else the surplus of assembled over

reassembled entropy can never become zero.

We are thus led to the conclusion that samples from non-differential sample

space S0 are each selected (i.e. assembled) with elementary probability 1=N

irrespective of state in case we are dealing with the statistical experiment of inflow

selection.

This was as far as inflow selection is concerned. For outflow selection equivalent

reasoning applies. For sake of completeness and because of the importance of the

argument we will deal with this in the same detail of argumentation as above for

inflow selection.

Outflow selection in differential sample space dSþ 0 is a process of selecting (i.e.

assembling) Zdt samples into non-differential sample space S0 randomly during

ðt; t þ dtÞ with the aim to rearrange and reorder (i.e. to reassemble) them for

purposeful reallocation of entropy into dSþ 0 . Let the assembled entropy of the Zdt

outflow-samples drawn from non-differential sample space S0 be Hmþ per sample.

þ

The reassembly of these samplesP in differential sample space dS0 effectuates the

entropy outflow HðY0 Þ ¼ i μi log μi per sample so that agents exploit a surplus

per sample of assembled entropy Hmþ over reassembled entropy HðY0 Þ on the

selection interval (t,t + dt).

P

Zdt HðY0 Þ ¼ Zdt i μi log μi is a measure of value of the outflow. It is also a

measure of the uncertainty economic agents face when they decide commissioning

economic equipment,

P sources and resources. In this respect greatest uncertainty is

attained if i μi log μi is at its maximum. This maximum is log N and is attained

for μi ¼ 1=N . That is,

X

H ð Y0 Þ ¼ i

μi log μi log N

What exactly does it mean if uncertainty is at its maximum log N with μi ¼ 1=N?

Well, this reflects the situation that economic agents cannot gather more than the

very minimum of knowledge from the selection decisions they take all the time on

the selection interval (t,t + dt). Such minimum reflects the complete lack of

knowledge of the selecting agents. With this in mind recall that outflow selection

is a process of selecting (i.e. assembling) Zdt samples into non-differential sample

space S0 randomly during ðt; t þ dtÞ with the aim to rearrange and reorder (i.e. to

reassemble) them for purposeful reallocation into differential sample space dSþ 0 . If

there is maximum uncertainty with respect to this achievement, this implies also

that the surplus of assembled entropy Zdt Hmþ of the unordered samples from S0

P

over reassembled entropy Zdt i μi log μi of the reordered samples within dSþ 0

vanishes. That is, if there is maximum uncertainty,

X X

Hmþ þ μ log μi ¼ 0 resulting in Hmþ ¼

i i

1

iN

log N with μi ¼ N1

42 2 Sets of Entropy, Selection, Venn Diagrams and Bitpulses

and it follows that Hmþ ¼ log N. This implies that the assembled Zdt samples from S0

will always get selected each with probability 1=N during ðt; t þ dtÞ irrespective of

the state in which they reside. Else the surplus of assembled over reassembled

entropy can never become zero.

We are thus led to the conclusion that samples into non-differential sample space

S0 are each selected (i.e. assembled) with elementary probability 1=N irrespective of

state in case we are dealing with the statistical experiment of outflow selection.

Furthermore the assembled entropy per sample from/into S0 during ðt; t þ dtÞ is the

same for inflow selection and outflow selection Hm ¼ Hmþ ¼ Hm :

than they get from the statistical reassembly in differential sample spaces dS 0 and

dSþ0 ? No they can’t, because the only thing agents do while assembling in S0 is

selecting samples that annihilate and/or originate on ðt; t þ dtÞ. That is all they do

and that is not enough to get more information. While they do so they “forget” to

select the great majority of samples that do not annihilate and do not originate

during ðt; t þ dtÞ. Agents do not select more than a differential number of samples

during the available time-interval ðt; t þ dtÞ, far from sufficient to select the entire

entropy content of S0 . No more information about S0 is gathered than about the

information of its differential decrease and increase. Thus we must conclude that

the selection of samples from non-differential sample space S0 takes place only

within the context of differential selection of inflow and outflow. We have argued

above that in this context a sample of S0 is selected with elementary probability 1=N

irrespective of whether it annihilates or originates and we conclude therefore that a

sample in non-differential sample space S0 is always selected (assembled) with

elementary probability 1=N .

Thus, in case of inflow selection as well as in case of outflow selection, the originally

disordered collections ofZdt samples are assembled from/intoS0 with probability ð1=N ÞZdt

in accordance with Boltzmann’s H-theorem. It follows that the entropy assembled

from/into S0 during ðt; t þ dtÞ is equal to log ð1=N ÞZdt ¼ Zdt log N for each of

the two experiments (inflow and outflow) and that on balance assembled entropy

does not precipitate nor evaporate within S0 during ðt; t þ dtÞ. It is only reassembled

entropy that causes the stock of entropy of S0 to change during ðt; t þ dtÞ.

Assembly is the process of collecting Zdt random samples from S0 during ðt; t þ dtÞ.

The entropy assembled from S0 in this way by inflow selection only or by outflow

selection only is Zdt Hm ¼ Zdt log N. This implies that the assembled entropy of Zdt

samples is the equivalent of Zdt log N bits of entropy. (Note that assembled entropy

is only equal to the number Zdt of samples in case N ¼ 2, i.e. for the two-sector

economy). It follows that the entropy assembled per sample is equal P to log N, whereas

the entropy reassembled per sample P is equal to H ð X 0 Þ ¼ i λi log λi for inflow

selection, respectively H ðY0 Þ ¼ i μi log μi for outflow selection.

2.3 Selection in Non-differential Sample Space of the Multi-sector Economy 43

These findings have the following interpretation. Samples were or get stocked in

S0 before/after they are selected. Their assembled entropy during ðt; t þ dtÞ is then

log N per sample. After they have been reassembled the selected samples have

entropy H ðX0 Þ, respectively HðY0 Þ, in S0 .

The surplus of assembled entropy over reassembled entropy is

!

X

Zdt log N Zdt H ðX0 Þ ¼ Zdt log N þ λi log λi in case of inflow selection

i

and

!

X

Zdt log N Zdt H ðY0 Þ ¼ Zdt log N þ μi log μi in case of outflow selection

i

The difference of Zdt ½log N H ðX0 Þ and Zdt ½log N H ðY0 Þ is the net

growth dC0 of the entropy stock C0 ¼ HðS0 Þ of S0 :

sample space is 1=N irrespective of the sector Si in which it resides. Thus, on behalf

of Boltzmann’s principle the state probability PrfSi g of Si is

1

PrfSi g ¼ N 1

¼ N ¼ 12 (2.13)

Clearly there are H ðSi Þ ¼ Ci bits of entropy stored in Si and H ðSi Þ=log N samples

stocked in Si . Each bit of the sector Si is assembled with probability 1=2.

However this does not imply that a statistical experiment in non-differential

sample space S0 can be executed involving the selection of all the samples stocked

in S0 because such experiment cannot be executed in real time. Agents will actually

only select Zdt samples of S0 in real time during the time-interval ðt; t þ dtÞ, i.e. Z

samples per unit of time, which is Z log N bits of S0 per unit of time. There is no way

for agents to select all the samples stored in S0 during the available time on ðt; t þ dtÞ.

This implies that generally

Ci 1

6¼

C0 N

space either as a statistical process of selecting samples each carrying log N of

entropy or as a statistical process of selecting bits each carrying a single bit of

entropy.

44 2 Sets of Entropy, Selection, Venn Diagrams and Bitpulses

Replicators, Selection Probabilities

As asserted in Sect. 1.6 of Chap. 1, I endorse the view expressed by Hodgson and

Knudsen that “an adequate explanation of economic evolution must involve the

three Darwinian principles of variation, inheritance and selection.” (Hodgson and

Knudsen 2006, pages 2, 5; Hodgson and Knudsen 2010, page 45). These three

principles form the cornerstone of biologic, social and economic evolution. “At a

high level of abstraction social and biologic evolution share the same general

principles” (Hodgson and Knudsen 2006, page 14). Thus, accepting that economic

evolution is based on the same general basic principles we must search for the way

of formalizing and interpreting these principles of variation, inheritance and selec-

tion in economic and social evolution.

This is the goal that H&K have set themselves and that is also the starting point

for the formulation of a genuine universal theory of economics in accordance with

the Shannon inspired line of argument I have put forward in the foregoing sections.

The ideas of Hodgson and Knudsen demonstrate a continual but consequent

transition of thought in the course of time. In a sense it resembles part of the related

process I went through since the late 1970s, when I got more and more dissatisfied

with the tenets of orthodox and mainstream economics. It is instructive to follow

this process. I shall therefore reflect and comment on it from my particular

background.

In his work on the evolution of institutional economics (Hodgson 2004) that

anticipates the jointly written papers of Hodgson and Knudsen, which deal with the

basic Darwinian principles of economic evolution, Hodgson affiliates himself

closely with the Veblian institutional account of the evolutionary process. He

makes a distinction between institutions on the one hand: the dynamic and complex

emergent survival structures that continually adapt in the course of time as a result

of evolutionary selection, and on the other hand: individuals, i.e. the agents that act/

select under the formal and informal rules, ideas and conceptions of the institutions

with which they are involved. In this Veblian conception of the economic evolu-

tionary process, replication (the copying process of the carriers of traits, habits,

routines, thoughts and complexity) and selection (of combinations of the carriers

that survive) are conceived as multiple-level processes governing both the devel-

opment and evolution of human institutions and human individuals (Hodgson 2004,

page 193). From the Veblian perspective the role of individuals on the one hand and

institutions on the other are irreducible to one another, but the evolutionary process

manifests itself in a variegated interaction of individuals and institutions. Hodgson

stresses the Veblian notion that the evolutionary process of replication and selection

is a process full of the continual unfolding of emergent properties. That is, it is a

“force” that continuously adapts to changing conditions and so creates ever new

combinations, ever novel forms of complexity and variety, ever changing

properties, causal chains, rules, order and conceptions of institutional nature.

Hodgson remarks that for a successful universal theory of selection it is required

2.4 Variation, Inheritance, Selection, Interactors/Agents, Replicators. . . 45

institutions on the one hand and units of selection (replicators6) on the other.

Clearly, in the mathematically oriented vocabulary of selection that I enunciated

in previous sections the units of selection are either the samples or the bits. Thus we

may here already conclude that replicators, samples and bits are more or less

synonyms. Much of what H&K remark in this respect is in line with this close

identification. However not all of it. And this is reason why I will make now and

then a distinction between the three concepts and elaborate on the specific

properties that H&K attach to replicators just to discuss and dismantle the

differences of conceptions. Where there is interpretational difference I will mention

that and also argue that this difference of interpretation cannot be consistently

maintained so that eventually we must adopt the complete identification.

In line with the earlier exposition of Hodgson, H&K take institutions and

individuals on the one hand and replicators (or units of selection) on the other to

differ from one another. They candidate institutions as the interactors involved with

the process of selecting the replicators. In the later publication of 2010 (Hodgson

and Knudsen 2010) they appear to attach a broader meaning to the term institution,

while reserving the interactor as engaged in selection. Can we conclude here that

they identify interactors with agents who select, which responds to a more standard

idea of economic selection? Well, the model of selection they advocate on pages

165–167 (Hodgson and Knudsen 2010) definitely suggests so, although H&K avoid

to speak of selecting interactors. Perhaps they prefer to consider the interactors as

entities that interact, just where I would prefer to say that events interact. Further

H&K appear to restrict the use of the term interactor to human (social)

organizations in evolutionary interaction with their environment. In this conception

the environment is presumably not treated as another interactor itself, a view that I

consider untenable. There is really no necessity to demand that selection can only

one-sidedly be executed by live interactors/populations. If that would be the case

how could evolution ever have taken off with primitive populations sharing no

more intelligence and/or vital force than their “primitive” environment held?

Let us elaborate on the two parallel experiments of economic statistical inflow

and outflow selection, with the help of Figs. 1.1 and 1.2 if needed. This concentrates

on the two-sector model of evolution, but it can easily be generalized to the multi-

sector model. There is a statistical experiment at the inflow side (the inflow

selection experiment) where Zdt unordered bits are assembled to reassemble/

sacrifice Zdt H ðX0 Þ ¼ Zdt ½HðX1 Þ þ HðX2 Þ ordered bits during the time-interval

ðt; t þ dtÞ . There is also a statistical experiment of evolutionary selection at the

outflow side (the outflow selection experiment) where Zdt unordered bits are

assembled to reassemble/create Zdt H ðY0 Þ ¼ Zdt ½HðY1 Þ þ HðY2 Þ ordered bits

during ðt; t þ dtÞ. The latter with the aim to replenish (and even more than replenish)

6

The term replicator was first introduced by Dawkins as a synonym for the gene: the genetic

replicator (Dawkins 1976, 1984, 1988, 1995).

46 2 Sets of Entropy, Selection, Venn Diagrams and Bitpulses

the loss of the reassembled sacrificed Zdt H ðX0 Þ ¼ Zdt ½HðX1 Þ þ H ðX2 Þ bits in

the course of production during ðt; t þ dtÞ.

The used Zdt H ðX1 Þ bits reduce the stock of labor capacity of S1 . The created

Zdt HðY1 Þ bits replenish/feed that labor capacity to provide for its needs. Labor

capacity is composed of C1 ¼ HðS1 Þ bits in state 1 that have accumulated up till

current time t. [See (2.3)]. This labor capacity is an entropy stock. Its selection,

whether of inflow or outflow character, is decided and executed by the laborers/

consumers. It is at the cost of the labor entropy stock when agents/laborers select to

execute labor and so use up labor capacity. It is at the benefit of the labor entropy

stock when agents/consumers select to consume and so contribute to creating labor

capacity.

The used Zdt H ðX2 Þ bits reduce the stock of entropy representing entrepreneurial

capacity C2 ¼ H ðS2 Þ. The invested Zdt H ðY2 Þ bits replenish/feed that entrepreneurial

capacity to provide for its needs. In this respect entrepreneurial capacity must

be considered to be the aggregate stock of bits in state 2 that has accumulated up till

current time t. This entrepreneurial capacity is an entropy stock. Its selection, whether

of inflow or outflow character, is decided and executed by the entrepreneurs/investors.

It is at the cost of the entrepreneurial entropy stock when agents/entrepreneurs select

to use up their entrepreneurial capacity for production, which is the cause of its wear

and tear. It is at the benefit of the entrepreneurial entropy stock when agents/investors

select to invest.7

I prefer to make here a more explicit semantic distinction between the samples of

selection and the agents who take the decisions to select those samples. Agents are

defined in accordance with the kind of decisions they take or with the kind of tasks

they undertake. That is,

• Investors are the agents who create entropy/value by investing.

• Consumers are the agents who create (labor) entropy/value by consumption.

• Entrepreneurs are the agents who annihilate entropy/value by the depreciation

of assets and by using up production inventories and supplies.

• Laborers are the agents who annihilate (labor) entropy/value by delivering labor

effort.

By taking selective decisions the agents add reordered entropy to or withdraw

reordered entropy from the unordered stocks of entropy they possess or represent

7

It is quite inevitable to make these connections. In fact: if agents/entrepreneurs select to use up

their entrepreneurial entropy, elementary logic and symmetry requirements demand that laborers

select to use up their labor entropy simply due to a related process of wear and tear of the labor

force. The ratio of this scheme of inflow selection is that the selective inflow of labor capacity

requires simultaneously the selective inflow of entrepreneurial capacity. The selected labor

entropy is what laborers wish to use up and the use of entrepreneurial entropy is what

entrepreneurs wish to be done when handling work. Clearly, the events of selecting, whether in

state 1 or in state 2, occur always at the same production-locations as well as simultaneously for

both selection parties (entrepreneurs and laborers). It has therefore all the requirements of a

statistical selection experiment of inflow.

2.4 Variation, Inheritance, Selection, Interactors/Agents, Replicators. . . 47

(the reordering is what we called reassembly). For investors and entrepreneurs this

is the stock of entrepreneurial entropy (capacity) of the investment sector. For

consumers and laborers this is the stock of labor entropy (capacity) of the consump-

tion sector (See Fig. 1.3 and the discussion in Sect. 1.9).

I consider the above division in classes of different agents as the most system-

atic. It provides for a satisfactory definition of agents. However, it is not essential to

allocate tasks to agents in this manner. One may just as well consider firms,

governments and institutions as decision taking agents. This is not the real problem

that we are facing here. The problem is how and by what mechanism the agents take

their selective decisions and how this can be described mathematically.

What follows from the above considerations is that the environment of biologic

evolution corresponds to the set S2 storing the entropy stock of entrepreneurial

capacity in the case of economic evolution. Where biologic evolution cherishes the

two-sector selective interaction between population and biotope (the environment),

the economic equivalent of that type of interaction is the interaction between labor

entropy and entrepreneurial entropy in respective order.

Although this correspondence is what makes Darwinism universally valid for all

kinds of biologic and social evolution, it is also a rather confusing classification

noticing that biologists and economists do not share a common vocabulary to

denote corresponding entities.

Let us now revert to the discussion of the model of evolutionary statistical

selection that Hodgson and Knudsen advocate. Does it fit in the above scheme

and in the affirmative how does it fit?

An important point that H&K claim is that the object of selection is a total of

available replicators (the units of selection) stocked in the interactors, because the

authors are aware that interactors host replicators (Hodgson and Knudsen 2010,

page 123). This corresponds with my observation in Sect. 2.3 of this chapter that

samples are stocked in the non-differential economy of S0 . Together with the

property that samples/replicators have a lifetime (the time they are hosted within

their interactor) this is part of the satisfaction of the third principle of Darwinian

evolution: the transmission (inheritance) of the information that the replicators

carry through time. It is at the end of their life that samples/replicators are selected

for inflow and cease existence. Then the information (entropy) they carry is used up

to serve producing new entropy (i.e. creating other samples/replicators that in turn

carry the information further). The interactor-inflow is formed by the samples/

replicators that are selected to be used up. The interactor-outflow is formed by the

samples/replicators that are selected to be produced.

It is however not completely clear whether H&K treat the environment as

another interactor, i.e. as a collective of economic agencies that participates in

selecting like the labor force does. I think they do not. I will demonstrate that the

denial of the environment as an interactor leads to a stalemate in realizing the

Shannon-Darwin time compression transition.

In accordance with the disputable idea that the environment is not an interactor,

Hodgson and Knudsen regard an interactor as an entity with boundaries between

itself and the environment (Hodgson and Knudsen 2010, pages 166, 240). Thus they

48 2 Sets of Entropy, Selection, Venn Diagrams and Bitpulses

interactors. But they do not regard them as the equivalent of the economic environ-

mental condition for consumers/laborers. Presumably H&K consider also laborers/

consumers to be part of that collective of interactors.

That uneven treatment of interactor and environment is at variance with Figs. 1.1,

1.2 and 1.3, which sustain the notion that the entrepreneurial environment is an

interactor (or a collective of interactors) with which laborers/consumers interact.

In their work of 2010 (Hodgson and Knudsen 2010) Hodgson and Knudsen

elaborate their ideas somewhat further with respect to this matter. They assume the

environmental condition to express itself in one or more environmental states

(Hodgson and Knudsen 2010, pages 165–167 and pages 239, 240). Well

indeed—within the context of a statistical selection theory—it is necessary to

discern between different states of selection. Although it is not completely clear,

they appear to suggest with their model that only the environment possesses

different states of selection and that interactors do not possess a state of selection.

Interactors are the selecting agents. They select units of selection (replicators) condi-

tional to a particular environmental state.8 That is what they suggest more or less. They

introduce pi;j as the conditional probability that a replicator (entity) residing in the i-th

interactor will cease to exist (expire) if a replicator (entity) residing in the j-th interactor

will cease to exist, conditional to a given environment E. This is a weird and incorrect

model of selection. Moreover it is restricted to inflow selection only. The definition of

probabilities of outflow selection, e.g. the probability μi of a replicator to originate in

the i-th interactor during (t,t + dt), is not considered while it plays a prominent role in

dealing with outflow selection. Moreover, the significance of pi;j defined in the

manner of H&K is not clear. First of all selection is always between states and if

they speak of the selection of an i-th and j-th interactor, they evidently select indices

i and j as representing states of selection, which clashes with H&K’s idea that only

the environment has different states. Secondly, mention that the replicator must

expire on a very small time-interval (t,t + dt) is not made, while at least a common

time-interval of selection needs to be discerned during which events of expiration

and origination occur. Moreover pi;j as defined by H&K does not clearly fit in the

generalized Shannon selection scheme, for which only the following probabilities

of inflow and outflow are relevant (See also Appendix B for the additional listing of

the most important relationships):

• the probability λi that a sample expires in state i on (t,t + dt),

• the probability μj that a sample originates in state j on (t,t + dt),

• the probability λðij jÞ that a sample expires in state i on (t,t + dt) conditional to

another sample originating in state j on (t,t + dt),

• the probability μðjjiÞ that a sample originates in state j on (t,t + dt) conditional to

another sample expiring in state i on (t,t + dt),

8

Note that any statistical selection theory demands that there is more than one state of selection,

for if there were only one, there is nothing to select. Hence it is required that there are at least two

different environmental states if interactors lack states.

2.4 Variation, Inheritance, Selection, Interactors/Agents, Replicators. . . 49

• the unconditional joint probability qi j that a sample expires in state i on (t,t + dt)

and another sample originates concurrently in state j on (t,t + dt).

The following general rules hold:

1. The event of expiration of a sample in state i and the event of expiration of

another sample in state j are statistically independent. Likewise the event of

origination of a sample in state i and the event of origination of another sample

in state j are statistically independent. Such independent events are selected

sequentially, i.e. in the process of executing two successive singular trials, one

with the outcome in state i, the other with the outcome in state j.

2. The event of expiration of a sample in state i and the event of concurrent

origination of another sample in state j are statistically dependent. This implies

þ

that the subsets of dSi and dSj overlap (See the Venn diagrams of Figs. 2.2, 2.4

and 2.5) for any i; j ¼ 1; 2, . . . . , N. See the discussion in Sect. 2.2.

Rule 2, which states statistical dependence between the event of expiration of a

sample and the concurrent event of origination of another sample assembled from/

þ

into sample space dS 0 \ dS0 and reassembled from/into overall sample space dS0 is

a very crucial one. If the events of origination on (t,t + dt) were not statistically

dependent on the events of expiration on (t,t + dt) and conversely, evolution will

not be possible as explained in Appendix F.9

Rule 1 states the absence of statistical interaction between the different succes-

sively ordered trials (and micro-events) of inflow selection on (t,t + dt). This is the

bottleneck in H&K’s model of inflow selection. It follows from rules 1 and 2 that

pi;j ¼ λi if it were not that H&K define the selection of the two replicators to be

executed conditional to the state of the environment. What this environmental

condition exactly means is not clear. It does not affect the probability of selection

if the condition is the event of expiration of another replicator in one of the states

the environment may possess. On the other hand it does affect the probability of

selection if the condition is the event of origination of another replicator in one of

the states the environment possesses. The measure of interaction depends on the

environmental state of replicator origination.

Presumably Hodgson and Knudsen had another idea in mind. They might have

assumed that their model of inflow selection reassembles the entropy outflow of the

collective of interactors (including the environment?), in the manner of Shannon’s

formula for the joint entropy H ðX0 [ Y0 Þ per trial of both inflow sequence hX0 i and

outflow sequence hY0 i of the communication channel:

X

H ð X 0 [ Y0 Þ ¼ pi;j log pi;j ?

i;j

9

It is recommended to read Appendix F after Sect. 4.1 has been dealt with.

50 2 Sets of Entropy, Selection, Venn Diagrams and Bitpulses

Unfortunately this formula does not reassemble entropy outflow if pi;j refers

to the occurrence of the expiration of one replicator in state i conditional to

the expiration of another in state j. The correct expression for the joint entropy

H ðX0 [ Y0 Þ is (2.7), which we have discussed previously in Sect. 2.2.

Another critique on H&K’s inflow selection model is: Why should the stock of

replicators that form the non-environmental interactors demonstrate evolutionary

growth conditional to the state(s) of an external environment/non-interactor? Of

course a surplus of selected outflow over selected inflow will cause the selecting

interactors to grow. However, net growth can only be maintained if there is a

continuous update of the environmental conditions to ever more favorable environ-

mental conditions in the course of time. This requires the entropy of the environ-

ment to change/evolve as well. Well, why should that happen spontaneously? The

entropy of the environment can only evolve if it is also object of evolutionary

selection. This implies that the environment is a replicating stock of replicators

which is also object of inflow and outflow selection. But such a stock cannot evolve

relative to its environmental conditions only. Its outflow can only evolve in

interaction with inflow of all interactors outside and inside the environment. This

requires that we must deal with the evolution of environment and non-

environmental interactors in a symmetrical co-evolutionary manner. In summary

the environment must be an interactor as well. In this connection it is also necessary

to grant states of selection to the collective of non-environmental interactors just as

H&K furnished the environment with states. This implies that we have again

arrived at the Shannon-inspired interpretation of Darwinian selection as suggested

by Figs. 1.1, 1.2 and 1.3.

In conclusion, Hodgson and Knudsen make an untenable separation between

interactors and the environment by treating the environment as an entity that is

something different than an interactor. In the way H&K suggest to apply Shannon’s

theory to economic evolution, it cannot be done.

Replicators are stocked within interactors. If replicators are selected they must

be created or used up in one of the available particular states. For the two-sector

model of evolutionary selection we have the minimum number of states, which is 2.

For the multiple sector model of evolutionary selection there are more than two

states and this implies that a replicator will be selected while coming to reside or

ceasing to reside in one of those multiple states. Replicators are similar but they

may vary in state from one other. Else selection would be impossible. If selected for

outflow in state j, they are created in that state and selected to join the stock of

replicators that reside in state j. This stock is nothing else than the entropy H Sj

of the interactor Sj in state j. Likewise if on inflow selection a replicator is selected

in state i, it is used up and ceases existence in the interactor Si that stocks the

replicators residing in state i.

It follows that we have just as many states as there are different sets of interactors.

It is not clear whether H&K realize that mathematical necessity. They consider

indeed groups of different interactors (group selection) and the possible selection of

multiple “component” replicators existing on different levels, but what they intend to

state with this is not very clear (Hodgson and Knudsen 2010, page 151). Do they

2.5 Bitpulses and the Definition of the Unit of Selection 51

suggest that a replicator may change state during its lifetime and so assume different

levels of state during its lifetime? This cannot be the case because a replicator must

maintain the same state all the time during its existence as we have discussed before.

In Sect. 2.6 we will give other arguments of mathematical necessity why replicators

must adhere to the same state during the time they exist.

The subject of defining the units of selection is perhaps the most difficult topic to

bring to a successful end. It must have a solution that links the Darwinian world of

evolution with the rigorous world of the mathematics of selection. The subject is

surrounded by many pitfalls on both sides of the coin. The problem is not a typical

economic (or social) problem. Biologists have also been heavily involved in a fierce

dispute about the units of biologic selection: genes, genotype, phenotype, a combi-

nation of genes, individuals, even the complete population or whatever else that has

been proposed to be the subject or object of selection. The question is still unsettled

and cause of much confusion among evolutionary biologists. For the greater part

the contrasting views can be reduced to unclear ideas of what the selection process

is all about. Once the selection process has been delimited mathematically accu-

rately and consistently, there is only one way of defining the unit of selection: a bit

of entropy or, which boils down to the same, a sample of assembled entropy log N

stored or to be stored in non-differential sample space S0 and reassembled in the

applicable differential sample space in the course of selection on the infinitesimally

small time-interval ðt; t þ dtÞ.

In the papers of 2006 and 2007 written jointly by Hodgson and Knudsen (2006,

2007), the authors contend that for biologic evolution the Darwinian mechanism of

replication by genetic inheritance warrants the transfer of complexity and variety

from the past into the future. We have already argued in the two preceding sections

that a similar process of replication explains the transfer of complexity and variety

in the case of economic (social) evolution. The conceptualization of the samples/

replicators/bits involved is a key issue in understanding economic evolution.

Hodgson and Knudsen (2007, page 53; 2010, pages 77, 122 and following) opt for a

quartet of features that are required for a suitable definition of the replicator concept:

1. Causal implication, which implies the ability to produce copies.

2. Similarity, which implies that the replicator copy is similar to the copied

replicator.

3. Information transfer, which implies that the generated copy carries and transfers

the same generative information as the copied replicator.

4. (Conditional) generative replication, which implies the generative capacity10 of

each replicator to replicate under initializing conditions.

10

Not to confuse with the conception of capacity as defined in Sect. 2.1.

52 2 Sets of Entropy, Selection, Venn Diagrams and Bitpulses

Entropy

content

logN

Sample/replicator

in state i

0

time

t–t t+q

random random

instant of instant of

origination expiration

t t+dt

A replicator exists from its instant t–τ of origination (moment of outflow selection) until its instant t + θ of expiration (moment of inflow

selection). During its existence it is always in the same state i. Different samples/replicators have different random instants of origination

and expiration and may be in different states, but during their existence each sample/replicator holds the same entropy content because of

the Darwinian principle of similarity. The entropy content originates at time t–τ and is used up at time t + θ.

(t,t + dt) is the current time-interval of selection. Only the samples/replicators that expire during (t,t + dt) and the samples/replicators that

originate during (t,t + dt) are selected as a result of inflow selection and outflow selection respectively. The sample/replicator in the above

drawing is not selected during (t,t + dt) because its instants of origination and expiration fall outside that time-interval of selection. It

remains stocked in the i-th interactor during (t,t + dt)

In this and the following section we shall first discuss in more detail to what

mathematical interpretations this leads with regard to the samples/replicators of

evolution. In the previous section we noticed that samples/replicators are or get

stocked in interactors during the time they exist. The interactor within which they

are stocked determines their state of selection.

This results in a universal time-dependent representation of a sample/replicator

as depicted in Fig 2.6. A sample/replicator exists when it carries information, order,

complexity, emergent properties for future transference to comply with the third

feature listed above. The latter process can only occur if a sample/replicator

possesses entropy content. Prior to its time instant t τ of origination the sample/

replicator does not exist and we may thus also contend that its entropy is zero then.

Likewise posterior to its time instant t þ θ of expiration the sample/replicator does

not exist anymore and its entropy is zero as well. However from its moment of

origination until its moment of expiration the sample/replicator exists and possesses

positive entropy content. Let me now list the following three properties of a sample/

replicator that is the subject/object of selection of a particular experiment of

statistical selection:

(a) The entropy content is the same for all samples/replicators during their exis-

tence, irrespective of the state in which they are selected.

(b) The entropy content is constant during the time a sample/replicator exists. It

does not vary with the passage of time.

(c) A sample/replicator remains in the same state during its existence.

2.5 Bitpulses and the Definition of the Unit of Selection 53

Entropy

content

logN

sample/replicator?

0

time

t–t t+q

random random

instant of instant of

origination expiration

t t+dt

the current

time-interval

of observation

Property (c) holds generally for any economy. It has already been discussed and

motivated by requirements of selection consistency in the previous sections. We will

bring forward another forceful argument in favor of this property in Sect. 2.6.

Properties (a) and (b) are perhaps less self-evident but they are a necessary conse-

quence of the second and third feature listed above. The argument is as follows.

Suppose that property (a) does not hold good. As a consequence a copy originating

within any particular state will generally not carry and transfer the same entropy as

the copied sample/replicator. This is incompatible with the second and especially the

third feature listed above. Let us then suppose that property (a) holds true but that

property (b) does not hold true. Since property (a) holds good and the third feature

listed above must be satisfied, all samples/replicators will hold the same entropy at

the moments they are reassembled, i.e. at the time instant t τ they originate and at

the time instant t þ θ they expire, irrespective of the state they get in, respectively

were in. This implies that the entropy of a sample/replicator is only fixed at a

universal constant value at t τ and at t þ θ but varies (or may vary) with the

passage of time for the other time instants in between. I have depicted this situation in

Fig. 2.7. In this figure the entropy of any sample/replicator is assumed to differ from

the constant value it has at the instants of origination and expiration. Well this

dynamic pattern of varying entropy cannot be maintained for two conclusive reasons:

• Mark that only the entropy content at the selection moments t τ and t þ θ of the

various samples/replicators determines the inflow and outflow of the economy.

Hence, the variation of entropy content of a sample/replicator at other time

instants than its initial and final moments of existence is totally irrelevant.

54 2 Sets of Entropy, Selection, Venn Diagrams and Bitpulses

Content of entropy at intermediate time instants is not selected and hence there

are no economic events that result from it or that have caused it. Moreover the

assumed variation of entropy content does not affect the transference of infor-

mation and complexity in the course of time. Consequently, if the character of

the variation of entropy content of a sample/replicator originating at t τ and

expiring at t þ θ is irrelevant, why not subscribe to the rectangular course it

might take?

• Another even more powerful reason is that the varying course of entropy content

in Fig. 2.7 demonstrates that also portions of entropy of the sample/replicator

originate and are used up at intermediate moments during the time it exists. This

implies that we can split up our original sample/replicator in sub-samples/

replicators that originate and expire during the time the original sample/

replicator exists. Consequently, there are events of entropy origination and

expiration at moments where they were formally mathematically absent.

Clearly, this is not a mathematically consistent way of describing evolutionary

selection. In conclusion, samples/replicators can only possess the same constant

entropy content during their entire life-time.

Having established the rectangular pattern depicted in Fig. 2.6 for any sample/

replicator, we must now conclude that each sample/replicator is the extension in

time of a constant content of entropy as long as it exists in accordance with our

contention in Sect. 2.3. We have established there that a sample has entropy log N.

However we are free to decide whether we wish samples each of log N bits as our

unit of selection or wish bits each stocking a single bit of entropy as our unit of

selection. It does not matter. We will often adhere to the bit as our unit of selection

in the sequel, but sometimes it is more convenient to use a sample of entropy log N

as our unit of selection.

If we choose for a bit as our unit of selection, each unit of selection carries a

single bit during its lifetime. Since the unit of selection has a lifetime it must be

stocked in the state i it is and during the lifetime it exists. This implies that non-

differential sample space S0 hosts all bits with a lifetime. As such these bits are not

yet selected but may be selected during ðt; t þ dtÞ. Pending selection this stock of

entropy represents assembled entropy rather than reassembled entropy, because as

long as bits are not selected on ðt; t þ dtÞ they remain hosted in S0 . Reassembled

entropy is the total of those bits that get reassembled in differential sample space.

However the number of bits in differential sample space is infinitesimally small in

comparison with the number of bits in non-differential sample space S0 . Hence the

bits of S0 that hold reassembled entropy form only a negligible differential portion

of the total non-differential entropy stocked in S0 . Reassembled entropy in S0 can

therefore be neglected relative to the rest of the stock in S0 . In conclusion the

economy S0 hosts all the bits currently existing and generally the sector Si hosts in

fact all Ci samples/replicators that are in state i.

In sum bits must have the dynamic form of rectangular pulses extending in time,

each pulse carrying the constant entropy content of one bit during its existence and

0 bits when it does not exist. We may just as well then replace the term bit as object

2.6 The Uniqueness of State of a Bitpulse 55

of selection by the term bitpulse carrying one bit of entropy in the course of time.

Thus the unit of selection is the equivalent of a single bitpulse carrying one bit of

entropy during its existence.

It is important to realize that the instants t τ of origination and the instants t þ θ

of expiration of sets of bitpulses are continuous random variables. At observation

time t it is of course impossible to know these instants in an exact determinist manner

for any of the bitpulses. Statistical selection theory can only establish relationships

between the aggregates of an economy. It does not predict how individual constitu-

ent entities at the micro-level behave deterministically. On the basis of the

relationships between the aggregates we can however derive the probability

distributions of the random variable τ of current lifetime and the random variable

θ of excess lifetime for each of the aggregate inflow and outflow variables. We shall

consider this subject in Chap. 5. It will deliver new starting-points for analysis of the

money economy and of the relationships between transmission and price inflation.

It is clear that the rectangular bitpulse of Fig. 2.6 shares the four features that

H&K discern in line with the three principles of Darwinian selection.

Moreover interactors can be conceived as holding stocks of information

(or stocks of many bitpulses). Interactors (otherwise than bitpulses) hold different

quantities of entropy varying and often growing in the course of time. On the other

hand bitpulses vary with respect to their instants of origination and expiration and

each of them stocks just a single bit of entropy during the time it exists.

that a bitpulse stays in the same state during the time it exists [property (c) of a

replicator listed in Sect. 2.5]. Well, let us nevertheless consider the situation that a

bitpulse exists that holds a portion of its entropy in state i and the remaining portion

of its entropy in state j ðj 6¼iÞ during the time it exists. This situation has been

depicted in Fig. 2.8 with A=B bits of entropy in state i and ð1 A=BÞ bits of entropy

in state j. Well the total constant content of entropy [here A=B þ ð1 A=BÞ ¼ 1 bit]

of a bitpulse is a relative measure on behalf of the principle of evolutionary

homogeneity. We may just as well assume that this constant level is B times as

large if expressed in other entropy bits that are B times as small. Herein B is a

number that is the same for each bitpulse and that does not vary as a function of

time. The much smaller choice of the unit of entropy effectuates that B times as

many bitpulses exist (I have called them sub-bitpulses in Fig. 2.8) that take over the

role of the former bitpulse. There are now, instead of only one bitpulse, A sub-

bitpulses in state i and B A in state j, all of them satisfying the property that they

are in the same unchanging state during the time they exist. Thus the complete

replacement of the old bitpulses, each by B sub-bitpulses, demonstrates that we can

always choose the unit of entropy so small that property c) of Sect. 2.5 will be

satisfied. Since A=B need not be a rational number, it follows that generally we must

56 2 Sets of Entropy, Selection, Venn Diagrams and Bitpulses

Entropy

content B

in small

bits (B–A) sub-bitpulses in state j

one small bit

A

sub-bitpulses in state i

0

time

t–t t+q

random random

instant of instant of

origination expiration

t t+dt

Suppose a bitpulse is not in a single unique state during its existence: a portion A/B is in state i and the rest (B–A)/B of it is in state j (j 6¼ i).

The replacement of the unit of entropy by a unit of entropy that is B times as small effectuates the replacement of each bitpulse by many sub-

bitpulses each residing in a single state only, as required. This demonstrates the necessity of choosing the dimension of the bit so as to hold

an infinitesimally small portion of entropy in order to rule out that a single bitpulse might reside in more than one state during the time it

exists

choose the unit of entropy infinitesimally small so that the approximation of the old

bitpulses by infinitely many of B sub-bitpulses can be made as accurately as we

wish. In case the argument of the Shannon-Darwin transition operation has not

convinced to rule out the possibility that still bitpulses may exist that reside in more

than one particular state, the above consideration demonstrates that the number of

such bitpulses can always be shown to be relatively vanishing provided the unit of

entropy is chosen infinitesimally small. This infinitesimally small nature of the unit

of entropy is necessary for other reasons, a subject that has been discussed before

and that will return again and again.

of Conditional Entropy

We have noticed in Sects. 2.1 and 2.3 that we can discern between three different

kinds of statistical experiments of selection; one is the inflow selection experiment,

another the outflow selection experiment and the third is the overall selection

experiment. A fourth process playing a role for successful selection is exchange.

The successive Zdt mutually independent trials of the inflow experiment effec-

tuate Zdt draws of samples each expiring in a particular state within sample space

dS

0 . We noticed that according

P to Shannon the reassembled entropy inflow of this

experiment is H ðX0 Þ ¼ i λi log λi per trial [See Sect. 1.6 and (1.1)]. Likewise

2.7 Elementary Probability, State Probability, Some Formulas of Conditional Entropy 57

the successive Zdt mutually independent trials of the outflow experiment effectuate

Zdt draws of samples each originating in a particular state within

P sample space dSþ 0.

This delivers the reassembled entropy outflow H ðY0 Þ ¼ j μj log μj per trial [See

also Sect. 1.6 and (1.1)]. Finally the successive Zdt trials of the overall experiment

effectuate Zdt concurrent draws of a sample to annihilate in any particular state and

another sample to originate concurrently in any particular state within sample space

þ

dS0 \ dS0 . This delivers,P also in accordance with Shannon, the reassembled

entropy H ðX0 [ Y0 Þ ¼ i;j qi j log qi j per trial [See Sect. 2.2 and (2.7)].

Formulas (1.1) and (2.7) are asymptotically valid for dt ! 0 and require the

number Zdt of trials to tend to infinity on (t,t + dt), conditions that we encountered

before as necessarily to be satisfied.

We will come to see in Sect. 4.1 of Chap. 4 at a later stage of analysis why these

formulas (1.1) and (2.7) are justified to hold generally. Shannon justifies these

equations in his seminal paper by an argument subjected to the typical ergodic

condition of the communication channel (Shannon 1948). I will produce a related

and certainly not less convincing general justification of these Shannon formulas

with necessary allowance for the typical non-stationary condition of evolutionary

selection.

In a micro-world of events where there are no other events than events of

elementary statistical selection, the probabilities λi (respectively μj and qi j) associated

with the probability of executing a single trial must be equal to the proportion of

þ þ

entropy residing within dS

i (respectively within dSj and within dSi \ dSj ) to the

þ

total entropy residing within sample space dS 0 (respectively within sample space dS0

þ

and within sample space dS0 \ dS0 ). Thus, in accordance with what has been

remarked11 in Sect. 2.2:

H ð Xi Þ H Yj

λi ðtÞ ¼ ; μj ðtÞ ¼ for i; j ¼ 0; 1, 2, 3, ; N (2.11)

H ð X0 Þ H ðY0 Þ

and

H X i \ Yj

qi j ¼ for i; j ¼ 0; 1, 2, 3, , N (2.6)

H ð X 0 \ Y0 Þ

Probability is a concept that is always connected with a particular experiment of

statistical selection. And it happens that there are two distinct, but related concepts

of probability: that of elementary probability and that of state probability. We shall

make the following distinction between the two competing concepts of probability:

11

The relationships (2.11) and (2.6) have also been listed in Appendix B. Equation (2.6) has been

listed as (B.9) in Appendix B.

58 2 Sets of Entropy, Selection, Venn Diagrams and Bitpulses

from sample space resides in a subset of that sample space. It renders the

probability of selecting one such tiny entity when it is selected separately.

I will reserve the notation Probf: : :g to denote elementary probability.

• State probability is the probability of a very large (tending to infinity) sequence

of consecutively repeated draws of all the assembled samples of entropy (Zdt in

number) in which the applicable sample space can be dissected. Repeated

sampling renders the state probability of all the tiny samples selected during

the execution of the statistical experiment. I will reserve the notation Prf: : :g to

denote state probability.

Both differential sets and non-differential sets possess an elementary probability

and a state probability. We have noticed before that the elementary probability of

selecting a bitpulse of any non-differential set is equal to 1=2. This is the elementary

probability of selection in the absence of knowledge due to the impossibility of

selecting all samples stocked in non-differential sample space S0 during the

available time-interval ðt; t þ dtÞ . There is no practical behavioral scheme of

selection granting agents any information about the entropy stock of a non-

differential sector. There is no time to do that. The relatively very few samples

(note their number is still infinite) that agents collect about non-differential sample

space by differential sampling only during the selection interval ðt; t þ dtÞ must

suffice. This renders the elementary probability 1=N of selecting a sample of

entropy from non-differential sample space S0 as we have argued in Sect. 2.3.

These samples derive their constant entropy content from assembly selection in

non-differential sample space. On the other hand all the samples of differential sets

can be sampled during ðt; t þ dtÞ simply by selecting and reassembling them

individually without replacement. Hence there is no problem of dealing with the

selection of differential sequences.

Boltzmann’s theorem (See Sect. 1.6) relates entropy H to state probability π by

the formula H ¼ –logπ or, what boils down to the same, by the formula 2H ¼ π.

E.g., in virtue of (1.1), with

P P

H ðX0 Þ ¼ i λi log λi , H ðY0 Þ ¼ j μj log μj

X

H ð X 0 [ Y0 Þ ¼ i;j

qij log qij

it follows that

X X

Zdt λ log λi Zdt μj log μj

Pr dS ¼2 i i ; Pr dSþ ¼2 j

0 0

and

X

Zdt qij log qij

PrfdS0 g ¼ Pr dS

0 [ dSþ

0 ¼2 i;j

2.7 Elementary Probability, State Probability, Some Formulas of Conditional Entropy 59

P P

Since H ðXi Þ ¼ λi j λj log λj and HðYi Þ ¼ μi l μj log μj on behalf of (1.1)

and (2.11) we have

X X

Zdt λi λ log λj Zdt μi μj log μj

Pr dS ¼2 j j ; Pr dSþ ¼2 j

i i

and state probability,

H dS

i HðXi Þ log Pr dSi

λi ¼ Prob dSi ¼ ¼ ¼

for i ¼ 0, 1, 2, , N

H dS0 H ðX0 Þ log Pr dS

0

and

h n oi

n o H dSþ

j H Yj log Pr dSþ

j

μj ¼ Prob dSþ

j ¼ þ ¼ ¼

for j ¼ 0, 1, 2, , N

H dS0 HðY0 Þ log Pr dSþ0

Let us further recall here Shannon’s definition of the conditional entropy HðY0 jX0 Þ

of the outflow sequence hY0 i . Shannon defined this conditional entropy as the

average of the entropy of Y0 for each value of X0 , weighted according to the

probability of getting that particular X0 .12 Similarly, the conditional entropy HðX0 jY0 Þ

of the inflow sequence hX0 i must be defined as the average of the entropy of

a sample of hX0 i for each value of the associated sample of hY0 i, weighted accord-

ing to the probability of getting that particular sample value of hY0 i . (See for

more elaborations Appendix B). It follows from the probability definitions in

Appendix B that

X X

H ðY0 jX0 Þ ¼ qi j log μ ðjjiÞ and H ðX0 jY0 Þ ¼ qi j log λ ðij jÞ (2.14)

i;j i;j

qi j qi j

μðjjiÞ ¼ and λðij jÞ ¼ (2.15)

λi μj

X X

H ðY0 jX0 Þ ¼ qi j log qi j þ qi j log λi

i;j i;j

12

Mathematically more sound is: “Conditional entropy H ðY0 jX0 Þ is the average of the entropy of a

sample of hY0 i for each value of the associated sample of hX0 i , weighted according to the

probability of getting that particular sample value of hX0 i.”

60 2 Sets of Entropy, Selection, Venn Diagrams and Bitpulses

and

X X

H ðX0 jY0 Þ ¼ qi j log qi j þ qi j log μj

i;j i;j

P P

Since j qi j ¼ λi and i qi j ¼ μ j ,

X X

H ðY0 jX0 Þ ¼ qi j log qi j þ λi log λi

i;j i

X X

H ðX0 jY0 Þ ¼ qi j log qi j þ μj log μj

i;j j

The state probabilities PrfSi g of the non-differential sectors Si have been given by

(2.13):

1

PrfSi g ¼ N ¼ 12 (2.13)

and Outflow, the Unit Price

j \ dSi as the subset of sample space dS0

þ

that dSj and dSi have in common. I noticed also that there are N 2 non-overlapping

subsets dSþ þ

j \ dSi whose union is dS0 \ dS0 . This implies that

X

H ð X 0 \ Y0 Þ ¼ H Xi \ Y j

i;j

The entropy Zdt H Xi \ Yj is a transmission. It is an “outflow” of entropy from

the sector Si into the sector Sj . We noticed in Sect. 2.2 that transmission/exchange

involves the creation and annihilation of a pair of balancing samples, a “pure” entropy

sample in exchange for a virtual sample of money. On balance it seems that nothing

has been created in the economy of S0 , because per trial we gain one sample of

entropy in dSþ

j while losing another in dSi during ðt; t þ dtÞ or conversely. Thus it

appears more appropriate to call this transmission financial entropy, involved with

the exchange of entropy in state j for money in state i or conversely. Formulated more

2.8 Transmission, “Pure” and Financial Value, Inflow and Outflow, the Unit Price 61

þ

accurately, in dSi \ dSj a sample at time t þ dt, created in state j on ðt; t þ dtÞ

exchanges for an equal entropy content of money sacrificed in state i on ðt; t þ dtÞ. Or

þ

alternatively, in dS

i \ dSj a sample at time t, annihilating in state i on ðt; t þ dtÞ

exchanges for an equal entropy content of money created in state j on ðt; t þ dtÞ.

Which of the two possibilities is at stake will be subject of a later discussion. That

discussion requires a lengthy mathematical argumentation.

þ

These considerations allow us to call the nature of entropy H dS

i \ dSj of

dS

i \ dSþ

j financial.

On the other hand H dSþ i can be considered to reflect a gross flow of “pure”

entropy production. Therefore we associate H dSþ i with the complete collection of

bitpulses originating or with the (unconditional) entropy outflow of economic

production within Si . By the same token H dS i is a gross flow of “pure” entropy

loss. We are therefore led to associate H dSi with the complete collection of

bitpulses sacrificed or with the (unconditional) entropy inflow of economic produc-

tion within Si .

The difference of outflow Yi ¼ Zdt H ðYi Þ and the conditional outflow

Yi ¼ Zdt H ðYi jX0 Þ is equal to the financial outflow Zdt H ðX0 \ Yi Þ. The difference

of inflow Xi ¼ Zdt HðXi Þ and the conditional inflow Xi ¼ Zdt H ðXi jY0 Þ is

equal to the financial inflow Zdt H ðXi \ Y0 Þ.

Conditional entropy outflow is that portion of entropy outflow that it has not in

common with inflow and conditional entropy inflow is that portion of entropy

inflow that it has not in common with outflow.

Equations (2.16) and (2.17) can easily be verified with the assistance of a Venn

diagram.

þ

Selected entropy outflow balances selected entropy inflow within dS 0 \ dS0 .

Thus there is no net entropy gain or loss involved in the transmission from Si to Sj.

It is just a matter of financially exchanging entropy within Si for entropy within Sj

during the time-interval (t,t + dt) (See Fig. 2.9). That scheme is completely

symmetric with respect to an interchange of X and Y.

So far all variables introduced have been stated in the dimensional unit of

entropy: bits. This is the unit of selection we need for analyzing the processes of

selection. On the other hand economic exchange is in money units. To convert flow-

variables stated in bits into their corresponding flow-variables stated in the ruling

money units we must multiply entropy by the unit-price of entropy currently valid

on the selection interval ðt; t þ dtÞ. For that purpose we define P ¼ PðtÞ to represent

the unit price of a bit of entropy at current time t. The similarity feature that the unit

of selection must necessarily satisfy forces P to be the same for any bit of entropy

irrespective of the state in which it may reside (See Sect. 2.5, feature 2).

62 2 Sets of Entropy, Selection, Venn Diagrams and Bitpulses

1

state i

0

time

with the origination of a sample in state j on (t,t+dt)

1

state j

0

time

t t+dt

The occurrence of a sample annihilating in state i concurrently with another sample originating in state j is merely a matter of financial

þ

exchange of a sample between the sectors Si and Sj. E.g. dS 2 \ dS2 is the differential subset of intercompany financial exchange in the

investment sector. Clearly the situation in dSþ þ þ

j \ dSi differs from the situation in dSj |dS0 . In dSj |dS0 there is “pure” creation of entropy.

þ

Furthermore in dS

j |dS0 there is “pure” annihilation of entropy

It follows that

money outflow ¼ PYi ¼ PZdt H ðYi Þ; money inflow ¼ PXi ¼ PZdt H ðXi Þ

Anticipating more detailed analysis in Chaps. 5 and 6 we mention here that the

following interpretations will ultimately take form:

money wages ¼ PZdt HðX1 jY0 Þ; money depreciation ¼ PZdt H ðX2 jY0 Þ

These relationships hold for flow variables of which the action is restricted to

ðt; t þ dtÞ, certainly not for flow variables covering one year as in the annual reports

of economic statistical agencies.

2.9 Capital and Liquidity Surplus 63

Let us next define the net growth of capital of Si as the difference of the conditional

outflow Z H ðYi jX0 Þ per unit of time and the conditional inflow Z H ðXi jY0 Þ per unit

of time. We shall denote capital by Ci . Then the net change dCi of capital is

In accordance with (2.4) dCi ¼ ci Ci dt is equal to Zdt ½HðYi Þ HðXi Þ. This is the

sum of two contributions: the non-financial component Zdt ½HðYi jX0 Þ H ðXi jY0 Þ

of net entropy growth and the financial component Zdt ½HðX0 \ Yi Þ H ðXi \ Y0 Þ

of entropy growth. That is,

The difference between dCi and dCi is a difference between the entropies of two

subsets of the transmission domain:

Whereas dCi is a net cash flow of entropy capital entering the sector Si during the

time-interval (t,t + dt), the difference d Ci dCi is an additional surplus of money

resources .I shall call this surplus the liquidity flux of the sector Si. It has the features

that are usually assigned to liquid resources.

Recall [See (2.5)] that the accumulated capacity Ci is equal to

ðt

Ci ðtÞ ¼ ðYi Xi Þdθ

1

Capacity growth dCi is the “pure” component of net entropy growth. dCi includes

also the net contribution of a virtual money component to entropy growth. dCi is the

surplus of outflow Yi ¼ Zdt H ðYi jX0 Þ over inflow Xi ¼ Zdt HðXi jY0 Þ of the

economic sector Si during (t,t + dt). Integration of d Ci dt over the time domain

yields

ðt

Ci ðtÞ ¼ ZðθÞ ½Hθ ðYi jX0 Þ Hθ ðXi jY0 Þdθ

1

Like capacity Ci, capital is a stock of entropy. It accumulates both the “pure” and

the financial flows of entropy of Si . Like capacity Ci , capital is expressed in the

dimension of bits.

64 2 Sets of Entropy, Selection, Venn Diagrams and Bitpulses

Since dCi and dCi are flows of entropy-change of capacity and capital on the

selection interval ðt; t þ dtÞ, it follows that PdCi and PdCi are the corresponding

flows of money capacity change and money capital change. PdCi is the surplus of

money outflow PZdt H ðYi Þ over money inflow PZdt H ðXi Þ:

PdCi is the surplus of money outflow PZdt H ðYi jX0 Þ over money inflow

PZdt H ðXi jY0 Þ:

because

Thus

Since d C0 and dC0 balance, the economy S0 is without an additional liquidity

surplus. For the sectors Si it is different. What is lent by a sector Si is borrowed by the

other sectors of the economy. And what is borrowed by a sector Si is lent by the

other sectors of the economy.

For the two-sector economy (2.18) and (2.4) state that the financial rewards/costs

of the consumption sector are counterbalanced by financial costs/rewards of the

investment sector. It is not difficult to see, by consulting a Venn diagram, why dCi

and dCi do not balance for i 6¼ 0:

þ

H dS H dS þ

i i dS0 ¼ H dSi \ dS0 and

þ þ

H dSi H dSi dS0 ¼ H dS0 \ dSi þ

þ

þ

Since H dS

i \ dS0 6¼ H dS0 \ dSi it follows immediately that

þ

H dSþ H dS 6¼ H dSþ

i i i dS0 H dSi dS0

Chapter 3

The Road from Generalized Darwinism

to Evolvodynamics

economic selection process straight, in line with Shannon’s mathematical contribu-

tion. That cannot be done without the Shannon-Darwin transition (see Chap. 1).

Quite frequently the units of selection, the replicators/bitpulses (that hold only

one single state, but stretch out in finite time), are mistaken for the results of

selection, the variations (that hold a sequence of selected random states, but do

not stretch out in finite time). Another mistake is the idea that the environment can

reside in different states, which is wrong. The environment can be in only one single

state. Also many explanatory accounts are based on a measure of fitness, a tauto-

logical concept inadequate to explain evolution. This chapter confronts such errors

with a reiteration of the processes of selection: (1) The repeated assembly of

bitpulses from (respectively into) the overall non-differential entropy stock on the

time-interval (t,t+dt) of selection. (2) The simultaneous reordering of the existing

sequence pattern of the selected bitpulses. (3) The concurrent reassembly of the

reordered sequence of the selected bitpulses into (respectively from) differential

entropy “stock.”

Many different sequences of entropy flow can be formed. These sequences are

called potential variations. Actually selection is aimed at the typical variations, a tiny

subclass of the potential variations. The remainder of the potential variations, the

atypical ones, will never get selected and are therefore purposeless. The typical

variations are purposeful because they are the only ones that can and will get selected.

The selected replicators/bitpulses are the building blocks of the variations.

Although we might consider habits, traits, customs, routines, thoughts, ideas etcet-

era to crystallize in replicators and in interactors/sectors as Hodgson and Knudsen

suggest, mathematical consistency demands evolutionary complexity to settle

down in replicators/bitpulses that each hold the same constant entropy content.

On the road from Generalized Darwinism to Evolvodynamics we must dismiss

unworkable ideas like “the whole is more than the sum of its parts” and instead

adopt reductionism as an indispensable tool of scientific analysis. Quantitative

science without exploiting reductionism to its utter limits is impossible.

Lecture Notes in Economics and Mathematical Systems 665,

DOI 10.1007/978-3-642-34056-7_3, # Springer-Verlag Berlin Heidelberg 2013

66 3 The Road from Generalized Darwinism to Evolvodynamics

as many hypotheses as there are phenomena to be explained.

To explain all nature is too difficult a task for any man or

even for any one age. It is much better to do a little with

certainty and leave the rest for others that come after, than to

explain all things by conjecture without making sure of any

thing.

Isaac Newton

Hodgson and Knudsen attach a specific meaning to complexity. The definition they

give (Hodgson and Knudsen 2010, formula (61) on page 128) is not so much a

definition of complexity but has another relevant interpretation after some

inaccuracies, that the authors did overlook, have been fixed. In the unadjusted

form proposed by H&K it cannot be fitted in a consequent mathematical theory

of evolutionary selection. I shall sum up what is wrong with it just to clarify how

Shannon’s theory should not be interpreted and how it should be properly

interpreted when making the transition from Shannon’s ergodic selection to

nonergodic Darwinian selection.

Hodgson and Knudsen begin their exposition on complexity with describing a

notional generative replicator as a binary sequence (string) of bits with a length of

Zdt bits.1 (Hodgson and Knudsen 2010, page 128). This description results in an

immediate conflict with what we have established in the foregoing with respect to

the properties of replicators. We have seen in Fig. 1.2 that the inflow and outflow

sequences of the two-sector economy are binary strings of samples of infinitesi-

mally small time-length dt. Such sequences consist of Zdt samples and each sample

represents a replicator, which is either in state 1 or in state 2 in case of the two-

sector economy. Samples/replicators on the other hand extend over finite time (their

lifetime) as we have argued in Sect. 2.5 (See also Figs. 2.6 and 2.9) but they remain

in the same state during their lifetime. Clearly, an inflow sequence hX0 i is not the

equivalent of a replicator, but consists of very many replicators (Zdt in number) that

annihilate during the time-interval ðt; t þ dtÞ of selection. We should also bear in

mind that the total lifetime of a replicator is finite, but that the time-length of the

sequences is T ¼ dt after the Shannon-Darwin transition operation. However H&K

mistake a replicator for a binary sequence (of bits or of samples; that does not

1

H&K use the symbol L to denote the sequence length and the symbol C to denote complexity. In

accordance with the notational conventions to which I adhere L is labor, Zdt is the sequence length

and C will be reserved to denote capacity. I will therefore not use the symbol L for sequence length

and replace it by Zdt in order to avoid confusion. Likewise I will not use the symbol C to denote

complexity but replace it by the symbol K in this section.

3.1 The Reduction of Uncertainty by Selection 67

tion about complexity. For example how to interpret their assertion “that—by

maximizing interactor fitness in the environment—the notional generative

replicator realizes the theoretical entropy value of Hmax ¼ Zdt bits.” I take it for

granted that we must replace “notional generative replicator” by its plural: the

sequence of “notional generative replicators.”

Furthermore Hodgson and Knudsen claimPthat the entropy of a population of

generative replicators is equal to HðXÞ ¼ i pi log pi in which pi is defined to

represent the probability at locus i.2 By defining PHðXÞ in this manner HðXÞ equals

the entropy inflow per trial rather then Zdt i pi log pi , which is the entropy

inflow over the entire time-interval of (t,t+dt). Furthermore Hodgson and Knudsen

define complexity K of a population of replicating entities as the difference of Hmax

and HðXÞ. That is,

X

K ¼ Hmax HðXÞ ¼ Zdt þ i

pi log pi (3.1)

They point out that they are here concerned with binary sequences of informa-

tion. Thus there are only two alternative states 1 and 2 to select. This implies that

there are only two alternative interactors: population (state 1) and environment

(state 2). Thus, if p is the probability of selecting a replicator in state 1, ð1 pÞ is

the probability of selecting a replicator in state 2. Then, following the definition of

HðXÞ that H&K propose, we arrive at HðXÞ ¼ ð1 pÞ logð1 pÞ p log p. This

is Shannon’s formula for the joint entropy inflow H ðX0 Þ per trial of the binary

selection model with chance λ1 ¼ p that state 1 is selected and chance λ2 ¼ 1 p

that state 2 is selected. If there is noise on the channel, the probability μ1 that state 1

is received at the outflow side is different from p. However, if the channel is

noiseless, μ1 ¼ λ1 ¼ p. This is the context in which Shannon proposed his theory

for the discrete channel (i.e., the channel with a finite number of states).

On the other hand Hodgson and Knudsen associate HðXÞ with the entropy of the

population only (while it actually should be the joint entropy inflow per trial of

population and environment together). Moreover the entropy of the population is a

stock quantity rather than a flow quantity like entropy inflow is. Further H&K state

that—by maximizing interactor fitness in the environment—the notional generative

replicator realizes the theoretical entropy value Hmax ¼ Zdt bits. The “maximization

of fitness” is the typical jargon of evolutionary biologists. Usually the term “fitness”

lacks universally applicable concreteness and preciseness, certainly within

an economic Shannon-inspired context. In terms of Shannon’s notational

preferences HðXÞ cannot be anything else than the entropy inflow per sample.

2

It may be that H&K understand by locus i the i-th sample of the sequence of Zdt samples.

However that would imply that there are Zdt different probabilities pi, which is incompatible with

the fact that we are here dealing with a binary sequence. Hence I must assume that “probability at

locus i” must be interpreted as the probability of being selected in state i of which there are only

two: state 1 and state 2.

68 3 The Road from Generalized Darwinism to Evolvodynamics

P

Observe that HðXÞ ¼ i λi log λi is a maximum if HðXÞ ¼ 1 . It follows that

the maximum of HðXÞ to which H&K refer is 1. If HðXÞ acquires that maximum,

all the pi ¼ λi share the same probability. This probability is ½ in case of the two-

sector economy. However generally 0 HðXÞ 1. Thus if Hmax is to represent the

maximum attainable value of HðXÞ, it must follow that Hmax ¼ 1. Pushing this

further by substitution in H&K’s equation (3.1) above, we get

X

K ¼ 1 HðXÞ ¼ Zdt þ i

pi log pi

P

Since HðXÞ ¼ i pi log pi in this binary case, it follows that Zdt ¼ 1, which

implies that the experiment of selection consists of one single trial only.

To avoid this inconsistency it is necessary to assume that H&K actually intend to

measure the entropy content over all Zdt samples of statistical selection.

P Thus it

appears that we must replace HðXÞ by Zdt HðXÞ ¼ Zdt i pi log pi and

the formula for Hmax by Zdt, the maximum that Zdt HðXÞ can attain. In that case

H&K’s formula (3.1) for complexity K must be replaced by

X

K ¼ Zdt Zdt HðXÞ ¼ Zdt þ Zdt i

pi logðpi Þ

P

Recall our assertion in Sect. 2.3 that Zdt HðXÞ ¼ Zdt i pi log pi is the uncer-

tainty that agents face knowing the probabilities pi only and that Zdt Hm ¼ Zdt log N

is the maximum uncertainty there is if the selecting agents lack all information about the

probabilities of the states [See expression (2.12)]. This implies that Hmax ¼ Hm in case

of the two-sector economy ðN ¼ 2Þ. Thus while selecting on ðt; t þ dtÞ, the selecting

agents succeed to reduce their uncertainty by

X

Zdt log N Zdt HðXÞ ¼ Zdt log N þ Zdt i

pi log pi

P economy N ¼ 2. Hence the reduction of uncertainty is equal

to Zdt þ Zdt i pi log pi . It follows that K is the reduction of uncertainty at the

inflow side of the economy that the selecting agents effectuate by their outcomes of

selection relative to the situation of absence of any a priori knowledge. If this is

what H&K intend, complexity K is the difference of the uncertainty in a state of

complete lack of knowledge and the uncertainty that agents actually face. The more

reduction of uncertainty, the more complexity at the inflow side. It is not clear why

this reduction of uncertainty should be called complexity.

The preceding discussion reveals the great conceptual difficulties involved with

a properly applied mathematical Shannon-inspired interpretation of the evolution-

ary process. My main objective will be to illustrate how the time-compression

operation T ! dt from Shannon towards Darwin should further be performed and

3.2 Combinations, Variations, Uncertainty and Information 69

Hodgson and Knudsen have an eye for the key role of Shannon’s theory of

information therein. The manner in which they endeavor to interpret Shannon in

the context of the maximization of interactor fitness is an attempt to crack the hard

nut. Unfortunately the road they take leads astray. Attempts to tackle the matter by

maximizing fitness will always break down on the impossibility to define a dynamic

measure of fitness that does not clash with the Shannon framework. Nevertheless it

is on the basis of extensive systematic reconnaissance of Darwinian conceptual

notions and Shannon’s conception of information that H&K pointed out what the

only direction is to successful economic scientific exploration. We will keep

pursuing that road further in the sequel.

Let us reconsider the example as illustrated in Fig. 1.2 and as dealt with in Sect. 1.7

with Zdt ¼ 21, λ1 ¼ μ1 ¼ 14=21, λ2 ¼ μ2 ¼ 7=21.

We shall first restrict the actual selection process to Zdt ¼ 21 samples so that—in

accordance with our exposition in Appendix A—we cannot apply Shannon’s formula

(1.1) because of the insufficient sequence-length. Instead formula (A.1) of Appendix A

is applicable and we establish that Zdt HðX0 Þ ¼ 16:827243 bits, Zdt HðX1 Þ ¼ λ1

16:827243 ¼ 11:218162 bits and Zdt HðX2 Þ ¼ λ2 16:827243 ¼ 5:609081 bits.

The sequential order in which the states are arranged in the inflow sequence hX0 i

does not affect the entropy inflow Zdt HðX0 Þ ¼ 16:827243, reassembled

by the

agents on ðt; t þ dtÞ. Neither does it affect the state probability Pr dS0 , which is

Pr dS

0 ¼ 2ZdtHðX0 Þ ¼ 216:827243 ¼ 8:59993 106

Hence we may consider all combinations of hX0 i that can be reassembled from

14 samples in state 1 and 7 samples in state 2 as equally likely. Below I have listed a

very few of these combinations. Among them also the combination

121121211212111211112 of samples (the fifth one) that is actually selected in

Fig. 1.2.

222222211111111111111

222222121111111111111

222222112111111111111

222221122111111111111

121121211212111211112

122121211212111211111

etcetera

70 3 The Road from Generalized Darwinism to Evolvodynamics

All of these combinations have the same state- probability 8:59993 106 and

share the same information content logð8:59993 106 Þ ¼ 16:827243 bits

within sample space dS 0 , because each of them has the same elementary inflow

probabilities: λ1 ¼ 14=21 and λ2 ¼ 7=21.

There are quite many different inflow combinations that can be realized given

the elementary inflow probabilities λ1 ¼ 14=21 and λ2 ¼ 7=21. We shall call them

variations. All of them share the same set of elementary probabilities. Let their total

number be Ω. That one of them will be selected from sample space dS 0 by the

selecting agents during ðt; t þ dtÞ is certain. Hence, since each of these variations has

the same state probability 8:59993 106, we must have that Ω 8:59993 106 ¼ 1.

!

It follows that Ω ¼ 7 !2114 ! ¼ 2

16:827243

¼ 116; 280 different inflow variations exist

that can actually be selected.

This implies that the assembly of 21 samples by agents on ðt; t þ dtÞ effectuates a

reassembly of economic resources such that 116,280 reassembled combinations of

inflow can be formed. Only a single combination of those 116,280 combinations is

actually selected. Its entropy is logð8:59993 106 Þ ¼ log 116; 280 ¼ 16:827243

bits. This entropy content reflects the economic significance/value of inflow. It

reflects also the uncertainty the selecting economic agents face because the more

variations that can be reassembled, the less firm they are in their decision to choose

the combination actually selected.3 Therefore Shannon uses the terms entropy,

information and uncertainty interchangeably.

Well, there are 116,280 equally likely combinations that can actually be selected

by the agents, given the 21 samples of the inflow selection experiment and given

λ1 ¼ 14=21 and λ2 ¼ 7=21. However, what about this number of combinations if the

elementary probabilities λ1 and λ2 are not given, i.e., are actually unknown? If

nothing is known about the probabilities λ1 and λ2 , we can only guess that the

following combinations of inflow can be formed in case of the two-sector economy:

111111111111111111111

111111111111111111112

111111111111111111121

111111111111111111122

111111111111111111211

111111111111111111212

111111111111111111221

etcetera

In this particular case 221 ¼ 2; 097; 152 different combinations can be formed.

This is much more than the 116,280 combinations that can actually be selected.

I call the 2,097,152 combinations the potential variations and the 116,280

combinations the typical variations. A potential variation requires 21 bits of

3

We may also argue that the more improbable the selected combination is, the more uncertain the

selecting agents are.

3.2 Combinations, Variations, Uncertainty and Information 71

entropy, which is nothing else than the number Zdt ¼ 21 of samples. It is the

uncertainty the economic agents face if they lack all the knowledge they need in

order to take purposeful selection decisions.

So far we have assumed in the example of this section that selection is

restricted to 21 samples in sample space. This had the advantage that the numbers

of typical and potential variations can be overseen and easily calculated respec-

tively from formula (A.1) and from 2 raised to the power of 21. However,

the actual selection process is concerned with a very large number Zdt of samples.

In that case Shannon’s formula (1.1) is applicable. If there are one million as many

samples we have Zdt ¼ 21;000;000 whereas λ1 ¼ μ1 ¼ 14=21 , λ2 ¼ μ2 ¼ 7=21

remain unchanged. It follows now from (1.1) that Zdt HðX0 Þ ¼ 19;284;212, Zdt

H ðX1 Þ ¼ λ1 19;284;212 ¼ 12;856;141 and Zdt HðX2 Þ ¼ λ2 19;284;212 ¼

6;428;071.

The sequence length of 21,000,000 is too large to write out the sequence of a

particular typical variation here. The total number Ω of typical variations is also

enormous: Ω ¼ 219;284;212 . This is a number of the order of 10 to the power

5,805,126,255. The number of potential variations is still much greater:

Ω ¼ 221;000;000 , which is a number of the order of 10 to the power 6,321,629,909.

Hence the number of typical variations is 10 to the power 516,503,654 as small

as the number of potential variations.

Shannon’s formulas (1.1) and (2.7) of asymptotic approximation are determined

by the elementary probabilities λi , μj , respectively qi j . The basic Shannon claim is

that—since the number of samples is always very very large—all the knowledge/

þ þ

information of differential sample space, dS

0 , dS0 , respectively dS0 \ dS0 , is

contained in the elementary probabilities. No more information/entropy per sample

can be gathered than what can be extracted from the knowledge structure of the

elementary probabilities. Thus, given the elementary probabilities, there is no

additional information per sample to gain and/or to lose by the selecting agents if

they choose another sequential order in which all the samples in state 1 and in state

2 are reassembled over the available sequence-length.

Another important observation in favor of Shannon’s fundamental claim is that

all samples are executed on the time-interval ðt; t þ dtÞ of infinitesimally small

length dt. That time-length is so very small that it is inconceivable that the order in

which the samples of different state are being selected by a great variety of agents

can affect the complexity in which the economy is being organized. The length of

the time-interval dt is so small that, economically, all Zdt trials take place

simultaneously. Thus in fact differences in the sequential order by which the states

are distributed over the samples, given the elementary probabilities of selection,

cannot have an economic effect. It is only changes of the elementary probabilities

of λ1 and λ2 that matter.

Note further that the maximum

P uncertainty Hm of 21,000,000 bits is attained by

maximizing HðX0 Þ ¼ i λi log λi ¼ λ1 log λ1 ð1 λ1 Þ logð1 λ1 Þ with

respect to λ1 ¼ 1 λ2 . It is easy to see that the maximum is attained for λ1 ¼ λ2 ¼ 12.

72 3 The Road from Generalized Darwinism to Evolvodynamics

Zdt Hmax that we considered (after correction) also in Sect. 3.1. It is the level of

uncertainty reflecting the hypothetical situation that economic agents would select

void of any reason. For the two-sector economy this is the case if λi ¼ 12. That would

rule out evolution to occur. Evolution of the two-sector economy sustains by the

fact that generally λi 6¼ 12 and μi 6¼ 12.

and Labor Input Probability

Xi

¼ H ðXi jY0 Þ ¼ λi H ðX0 jY0 Þ (3.2)

Zdt

and

Yj

¼ H Yj jX0 ¼ μj H ðY0 jX0 Þ (3.3)

Zdt

H Xi \ Yj ¼ H Yj H Yj jXi ¼ H ðXi Þ H Xi Yj (3.4)

the Venn

diagram

(Figs. 2.4

or 2.5). It follows also from the relation H Yj H Xi [ Yj ¼ H Yj jXi and (B.8)

in Appendix

B.

H Xi \ Yj in the left side of (3.4) is the entropy resulting from the events

þ

occurring within dS i \ dSj . The probability of this occurrence per trial is qij (see

Sects. 2.2 and 2.4 and Appendix B). We have from (2.6):

H X i \ Yj ¼ q i j H ð X 0 \ Y0 Þ (3.5)

H ðXi Þ H Yj

λi ðtÞ ¼ ; μj ðtÞ ¼

H ð X0 Þ H ðY0 Þ

X X X X

μj ¼ q0j ¼ q ; λi ¼ qi0 ¼

i ij

qi j ; q00 ¼ q ¼

i i0 j

q0j ¼ 1 (B.1)

j

3.4 Generative Replication and the Definition of the Replicator 73

H Yj ¼ H Yj jX0 þ H X0 \ Yj ¼ H Yj jX0 þ q0j H ðX0 \ Y0 Þ

¼ H Yj jX0 þ μj HðX0 \ Y0 Þ

Hence

μj H ðY0 Þ ¼ H Yj jX0 þ μj HðX0 \ Y0 Þ

so that

H Yj jX0 ¼ μj ½H ðY0 Þ H ðX0 \ Y0 Þ ¼ μj HðY0 jX0 Þ

It follows that μj is the quotient of H Yj jX0 and H ðY0 jX0 Þ. Further, in virtue of

(2.11),

H Y j j X0 H Yj Yj

μj ¼ ¼ ¼ (3.6)

H ðY0 jX0 Þ H ðY0 Þ Y0

λi ¼ ¼ ¼ (3.7)

H ðX0 jX0 Þ H ðX0 Þ X0

If we hold on adhering to the convention that S1 is consumption sector, S2 is

investment sector, (3.6) implies that μ1 is the propensity to consume and μ2 the

propensity to invest. Therefore we will call μ1 consumption probability, μ2

investment probability and λ1 will be called labor input probability.

Hodgson and Knudsen hang on to the four features listed in Sect. 2.5 as a general

definitional description of the replicator. They pay much attention to discussing the

matter (Hodgson and Knudsen 2010, Chap. 6). They contend that the first three

(causality, similarity and information transfer) of these four features are necessary

but not enough (Hodgson and Knudsen 2010, page 119). To complete the definition

they add the mechanism of generative replication as a fourth definitional prerequi-

site for the replicator. They assert that this generative property is a necessary feature

to exclude the possibility that e.g., a paper copying machine can also be called a

replicator (Hodgson and Knudsen 2010, page 121).

74 3 The Road from Generalized Darwinism to Evolvodynamics

Well the latter statement is not without some contradiction because the action of

a paper copier may also contribute to evolutionary growth as far as it invites users to

exploit increasingly innovative usage of the copier.

More particularly, evolutionary progress is not the sole result of outflow (i.e.,

generative) selection, but also the result of inflow (i.e., degenerative) selection.

Evolutionary systems do not only increase in complexity, they may also

decrease in complexity. Both processes occur simultaneously and one may

dominate the other for some time. Hence statistical selection may also result

in the decrease of aggregate complexity. That decrease may predominate in the

end. This is the phase when species become extinct, often after a period of

prosper (In fact this has been the overwhelming rule with respect to the

evolution of life on earth since many millions of years. The species that live

now on earth form a tiny fraction of all the species that have ever lived on

earth). Likewise institutions, economic enterprises and social organizations will

follow a similar pattern of initial evolutionary prosper and ultimate decline in

the end. It is often argued that in the end extinction of one particular species is

followed up by more complex entities, but this observation is typically anthro-

pocentrically colored by the eye of the human researcher of the evolutionary

process. Recall entropy is a relative concept. Different species (i.e., of different

evolutionary systems) do not share similar preferences about the quantity of

entropy of their environment. There is no connection. In summary we might just

as well purport that a replicator must have the feature of degenerative replica-

tion. This is what makes a paper-copying machine certainly also a collection of

replicators, since the machine will ultimately stop working and become replaced

by a better model.

The fact is that there is inflow selection (degeneration) and outflow selection

(generation). If we accept the mechanism of generative replication as a fourth

definitional feature of the replicator on behalf of outflow selection, we must

accept as well the mechanism of degenerative replication as a fifth definitional

feature of the replicator. This looks like a contradiction, although it is not if we

accept that replicators originate (are being generated) as well as annihilate (are

being degenerated). Well, I think that the concept of replicator can better be

defined within the context of the complete mathematical theory of evolutionary

statistical selection, i.e., it must be incorporated in the mathematical details of

that theory. It is therefore preferable to replace the term replicator by the term

“bitpulse.” This will clarify firstly that all replicators carry an even amount of

entropy during their lifetime, secondly that all of them have a variegated

random lifetime during which they remain stocked within an interactor of

their particular state, thirdly that as selected inflow bitpulses they are

sacrificed/used up to produce new outflow bitpulses, fourthly that as selected

outflow bitpulses they contribute to replenishing the stock of bitpulses within

the various interactors and fifthly and finally that they transport the information

they carry from the past into the future over their lifetime by processes of

exchange.

3.5 Habits, Traits, Customs, Routines and the Limits of Informational Knowledge 75

But we can also settle the definitional question of the units of selection in a

satisfactory manner with the following extraordinary simple definition:

A sample/replicator/bitpulse is a unit of selection that holds, carries and transfers the same

amount of information irrespective of time and state during the time it exists

else than the statement of a (universally valid) first principle, because its validity

does not depend on the time when or on the state in which the replicator is observed

or considered. And by referring explicitly to the amount of (the Shannon defined

average concept of) information we have been rescued from the need to detail the

sorts of micro-informational aspects it consists of or may consist of, which in itself

is an impossible undertaking.

of Informational Knowledge

In their 2007 paper Hodgson and Knudsen candidate entities like thoughts and ideas

as the replicators of social evolution (Hodgson and Knudsen 2007). However later

they opt for habits and more specifically traits, customs and routines as the

replicators of social selection because “they satisfy the conditions of longevity,

fidelity and fecundity” (Hodgson and Knudsen 2010, page 80). In comparison with

their position in 2007 they have decided that “the replication of unobservable habits

of thought is less straightforward.”

The disadvantage of the direct identification of replicators with “gene-like

replicators” as habits, traits, customs and routines as with thoughts and ideas is

that it may make us think that replicators differ from one another and are no longer

similar with respect to their entropy content. Similarity, the second feature of

replicators (see Sect. 2.5) is then explained as applying to many different replicators

(like complete genes in biological evolution) each satisfying the similarity condi-

tion for itself by copying only. Unless we cut them up into small abstract pieces of

similar constant entropy content (the “bit-like replicators” or bitpulses), they do not

satisfy all similarity conditions required for statistical selection. Thus we should

keep in mind that there is always the common unit of entropy in which to express

the measure of evolutionary complexity of habits, traits, customs, routines,

thoughts, ideas and so on.

One may think to reject the latter conception of the bit-like replicator as being too

abstract and instead opt for the gene-like replicator (varying in entropy content), but

the question then is: what is so concrete about unspecified habits, traits, customs,

routines, thoughts and ideas of which we don’t know and—worse still—of which we

will never come to know their individual entropy content by comparative measure-

ment? Remember entropy is a statistical average of a random variable. It is physically

and economically impossible to measure the entropy content of each replicator

individually. Moreover, what makes us think that the entropy content of a copy of

76 3 The Road from Generalized Darwinism to Evolvodynamics

a gene-like replicator remains equal to the entropy content of the original in the

course of time? If it doesn’t remain constant, the copy process of a gene-like

replicator will always produce the “same” gene-like replicator with an entropy

content that is continually changing. This implies that the feature of similarity

irrespective of time and state has not been complied with satisfactorily. It is therefore

untenable to consider habits, traits, routines, thoughts etcetera as being similar if they

differ in entropy content and if they are not mathematically defined to contain

each the same entropy content and if they are not to fall apart in units of selection

with the same constant entropy content.

A consistent mathematical contextual delimitation of the replicator concept is far

to be preferred. Recall that all statistical selection theories (including evolutionary

selection theory) are ignorant about what in detail is going on at the level of each

individual trial of the statistical experiment. Remind the outcome is always a

random occurrence. For the study of a selection experiment only the state and the

probability of the state in which the replicator is selected is relevant (and note that

this probability is an average time-dependent variable). So as regards the selection

process, why bother about the details of what the composition and the features of

the selected item are (other than its state and its average probability of occurrence)

at the level of micro-economic selection?

As a result of the selection processes a stock of replicators settles within the

selecting interactors. During the time replicators do not originate or annihilate they

are stocked in entrepreneurial capacity and labor capacity (in the case of the two-

sector economy) and in their storage position we might assert that they form a

complex of ideas, traits, habits, customs, routines and perhaps even thoughts

stocked in S0 , i.e., in the interactors. The entropy stock of all of these replicators

can be regarded as the aggregate entropy of habits, thoughts, traits, routines etcetera

of the economy. Thus an indirect identification of replicators with “gene-like

replicators” as habits, traits, customs and routines, thoughts and ideas is possible

as long as they are not subject/object of selection and remain stocked in the

interactors. What we can then perhaps say in this respect is that thoughts, ideas,

habits, customs etcetera are principal storage factors that serve as an ordered set of

recipes, a collective of equipment and crystallized prescripts for production and

directions for use for all sorts of items of value during the selection-interval (t,t+dt)

and for enabling production-workers/wage-earners to do their work during (t,t+dt).

They remain stocked as ideas, traits, customs, prescripts, routines, intuitions in non-

differential sample space S0 . By assembling samples of them in the form of

bitpulses during ðt; t þ dtÞ (in the manner described in Sect. 2.3) they contribute

to reassembled inflow and outflow after reordering the samples as part of the

selection processes. As such ideas, traits, customs, routines, intuitions, stocked as

part of the entropy of S0 , contribute to further economic evolution after differen-

tially selected very small portions of them, cut up in bitpulses each carrying one bit,

have been reordered by reassembly of their entropy. This is the connection we must

keep in mind.

However, by cutting these gene-like replicators up, the interactors are just as well

stocks of bit-like replicators. Only bit-like replicators are subject/object of selection.

3.5 Habits, Traits, Customs, Routines and the Limits of Informational Knowledge 77

number of bitpulses carrying always the same constant small amount of entropy.

The very large majority of replicators resident at a particular time-instant t,

respectively t+dt, is not part of inflow and outflow during (t,t+dt). By far the large

majority of what was stocked in S0 at time t remains stocked in S0 during (t,t+dt).

And by far the large majority of what is stocked in S0 at time t+dt was already

stocked in state S0 at time t.

In summary, the content of entropy stocked in entrepreneurial capacity and labor

capacity is a reservoir of replicators. Only a very tiny portion, the flow of bitpulses

selected on ðt; t þ dtÞ , determines the current flows of the economy. Economic

performance and the selection motives associated with it depend on many factors,

so many and variegated that it is preferable not to enter into detailing the

replicators. We will never catch a complete image by trying to list the whims and

fancies of replicators categorically.

Let us consider in this respect for instance the role of confidence and the impact

of economic policy of governments and central bankers. Confidence and policy

influence selection behavior of agents considerably. The burning question is then

how continual adjustments of these motive powers, in response to the business

cycle fluctuations, relate to the gene-like replicators, i.e., to the thoughts, ideas,

traits, habits and customs that are actually selected on ðt; t þ dtÞ . Clearly those

economic adjustments will get reflected in the continual introduction of new

thoughts, new ideas, new traits, novel habits and novel customs and in the continual

replacement of old thoughts, old ideas, old traits, outdated habits and customs

during ðt; t þ dtÞ. Hence the replicators that affect the immediate performance of

the economy are far from having a sufficient degree of stability as Hodgson and

Knudsen consider desirable for replicators to possess if that stability does not refer

to the constant entropy content each of them must carry (Hodgson and Knudsen

2010, page 136). Only the replicators that remain stocked in S0 (i.e., the decision

centers of S1 and S2) remain sufficiently stable, because the large majority of them is

not assembled during ðt; t þ dtÞ. The question keeps returning: why should we detail

that relatively stable stock of replicators so much if they do not really contribute to

direct quantitative explanation, description and forecast of the current economic

cycle? The gap between replicators/habits and replicators/samples/bitpulses can

therefore best be bridged by accepting the mathematically consistent idea that

bitpulses are tiny time-dependent pulses each carrying a single bit of entropy the

time they exist and possessing random lifetimes.

One can also put these comments in another perspective. H&K’s identification

of habits, traits, customs, routines, etcetera with replicators will only result in a

better explanation of economic evolution than the Shannon-inspired explanation

can offer if the required detailed variegated informational knowledge about these

features (e.g., the entropy content of each of these replicators) is available to the

selecting agents. Unfortunately it is not.

In the end it is all about what the limits of available information are within an

economy. Is there still knowable micro-information about the compositional details

of a replicator? Or is there not, so that eventually a replicator must be the equivalent

78 3 The Road from Generalized Darwinism to Evolvodynamics

of one bitpulse? We will return to dealing with those questions later in Chap. 4. It is

all about what information actually is. H&K seek it in the micro-leveled details of

habits, traits, customs, routines, thoughts, but do these entities hide any knowable

information if we cannot observe the variable extent of their individual role

quantitatively? Is information rather not an average statistical concept, dependent

on the elementary probabilities of selection?

Hodgson and Knudsen repeat stressing that replicators are similar, but we have

already argued that we cannot be certain about their similarity if there is no way to

observe and measure the individual content of each of the replicators. Moreover

there are several passages in their work that may need some further amplification to

substantiate that similarity as a general feature. One of these passages is concerned

with multiple level selection.

H&K contend that there are multiple levels of replication from which is selected

(Hodgson and Knudsen 2010, page 80). If multiple selection is nothing else then

multi-sector selection, this is ok. It is then merely a generalization of two-sector (or

binary) selection. However if they understand something else by multiple level

selection, it may be confusing.

In their table on page 173 (Hodgson and Knudsen 2010) Hodgson and Knudsen

discern between multiple ontological levels of selection from high to low: organi-

zational level, group level, individual level. They contend that the composition of

the replicators differs dependent on the applicable level. “The major information

transition that laid down the habitual foundation of culture involved the develop-

ment of a new type of generative replicator” (Hodgson and Knudsen 2010, page

188). At the individual level and group level genes and habits are the replicators, at

the organizational level routines, habits and genes are the replicators. H&K suggest

that the layers of evolution succeed each other from low to high. Well this is all

right if we strictly adhere to the point of view that the replicators of the different

layers of evolution keep the same constant content of entropy (of one bit each)

indefinitely. Else there will be a transition from one layer to its successive higher

layer with replicators that possess a time-dependent content of entropy during the

time they exist as in Fig. 2.7, which is mathematically inconsistent as we have

argued before. Thus we may allow successive phases of multi-level evolution to

exist if the same evolving system (e.g., a particular evolving population with its

evolving environment) remains subject and object of evolution. In that case the

system evolves from a lower entropy content to a higher entropy content that is so

much different from its original content that we prefer to conclude that it has

reached a higher ontological level of evolution.

The study of evolution concentrates always on a particular closed system S0

consisting of N different sectors. We may regard and study an infinite variety of

parallel systems of evolutionary development within our universe, each involving

3.7 Reductionism, Emergentism and Homogeneity 79

of evolution for which the same derivable set of equations of aggregate inflow,

outflow and transmission holds true. When we choose to study a particular (closed)

system of evolution (e.g., a colony of bees interacting with its specific environ-

ment), only the inflows and outflows of that system counts. There is of course

dependence on other evolutionary systems such as that of birds that have the bees

on their menu, but this manifests itself in the environment of the bees (its entropy

stock and its entropy inflow and outflow).

development (Hodgson 2004). The underlying philosophy of emergentism is that

evolution is a process of creative synthesis: a continual process of creating

structures of a completely different, higher layer than the lower layered structures

from which they are being composed (e.g., Hodgson 2004, pages 244–245). “Thus

although evolutionary processes of selection may have a physical basis, the effects

of evolutionary selection cannot be reduced to physics alone.”

Passages of similar content are repeated by Hodgson and his collaborator

Knudsen in their work of 2010 (Hodgson and Knudsen 2010). The authors consider

this form of emergentism to contrast with reductionism, the philosophy that we can

always describe the whole in terms of its constituents.

They are critical with respect to the explanation the reductionist method of

analysis is capable to offer for evolutionary processes. They contend that the

emergent properties of evolution can never fully be caught by this method of

analysis. In this respect emergentism is often summarized in the adage “The

whole is more than the sum of its parts.” (e.g., Hodgson 2004, page 102). H&K

appear to support this popular phrase. “Generally, the goal of explaining wholes

entirely in terms of their parts is a mirage” (Hodgson and Knudsen 2010, page 189).

I regret these views. They underestimate the power and prominent role of

reductionist reasoning in the sciences. Let me first make clear that we are talking

about science and in particular the scientific method. Reductionism is the outstanding

tool we need if useful and sufficiently accurate quantitative measurements of the

phenomena to be investigated (e.g., of aggregate inflow and outflow and average

price-level) are available. If they are absent for a particular domain of social

enquiry, only secondary results of the evolutionary process (see Sect. 1.3) can be

observed, although it remains still possible to apply the derived reductionist system

of equations of aggregate inflow, outflow and transmission. However unfortunately

without a possibility to test these equations against available data in this particular

domain.

Reductionism keeps explaining the whole in terms of its constituents. And to

preclude misunderstanding: nothing else than that is the intention of quantitative

science, including economic science. Economic science is no exception. It does not

80 3 The Road from Generalized Darwinism to Evolvodynamics

have its own methodological standards because the methods of science are univer-

sal. The differential geometrical method by which Newton derived the three laws of

Kepler is a perfect illustration of the fact that the method of science is reductionist.

In a similar manner emergent Darwinian evolution can only be effectively

described as a differential selection process during an infinitesimally small time-

interval (t,t+dt). This is the necessary reductionist step to be taken for analyzing

Darwinian evolution in order to remove the clouds that obstruct our view on the

matter. As long as that step is not considered, the weather will remain bad and

science is more or less in a deadlock. The history of the much older science of

physics has demonstrated that time after time.4

In the present exposition it is the mathematical reduction of time and value to

infinitesimally small lengths of time and infinitesimally small units of entropy that

led to the disclosure and exploration of differential sample spaces of selection in

which all the events occurring in an economy during the time-interval (t,t+dt) are

brought together. Thereupon, it was this reductionist differential approach that

made it possible to employ the effectiveness of Venn diagrams, which turn out to

be indispensable for understanding economic relationships. Without the tool of

mathematical reduction it is unthinkable that so much progress and so much insight

can be attained.

Thus I strongly oppose the idea that there is a potential conflict between the

emergent character of the evolutionary process and the reductionist approach.

Reductionism is the method of science. The idea that reductionism is the wrong

approach usually pops up when there are phenomena for which an adequate

(reductionist) scientific explanation is still lacking. Besides what does the obscure

phrase that the whole is not the sum of its parts mean? Perhaps 3 þ 4 ¼ 9? or 3 þ 4

¼ 10? or 3 þ 4 ¼ 11?. It would be very welcome to know the answer or do we mean

that there are at least several answers or that there is no answer? Science cannot be

built upon such talk. Or do we mean that HðXÞ þ HðYÞ does not equal H ðX [ Y Þ

but rather H ðX [ Y Þ HðX \ Y Þ ? If the latter is what we intend, we are back

at Shannon-inspired evolution. However, within that Shannon-inspired framework

3 þ 4 equals 7 as it always did.

The variety of emergent properties does not imply that emerging properties are

elusive, impossible for science to evaluate quantitatively. If evolution would

produce emergent properties that have no measure, we cannot grapple with evolu-

tion quantitatively. If there is no measure to express the extent of it, there can be no

variables to represent the extent of evolutionary complexity and order such as

inflows, outflows and stocks of entropy. Neither can there be a manner to order

evolutionary processes and can there be tools to analyze evolution like a carpenter

cannot use his tools if there is no way to measure his piece of work. Irrespective of

the many terms, such as e.g., uncertainty, information, knowledge, complexity,

4

No more oppressive has been the deadlock of Ptolemaic astronomy lasting from the hey-days of

the Roman empire, extending over the middle ages until the epoch of Kepler, Gallilei and Newton

finally arrived.

3.7 Reductionism, Emergentism and Homogeneity 81

demands that the scientific principles of continuity, measurability and Newtonian

reductionism are in force for any quantitative science. Economic phenomena have

their own domain of events and their own phenomena of investigation and should of

course always be explained in terms of their own events, their own phenomena and

their own concepts. The investigation of the domain of economic emergentism is

the exclusive domain of economic enquiry. We should therefore realize that the

economic domain of enquiry has its own unit of dimension by which the magnitude

or the changing magnitude of the emergent phenomena must be measured: the unit

of entropy: the bit. Since Hodgson and Knudsen create the impression to get on with

Shannon’s conception of information/entropy as a measure of emergentism,

Shannon’s bit of information/entropy has been accepted by them more or less as

a unit of emergentism (Hodgson and Knudsen 2006, 2010). The acceptance of such

units of dimension is necessary for the quantification of any science and hence we

must consider the content of information as the measure to express the extent of the

emergent properties that manifest themselves in the economy. In this way the extent

of an emergent property can be expressed with the help of a continuous scale of

information. The unit of entropy is the measure in which to express everything

emerging in the economic domain.

A supposed contradiction between emergentism and reductionism rests upon a

misapprehension, a slip of thought of the human mind that overlooks an essential

aspect of the method of science. To illustrate this by another example let us revert to

the beginning of the twentieth century when Einstein wrestled with the problem of

extending the postulate that the same physical laws hold good with respect to any

chosen system of coordinates to include also the class of phenomena of accelerated

motion (the principle of general relativity). With his theory of special relativity

Einstein had already derived the Lorentzian equations of transformation between a

pair of four-dimensional space/time coordinate-systems. However, the application

of special relativity was restricted to coordinate systems which were in relative

uniform translation with respect to one another (Einstein et al. n.d.). General

relativity created a novel domain of emergent space/time configurations that

could not be analyzed in terms of the space/time configurations of special relativity.

Einstein realized that special relativity was still applicable within an infinitesimally

small differential space/time volume dxdydzdt to sufficient degree of accuracy. That

inspired him to follow a reductionist differential approach. Thus he chose an

infinitesimally small space/time volume dxdydzdt to tackle the local situation of

general relativity. In fact this reductionist approach was the only way the problem

could be analyzed effectively with the laws of special relativity holding good in that

infinitesimally small space/time volume to sufficient degree of approximation. The

ultimate result was a completely novel theory of gravitation that assisted physicists

to discover the expansion of the universe, the big bang, black holes and to

understand many other interstellar phenomena and relationships.

The lesson is again that a particular domain of phenomena must be analyzed

within the local differential context in which the laws of those phenomena do not

change to sufficient degree of approximation. Newton’s universal method of

82 3 The Road from Generalized Darwinism to Evolvodynamics

under investigation. The idea that the application of the method of Newtonian

reductionism, often ventilated by practitioners of the social sciences, cannot explain

the emergence of a novel domain of scientific enquiry is off the mark. The history of

science does not corroborate that. And the idea that this method of Newtonian

reductionism is restricted to the application of mechanical laws of material objects

alone is just as absurd. Reductionism and differential analysis can and must be

applied to study any scientific domain of phenomena irrespective of its nature

(physical, economic or whatever). Only in cases where a database of quantitative

measurements is not available (which is often the case for social sciences other than

economics), the application of the reductionist method may lack significance if

there is no possibility to test the theory. However, without the availability of data it

is just as impossible to test the quantitative predictions of any alternative theory that

is said to be non-reductionist. The suggestion that evolutionary science is non-

reductionist is therefore an improvable dogma, nothing more than speculation.

In conclusion a conflict between emergentism and reductionism does not really

exist. It is a construction of the human mind resulting from an incomplete under-

standing of evolutionary selection. Quantification presupposes the acceptance of

unrestricted reductionism.

The application of reductionist tools is linked up with the principle of evolution-

ary/physical homogeneity (see Sect. 1.2). The measurement of homogeneous

variables is a form of reductionism since it provides for expressing the “weight”

of the variable in numbers of an applicable unit of dimension. In turn the unit of

dimension can be given a fixed magnitude (e.g., for mass: a kilogram or a gram; for

distance: a hectometer or a centimeter, etcetera). In virtue of the principle of

physical/evolutionary homogeneity we are free to choose the unit of dimension in

which a variable is expressed be it that it must reflect the (emergent) quantity of that

variable.

If we choose to measure a distance in kilometers, a replacement of the

kilometer by the centimeter as the unit of dimension will have that measure

multiplied by a constant factor of 100,000. Nevertheless we may take it for granted

that the measured distance has not changed but only the unit in which it is

expressed. The same holds true for value expressed in dollars, in Euro’s, in bits

or in micro-bits.

The reduction of the unit of dimension is based on the principles of continuity

and homogeneity. This implies that there is no lower bound with respect to the

smallness of the chosen unit of dimension. There may however be a limit imposed

by the bounds of applicability of the laws that define the measured variables or

govern the relationships between the measured variables of the domain of scientific

investigation. However in that particular case we enter a novel domain, a new layer,

of scientific enquiry with (usually) some other ensembles of variables to which

unrestricted reductionism and the principles of homogeneity and continuity of

measurement apply once again. Hence, within a particular domain of scientific

enquiry the premise is always that unrestricted reductionism in combination with

the principles of continuity and homogeneity ultimately applies. The big point is to

3.7 Reductionism, Emergentism and Homogeneity 83

trace and locate the correct differential space of reduction. Reductionism has no

mathematical limits in the small, just like Newtonian differentiation meets no

mathematical limits in the small. The Newton/Leibniz/Fermat theory of differenti-

ation is the crown-jewel of reductionist reasoning. It can be applied in many

different ways. Unfortunately it can also be maltreated as illustrated by the tenets

of economic marginalism (see Sect. 1.9). But maltreatment can never disqualify the

application of reductionist reasoning.

Chapter 4

Blind and Purposeful Selection

because it applies to ergodic rather thanP to nonergodic selection. It is demonstrated

that Shannon’s entropy kH ¼ k i ωi log ωi is the maximum information/

knowledge that selecting agents can unwittingly gather from k repeated selective

trials, given that ωi is the chance of selecting a sample in state i conditional to

P kH

i ωi ¼ 1. The number of typical variations that can be selected is 2 , far less than

k

the number 2 of potential variations. The probability of selecting a typical variation

is 2kH . Thus the joint probability of selecting any typical variation is 2kH 2kH

¼ 1. Hence potential variations other than typical will never get selected. The more

typical variations selected the more choice we have. This implies that uncertainty/

information must be defined as a strictly increasing function of 2kH: kH is such

function. As kH is also the only function that is homogeneous it follows that it is the

correct measure of uncertainty/information. The probability of selecting an atypical

variation is zero. Thus agents consider atypical variations as rubbish, not worth of

selecting. Only typical variations are meaningful to them because they are the

variations that they can and will actually select. This implies that evolution is

meaningful rather than blind.

The concurrent origination of a bitpulse and annihilation of another bitpulse

(overall selection) is a subject that will be dealt with in much more detail in Chap. 5.

Here it will be touched upon just to illuminate that it is narrowly connected with the

exchange of entropy for money or for money-like entities. The money flow holds a

content of entropy. However money is virtual entropy. It misses the lifetime that

bitpulses share.

In the last section of this chapter but one we turn to derive an important formula

connected with the elementary selection probabilities qi j of pair wise concurrent

selection. It results in the conclusion that any multi-sector economy is determined

by only three degrees of freedom.

Lecture Notes in Economics and Mathematical Systems 665,

DOI 10.1007/978-3-642-34056-7_4, # Springer-Verlag Berlin Heidelberg 2013

86 4 Blind and Purposeful Selection

prove it’s impossible. It’s very unlikely”. At that he said,

“You are very unscientific. If you can’t prove it impossible

then how can you think it’s unlikely?”

Richard P. Feynman

We have discussed in Sect. 3.2 the basic Shannon claim that all the information is

contained in the elementary probabilities of selection. That claim was also the basis

for the statement in Sect. 2.3 that the selection (the assembly) of any sample from or

into non-differential sample space S0 occurs with elementary probability 1=N.

However the arguments in Sects. 2.3 and 3.2 rested on the prior adoption of

Shannon’s conception of information. We took it for granted in Sects. 2.3 and 3.2

that the formulas (1.1) and (2.7) were the correct expressions for the content of

information:

X X

H ð X0 Þ ¼ λi log λi and H ðY0 Þ ¼ μj log μj (1.1)

i j

X

H ð X 0 [ Y0 Þ ¼ qi j log qi j (2.7)

i; j

tion/uncertainty

P and choice. That is, given a partition of events with probabilities

ωi ω i ¼ 1 , the information content or uncertainty of this partition is given by

P i

i ωi log ωi per sample. What lacks in the arguments exchanged in Sects. 2.3

and 3.2 is a solid justification for applying these expressions as defining the

content of information and uncertainty within the selection context of their

specific sample space. We shall now consider the subject in the present section

in its full perspective.

Shannon justified the definition of information as given in (1.1) and (2.7) within

the mathematical context of the ergodic communication channel. In the evolution-

ary economic context we might follow without much further investigation

Shannon’s argumentation to explain the relevance of (1.1) and (2.7) as proper and

self-evident expressions for the content of information. However Shannon’s

approach covers the typical situation of sequences extending over finite time T .

It is less suited for dealing with sequences of infinitesimally small time-length dt.

I will give another forceful, though related, argument to justify Shannon’s concept

of information as given in (1.1) and (2.7) for the evolutionary situation. That

argument has been partly inspired by E.T. Jaynes’ exposition of what he called

the Wallis derivation (Jaynes 2004, Chap. 11).

4.1 The Significance of Shannon’s Information Concept 87

statistical experiment of Zdt repeated trials of selecting a sample from/into differ-

ential sample space during (t,t þ dt). With each trial a sample will be reassembled

from/into a particular state of a differential sample space. In Sect. 3.2 we noticed

that there are many ways in which the different states of selection can be ordered

over Zdt samples given the elementary probabilities of states. Any particular

sequence that results as outcome of the selection experiment over ðt; t þ dtÞ was

called a variation. However, we considered only two-sector selection in Sect. 3.2.

We shall here discuss the matter in the more general context of the N- sector

economy.

The process of reassembling resources over N different sectors is equivalent

to a statistical experiment of k ¼ Zdt repeated trials of selecting very small

even samples during (t,t þ dt). Then with each trial a sample will be allocated

from/into a particular state of the differential sample space involved.

In the case of inflow selection we withdraw (assemble) samples from the

economy S0 by selecting k ¼ Zdt even samples in consecutive order out of a

“basket” dS 0 ðtÞ originally filled with k samples at time t. ωi ¼ λi is here

the probability that a sample will be reassembled from dS i . After having executed

all k trials of the experiment the basket dS 0 ðt þ dtÞ is empty at time t þ dt.

In the case of outflow selection the best explanation is provided by letting time

run in reverse direction. We add (assemble) samples into the economy S0 by placing

k ¼ Zdt even samples in consecutive order into a “basket” dSþ 0 ðt þ dtÞ that will

eventually be filled with k samples at time t þ dt. ωi ¼ μi is here the probability that

a sample will be reassembled from dSþ i ðt þ dtÞ at an earlier time-instant than t þ dt

on (t,t þ dt). After execution of all k trials of the experiment during (t,t þ dt) the

basket dSþ 0 ðtÞ is empty at the earliest time t of (t,t þ dt).

Thus we see that the mathematics of outflow selection within sample space dSþ 0

can be regarded as similar to the mathematics of inflow selection within sample

space dS 0 by reversing the arrow of time.

In the case of overall selection we assemble samples of differential sample space

þ þ

dS

0 \ dS0 in consecutive order from/into a “basket” dS0 ðtÞ [ dS0 ðt þ dtÞ filled

with k ¼ Zdt samples. Now samples will be reassembled from/into overall sample

þ

space dS 0 [ dS0 : The mathematics of samples reassembling from/into sample

space dS0 ðtÞ [ dSþ

0 ðt þ dtÞ can be regarded as similar to that of inflow and outflow

þ

selection in sample space dS 0 ðtÞ respectively in sample space dS0 ðt þ dtÞ.

Each process of reassembly can be dealt with as a process of executing k

consecutive drawings of samples “from a basket” that is initially filled with k

samples and therefore we can deal with these three processes mathematically in a

similar way.1 From this common point of tractability, it follows that at the start of

1

There are some mathematical subtleties that we shall not consider in much detail here. One of

them is that the number k of samples depends on time. This implies that for the inflow selection

process the number of k samples in the basket depends on the time t the inflow selection

experiment starts. That is k ¼ k(t). On the other hand for the outflow selection process the number

of k samples in the basket depends on the time t þ dt the outflow selection experiment starts.

88 4 Blind and Purposeful Selection

the process of selection there are ki ¼ ωi k samples within the “basket” in the i-th

state such that

X

N X

N

k¼ ki ¼ ωi k in which N is the number of states

i¼1 i¼1

knowledge of the probabilities ωi. If beforehand all ωi are exactly known—then we

know k and all the ki beforehand. In that case we know from combinatorial analysis

that the number Ω of ways k samples can be distributed over differential sample

space such that ki are in state i is equal to

k!

Ω¼ (4.1)

k1 ! k2 ! kN !

P implies that there are Ω different equally likely ways (variations) to allocate

This

k ¼ i ki samples over the various sectors (states). The probability W is the same

for each of these variations/sequences:

k1 ! k2 ! kN !

W¼ (4.2)

k!

These equally likely variations are the only variations that can be chosen subject

to the knowledge of ωi . It reflects the information-situation of the agents if the

selecting agents manage to use all the knowledge contained in the probabilities ωi .

Let us then first see whether and how agents succeed to get access to that informa-

tion by their selection behavior. The way agents manage that, is in fact extraordi-

narily simple.

Inflow reassembly is a process of drawing samples from a basket dS 0 ðtÞ originally

filled with k samples at time t. In the end at time t þ dt all samples have been drawn

and the box dS 0 ðt þ dtÞ is empty. This is typically a statistical selection experiment

without replacement. Likewise outflow reassembly is a similar selection experiment

without replacement with the arrow of time reversed. A similar remark applies to the

þ

case of overall reassembly within differential sample space dS 0 [ dS0 . Having

concluded that, we can return to the mathematics of selection without replacement

within differential sample space because this is how agents actually select. The

chances of selecting a sample in a particular differential subset will now differ

dependent on the consecutive order in which the samples happen to become selected

in the various states within the applicable differential sample space.

That is k ¼ k(t þ dt). Clearly k(t) 6¼ k(t þ dt). However since k(t) is proportional to dt, the

difference between k(t) and k(t þ dt) will only have a second order effect in dt so that this

difference will vanish as dt ! 0.

4.1 The Significance of Shannon’s Information Concept 89

results in the selection of one specific variation/sequence out of exactly the

same set of typical variations as formed from the distribution of k samples

conditional to the fact that ki ¼ ωi k of them always come to reside in state i.

Hence the number Ω is the same as given by (4.1). The probability of each of the

typical variations that can be selected in this manner is also the same probability W

as given before by (4.2) [The details of the mathematics of selection without

replacement can e.g. be found in Jaynes (2004), Chap. 3. A less elaborate standard

proof has been given for the case of two-sector selection in Appendix E]. In

summary we have:

k! k1 ! k2 ! kN !

Ω¼ and W ¼

k1 ! k2 ! kN ! k!

exactly the same information as if they had complete knowledge of the

selection probabilities ωi before they started the experiment of statistical selection

on (t,t þ dt). This implies that—by their actual selection behavior—the selecting

agents succeed to select one out of the class of Ω ¼ W 1 typical variations of which

each has the same probability W to occur. Agents cannot gather more information

about the combination/sequence that they select, because there is no more informa-

tion than available in the knowledge of ωi. That is, the class of probabilities ωi is all

we know concerning which event will happen to occur. This implies that W 1 is a

measure of the maximum information that the agents can gather from the knowl-

edge of ωi. The smaller W is, the more information will be gathered by the agents in

the course of selection.

By applying Stirling’s asymptotic approximation

pﬃﬃﬃﬃﬃﬃﬃﬃﬃﬃ

ki χ

ki ! ¼ ðki Þ 2π ki exp ki þ with 0 < χ < 1

12ki

log W. That is, for k ! 1 conditional to ki =k ! ωi :

X

log W ¼ k ωi log ωi 12ðN 1Þ log k for k ! 1 (4.3)

i

usually suffice:

X

log W ¼ k ωi log ωi ¼ k H (4.4)

i

Herein

H ¼ i ωi log ωi per sample of the statistical experiment of selection. log W

90 4 Blind and Purposeful Selection

selecting agents over the entire time-interval ðt; t þ dtÞ of selection.

Note that log W is a strictly decreasing function of W.

Mark also that the number Ω of typical variations is 2 log W ¼ 2kH in virtue

of (4.1), (4.2) and (4.4). These typical variations are the only sequences that can

occur subject to the knowledge of ωi . Each of the typical variations has the same

probability W ¼ 2kH of occurrence. In this respect their joint probability

of occurrence is the product of their number 2kH and their individual probability

W ¼ 2kH . That is 2kH 2kH ¼ 1 as required.

There is an important point yet to be considered. We have thus far established

that W 1 is a measure of the information that the selecting agents reassemble from

the knowledge of the probabilities ωi . However W 1 is not the only measure to be

considered for a general definition of information. Any strictly increasing function

FðW 1 Þ of W 1 will do equally well as a general measure of information. Thus we

need an additional criterion to establish what kind of function F ðW 1 Þ should

actually be, i.e. a criterion implying the self-evident definition of information. To

define the concept of information unambiguously this can only be achieved by

another very plausible but also strictly necessary condition of evolutionary homo-

geneity. Recall Zdt ¼ k is the number of samples on the time-interval (t,t þ dt) of

selection. If we multiply that number k of samples by a factor A we may expect the

information content that the agents succeed to gather to multiply by that factor A as

well. Thus the additional necessary condition to be stated with respect to a measure

of information is that it should be proportional to the number Zdt ¼ k of samples on

the selection interval (t,t þ dt). Well it is easy to see that multiplication of the

number k by a factor A will cause the probability of a typical variation to rise to W A.2

It follows that

F W A ¼ A F W 1 (4.5)

X

F W 1 ¼ k log W ¼ k H ¼ k ω log ωi

i i

(4.6)

P

Expression (4.6) justifies that Shannon’s formula H ¼ i ωi log ωi is the

correct general definition of information/uncertainty per sample, thus confirming

the two expressions of (1.1) and expression (2.7) as measures of information/

uncertainty. It is associated with the fact that 2kH equally likely typical variations

can possibly be selected by the agents, each with probability 2kH . The expression

for H is also the correct measure for uncertainty per sample that the agents face

while selecting, because the smaller the state probability 2kH of selection, the more

uncertain agents are about the outcome of selection.

2

Provided k and Ak are very large. Recall the discussion in Appendix A.

4.2 Blind Selection 91

choice from 2 into 4 states w

1–q w (1–q)

s (1–w)s

1–w

1–s (1–w)(1–s)

Let us for completeness sake consider the selection scheme of Fig. 4.1. The rule

is that—if there is only choice between two states with ω ¼ ω1 ¼ 1 ω2—entropy/

information is given by Hω ¼ ω log ω ð1 ωÞ logð1 ωÞ . And if the two-

sector selection splits into four states as in Fig. 4.1, entropy/information is

ð1 ωÞð1 sÞ log½ð1 ωÞð1 sÞ

ð1 ωÞ ½s log s þ ð1 sÞ logð1 sÞ

That is,

H ¼ Hω þ ω Hq þ ð1 ωÞHs

the two states of probability q and 1 q. Hs ¼ s log s ð1 sÞ logð1 sÞ is the

entropy of selecting between the two states of probability s and 1 s.

It is not difficult to lift the condition that Hω , Hq and Hs should be the

entropy/information of two-sector selections. Generally, if ωi are the respective

probabilities of selection that constitute Hω and the choice of each state i splits

up into the selection of sub-sectors j each with probability si j , then

X X X X X

H ¼ Hω ωi si j log si j ¼ ωi log ωi ωi si j log si j (4.7)

i j i i j

of selecting (i.e. assembling) k ¼ Zdt samples from non-differential sample space

S0 randomly during ðt; t þ dtÞ with the aim to arrange and order (i.e. to reassemble)

them for purposeful reallocation of entropy into differential sample space. Let the

reassembled entropy be denoted by kH as in the previous section. We have justified

92 4 Blind and Purposeful Selection

in Sect. 4.1 that the information/uncertainty acquired byP the selecting agents on

ðt; t þ dtÞ is equal to the reassembled entropy kH ¼ k i ωi log ωi . This is the

maximum amount of information/uncertainty that the selecting agents can

acquire. We have also argued in Sect. 2.3 that the reduction

P of uncertainty realized

by agents on ðt; t þ dtÞ is k log N kH ¼ k log N þ k i ωi log ωi. Herein k log N ¼

Zdt log N is the entropy randomly assembled from non-differential sample space S0

during ðt; t þ dtÞ necessary for reassembly in differential sample space. This implies

that the elementary probability ProbfSi g of selecting a sample from Si is equal to

1=N (i 6¼ 0).

Mark that ProbfSi g differs from the elementary probability ωi (See Sect. 2.7).

In the hypothetical case that agents would not reassemble their samples in

differential sample space with elementary probability ωi, but with even probability

1=N for all states i, agents would not realize a reduction of uncertainty by their

selection behavior. The latter selection behavior amounts to a case of completely

random reassembly of samples, which we shall call blind selection.

Blind selection does not result in any acquirement of information (or knowledge)

by the selecting agents during the selection interval ðt; t þ dtÞ. Clearly, agents do not

select blindly. Blind decision making is not the way by which selecting agents are

led while investing, consuming, putting equipment and other production capacity

out of use and employing labor effort. The elementary probability by which they

reassemble their samples is ωi, which will generally differ from 1=N. Their selection

behavior will bring about a reduction of uncertainty. By doing so agents select with

purpose rather than blindly and pure randomly.

Blind selection implies that the knowledge of the probabilities ωi is completely

ignored in the process of selection. Then the only thing we can say is that N states

can get allocated in N k ¼ 2k log N different ways over k samples. This number N k is

the maximum possible number of variations the agents would then make while

selecting on ðt; t þ dtÞ. We have called these variations the potential variations in

Sect. 3.2, where we only considered the case of the two-sector economy, in order to

distinguish this set of potential variations from the set of typical variations, which is

a subset of the set of potential variations. By ignoring the knowledge of ωi it would

remain hidden that the typical variations are the only variations that can actually be

selected. We have seen in Sect. 2.3 that—in the absence of any knowledge about

the probabilities ωi —each sample will be assembled with probability 1=N and that

the assembled entropy is then log N per sample. Subject to this ignorance of the

knowledge of ωi , each of the variations will then be assigned the probability

N k ¼ 2k log N of occurrence.

It is easy to see that the reassembled entropy H per sample is smaller or equal to

the assembled entropy log N per sample, i.e. H log N. Thus typical variations that

in fact have a probability W ¼ 2kH of occurrence, are assigned a much smaller

probability 2k log N were the knowledge of ωi completely ignored in the process of

selection, i.e. were selection blind.

Equality of reassembled entropy H and assembled entropy log N will only be

attained if all the ωi equal 1=N. Generally this is not the case. It cannot be the case if

4.2 Blind Selection 93

evolution is to occur. E.g. for the modern two-sector economy the outflow proba-

bility of consumption μ1 (the propensity to consume) is of the order of 0.7.

The inflow probability λ1 of labor is of the same order. This implies that generally

H < log N so that typical variations have a much greater probability than N k to

occur because (with N 2).

N k N kH ! 0 for k ! 1

Moreover the knowledge of ωi implies the information that only the typical

variations with equal probability W ¼ 2kH can be selected and that all the other

variations (in number 2k log N 2kH ¼ N k 2kH ) have vanishing zero probability to

occur.

It follows that, if the knowledge of ωi were ignored, the chance of selecting an

atypical variation is so small that it will factually never occur relative to the

occurrence of a typical variation. However the selecting agents do in fact not ignore

the knowledge of ωi but unwittingly exploit it by selecting without replacement and

so they succeed to acquire the maximum attainable knowledge to their own benefit.

It is sometimes debated by practitioners of the social sciences whether the

Shannon measure of Zdt H reflects all the information that agents can gather

over the time-interval (t,t þ dt). Hodgson and Knudsen accept the Shannon infor-

mation concept to express the information content, complexity and emergent

properties of social evolution quantitatively. Nevertheless they adopt the view

that this Shannon measure “omits key features of information such as ideas and

knowledge in the human domain, particularly meanings and interpretations”

(Hodgson and Knudsen 2010, pages 123, 124). Perhaps this explains their predilec-

tion for identifying habits, traits, customs, ideas and routines with replicators.

Nevertheless they remark that information cannot be defined more narrowly than

Shannon information because of the high level of generality of their conceptual

discussion (Hodgson and Knudsen 2010, page 124).

Well the idea that Shannon’s information concept misses key features as ideas,

knowledge, meanings and interpretations in the economic human domain is a

curious one. The first thing to stress here again is that Shannon entropy/information

is a statistical average (an aggregate) over all the events occurring at the micro-level

of human behavior during (t,t þ dt). The critique on this statistical average concept

of information often enlarges on the richness and variety of micro-behavior of

individual decision-making agents with the unproven suggestion that the mathe-

matics of Shannon can of course never catch up with that variety. We are here

however concerned with different categories: one (Shannon entropy) at the aggre-

gate average level at a particular instant t of time, the other unknowable multifari-

ous phenomena at the micro-level at the same instant t of time.3 This is not a correct

comparison. Furthermore were the Shannon concept of information to miss those

3

Mark that the Shannon average conception of information is not a time-average, but an average

over all micro-economic events at a particular time.

94 4 Blind and Purposeful Selection

key features of variety, the argument can only be taken seriously if those key

features are knowable and affect the selection by the economic agents on (t,t þ dt).

This can only be the case if there are typical variations that hold portions of

replicators (representing such a key feature) with larger information content per

replicator than the average. This is quite impossible. If some replicators hold more

information than other replicators, this is at variance with the second and third

feature defining the replicator of evolution (See Sect. 2.5). Samples, bitpulses,

replicators must be similar. Therefore the contention that Shannon’s information

concept misses key features of information in the human domain is untenable unless

we reject the complete idea of generalized Darwinian evolutionary selection,

a consequence that, I assume, Hodgson and Knudsen do not desire to accept.

Moreover, entropy is fluent. It is impossible to trace afterwards that a particular

sample spent in the i-th sector is actually residing in the i-th sector. Replicators,

samples have no individual label, neither an identity paper nor some individual

certificate. The sample may just as well be anywhere else and consequently

meanwhile have been substituted in the i-th sector by any other sample of entropy

such that the elementary probabilities ωj of entropy over the various states j remain

unaffected. Thus the only certain thing we can say about economic allocation and

reallocation is that the joint number of samples spent (or used up) in a particular

sector i during the time-interval of selection is always ki . There is no way to avoid

that conclusion given the selection probabilities ωi .

Is evolution the result of meaningful and purposeful selection? Or is it just the result

of mere blind chance? This has been a subject of much dispute among evolutionists.

The majority of evolutionary biologists has adopted the view that evolution is

without purpose and meaningless. E.g. Jacques Monod (1971) and in particular

Richard Dawkins (1976, 1984, 1988, 1995) have incessantly described evolution as

a blind selection process. Their point is that there are very, very many variations,

the potential variations, that can be selected. The chance to get selected is assumed

to be the same and very small for each variation (This is the common but incorrect

assumption made by almost all evolutionary biologists). It follows then from the

previous assumption that it is a matter of mere blind chance for a single variation to

get selected. And hence, it is mere blind chance that we are the ones that have

survived. The viewpoint expressed by Monod and Dawkins is not very welcome to

economists and has been a formidable obstacle for economists to adopt the view

that economics is evolutionary. Economists do not like to consider the allocation/

reallocation of economic entities as an activity subjected to the whims and fancies

of blind random forces only. Economic behavior is considered to be fairly purpose-

ful, not in all respects rational and optimal, but just reasonable at an average level

and meaningful, certainly not irrational and not without any purpose. This is also

4.3 Purpose and Shannon’s Existence Theorem 95

the opinion that Hodgson and Knudsen express (Hodgson and Knudsen 2010,

page 48) and I endorse that view.

However, H&K postulate that intentionality is an evolved property. Thus, so

they reason, humans select purposefully. It is the easiest way to refute the point of

view of the proponents of blind evolutionary selection. But there is a serious

difficulty involved with this counter argument. It does not really refute the idea

that all variations (inflow-variations as well as outflow-variations, superior as well

as inferior) are selected with equal chance of selection. If all potential variations are

selected with equal chance, it does not really make a difference for the selecting

agents what they actually select. If it would make a difference, the individual

selection probabilities of the potential variations would differ. If the selection

probabilities do not differ, then indeed selection is blind with respect to what is

selected. That is the point the blind selection proponents make and it is a good point

were it not that all potential variations do not possess an equal probability of

selection as we will stress here again in this section. But this is not the stand

Hodgson and Knudsen take. The reply they give does not really enter into the

matter.

The flaw in the argument of Monod and Dawkins is not that they rule out the

goal-directedness of the evolutionary process beforehand. Their point is that if

agents were to select purposefully they would not select all the variations, bad or

good, with the same probability of selection. Instead they would select the purpose-

ful with a much greater chance than the purposeless variations. Since Monod and

Dawkins take it for granted—on the basis of their inadequate interpretation of

Darwinian selection—that all potential variations are equiprobable, they conse-

quently conclude that agents do not select purposefully, but blindly without any

preference for what they select.

The crucial point in the argumentation is therefore whether Monod and Dawkins

are right in assuming that all variations, the atypical as well as the typical variations

(See Sects. 3.2 and 4.1), are selected with equal chance. Clearly that assumption is

wrong. Monod and Dawkins neglect the role of the selecting agents and they also

neglect the effect of that role on the value that these agents attach to the various

variations between which they must select. The agents value and devalue variations

in the course of executing the selection of inflow and outflow.

In the previous sections it has been demonstrated that, if selecting agents act

without using any knowledge, the total number of variations/sequences that the

selecting agents can select on the time-interval (t,t þ dt) of selection is equal to

2klog N . We have also demonstrated that, quite the contrary, the selecting agents use

all the knowledge that comes available during the process of selection to their

maximum advantage. As a result of that exploitation of knowledge only 2kH typical

variations, in number a vanishing portion of the number 2klog N of potential

variations, are favored by the selecting agents. That is,

2klog N 2kH ! 0 for k ! 1

The fact then is that there are an overwhelming number of variations (the

atypical ones) that will never get selected. These rejected variations have a

96 4 Blind and Purposeful Selection

of selection of variations sharing probability

2−k log N to get selected

2− k log N

0

Sequence number of variations

arranged in order of increasing

probability

The variations have been arranged in order of increasing state-probability on the absciss. The probability of selection per variation has been

set out on the ordinate, but all variations are equally likely.

The number of variations is 2k log N , each sharing the same probability 2k log N . The joint probability is 2k log N 2k log N ¼ 1 as required

vanishing probability zero to get selected. On the other hand the typical variations

are the only sequences that can be selected, each with the same finite chance 2kH of

selection.

The above argumentation implies that the agents use all the available applicable

knowledge while selecting. Therefore selection is not blind; instead it is meaningful

and purposeful. And hence the selected typical variations are meaningful and

purposeful. The rest of the variations is meaningless. That rest is junk with

vanishing zero probability to get selected.

The thesis that actually agents can only select meaningful variations and actually

never select one of the very many purposeless and unprevailing variations I shall

call Shannon’s existence theorem. In fact that theorem states that only purposeful

variations can exist. The above argumentation by which the theorem is established

is closely related to the argument by which Claude Shannon justified his definition

of information transmitted over the communication channel (Shannon 1948; See

also Jaynes 2004; Papoulis 1985).4 Figures 4.2 and 4.3 clarify the argument

visually. Figure 4.2 represents the Monod/Dawkins conception of evolutionary

selection. It is based on the wrong perception that each variation is selected with

equal probability of selection. Figure 4.3 illuminates the correct Shannon-inspired

conception. P

In Sect. 4.1 it was argued that Zdt H ¼ Zdt i ωi log ωi is the maximum

amount of information that the selecting agents can derive from the knowledge

that they gather gradually during the selection process. No more information than

Zdt H and no less.

4

For good order’s sake, Claude Shannon listed his related theorem as one of the theorems in

Shannon (1948). The proof requires specific adaptations in the mathematical argumentation within

the context of the transmittance and reception of stationary sequences with a finite time-length T

rather than with a vanishing time-length dt.

4.3 Purpose and Shannon’s Existence Theorem 97

Total number 2k⋅H of

of purposeless variations sharing

purposeful variations

probability 0 to get selected

sharing probability 2−k⋅H

Probability to get selected

of selection

2−k⋅H

arranged in order of increasing

probability

Total joint number 2k⋅log N

of variations

The variations have been arranged in order of increasing state-probability on the absciss. The probability of selection per variation has been

set out on the ordinate.

The fraction of the number 2kH of purposeful sequences relative to the total number 2klog N of all variations (i.e. purposeless and purposeful

together) tends to 0 for k!1, i.e. the fraction 2kH 2klog N ! 0 for k ! 1.

Note that the probability of selection of any purposeless sequence is 0 and that the probability of selection of any purposeful sequence is

2kH 2kH ¼ 1. This implies that purposeless variations will never get selected (or more precisely their probability of occurrence is zero)

and that purposeful variations are the only combinations selected by the economic agents

From the point of view of evolutionary selection Zdt H ðY0 Þ can be interpreted

as a maximum level of attainable aggregate outflow information that economic

agents on outflow selection acquire. By their selection behavior they make the best

of it they can by choosing a strategy and deal with the situation as purposefully and

as best as possible given the skills, knowledge and opportunities they have. In this

way they manage to reach the maximum attainable level Zdt H ðY0 Þ of outflow

information during the selection interval (t,t þ dt).

Likewise from the point of view of evolutionary selection Zdt H ðX0 Þ can be

interpreted as a maximum level of attainable aggregate inflow information that

economic agents on inflow selection acquire. By their selection behavior they make

the best of it they can by choosing a strategy and deal with the situation as

purposefully and as best as possible given the skill, knowledge and opportunities

they have. In this way they manage to reach the maximum attainable level

Zdt HðX0 Þ of inflow information during the selection interval (t,t þ dt). The

economic agents actually select only a single inflow variation and only a single

outflow variation out of a gigantic supply of inflow, respectively outflow, variations

during (t,t þ dt). The vast majority of the variations (the atypical ones) will be

immediately rejected, they will never be selected because the selecting agents know

or feel that these variations don’t work or the agents just don’t like them. Thus

agents will not select a butcher to get employed to bake bread in a bakery. Nor will

they send a ship on the highway to transport cargo to a foreign country. Neither will

a consumer/agent purchase chocolates for his love if she hates sweets. What

98 4 Blind and Purposeful Selection

remains for potential selection are the relatively very few meaningful typical

variations among the enormous supply of (potential) variations. According to

Shannon’s existence theorem these favored meaningful typical variations have

each equal probability of being realized. Thus a baker has a chance to get employed

in a bakery, a ship has a chance to sail cargo abroad over the sea, and a lady which

hates sweets but is fond of flowers has the chance to get surprised by a bouquet of

flowers.

It follows that Shannon’s justification of his conception of information and

uncertainty was also in the notion that agents can factually only select typical

variations each occurring with even probability W , from which he concluded—

like in Sect. 4.1—that more information is gathered the smaller W is. This is more

or less also the argument we used in Sect. 3.2 to motivate the Shannon definition of

information.

The additional argumentation we gave in Sect. 4.1 with respect to the argument

given in Sect. 3.2 is the observation that agents get unwittingly full access to the

source of hidden knowledge that is in the elementary probabilities because they

select without replacement. This observation was still wanting in the argument

developed in Sect. 3.2. I think the latter observation completes the best argumenta-

tion there is to justify Shannon’s information concept.

Inheritance. Some More Calculations

Let us now return to considering the arithmetic and the mathematics of the selection

of samples in another way. We shall deal with the two-sector economy only so that

each of the samples has the possibility to reside in state 1 (the consumption sector)

or, alternatively, to reside in state 2 (the investment sector). The economy can then

be considered as a stock of entropy consisting of an endless number of samples

stored in that economy either in the consumption sector or in the investment sector.

The joint number of samples stored in the investment sector is entrepreneurial

capacity, the joint number of samples stored in the consumption sector is labor

capacity.

Each sample of the economy observed at current time t has originated at its

specific (random) initial time t τ ðτ > 0Þ in the past and will annihilate at its

specific (random) final time t þ θ ðθ > 0Þ in the future. We have visualized the joint

stock of samples resident in the economy in Fig. 4.4. This has been done quite

schematically just to clarify that there are many individual samples with limited

lifetime that together form the joint entropy stocked in the economy, i.e. in

investment sector and consumption sector. Clearly, the initial rise of the joint

content of entropy from the non-existence level of 0 bits, followed by a later decline

to the non-existence level of 0 bits again, as illustrated in Fig. 4.4, is generally not

representative for the entropy of an economy. Here it has only been done to

4.4 Blind Selection, Purposeful Selection and Economic Inheritance. Some More. . . 99

Number of

samples in Approximation of a set by

a set various samples each with

its own initial time and

final time

0

time

Future

Past

Single sample lifted

Entropy out of the stock of

in bits samples that

represents the

population at

logN current time t

t -t t +q

current time t

Entropy is absent before the initial time and after the final time of the bitpulse. Entropy is log N bits per sample in between these two

instants. Current selection will take place on a time interval ðt,t þ dtÞ of very small duration dt in the very vicinity of current time t. It affects

only that part of the stock of samples that is ceasing existence on ðt,t þ dtÞ and that is coming into existence on ðt,t þ dtÞ

demonstrate the various initial times and final times of the constituting samples in a

rather specific manner.

The samples stocked in the economy of Fig. 4.4 await their moment of differen-

tial selection. This is clarified in Fig. 4.5. Here we have been drawing the selected

(inflow) samples that cease existence on (t,t þ dt) and the selected (outflow)

samples that originate on (t,t þ dt).

Each inflow sample has had its specific finite time-instant t τ of origination in

the past. Each outflow sample will have its specific finite time-instant t þ θ of

100 4 Blind and Purposeful Selection

varying excess lifetimes q exist

into the future. Their annihilation

in the future extends beyond the

Outflow samples of small time interval (t,t+dt ) . In this

+ − manner order, information, skills,

dS0 | dS0 coming

methods of production, techniques

into existence

and value transfer from the past

into the future affecting “economic

Outflow samples of inheritance”

− +

dS 0 Ç dS 0 coming

A

into existence t +q

B

C

a

t −t b Time

c

Inflow samples of

− +

dS 0 Ç dS0 ceasing

Annihilating inflow samples with

existence

varying current lifetime t emanate

from the past.

Their origination in the past Inflow samples of

anticipates the small time interval − +

dS 0 | dS0 ceasing

(t,t+dt). In this manner order,

existence

information, skills, methods of

t t+dt

production, techniques, and value

transfer from the past into the future

affecting “economic inheritance” Time interval

(t,t+dt) of current

selection

Fig. 4.5 The creation and annihilation of samples of value on the time interval (t,t þ dt) of

selection.

The transmission of inflow and outflow manifests itself in the concurrent selection of the pairs Aa, Bb and Cc of outflow/inflow samples.

þ þ þ

Outside dS

0 \ dS0 overall selection reassembles inflow samples to annihilate in dS0 |dS0 and outflow samples to originate in dS0 |dS0

the time instants t τ and t þ θ are far-away from the time t of observation. So these

time-instants are not on the drawing-paper.

The samples of Fig. 4.5 lend themselves to get combined—during a particular

time interval (t,t þ dt) of selection—in a vast number of different potential

(entropy) variations each with a different sequence of samples in state 1 and

samples in state 2. Here the number of potential variations is very large but still

finite. Actually the total number of samples that is created or sacrificed on ðt,t þ dtÞ

is infinite so that we can apply the asymptotic approximations for the number and

probability of the variations purposefully selected and the number and probability

of the junk variations never selected as given in Sect. 4.1.

Figure 4.5 throws also more light on overall selection. The transmission

H Xi \ Yj is nothing else than the joint exchange of entropy between the i-th

sector of the economy and its j-th sector to prepare for its reassembly in the process

of overall selection. Let me clarify this connection for the transmission HðX0 \ Y0 Þ

with the help of a Venn diagram (e.g. Fig. 2.3) and the scheme of originating

outflow samples and annihilating inflow samples of Fig. 4.5 by marking the pairs of

outflow samples and inflow samples that combine in the latter figure. The outflow

4.4 Blind Selection, Purposeful Selection and Economic Inheritance. Some More. . . 101

samples marked with A, B and C combine with the inflow samples marked with a, b

and c in respective order. Note that as a consequence of their simultaneous selection

A and a are selected as a concurrent Aa pair of samples, likewise B and b are

selected as a concurrent Bb pair of samples and C and c are selected as a concurrent

Cc pair of samples. Thus the interaction between inflow and outflow manifests itself

in the concurrent selection of these pairs Aa, Bb, Cc of “pure” and virtual entropy5

þ

within the intersection area dS

0 \ dS0 . The result is that equal quantities of entropy

will annihilate and originate in the intersection area as required. This is exactly the

requirement to be satisfied to identify transmission with the volume of financial

exchange.

On the other hand unequal quantities of entropy will be reassembled in

dSþ dS and dS dSþ .

0 0 0 0

Let us—as in Sect. 3.2—for illustrative and explanatory purposes consider in

more detail the hypothetical situation depicted in Fig. 4.5 for which only a very

limited number of samples are selected on ðt,t þ dtÞ. In that case we can do the

numerical calculations of numbers and probabilities without using the asymptotic

approximations of Sect. 4.1, but instead use the exact formula as given by (A.1) of

Appendix A and by (4.1). For instance: if all that is selected during the time-interval

(t,t þ dt) are Zdt ¼ 10 samples either within state 1 or within state 2, the number of

potential variations is 210 ¼ 1024: Part of these variations has been listed in

Table 4.1. There are already too many to list all of them on one page. Only one

of the 1024 potential variations is actually selected during (t,t þ dt). If there are 7

of the 10 samples in differential outflow sample space in state 1 as in Fig. 4.6,

agents will always select a purposeful typical variation that has 7 samples in state 1

and 3 samples in state 2. The number of typical variations that can be selected by the

agents in this way is 10!=ð7! 3!Þ ¼ 120. [See e.g. (4.1) and Sect. 4.1]. The typical

variations have been bold printed in Table 4.1, but note that we cannot list all 120 of

them in the table. Only one of the typical variations is actually selected by the

agents (as a result of selection without replacement). As we have argued this is

achieved in a purposeful manner. The selected typical variation has a chance 1=120

to occur. Since all other typical variations have the same chance of selection, the

probability to select any purposeful typical combination is 120 1=120 ¼ 1. Hence

the probability of selecting a purposeless atypical variation is zero. No chance left

for that.

We have now the opportunity to detail the property that bitpulses possess finite

lifetime! One single sample drags on the same content of entropy during its

lifetime. The economic replicator is the equivalent of the sample with a lifetime.

þ

The intersection domain dS 0 \ dS0 is the domain of exchange. Here the various

pairs of bitpulses exchange for money or conversely: A for a, B for b and C for c.

The phenomenon of exchange is typical for the processes of selection within the

transmission domain. It can be explained as follows:

þ

We must discern between “pure” entropy bitpulses within dS 0 \ dS0 that leave

a trace of entropy and the counterbalancing virtual bits of entropy (money/

5

The difference between “pure” and virtual entropy will be defined more comprehensively in

Sect. 5.2 and within the context of Chaps. 5 and 6.

102 4 Blind and Purposeful Selection

Table 4.1 Evolutionary variation and selection in the hypothetical case that there are only 10

samples that get selected either within state 1 or within state 2 and if the elementary probability ω

of selecting a sample within state 1 is equal to ω ¼ 0.7. In this case the total number of possible

(atypical) combinations (the number of variations) is 210 ¼ 1024. The total number of actually

selected purposeful typical variations (bold printed) is much smaller and equal to:

Ω ¼ k1 !kk

!

2!

¼ 7 !103! ! ¼ 120 with k1 ¼ ω k and k2 ¼ ð1 ωÞk

List of potential variations

1111111111 1111111112 1111111121 1111111122 1111111211 1111111212

1111111221 1111111222 1111112111 1111112112 1111112121 1111112122

1111112211 1111112212 1111112221 1111112222 1111121111 1111121112

1111121121 1111121122 1111121211 1111121212 1111121221 1111121222

1111122111 1111122112 1111122121 1111122122 1111122211 1111122212

1111122221 1111122222 1111211111 1111211112 1111211121 1111211122

1111211211 1111211212 1111211221 1111211222 1111212111 1111212112

1111212121 1111212122 1111212211 1111212212 1111212222 1111221111

. . .. . .. . .. . .. . . . . .. . .. . .. . .. . . . . .. . .. . .. . .. . . . . .. . .. . .. . .. . . . . .. . .. . .. . .. . . . . .. . .. . .. . .. . .

. . .. . .. . .. . .. . . . . .. . .. . .. . .. . . . . .. . .. . .. . .. . . . . .. . .. . .. . .. . . . . .. . .. . .. . .. . . . . .. . .. . .. . .. . .

. . .. . .. . .. . .. . . . . .. . .. . .. . .. . . . . .. . .. . .. . .. . . . . .. . .. . .. . .. . . . . .. . .. . .. . .. . . . . .. . .. . .. . .. . .

1212111212 1212111211 1212111122 1212111121 1212111112 1212111111

1212112121 1212112112 1212112111 1212111222 1212111212 1212111221

1212121111 1212112222 1212112221 1212112212 1212112211 1212112122

1212121212 1212121211 1212121211 1212121122 1212121121 1212121112

1212122122 1212122121 1212122112 1212122111 1212121222 1212121221

1212211112 1212211111 1212122222 1212122221 1212122212 1212122211

1212211222 1212211221 1212211212 1212211211 1212211122 1212211121

1212212212 1212212211 1212212122 1212212121 1212212112 1212212111

. . .. . .. . .. . .. . . . . .. . .. . .. . .. . . . . .. . .. . .. . .. . . . . .. . .. . .. . .. . . . . .. . .. . .. . .. . . . . .. . .. . .. . .. . .

. . .. . .. . .. . .. . . . . .. . .. . .. . .. . . . . .. . .. . .. . .. . . . . .. . .. . .. . .. . . . . .. . .. . .. . .. . . . . .. . .. . .. . .. . .

. . .. . .. . .. . .. . . . . .. . .. . .. . .. . . . . .. . .. . .. . .. . . . . .. . .. . .. . .. . . . . .. . .. . .. . .. . . . . .. . .. . .. . .. . .

2221221111 2221221112 2221221121 2221221122 2221221211 2221221212

2221221221 2221221222 2221222111 2221222112 2221222121 2221222122

2221222211 2221222212 2221222221 2221222222 2222111111 2222111112

2222111121 2222111122 2222111211 2222111212 2222111221 2222111222

2222112111 2222112112 2222112121 2222112122 2222112211 2222112212

2222112221 2222112222 2222121111 2222121112 2222121121 2222121122

2222121211 2222121212 2222121221 2222121222 2222122111 2222122112

2222122121 2222122122 2222122211 2222122212 2222122221 2222122222

2222211111 2222211112 2222211121 2222211122 2222211211 2222211212

2222211221 2222211222 2222212111 2222212112 2222212121 2222212122

2222212211 2222212212 2222212221 2222212222 2222221111 2222221112

2222221121 2222221122 2222221211 2222221212 2222221221 2222221222

2222222111 2222222112 2222222211 2222222212 2222222221 2222222222

Note that neither all of the potential variations nor all of the purposeful typical variations have

been listed in the table for practical reasons. The sixth typical variation (1212111211) in the

second column of the list is the one actually selected in the example illustrated in Fig. 4.6.

4.4 Blind Selection, Purposeful Selection and Economic Inheritance. Some More. . . 103

(1212111211) of the joint outflow of

10 samples during the time interval

(t,t + dt).

(1) = sample selected in state 1.

(2) = sample selected in state 2.

into existence as a

sequence of selected

states (1212111211). 1

t is here the initial time 2

of the ten outflow 1

samples. t + q is final 2

time of the samples with 1

excess lifetime q varying 1

1

per outflow sample.

2

1 t +q

1

Time

t t + dt

Time interval

(t,t + dt) of

current selection

Fig. 4.6 The statistical experiment of outflow selection of samples during the time interval

(t,t þ dt) of selection.

Only a single one of the purposeful typical sequences of the outflow samples is actually selected, but all the purposeful sequences have equal

probability to get selected. The remaining possible combinations (the variations) have zero probability to get selected. Because of that they

are purposeless

þ

liquidity/accounts receivable etcetera) within dS 0 \ dS0 that leave no trace of

entropy except for an eventual surplus of virtual bits. “Pure” entropy (or just the

collection of bitpulses) has lifetimes and leaves as such a trace of entropy in the

course of time. Virtual bits of entropy have no lifetimes and therefore they cannot

be bitpulses. The pair wise selection of samples will manifest itself in two

possible ways:

þ

1. In the intersection domain dS 0 \ dS0 a bit a of virtual entropy sacrifices its

imaginary content of a single bit of entropy at its manifestation time θ0

ðt θ0 t þ dtÞ in exchange for a concurrently created bitpulse A at initial

þ

time τ ðt τ t þ dtÞ within dS0 \ dS0 .

þ

2. In the intersection domain dS0 \ dS0 a bitpulse b is sacrificed at its final time θ

ðwith t θ t þ dtÞ to create concurrently a virtual bit B of entropy at its

manifestation time τ0 ðt τ0 t þ dtÞ.

104 4 Blind and Purposeful Selection

þ

There are (infinitely) many of these pair wise occurrences within dS 0 \ dS0 (we

have only depicted three of those pairs in Fig. 4.5). Since the various virtual bits

cancel as far as they can, they leave only a surplus of created virtual bits over

annihilating virtual bits or a surplus of annihilating virtual bits over created virtual

þ

bits within dS

0 \ dS0 .

Thus if there is a surplus Δ of annihilating virtual bits over created virtual bits

þ

within dS0 \ dS0 during ðt; t þ dtÞ, then:

þ

• the number of created “pure” bitpulses is Zdt H dS 0 \ dS0

þ

• the number of annihilating “pure” bitpulses is Zdt H dS 0 \ dS0 Δ

• the number of annihilating virtual bits is Δ

On the other hand if there is a surplus Δ of created virtual bits over annihilating

þ

virtual bits within dS

0 \ dS0 during ðt; t þ dtÞ, then:

þ

• the number of created “pure” bitpulses is Zdt H dS 0 \ dS0 Δ

• the number of created virtual bits is Δ

þ

• the number of annihilating “pure” bitpulses is Zdt H dS 0 \ dS0

The contended cancellation of a pair of virtual bits, of which one manifests itself at

another time τ0 on ðt; t þ dtÞ than the manifestation time θ0 of the other on ðt; t þ dtÞ,

may meet some reserves as it appears that complete cancellation can only be realized

if τ0 ¼ θ0. Likewise the creation (annihilation) of a “pure” bitpulse at a particular time

on ðt; t þ dtÞ in exchange for a virtual bit at another manifestation time on ðt; t þ dtÞ

may call forth similar reserves. However, the distribution of initial times, final times

and manifestation times over the selection interval ðt; t þ dtÞ is of no significance. As

we already remarked in Sect. 3.2 “the time-length dt of the selection interval is so

small that, economically, all Zdt trials take place simultaneously. Thus in fact

differences in the sequential order by which the states are distributed over the samples,

given the elementary probabilities of selection, cannot have an economic effect”.

Selections are carried out individually by very many economic agents. How we order

their individual selection decisions sequentially over the time-interval ðt; t þ dtÞ in the

course of time is quite irrelevant noticing that dt ! 0 . The entropy flows remain

unaffected. There is no information in the way initial times and final times of bitpulses

and manifestation times of virtual bits are ordered on the selection interval ðt; t þ dtÞ.

Exchange or its equivalent, transmission, facilitates information to transfer

continually from the past into the future so that the evolutionary process can go

on. Clearly, simultaneously with the exchange process entropy will be reordered

(reassembled) in response to outflow selection and inflow selection, resulting in a

þ þ

gain of entropy in dS0 dS0 , respectively a loss of entropy in dS0 dS0 and similar

þ

gains and losses of entropy in the transmission domain dS 0 \ dS0 due to overall

selection (See Sect. 4.5).

Hodgson and Knudsen assert the realization of information transfer from the past

into the future (the Darwinian principle of inheritance) to depend on the mechanism

of generative replication by which they understand the copying of replicators at the

4.4 Blind Selection, Purposeful Selection and Economic Inheritance. Some More. . . 105

end of their lifetime into new replicators at the beginning of their lifetime. Well,

replication is certainly quite necessary to warrant the effect of economic inheri-

tance. However for completeness sake, the generation (creation) of new replicators

is only one side of the coin. There is also the degeneration (sacrifice) of old

repliclators. So why add the adjective generative? I do not think that the terms

generative and degenerative contribute to catching the essence of conveying

information from the past into the future. Instead exchange is the right term. To

warrant that information is conveyed by information carriers (the replicators/

bitpulses) in the course of time, these carriers must possess lifetime. Else entropy

does not circulate and then the samples are incapable of replication and cannot pass

the information of the past into the future. However, we all know that the economy

produces entropy that possesses lifetime: Production equipment is used for lengthy

periods of time; laborers apply their skills and experience during many laborious

years. Thus Darwinian inheritance (otherwise a typical mechanism of evolutionary

genetically based biology which is less appropriate for describing economic evolu-

tion) meets its economic counterpart in the circulating properties of entropy with a

lifetime.6 Methods of production and skills are stored and expressed as entropy with

a lifetime in entrepreneurial capacity (state 2) as well as in labor capacity (state 1).

Let us revert to the hypothetical selection situation of Table 4.1. Recall that only

the 120 purposeful typical variations have each a chance 1=120 to get actually

selected. The remaining number of 1024 120 ¼ 904 atypical variations has zero

chance to get selected and these variations are therefore purposeless (on behalf of

Shannon’s existence theorem).

Actually only one out of the purposeful typical variations will be selected on

ðt,t þ dtÞ. In Fig. 4.6 I have assumed that the typical outflow sequence (1212111211),

composed of the 10 samples, is the specific typical outflow variation actually

selected. It could of course—with equal probability—have been one of the other

bold printed purposeful typical variations listed in Table 4.1. The one selected in

Fig. 4.6, allocates the 2nd, 4th and 8th sample to state 2 and the other samples to state 1.

Note this is only the outcome of the outflow selection experiment on ðt,t þ dtÞ. It must

yet be completed with the outcome of the inflow selection experiment.

As stressed before the number of Zdt ¼ 10 samples is a hypothetical case. That

number is far too small to represent the actual situation of evolutionary selection.

To improve on the scheme we must have the number of samples to tend to infinity.

In Sect. 1.7 we discussed the effects of increasing Zdt on the Shannon formula (1.1).

It was further analyzed in Appendix A and Sect. 3.2. Let us now see what the effects

of increasing Zdt are on the number of potential variations and the number of typical

variations here. To see what happens let us successively multiply the number of

samples by increasingly greater powers of 10, i.e. from 10 to 100 to 1,000 to 10,000

6

There is a remarkable correspondence in the aim expressed in the sub-title Bringing Life Back

into Economics of Hodgson’s 1993 book (Hodgson 1993) and the finding that lifetime is the

necessary requisite to reach that goal. Indeed evolution is about the development of life and life

needs lifetime to exist.

106 4 Blind and Purposeful Selection

Table 4.2 Numbers of potential variations and numbers of actually selected purposeful sequences

for different numbers of samples

Probability of

selecting a

single Quotient of number of

Number Number of Number of purposeful typical purposeful potential variations

Zdt of potential variationsa variation and number of

samples variations ðω ¼ 0:7Þ ðω ¼ 0:7Þ purposeful variations

10 2 ¼ 1024

10 120 1 =120 8.533

100 2100 100!=ð70! 30!Þ 288 288 212

1,000 21000 1000!=ð700! 300!Þ 2881 2881 2119

10,000 210000 10000!=ð7000! 3000!Þ 28812 28812 21188

a

The numbers in the 3rd, 4th and 5th row of this column have been calculated by applying the

following very accurate asymptotic approximation:

log[k!/(k1!k2!)] ¼ –[(1–ω)log(1–ω) þ ωlogω]k – ½log[(1–ω)ωk] – ½log(2π)

while keeping the quotient ω ¼ ω1 of the number of samples in state 1 and the total

number of samples within sample space (the “basket” of selection) at exactly 70 %.

The larger the number of samples in differential sample space, the better the

asymptotic approximation, as dealt with in Sect. 4.1, must be. For instance if the

number of samples is 100, the number of potential variations is a very huge number:

actual selection is then approximately 288, which is about a factor 212 ¼ 4096

smaller than the number of potential variations. The larger we choose the total

number of samples, the larger this factor gets (See the data in the fifth column of

Table 4.2 for increasing number of samples). Thus we see again that the quotient of

the number of purposeful typical sequences to the number of potential variations

tends to zero if the number Zdt of samples tends to infinity. This will be realized in

the mathematical limit by choosing the unit of entropy infinitesimally small.

Note also that the joint probability of selecting any of the purposeful sequences

on the time interval (t,t þ dt) of selection is always 1 (i.e., the product of the

number in the third column and the probability in the fourth column of the above

Table 4.2). Hence, there is no chance left to select any of the remaining purposeless

variations.

This is the general rule of blind selection. Blind selection is restricted to non-

differential sample space only. But it may occur in combination with differential

selection.

4.5 Selection in Overall Sample Space 107

þ

Let us consider the intersection dSi \ dSj ði; j ¼ 1 or 2Þ. This is the space in

which even samples of inflow annihilating in state i and outflow originating in state j

combine concurrently to reassemble entropy inflow and entropy outflow. The

probability by which an inflow sample annihilating in state i and an outflow sample

originating in state j are assembled concurrently is qi j. Recall that the sampling rate

in overall sample space dS0 is Z. Hence there are Zdt qi j different trials within

þ

dSi \ dSj , which bring forth reassembled entropy annihilating in state i together

with reassembled entropy originating in state j . The reassembled probability of

selecting all the samples during ðt; t þ dtÞ is

Zdtqi j

qi j

Thus the total reassembled entropy annihilating in state i and originating in state j

during ðt; t þ dtÞ is

Zdtqi j

log qi j ¼ Zdt qi j log qi j

originating in state j per trial.

þ

Figure 4.7 presents a graphical sketch of the selection process within dS i \ dSi .

The experiment differs markedly from (stand-alone) inflow and outflow selection.

Here a single trial of the overall experiment is the drawing of a single concurrent

pair of samples, of which one sample always annihilates in a fixed state i and the

other always originates in a fixed state j on (t,t þ dt) simultaneously.

There is another way to calculate the latter reassembled entropy.

þ

We can find the reassembled entropy qi j log qi j per trial of dS

i \ dSi also in an

indirect manner

by considering the portion that each of the two unconditional entropy

flows H Yj and H ðXi Þ contributes to the reassembled entropy of qi j log qi j .

• One portion is the entropy of a sample to originate in state j on (t,t þ dt). This

results in the entropy H Yj of the originating sample but to determine its entropy

contribution properly we must weight it by the probability ProbfSi g ¼ 1=N of

sample in statei in S0 (i ¼

preselecting/assembling the associated annihilating 6 0). It

follows that it contributes an entropy flow H Yj ProbfSi g ¼ H Yj =N to qi j

log qi j . Clearly, this is the portion of entropy of qi j log qi j in Fig. 4.7 from the

perspective that the origination of a sample in state j of differential sample space on

(t,t þ dt) is certain and that the required additional sample of annihilation in state i

is yet to be appended with elementary probability ProbfSi g ¼ 1=N of assembly/

preselection within non-differential sample space S0 .

• Another portion is the entropy of a sample to annihilate in state i on (t,t þ dt). This

results in the entropy H ðXi Þ of the annihilating sample but to determine

its entropy

contribution properly we must weight it by the probability Prob Sj ¼ 1=N of

preselecting/assembling the associated originating sample in state j in S0 ðj ¼ 6 0Þ.

108 4 Blind and Purposeful Selection

logN

0

time

logN

0

time

t Number of samples t + dt

is Zdt ⋅ qij

Concurrent creation in state j and annihilation in state i of pairs of samples on (t,t þ dt). The samples behave as if they are pair wise being

exchanged. In the drawing one pair has been bold printed; another pair has been sketched by dotted lines. There are many more pairs

of concurrent samples on (t,t þ dt). The total number of different pairs formed by samples annihilating in state i and originating in state j on

(t,t þ dt) is Zdt qi j . Each pair is selected with equal probability qi j on (t,t þ dt). Thus the reassembled probability of selecting concurrent

samples during (t,t þ dt) of which one is being sacrificed in state i and the other created in state j is

Zdtqi j

qi j and the associated entropy is Zdt qi j log qi j

qi j log qi j . Clearly, this is the portion of entropy of qi j log qi j in Fig. 4.7

from the perspective that the annihilation of a sample in state i of differential

sample space on (t,t þ dt) is certain and that the required additional sample of orig-

1=N of assembly/preselection within non-differential sample space S0 .

• Well this is not all. The two portions of entropy just calculated share a common

portion H Xi \ Yj ¼ qi j HðX0 \ Y0 Þ of entropy that is yet to be deducted from

their total of entropy they contribute to qi j log qi j :

H Yj =N þ H ðXi Þ=N

That common portion is the result of statistical dependence between the events

of origination in state j and the events of annihilation in state i. This is the entropy

of the event that the assembly/selection of the annihilating sample in state i of

non-differential space S0 would occur concurrently with the assembly/selection

of the originating sample in state j of non-differential

space S0 during the

selection interval (t,t þ dt). This portion H Xi \ Yj of concurrent entropy is yet

to be deducted from the above total H Yj =N þ H ðXi Þ=N to avoid a double count

because dSþ

j and dSi have it in common.

In summary,

1 1

qi j log qi j ¼ H ðXi Þ þ H Yj qij H ðX0 \ Y0 Þ ði; j ¼ 1,2,3, , NÞ (4.8)

N N

4.6 The Three Degrees of Freedom of Evolution 109

X X X X

N qij log qi j ¼ H ðXi Þ þ H Yj N q i j H ð X 0 \ Y0 Þ (4.9)

i; j i; j i; j i; j

X X

H ðXi Þ ¼ N H ðX0 Þ and H Yj ¼ N H ðY0 Þ

i; j i; j

P P

Moreover, on behalf of (B.4) of Appendix B, qi j ¼ 1 and qi j log qi j ¼

H ðX0 [ Y0 Þ. After substitution in (4.9) it follows that

N H ð X 0 [ Y0 Þ ¼ N H ð X 0 Þ þ N H ð Y 0 Þ N H ð X 0 \ Y 0 Þ

2qi j log qi j ¼ H ðXi Þ þ H Yj 2H Xi \ Yj ði; j ¼ 1, 2Þ (4.10)

With the help of the Venn diagram of Fig. 2.4 and the auxiliary subsets A, B, C,

D, E, F, G and U as given in this diagram we establish for the two-sector economy:

2q12 log q12 ¼ HðAÞ þ HðCÞ þ HðEÞ þ HðGÞ

(4.11)

2q21 log q21 ¼ HðBÞ þ HðCÞ þ HðEÞ þ HðUÞ

2q22 log q22 ¼ HðAÞ þ HðDÞ þ HðFÞ þ HðUÞ

q11 log q11 þ q12 log q12 q21 log q21 þ q22 log q22 ¼ HðBÞ HðAÞ

¼ ð2μ 1Þ HðY0 jX0 Þ

so that

q11 log q11 þ q12 log q12 q21 log q21 þ q22 log q22

H ðY0 jX0 Þ ¼ (4.12)

ð2μ 1Þ

110 4 Blind and Purposeful Selection

q11 log q11 þ q21 log q21 q12 log q12 þ q22 log q22

H ðX0 jY0 Þ ¼ (4.13)

ð2λ 1Þ

and

q11 log q11 q22 log q22 þ q12 log q12 þ q21 log q21 ¼

¼ HðDÞ þ HðFÞ HðCÞ HðEÞ ¼ 2 12 q11 q22 H ðX0 \ Y0 Þ

so that

q11 log q11 q22 log q22 þ q12 log q12 þ q21 log q21

H ð X 0 \ Y0 Þ ¼ (4.14)

2 12 q11 q22

X

H ðY0 jX0 Þ HðX0 jY0 Þ ¼ H ðY0 Þ H ðX0 Þ ¼ i

ðμi log μi λi log λi Þ

X q11 log q11 þ q12 log q12 q21 log q21 þ q22 log q22

ðμi log μi λi log λi Þ ¼ þ

i

ð2μ 1Þ

q11 log q11 q12 log q12 þ q21 log q21 þ q22 log q22

ð2λ 1Þ

(4.15)

and q22 ¼ 1 þ q μ λ expression (4.15) is an equation in the three time-

dependent unknowns μ, λ and q.

Thus all the elementary probabilities can be calculated if two of them are known.

To calculate all the economic variables we need also the knowledge of the time-

dependent sampling rate Z. This implies that the two-sector economy is a system

with three degrees of freedom. That is, once the data of three independent time-

series (e.g. μðtÞ, λðtÞ and Y0 ðtÞ or any other independent trio of time-series) are

available, we can calculate all the other economic variables of the two-sector

economy as functions of time.

For the three-sector economy (4.8) assumes the form

3qi j log qi j ¼ H ðXi Þ þ H Yj 3H Xi \ Yj for i; j ¼ 1; 2, 3

With the help of the Venn diagram of Fig. 2.5 this results in the following

equations for the three-sector economy:

4.6 The Three Degrees of Freedom of Evolution 111

We will not work this out any further. To solve this system on the basis of

available data of some of its time-series is a matter of numerical analysis. We

shall suffice with a calculation of the number of degrees of freedom to get an idea

of the numerical job. Clearly, the above system of equations is a system of 9

equations in the elementary probabilities μj , λi and qi j . That is, the number of

different elementary probabilities is 3 þ 3 þ 9 ¼ 15. The number of equations is

5 more than the four equations (4.10) of the two-sector economy. The number of

elementary probabilities is 7 more than the 8 elementary probabilities μj, λi and qi j

of the two-sector economy. Thus at first glance it appears that for the three-sector

economy there are 4 [i.e. (15 8) (9 4) þ 2] more elementary probabilities

than there are equations describing the relationships between these elementary

probabilities, i.e. two more than for the two-sector

P economy.P However in the two-

sector economy there are only four equations q

i ij ¼ μj , j qi j ¼ λi instead of

six of them for the three-sector economy. Hence it follows, with the additional

time-series of Z, that the number of degrees of the three-sector economy is also

three (6 4 þ 1), the same as for the two-sector economy.

The above reasoning can be extended to the N-sector economy as follows. The

number of equations of the type (4.8) is N 2. Relative to the ðN 1Þ-sector economy

this number has increased by N 2 ðN 1Þ2 ¼ 2N 1. The number of variables of

the type μj , λi and qi j is N 2 þ 2N ¼ N ðN þ 2Þ: Relative to the ðN 1Þ-sector

economy this number has increased by N ðN þ 2P Þ ðN 1ÞðP N þ 1Þ ¼ 2NP þ 1.

The number of independent equations of the type i q i j ¼ μ j , j q i j ¼ λ i , j μj

P

¼ 1 and j μj ¼ 1 is 2ðN þ 1Þ: Relative to the ðN 1Þ-sector economy this number

has increased by 2. Hence the number of degrees of freedom of the N -sector

economy is ð2N þ 1Þ ð2N 1Þ 2 ¼ 0 more than the number of degrees of

112 4 Blind and Purposeful Selection

the two-sector economy is 3, it follows by induction that the multi-sector economy

has three degrees of freedom irrespective of the number N of its sectors. □7

This implies that theoretically the observational data over time of a minimum

number of 3 independent economic time series are required to calculate and predict

the time-course of all the other macroeconomic variables. The accuracy of

computations will increase by collecting the observational data of more than

three time series.

7

If the timeseries of the unit price PðtÞ are considered to be unknown as well, the number of

degrees of freedom is 4. I conjecture that this fourdimensional behavioral freedom of decision

within economic value-space-time is connected with the behavioral freedom of loco-motion

within four-dimensional physical space-time. It is an attractive line of explanation, but a complete

convincing demonstration is still lacking.

Chapter 5

Exchange and the Circulation of Entropy

present time t and the (initial) time τ of origination in the past. They have also an

excess lifetime, the positive difference θ t between the (final) time θ of annihila-

tion in the future and the present time t. We shall consider the probability

distributions of current lifetime and excess lifetime of the bitpulses. There are

different probability distribution functions for the outflux bitpulses, influx bitpulses,

output bitpulses and input bitpulses. These probability distributions are very much

related to the circulation rates of outflux, influx, output and input.

We must however be cautious: outflux and influx bitpulses exist unconditionally.

However output bitpulses can only exist subject to the presence of inflationary

conditions and input bitpulses can only exist subject to the presence of deflationary

conditions. Hence a distribution function of output bitpulses does not exist under

deflationary conditions and a distribution function of input bitpulses does not exist

under inflationary conditions.

All this and inflation and deflation are pretty much related to the flow of money,

the virtual entropy that is exchanged for the entropy of bitpulses.

money.

James Madison

related to entropy in virtue of Boltzmann’s principle. Selection is concerned with

entropy. This brings about the study and analysis of the dynamic variables of the

Lecture Notes in Economics and Mathematical Systems 665,

DOI 10.1007/978-3-642-34056-7_5, # Springer-Verlag Berlin Heidelberg 2013

114 5 Exchange and the Circulation of Entropy

us to approximate the time-dependent course of these dynamic variables by random

series of rectangular bitpulses.

These bitpulses are stored in non-differential sets S of entropy representing the

state they are in. Each bitpulse has an initial time (the time of origination) and a

final time (the time of annihilation). The collection of bitpulses stocked in a

particular non-differential set S consists of many bitpulses with varying initial

times t τ ðτ > 0Þ and final times t þ θ ðθ > 0Þ as observed at time t. It is here where

we encounter another class of probabilities: the probabilities that a bitpulse of the

set S has a lifetime within certain bounds. The set of varying current lifetimes τ and

the set of varying excess lifetimes θ of the mother set S of the bitpulses form so called

random variables of current lifetime and excess lifetime. To analyze this further and

we shall do so in this chapter, we need consider the probability distributions of these

random lifetimes. The analysis of probability involved with this subject of proba-

bility theory differs considerably from what we have dealt with in previous

chapters. Nevertheless the results of this analysis determine how we must interpret

the various variables of inflow, outflow and transmission that we encounter in the

Venn diagram presentation of the evolutionary process.

Bitpulses are appropriate and strictly necessary to quantify and analyze the

processes of selection. On the other hand economic exchange is executed in

money units and since we need to study exchange processes just as badly as

selection processes, we must also investigate how the exchange in the dimension

of money units affects the probability distributions of current lifetime and excess

lifetime of the bitpulses.

Any bitpulse residing in a particular state must always originate and annihilate in

the same state as the state in which it resides. This property implies that the stock

Cþ

i ðtÞ of bitpulses in Si that has originated in the past is the same as the stock Ci ðtÞ

of bitpulses in Si that will annihilate in the future. That is,

Cþ

i ðtÞ ¼ Ci ðtÞ ¼ Ci ðtÞ

Let further Viþ ðtÞ be the money value of exchange for which the total stock Ci ðtÞ

of bitpulses present at current time t has been acquired (originated) in the past.

Further let Vi ðtÞ be the money value of exchange for which this total stock Ci ðtÞ of

bitpulses present at current time t will be liberated in the future.

Although Cþ

i ðtÞ ¼ Ci ðtÞ, this property need not imply that the money exchange

value of the bitpulses in S0 that have originated within Si in the past balances the

money exchange value of the same bitpulses in S0 for which they will annihilate

within Si in the future. Generally the money exchange value Viþ ðtÞ for which the

capacity stock Ci ðtÞ of Si has been acquired differs from the money exchange value

for which this capacity stock will be exchanged in the future. That is,

5.2 The Different Sorts of Bitpulses: Outflux, Output, Influx, Input and. . . 115

because the total historic money expenditures for which C0 ðtÞ has been built up by

processes of entropy origination must eventually be liberated/exchanged in the

future by processes of entropy annihilation within S0 .

Input and Transmission

Consider the Venn diagram of the multi-sector economy. The transmission domain

þ

dS0 \ dS0 is the domain of events of exchange, the location where selection events

of entropy are settled by money exchange. Each entropy bit is worth the same

common average unit price PðtÞ.

On the other hand dSþ 0 and dS0 are

domains where entropy is created and

þ

annihilated. The entropy flow Zdt H dSi dS0 I shall call the outflux of Si .

þ

The entropy flow Zdt H dS dS I shall call the influx of Si . The entropy flows

þ i 0

þ

Zdt H dSi \ dS0 and Zdt H dS

i \ dS0 are financial flows of entropy of Si

expressed in the dimension of bits. It is what we have also called transmissions after

Shannon. I shall also call them financial flows just to stress their economic meaning

with respect to the exchange process of entropy for money or for money-related

certificates of value like accounts receivable and accounts payable.

These financial flows may reflect the origination of bitpulses in exchange for

þ

money within dS 0 \ dSi . They may also reflect the sacrifice of bitpulses in

þ

exchange for money within dS i \ dS0 , dependent on the circumstances. The

money value of these financial flows is PZdt H dS0 \ dSþ i , respectively PZdt H

dSi \ dSþ0 .

The entropy flow Zdt H dSþ i I shall call the output of Si . The entropy flow

Zdt H dSi I shall call the input of Si . From the perspective of selection all the

entropy within dSþ 0 , thus including the financial entropy output originating within

þ

dSi \ dS0 , does contribute to the procreation of purposeful output variations and

likewise all the entropy within dS 0 , thus including the financial entropy input

þ

annihilating within dS i \ dS 0 , does contribute to the sacrifice of purposeful input

variations.

In accordance with the above terminology the bitpulses of dSþ dS and of

þ

i 0

dSi dS0 will be called outflux bitpulses, respectively influx bitpulses of Si. Likewise

the bitpulses of dSþ

i and of dSi will be called output bitpulses, respectively input

bitpulses of Si : Output bitpulses include the outflux bitpulses. Input bitpulses

include the influx bitpulses.

The creation of bitpulses and the annihilation of bitpulses on ðt;t þ dtÞ within the

þ

transmission domain dS 0 \ dS0 do of course depend on the availability of events

116 5 Exchange and the Circulation of Entropy

that create value, respectively that annihilate value. But there is something special

þ

with the creation and annihilation of financial value within dS 0 \ dS0 .

We must distinguish between “pure” entropy, which consists of bitpulses with a

þ

lifetime within dS 0 \ dS0 . This is the entropy of bitpulses that possess probability

distributions of current lifetime and excess lifetime. This is also the entropy that

þ

exchanges for units of exchange (e.g. money) in dS 0 \ dS0 : These units of

exchange do not constitute bitpulses, but they have entropy content without having

lifetime (to calculate that entropy content just divide their money content by P).

They form a collection of bits of entropy without probability distributions of current

lifetime and of excess lifetime (money and money-like accounts have no lifetime).

This collection of bits I will call virtual entropy. Like a virtual particle in physics

manifests itself in interaction with the creation and annihilation of real particles,

virtual economic entropy manifests itself in interaction with the origination and

annihilation of “pure” economic entropy.

The origination of “pure” bitpulses in exchange for money and, alternatively, the

annihilation of “pure” bitpulses in exchange for money are mutually exclusive.

þ

That is, either “pure” bitpulses are created in exchange for money within dS 0 \ dS0

during ðt;t þ dtÞ or “pure” bitpulses are annihilating in exchange for money within

þ

dS0 \ dS0 during ðt;t þ dtÞ. The first situation develops subject to the constraint of

average price inflation. The second, alternative, situation develops subject to the

constraint of average price deflation. Each in a very specific but related manner.

Let me first explain the constraint of average price inflation. Note that in the

money economy the gross increase of capacity C0 is provided for by money output,

i.e. the money value of entropy output. In the course of time the unit price P of a bit

of entropy changes. Nevertheless exchange is in money units and the entropy output

at time t is exchanged for another unit price than the unit price of entropy output at

an earlier time t τ. Thus the total C0 ðtÞ of entropy output accumulating in the

capacity stock over the distant past until current time t, i.e. over the time-interval

ð1; tÞ, as far as it has not been used up in the past before time t, will have been

acquired for an average historic unit price per bit of entropy different from the

þ

current unit price PðtÞ per bit of entropy. Let, for convenience of explanation,Pi ðtÞ

denote the average historic unit price of the entropy Ci ðtÞ stocked in Si at time t.

þ

Now, if on an average prices in S0 have risen in the past such thatP0 ðtÞ < PðtÞ at

time t, then the exchange of entropy selected from the entropy stock C0 ðtÞ during

þ

ðt; t þ dtÞ will be accompanied by a financial gain PðtÞ P0 ðtÞ per bit of entropy

exchanged. Clearly, this implies that subject to the constraint of average historic

price inflation there is a financial output on top of the outflux PZdt H dSþ

0 dS0 :

þ

The total of this financial output is PZdt H dS0 \ dS0 ; the entropy flow

þ

originating within the transmission domain dS 0 \ dS0 .

Well the reader might now object that we have neglected the eventual simulta-

þ

neous occurrence of loss of financial value within dS 0 \ dS0 during ðt;t þ dtÞ .

However that objection is ill-founded. If there is average price inflation in S0 such

þ

that PðtÞ P0 ðtÞ > 0, the annihilation of bitpulses in exchange for money in S0 on

5.2 The Different Sorts of Bitpulses: Outflux, Output, Influx, Input and. . . 117

ðt; t þ dtÞ would imply the absurdity that bitpulses each with a negative load of one

bit annihilate in the differential subset dS

0 . However the entropy content transferred

by a bitpulse is always a positive single bit as we have argued in the foregoing.

There is no way to escape the h conclusion that subject i to the constraint of

þ

average historic price inflation i:e: for PðtÞ P0 ðtÞ > 0 the complete entropy

þ

flow PZdt H dS 0 \ dS0 represents financial output of bitpulses originating in S0

in exchange for money during ðt;t þ dtÞ.

The argumentation is almost analogous if the constraint of average price defla-

tion applies. Note that in the money economy the gross decline of capacity C0 is

provided for by money input, i.e. the money value of entropy input. In the course of

time the unit price P of a bit of entropy changes. Nevertheless exchange is in money

units and the entropy input at time t is exchanged/liberated for another unit price

than the unit price of the entropy input at a later time t þ θ. Thus the total C0 ðtÞ of

entropy input to be sacrificed onward from current time t over the future, i.e. over

the time-interval ðt; 1Þ, as far as it will not be produced in the future after time t,

will be sacrificed for an average future unit price per bit of entropy different from

the current unit price PðtÞ per bit of entropy. Let, for convenience of explanation,

Pi ðtÞ denote that average future unit price of the entropy Ci ðtÞ stocked in Si at time t.

Now, if on an average prices in S0 decline in the future (this is the condition of

average price deflation) such thatP0 ðtÞ < PðtÞ, then the exchange of entropy selected

for input from the entropy stock C0 ðtÞ during ðt;t þ dtÞ implies that one sacrifices

PðtÞ P0 ðtÞ more money per bit of sacrificed entropy at current time t than the

average future unit price for which it will be sacrificed in the future. Clearly, this

entails a financial loss subject to the constraint of average price

þdeflation.

This

financial loss is financial input on top of the influx PZdt H dS dS . The total of

þ

0 0

this financial input is PZdt H dS 0 \ dS0 , the entropy flow annihilating within the

þ

transmission domain dS 0 \ dS0 in exchange for money.

Note that, if there is average price deflation such that P0 ðtÞ PðtÞ < 0, we

þ

cannot have entropy originate in exchange for money within dS 0 \ dS0 on

ðt; t þ dtÞ because that will have the absurd consequence that bitpulses each with

a negative load of one bit originate in the differential subset dSþ 0 . Thus there is no

way to escape

the conclusion that subject to the constraint of average future price

þ

deflation P0 ðtÞ PðtÞ < 0 the complete entropy flow PZdt H dS 0 \ dS0

represents financial input of bitpulses annihilating within S0 during ðt;t þ dtÞ.

Let us then summarize what we have so far established:

þ

We have claimed that to understand the meaning of transmission H dS 0 \ dS0

we must discern sharply between two mutually exclusive cases:

þ

• The case of average price inflation in S0 with PðtÞ P0 ðtÞ > 0. Subject to this

constraint not only outflux bitpulses are being created within dSþ

0 dS0 on the

selection interval ðt;t þ dtÞ, but on top of that financial entropy is created within

þ

dS0 \ dS0 in exchange for virtual money on the time-interval ðt;t þ dtÞ of

selection. The total of bitpulses thus created on ðt;t þ dtÞ forms the complete

118 5 Exchange and the Circulation of Entropy

collection of output bitpulses of S0. We will call this case the inflationary mode

of evolution.

• The case of average price deflation in S0 with P0 ðtÞ PðtÞ <þ 0. Subject to this

constraint not only influx bitpulses annihilate within dS

0 dS0 on the selection

interval ðt; t þ dtÞ, but on top of that financial entropy is annihilating within

þ

dS0 \ dS0 in exchange for virtual money on the time-interval ðt; t þ dtÞ of

selection. The total of bitpulses thus annihilating on ðt; t þ dtÞ forms the complete

collection of input bitpulses of S0 . We will call this case the deflationary mode of

evolution.

þ

The transmission domain dS 0 \ dS0 is the intersection (the common domain) of

events of origination and events of annihilation. If the constraint of average price

S0 ,þwe

inflation applies within conclude from our explanations in Sect. 4.4 that

the output Zdt H dS0 \ dS0 of originating bitpulses is counterbalanced by a flow

þ

Zdt H dS 0 \ dS0 Δ of “pure” annihilating bitpulses and a flow of Δ

“annihilating” virtual bits with the number Δ yet unsettled. However, since we

have argued in the above that the constraint of average price inflation rules out the

þ

annihilation of “pure” bitpulses within dS 0 \ dS0 , we must now further conclude

that Zdt H dS0 \ dSþ 0 Δ ¼ 0 in the inflationary mode of evolution. That is, in

the inflationary mode of evolution we have only a flow Zdt H dS \ dSþ of

0

þ

0

created “pure” bitpulses counterbalanced by a flow Zdt H dS0 \ dS0 of

“annihilating” virtual bits.

If on the other hand the constraint of average price deflation applies in S0 , we

þ

conclude from our explanations in Sect. 4.4 that the input Zdt H dS 0 dS0 of

\

annihilating bitpulses is counterbalanced by a flow Zdt H dS0 \ dSþ 0 Δ of

“pure” originating bitpulses and a flow of Δ “originating” virtual bits with the

number Δ yet unsettled. However, since we have argued in the above that the

constraint of average price deflation rules out the origination of “pure” bitpulses

þ þ

within dS 0 \ dS 0 , we must now further conclude that Zdt H dS 0 \ dS 0 Δ¼ 0

in the deflationary mode of evolution.

That is,in the deflationary mode of evolution

þ

we have only a flow Zdt H dS \ dS of annihilating “pure” bitpulses

0 0

þ

counterbalanced by a flow Zdt H dS0 \ dS0 of “created” virtual bits.

In summary, there is either a surplus of “annihilating” virtual bits (in the

inflationary mode of evolution) or a surplus of “originating” virtual bits (in the

deflationary mode of evolution).

As the inflationary and deflationary mode of evolution rule out one another,

þ

we may extend similar conclusions to the transmission domains dS 0 \ dSi and

þ

dSi \ dS0 in which all money exchange of the sector Si is being handled. In this

respect we must discern sharply between two mutually exclusive cases of money

exchange within the sector Si :

þ

• In the inflationary mode of evolution with PðtÞ Pi ðtÞ > 0 not only outflux

bitpulses are being created within dSþ

i dS0 on the selection interval ðt; t þ dtÞ,

5.3 The Circulation of Bitpulses 119

Number of

bitpulses

0

t–t t t+q

time t

current excess

lifetime t lifetime q

lifetime t +q

Fig. 5.1 Any bitpulse can be attributed a total lifetime, a current lifetime τ (or age) and an excess

lifetime θ

þ

but on top of that a financial entropy Zdt H dS 0 \ dSi of “pure” bitpulses

þ

is created within dS \ dS in exchange for a counterbalancing flow of

þ

00 i

Zdt H dSi \ dS0 Δ “annihilating” virtual bits on the time-interval ðt; t þ dtÞ

of selection.

Clearly Δ0 must equal the surplus of Zdt H dS þ

i \ dS0 over Zdt H dS0 \ dSi

þ

• In the alternative deflationary mode of evolution with Pi ðtÞ PðtÞ < 0 not only

influx bitpulses are annihilating within dS þ

i dS0 on the selection

interval

þ

ðt; t þ dtÞ, but on top of that a financial entropy Zdt H dS i \ dS 0 of “pure”

þ

bitpulses is annihilating within dSi \ dS0 in exchange for a counterbalancing

þ

flow of Zdt H dS 0 \ dSi Δ00 “created” virtual bits on the time-interval

ðt; t þ dtÞ of selection.

Clearly Δ00 must equal the surplus of Zdt H dS 0 \ dSi

þ

over

ZdtH dSi \ dSþ 0 in order to warrant that money exchange balances within Si .

In the sequel we shall avoid to use the adjective “pure” as much as possible if

entropy isn’t virtually.

and Excess Lifetime of Bitpulses

To set the stage for the treatment of the probability distributions of entropy lifetime

let us reconsider in Fig. 5.1 the various bitpulses that constitute the stock of the set Si

of entropy in the course of time as e.g. earlier depicted in Fig. 4.4. Each bitpulse of

the set Si, observed at time t, has an initial time and a final time, which determines its

total lifetime, current lifetime (or age) and excess lifetime. It has originated at an

120 5 Exchange and the Circulation of Entropy

initial time ðt τÞ prior to observation time t and will become annihilated at a final

time ðt þ θÞ posterior to observation time t. τ is the current lifetime; θ is the excess

lifetime and ðτ þ θÞ is the (total) lifetime of the bitpulse.

We shall be concerned with the probability distribution of current lifetime of the

bitpulses of Si and also with the probability distribution of excess lifetime of the

bitpulses of Si , as observed at time t. At first we shall deal with the probability

distribution of current lifetime of the outflux bitpulses (Sects. 5.3.2 and 5.3.3). Next

we will consider the probability distribution of excess lifetime of the influx

bitpulses (Sect. 5.3.4). Furthermore we will consider in Sect. 5.3.5 the probability

distribution of current lifetime of the output bitpulses. This probability distribution

can only exist in the inflationary mode of evolution. It does not exist in the

deflationary mode of evolution because output consists partly of virtually “created”

entropy in case the deflationary mode of evolution applies. As the variable of

current lifetime of (partly) virtual entropy cannot be defined (it does not exist),

we cannot define its probability distribution either.

Finally we will consider in Sect. 5.3.6 the probability distribution of excess

lifetime of the input bitpulses. This probability distribution can only exist in the

deflationary mode of evolution. It does not exist in the inflationary mode of

evolution because input consists partly of virtually “annihilating” entropy in case

the inflationary mode of evolution applies. As the variable of excess lifetime of

(partly) virtual entropy cannot be defined (it does not exist), we cannot define its

probability distribution either.

Outflux Bitpulses

bitpulses of Si : Φi ðt,τÞ is defined as the probability of drawing, at observation

time t , an arbitrary bitpulse from the set Si of Ci bitpulses that has a current

lifetime smaller than or equal to τ conditional to the certainty of events within

dS0 over the complete time-domain:

Φi ðt,τÞ ¼ Prob y τ dS

0 at time t (5.1)

outflux bitpulse of Si. (Note that the lower case letter y is also used in a completely

different context as the net growth rate of entropy output Y. Confusion may easily be

avoided since it will always be clear in which context the symbol y is used).

Mark also that the conditional listing of dS 0 in the right side of (5.1) defines the

sample space of the outflux bitpulses into which is selected in the course of time t.

This conditional choice affects our outcomes.

5.3 The Circulation of Bitpulses 121

1 1– F i (t,t )

1

0 t-axis

t-axis

Fig. 5.2 The probability distribution 1 Φ

Note further that Ci ðtÞΦi ðt,τÞ is the total number of outflux bitpulses of the set Si,

observed at time t, that have originated since ðt τÞ.

In order to conceive Φi ðt,τÞ as a continuous differentiable function of τ , it is

necessary for Ci to tend to infinity. This requirement will be realized since

theoretically the bit is chosen infinitesimally small (See our previous discussions).

As a matter of fact

density function of current lifetime:

@ Φi ðt,τÞ

φi ðt,τÞ ¼

@τ

It follows that

ðτ

Φi ðt,τÞ ¼ φi ðt,ξÞ dξ

0

Generally, φi ðt,τÞ andΦi ðt,τÞ are functions of observation time t as well and we

have referred to this time-dependency by explicitly quoting the dependence on t.

We must after all draw a sharp distinction between the functional dependence on

t and the functional dependence on τ. Figure 5.2 illustrates the difference between

either dependence for the probability 1 Φi ðt,τÞ in solid geometric perspective.

We refer to current lifetime τ as it is observed at time t. Note, we are not allowed to

identify Φi ðt θ,τ θÞ with Φi ðt,τÞ. That is, the number of outflux bitpulses of Si

having a current lifetime not larger than ðτ θÞ and observed at a time-distance θ

before time t, need not equal the number of outflux bitpulses of Si with a current

lifetime not in excess of τ that are perceived at time t. Similarly Φi ðt θ,τÞ 6¼Φi ðt,τÞ.

122 5 Exchange and the Circulation of Entropy

Outflux Bitpulses

assuming y τ:

y τ dS

Φi ðθ j y τÞ ¼ Prob y θ j 0

Prob y θ; y τ dS

¼ 0

by definition

Prob y τ dS 0

But, if θ τ; Prob y θ; y τ dS

0 ¼Φi ðt,θÞ Φi ðt,τÞ so that

Φi ðθ j y τÞ ¼

1 Φi ðt; τÞ

and if θ < τ; Φi ðθ j y τÞ ¼ 0

After differentiating to θ we arrive at the associate conditional density

φi ðθ j y τÞ:

φi ðt,θÞ

φi ðθ j y τÞ ¼ for θ τ

1 Φi ðt,τÞ

and

φi ðθ j y τÞ ¼ 0 for θ < τ

ζ i ðt,τÞ ¼ φi ðτ j y τÞ

ζ i ðt,τÞdτ is the probability that an outflux bitpulse of Si, observed at time t, has its

current lifetime between τ and τ þ dτ assuming that it is not younger than τ.

Stated differently, ζ i ðt,τÞdτ is the probability that an outflux bitpulse that exists

at observation time t, will have originated at an initial time between t ðτ þ dτÞ and

t τ; assuming we extend our inquiry only to those outflux bitpulses, which

originate not later than time t τ.

Connected with this interpretationζ i ðt,τÞ is called a circulation rate of the outflux

bitpulses that are not younger than τ.

Proceeding further we obtain,

φi ðt,τÞ @ Φi ðt,τÞ=@τ

ζ i ðt,τÞ ¼ φi ðτ j y τÞ ¼ 1

Ð ¼ (5.2)

1 Φi ðt,τÞ

φi ðt,ξÞdξ

τ

5.3 The Circulation of Bitpulses 123

at initial time t τ.

Since Ci ðtÞ is the number of bitpulses stocked in Si, it follows that the number of

outflux bitpulses stocked in Si that have a current lifetime between t ðτ þ dτÞ and

t τ (as observed at time t) must be equal to:

ζ i ðt,τÞCi ðtÞdτ

This number does not include the outflux bitpulses originated between

t ðτ þ dτÞ and t τ that have ceased existence before time t, because they cannot

be observed at time t anymore.

If we choose τ ¼ 0 , we find the number of outflux bitpulses that come into

existence on the infinitesimally small time interval ðt dτ; tÞ of duration dτ. With

dτ ¼ dt this number (in bits) is:

This is what I have called the outflux of Si. ζ i ðtÞ is a rate of outflux circulation of

the sector Si . As PðtÞ is the unit price of a bit of entropy on the selection interval

ðt; t þ dtÞ it follows that the money value of the outflux of Si is equal toζ i PCi dt. This

is what I call the money outflux of Si .

Lifetime of Influx Bitpulses

In like manner as we have set out the basic theory of the probability distribution of

current lifetime of outflux bitpulses, we can deal with the theory of the probability

distribution of excess lifetime of influx bitpulses. We will sketch the main lines of

the theory of the distribution of excess lifetime, which is associated with the events

of annihilation of the influx bitpulses only.

LetΨ i ðt,θÞ denote the probability of selecting, from the set Si of Ci ðtÞ bitpulses at

observation time t; an influx bitpulse with excess lifetime not in excess of θ

conditional to the certainty of events within dSþ 0 over the complete time-domain:

Ψ i ðt,θÞ ¼ Prob x θ dSþ

0 at time t (5.4)

at random from Si : (Note that the lower case letter x is also used in a completely

different context as the net growth rate of entropy inflow X. Confusion may easily be

avoided since it will always be clear in which context the symbol x is used).

Mark also that the conditional listing of dSþ 0 in the right side of (5.4) defines the

sample space of the influx bitpulses from which is selected in the course of time t.

This conditional choice affects our outcomes.

124 5 Exchange and the Circulation of Entropy

Finally note that Ci ðtÞΨ i ðt,θÞ is the total number of influx bitpulses of the set Si ,

observed at time t, which will annihilate before ðt þ θÞ. Clearly,

density function of excess lifetime:

@ Ψ i ðt,θÞ

ψ i ðt,θÞ ¼

@θ

It follows that

ðθ

Ψ i ðt,θÞ ¼ ψ i ðt,ξÞ dξ

0

Generally, ψ i ðt,θÞ and Ψ i ðt,θÞ are functions of observation time t as well and we

have referred to this dependency by explicitly quoting the dependence on t.

The conditional probability distribution Ψ i ðτ j x θÞ is the probability of x τ

assuming x θ:

x θ dSþ

Ψ i ðτ j x θÞ ¼ Prob x τ j 0

Prob x τ; x θ dSþ

¼ 0

by definition

Prob x θ dSþ0

But, if τ θ; Prob x τ; x θ dSþ

0 ¼ Ψ i ðt,τÞ Ψ i ðt,θÞ so that

Ψ i ðt,τÞ Ψ i ðt,θÞ

Ψ i ðτ j x θÞ ¼

1 Ψ i ðt,θÞ

and if τ < θ; Ψ i ðτ j x θÞ ¼ 0

Differentiating to τ to arrive at the associate conditional density ψ i ðτ j x θÞ,

ψ i ðt,τÞ

ψ i ðτ j x θÞ ¼ for; τ θ

1 Ψ i ðt,θÞ

and

ψ i ðτ j x θÞ ¼ 0 for τ < θ

ρi ðt,θÞ ¼ ψ i ðθ j x θÞ

5.3 The Circulation of Bitpulses 125

ρi ðt,θÞdθ is the probability that an influx bitpulse of Si, observed at time t, has its

excess lifetime between θ and θ þ dθ assuming that it will still live longer than θ.

Stated differently, ρi ðt,θÞdθ is the probability that an influx bitpulse that exists at

observation time t, will annihilate at a final time between t þ θ and t þ ðθ þ dθÞ,

assuming we extend our inquiry to influx bitpulses that do not annihilate anterior to

time t þ θ.

Connected with this interpretation ρi ðt,θÞ is a circulation rate of influx bitpulses

that live longer than θ.

Proceeding further we obtain,

ψ i ðt,θÞ @ Ψ i ðt,θÞ=@θ

ρi ðt,θÞ ¼ ψ i ðθ j x θÞ ¼ 1

Ð ¼ (5.5)

1 Ψ i ðt,θÞ

ψ i ðt,ξÞdξ

θ

ρi ðt,θÞ is a characteristic rate of influx bitpulses that will annihilate at final time

t þ θ.

Since Ci ðtÞ is the number of bitpulses of Si , it follows that the number of influx

bitpulses observed in Si (observed at time t) that has an excess lifetime between t þ θ

and t þ ðθ þ dθÞ must be equal to:

ρi ðt,θÞCi ðtÞdθ

This number does not include the influx bitpulses annihilating between t þ θ and

t þ ðθ þ dθÞ that will come into existence after time t , because they cannot be

observed at time t when they don’t yet exist.

If we choose θ ¼ 0, we find the number of influx bitpulses that cease existence on

the infinitesimally small time interval ðt,t þ dθÞ of duration dθ. With dθ ¼ dt this

number (in bits) is:

ρi ðt,0ÞCi ðtÞdt ¼

ρi ðtÞCi ðtÞdt (5.6)

This is what I have called the influx of Si . ρ

the sector Si : As PðtÞ is the unit price of a bit of entropy on the selection interval

ðt; t þ dtÞ it follows that the money value of the influx of Si is equal to ρi PCi dt. This

is what I call the money influx of Si .

Probability Distribution of Current Lifetime of Output

Bitpulses

Like the collection of outflux bitpulses and the collection of influx bitpulses of Si

have their characteristic time-dependent probability distributionsΦi ðt,τÞ andΨ i ðt,θÞ

of current lifetime τ and excess lifetime θ, the collection of output bitpulses has its

126 5 Exchange and the Circulation of Entropy

inflationary mode of evolution applies. In the present subsection I shall first

consider the creation of output bitpulses if that particular mode of evolution applies.

Let Φi ðt,τÞ be the probability distribution of current lifetime τ of the collection of

output bitpulses within Si : The interesting question is what the connection is

between the probability distributions Φi ðt,τÞ and Φi ðt,τÞ.

Just as in Sect. 5.3.2 for outflux bitpulses, the probability distribution Φi ðt,τÞ of

current lifetime is formally defined as the probability of drawing, at observation

time t, an arbitrary bitpulse from the set Si of bitpulses constituting its stock that has

a current lifetime smaller than or equal to τ:

In this, y is now the random variable of current lifetime τ of an output bitpulse of Si.

Furthermore note the condition that the events within dS 0 are certain to occur, as

stated in Sect. 5.3.2 for the outflux bitpulses, has been dismissed for the output

bitpulses. The condition that the events dS 0 are certain to occur defines only the

outflux events that occur in Si , but we are here concerned with all the output

bitpulses.

The partial derivative φi ðt,τÞ of Φi ðt,τÞ to current lifetime τ is the probability

density function of current lifetime of the output bitpulses:

@ Φi ðt,τÞ

φi ðt,τÞ ¼

@τ

granted that Φi ðt,τÞ is differentiable to all τ.

The conditional probability distribution Φi ðθ j y τÞ is the probability of y θ

assuming y τ:

Probfy θ; y τg

Φi ðθ j y τÞ ¼ Probfy θ jy τg ¼ by definition

Probfy τg

output bitpulses,

φi ðt,θÞ

φ i ðθ j y τ Þ ¼ for θ τ

1 Φi ðt,τÞ

and

φi ðθ j y τÞ ¼ 0 for θ < τ

The circulation rate ζ i ðt,τÞ of the output bitpulses not younger than τ is defined as

ζ i ðt,τÞ ¼ φi ðτ j y τÞ

5.3 The Circulation of Bitpulses 127

time t, has originated at an initial time between t ðτ þ dτÞ and t τ, assuming

we extend our inquiry only to output bitpulses that originate not later than time t τ.

We have here the equivalent of (5.2):

φi ðt,τÞ @ Φi ðt,τÞ=@τ

ζ i ðt,τÞ ¼ φi ðτ j y τÞ ¼ 1

Ð ¼

1 Φi ðt,τÞ

φi ðt,ξÞdξ

τ

time t τ.

Since Ci ðtÞ is the number of bitpulses stocked in Si, it follows that the number of

output bitpulses stocked in Si (as observed at time t) that have a current lifetime

between t ðτ þ dτÞ and t τ must be equal to:

ζ i ðt,τÞCi ðtÞdτ

This number does not include the output bitpulses originated between

t ðτ þ dτÞ and t τ that have ceased existence before time t, because they cannot

be observed at time t anymore.

If we choose τ ¼ 0; we find the number of output bitpulses that come into

existence on the infinitesimally small time interval ðt dτ; tÞ of duration dτ. With

dτ ¼ dt this number (in bits) is:

ζ i ðtÞ is a rate of output circulation of the sector Si. This is what I have called the

output of Si . As PðtÞ is the unit price of a bit of entropy on the selection interval

ðt; t þ dtÞ it follows that the money value of the output of Si is equal to ζ i PCi dt. This

is what I call the money output of Si .

Probability Distribution of Excess Lifetime of Input

Bitpulses

excess lifetime only if the deflationary mode of evolution applies. We shall deal

with that subject in the present subsection.

Let us extend the method of analysis applied in the previous subsection to the

probability distribution Ψ i ðt,θÞ of excess lifetime θ of the input bitpulses in the set Si.

The probability distribution Ψ i ðt,θÞ of excess lifetime θ of input bitpulses in the

set Si will be formally defined as the probability of drawing, at observation time t, an

128 5 Exchange and the Circulation of Entropy

arbitrary bitpulse from the set Si of input bitpulses constituting its stock that has an

excess lifetime smaller than or equal to θ:

In this, x is now the random variable of excess lifetime θ of an input bitpulse of Si.

Furthermore note the condition that the events within dSþ 0 are certain to occur, as

stated in Sect. 5.3.4 for influx bitpulses, has been dismissed. That condition defines

the influx events only. However we are here dealing with all the input events of

annihilation within Si . This represents the unconditional complete set of input

events.

The partial derivative ψ i ðt,θÞ of Ψ i ðt,θÞ to excess lifetime θ is the probability

density function of excess lifetime of the input bitpulses:

@ Ψ i ðt,θÞ

ψ i ðt,θÞ ¼

@θ

The conditional probability distribution Ψ i ðτ j x θÞ is the probability of x τ

assuming x θ:

Probfx τ; x θg

Ψ i ðτ j x θÞ ¼ Probfx τ jx θg ¼ by definition

Probfx θg

input bitpulses,

ψ i ðt,τÞ

ψ i ðτ j x θ Þ ¼ for τ θ

1 Ψ i ðt,θÞ

and

ψ i ðτ j x θÞ ¼ 0 for τ < θ

The circulation rate ρi ðt,θÞ of the input bitpulses not younger than θ is defined as

ρi ðt,θÞ ¼ ψ i ðθ j x θÞ

time t, will cease to exist at a final time between t þ θ and t þ ðθ þ dθÞ, assuming

we extend our inquiry only to input bitpulses that will annihilate not earlier than

time t þ θ. We have here the equivalent of (5.5):

ψ i ðt,θÞ @ Ψ i ðt,θÞ=@θ

ρi ðt,θÞ ¼ ψ i ðθ j x θÞ ¼ 1

Ð ¼

1 Ψ i ðt,θÞ

ψ i ðt; ξÞdξ

θ

5.4 The Probability Distribution of Outflux and Influx and the Markov Property 129

ρi ðt,θÞ is a characteristic rate of input bitpulses that will cease to exist at final

time t þ θ ðθ > 0Þ. Since Ci ðtÞ is the number of bitpulses of Si , it follows that the

number of input bitpulses observed in Si that has an excess lifetime between t þ θ

and t þ ðθ þ dθÞ must be equal to:

ρi ðt,θÞCi ðtÞdθ

This number does not include the input bitpulses annihilating between t þ θ and

t þ ðθ þ dθÞ that will come into existence after time t , because they cannot be

observed at time t when they don’t yet exist.

If we choose θ ¼ 0, we find the number of input bitpulses that cease existence on

the infinitesimally small time interval ðt,t þ dθÞ of duration dθ. With dθ ¼ dt this

number (in bits) is:

This is what I have called the input of Si . ρi ðtÞ is a rate of input circulation of

the sector Si . As PðtÞ is the unit price of a bit of entropy on the selection interval

ðt; t þ dtÞ it follows that the money value of the input of Si is equal to ρi PCi dt. This is

what I call the money input of Si .

and the Markov Property

Let us consider the union of the conditional differential sets dSþ þ

0 dS0 and dS0 dS0 .

We shall denote this union by the symbol dS0 . Thus

þ

d S0 ¼ dSþ

0 dS0 [ dS0 dS0

Mark dSþ þ

0 dS0 does not overlap with dS0 dS0 (See the Venn diagram). If we let

dS0 represent the differential sample space dS0 of an economy, it must follow

that for this economy dS0 ¼ d S0 and hence that this must be an economy for which

þ

dS0 \ dS0 is the null set. That is

dS þ

0 \ dS0 ¼

In accordance with what has been derived in Appendices F and G this implies

that for this economy all the outflow events are statistically independent

of all the

þ

inflow events. As only outflux events are involved within dS0 dS0 and only influx

þ

events are involved in dS

0 dS0 , we conclude that generally outflux events are

statistically independent of influx events.

130 5 Exchange and the Circulation of Entropy

independence will reduce the complexity of the expressions for the probability

distributions of current lifetime of outflux and excess lifetime of influx.

A process for which there is statistical independence between the events of

entropy origination and the events of entropy annihilation given current time t is

called a Markov process. I shall therefore say that selection in sample space d S0

possesses the Markov property.

In the sequel I will derive a consequence of the Markovian property that involves

the behavior of the outflux and influx circulation rates ζ i ðt,τÞ and ρi ðt,θÞ in dS0. The

argument follows the same line of reasoning for ζ i ðt,τÞ as well as for ρi ðt,θÞ .

Therefore I will give that argument only in detail for ζ i ðt,τÞ.

We have established in Sect. 5.3.3 that the entropy outflux of the circulating

bitpulses in Si that have a current lifetime between t ðτ þ dτÞ and t τ must

be equal to ζ i ðt,τÞCi ðtÞdτ. This does not include the bitpulses, originated between

t ðτ þ dτÞ and t τ, that have ceased existence before t.

Similarly we have established in Sect. 5.3.4 that the entropy influx of the

circulating bitpulses in Si that have an excess lifetime between t þ θ and t þ ðθ þ dθÞ

must be equal to ρi ðt,θÞCi ðtÞdθ. This does not include the bitpulses, ceasing existence

between t þ θ and t þ ðθ þ dθÞ, that have originated after t.

For τ ¼ 0 we get the entropy outflow ζ i ðtÞCi ðtÞdt that originates during the

selection interval ðt; t þ dtÞ: This is a number of bitpulses originating in the

conditional differential subset dSþ

i dS0 of Si on ðt; t þ dtÞ.

Likewise for θ ¼ 0 we get the entropy inflow ρi ðtÞCi ðtÞdt that expires during the

selection interval ðt; t þ dtÞ . This is a number of bitpulses annihilating in the

conditional differential subset dS þ

i dS0 of Si on ðt; t þ dtÞ.

ζ i ðt,τÞdτ is the probability (given that dS 0 is certain to occur) that an outflux

bitpulse drawn at observation time t from the subset of outflux bitpulses of the set

Si, that are older than τ, has originated between t τ dτ and t τ. Thus, if Ci ðtÞ

is the number of outflux bitpulses in Si , the number observed at time t, including

the bitpulses thereof that ceased existence on ðt τ; tÞ, is ζ i ðt,τÞCi ðtÞdτ . These

ζ i ðt,τÞCi ðtÞdτ outflux bitpulses form a subset S1 of Si . Since these bitpulses are

observed to be present at time t; all of them—as they originated on the time-

interval ðt τ dτ,t τÞ—must have continued to exist until observation time t.

Let now S3 be the subset of ζ i ðt τ,0ÞCi ðt τÞdτ outflux bitpulses that came

into existence in the past between t τ dτ and t τ and that were observed to be

present at time t τ and for that reason have not yet (at time t τ) ceased to exist on

ðt τ dτ,t τÞ. S3 is not a subset of Si ðtÞ at time t because it contains also outflux

bitpulses that cease to exist between t τ and t which are not part of Si ðtÞ at time t.

But it is clear that the set S1 is a subset of the set S3 containing all the original

outflux bitpulses that came into existence between t τ dτ and t τ. Additional

to the subset S1 , S3 contains also the outflux bitpulses (created between t τ dτ

and t τ) that have annihilated on the time-interval ðt τ,tÞ.

Let furthermore S2 be the subset of ζ i ðt θ,τ θÞCi ðt θÞdτ outflux bitpulses

that came into existence in the past between t τ dτ and t τ and that are still

5.4 The Probability Distribution of Outflux and Influx and the Markov Property 131

observed to be present at time t θ (with θ < τ) and for that reason have not yet (at

time t θ) ceased to exist on ðt τ,t θÞ.

It is obvious that S1 is a subset of S2 and that in turn S2 is a subset of S3 so that

S1 S2 S3

The set S1 is a subset of the set S2 , the latter containing all the original outflux

bitpulses that were observed at time t θ > t τ and that came into existence

between t τ dτ and t τ. Additional to the subset S1; S2 contains also the outflux

bitpulses of S3 that will annihilate on the time-interval ðt θ; tÞ.

Recall that the circulation rate of S1 on the time-interval ðt τ dτ; t τÞ is

ζ i ðt; τÞ at observation time t. Since the outflux bitpulses of S2 are observed at time

t θ (with θ < τ), their circulation rate on the time-interval ðt τ dτ,t τÞ is

ζ i ðt θ,τ θÞ.

S1 is the remaining subset of bitpulses of S2 only after a process of random

annihilation has removed these bitpulses from S2 during the time-interval of

ðt θ; tÞ. However, since the random selection of annihilating bitpulses at time-

instances that differ from the time-instances of creating bitpulses are mutually

independent as a consequence of the Markov property, it must follow that the

statistical averages of outflux of S2 on ðt τ dτ,t τÞ cannot be affected by

the process of annihilation. Therefore, it follows that the outflux bitpulses in S1 that

remain—after the outflux bitpulses from S2 have been removed by a process of

random annihilation—share the same circulation rate with the outflux bitpulses of

S2 on the time-interval between t τ dτ and t τ. That is,

observation time t and current lifetime τ, we are allowed to regardζ i as a function of

initial time ðt τÞ only. That is ζ i ðt,τÞ ¼ ζ i ðt τÞ. It follows that

ζ i ðt,τÞ ¼ ζ i ðt τÞ (5.8)

With this in mind, let us integrate both sides of (5.8) over the τ- domain. Then,

with the help of (5.2):

ðτ

ln 1 Φi ðt,τÞ ¼ ζ i ðt ξÞ dξ (5.9)

0

This results in

8 τ 9

< ð =

Φi ðt,τÞ ¼ 1 exp ζ i ðt ξÞ dξ (5.10)

: ;

0

132 5 Exchange and the Circulation of Entropy

and

8 τ 9

< ð =

φi ðt,τÞ ¼ ζ i ðt τÞ exp ζ i ðt ξÞ dξ (5.11)

: ;

0

time-interval between t τ dτ and t τ is concerned.

The analogous line of reasoning may be followed for the rate ρi ðt; θÞ of influx

circulation on an infinitesimally small time-interval between t þ θ and t þ θ þ dθ.

The outcome will be that the circulation rate

ρi ðt; θÞ is a function of final time t þ θ

only. The details do not add novel points of view so that we shall leave the subject

as an exercise to the interested reader. Here we shall only state the resulting

expressions:

ρi ðt,θÞ ¼

ρi ð t þ θ Þ (5.12)

ðθ

ln 1 Ψ i ðt,θÞ ¼

ρi ðt þ ξÞ dξ (5.13)

0

8 θ 9

< ð =

Ψ i ðt,θÞ ¼ 1 exp ρi ðt þ ξÞ dξ (5.14)

: ;

0

8 θ 9

< ð =

ψ i ðt,θÞ ¼

ρi ðt þ θÞ exp ρi ðt þ ξÞ dξ (5.15)

: ;

0

Equations (5.8) and (5.12) emphasize that the outflux and influx circulation rates

depend on current time t only.

Evolution

We are here dealing with the inflationary mode of evolution. This implies that the

probability distribution Φi ðt,τÞ of current lifetime τ of output bitpulses exists and

that the probability distribution Ψ i ðt,θÞ of excess lifetime θ of input bitpulses does

not exist.

5.5 The Circulation of Output in the Inflationary Mode of Evolution 133

Φi ðt,τÞ and Φi ðt,τÞ of current lifetime relate respectively to the rate of outflux

circulation and to the rate of output circulation in this particular case. We have not

yet bridged the connection betweenΦi ðt,τÞ and Φi ðt,τÞ. This will have our attention

now. The relationship between Φi ðt,τÞ and Φi ðt,τÞ is closely related with the time-

course of the unit price PðtÞ of a bit of entropy. This time-dependent course of P is

the cause that these probability distributions differ from one another. As we are here

dealing with the origination of bitpulses within dSþ i (i.e. including the transmission

domain dSþ

i \ dS0 ), for analysis to make sense the inflationary mode of evolution

can only apply.

Note that Φi ðt,τÞ ¼ Φi ðt,τÞ if P is a constant over the entire time-domain. Recall

also our discussion with respect to the inflationary mode of evolution in Sect. 5.2. In

þ

this section we demonstrated that if the constraint PðtÞ Pi ðtÞ > 0 of average price

þ

inflation applies, all entropy creation (entropy output) is in dSþ i (i.e. in dS i dS0 as

well as in dSþ i \ dS

0 ). Financial entropy creation in dS þ

i \ dS

0 occurs in exchange

for virtual entropy (money).

We shall now consider the structure of the probability distribution of the output

bitpulses subject to the above constraint of average price inflation. Meanwhile we

þ

will solve how the average historic unit price Pi ðtÞ of Si relates to the current unit

price PðtÞ, a question that we haven’t yet considered in Sect. 5.2.

To get things straight we must follow the money value involved with the exchange

of entropy. We can look at that money exchange value from two perspectives: that of

the money involved with the creation of outflux bitpulses and that of the money

involved with the creation of output bitpulses. However, irrespective of the perspec-

tive chosen the money value exchanged cannot be different.

To deal with the matter we need to introduce some more variables that underlie

both Φi ðt,τÞ and Φi ðt,τÞ.

Let Cþi ðt,ξÞ be the number of bitpulses in stock in S0 at observation time t that

have emerged in state i posterior to time t ξ. Let further Viþ ðt,ξÞ be the aggregate

total of the money value exchanged at time t in response to the emergence of

bitpulses within Si after time t ξ.

Mark Cþ þ

i ðt; 1Þ ¼ Ci ðtÞ ¼ Ci ðtÞ is capacity, the total of the entropy of bitpulses,

residing in S0 at time t and which has originated within Si in the past, i.e. before time t

(See Sect. 5.1). Mark also Viþ ðt; 1Þ is the total historic money exchange value of

bitpulses, residing in S0 at time t, which have originated within Si in the past, i.e.

before time t. Clearly Viþ ðt; 1Þ like Ci ðtÞ depends on time t only and for this reason

we may write

i ðt,ξÞ and Vi ðt,ξÞ contribute to the gross emergence

of bitpulses and respectively to the money for which they are being exchanged on

this infinitesimally small time-interval ðt ξ dξ; t ξÞ.

134 5 Exchange and the Circulation of Entropy

As Cþ þ

i ðt,ξÞ ¼ Ci ðtÞΦi ðt,ξÞ, the gross number @ξ Ci ðt,ξÞ of bitpulses originating

between t ξ dξ and t ξ is

@ξ Cþ

i ðt,ξÞ ¼ Ci ðtÞ φi ðt,ξÞdξ (5.16)

On the other hand, as Viþ ðt,ξÞ ¼ Viþ ðtÞ Φi ðt,ξÞ, the money @ξ Viþ ðt,ξÞ exchanged

in dSþ

i for the acquirement of these bitpulses between t ξ dξ and t ξ is

because φi ðt; ξÞdt is the gross chance that an output bitpulse is created between

t ðξ þ dξÞ and t ξ . The bitpulses that have emerged in the sector Si are

exchanged for unit price Pðt ξÞ at time t ξ. The money value exchanged is then:

i ðt,ξÞ (5.18)

Ci Cþ

i ðt,ξÞ ¼ Ci 1 Φi ðt,ξÞ (5.19)

and

Viþ Viþ ðt,ξÞ ¼ Viþ ½1 Φi ðt,ξÞ (5.20)

Herein Ci 1 Φi ðt,ξÞ is the entropy stock of the bitpulses that have originated

before time t ξ and Viþ ½1 Φi ðt,ξÞ is the money exchange value of the bitpulses

that have originated before time t ξ.

It follows further from (5.18) and (5.16) that

@ þ

V ðt,ξÞ ¼ Pðt ξÞCi ðtÞφi ðt,ξÞ

@ξ i

ðτ

Viþ ðt,τÞ ¼ Ci ðtÞ Pðt ξÞφi ðt,ξÞdξ

0

If τ tends to infinity, we get the formula for the money exchange value Viþ ðtÞ of

all the bitpulses that reside in S0 at time t and that have originated in state i in the past.

That is,

ð

1

þ þ

Vi ðtÞ ¼ Vi ðt,1Þ ¼ Ci ðtÞ Pðt ξÞφi ðt,ξÞdξ (5.21)

0

5.5 The Circulation of Output in the Inflationary Mode of Evolution 135

þ

The quotient of Viþ ðtÞ and Ci ðtÞ is the average bit price Pi per bit spent within Si

in the past as observed at current time t. It follows that

þ Viþ ðtÞ

Pi ðtÞ ¼ (5.22)

Ci ðtÞ

þ

Of course Pi ðtÞ is also a random function of time.

It follows further that

ð

1

þ

Pi ¼ Pðt ξÞφi ðt,ξÞdξ (5.23)

0

þ

Pi ðtÞ is the average historic unit price of the outflux bitpulses stocked in S0 at

time t that have originated in state i in the past. This is the average historic unit price

for which these bits have been acquired in the past. It does not match the current

unit bit price PðtÞ. Mark that Viþ ðtÞ is not equal to the product of Ci ðtÞ and PðtÞ,

because the average historical unit price spent on outflux bits in the past (before

observation time t) is another than the current unit price PðtÞ at time t.

I shall now derive two important theorems that relate the circulation of the output

bitpulses to the circulation of the outflux bitpulses. The first theorem to be derived is

þ

ζ i ðtÞ ¼ ζ i ðtÞ þ pþ

i ðtÞ conditional to PðtÞ Pi ðtÞ 0 (5.24)

þ

Mark that we claim (5.24) to be valid only if PðtÞ Pi ðtÞ 0, i.e. if there is

average price inflation within Si at current time t . This marks the inflationary

constraint for the specific sector Si .

Proof of theorem (5.24): The right side Viþ ½1 Φi ðt,ξÞ of expression (5.20) renders

the money exchange value of output bitpulses that have originated before time t ξ.

þ

Now recall from (5.22) that Pi ðt ξÞ is the average price spent per bit within Si in

the past at time t ξ. Further, the number of outflux bitpulses

that have originated

before time t ξ and are still present at time t is Ci 1 Φi ðt,ξÞ . It follows that

þ

Pi ðt ξÞ must also be the quotient of Viþ ½1 Φi ðt,ξÞ and Ci 1 Φi ðt,ξÞ . That is,

þ

Viþ ½1 Φi ðt,ξÞ ¼ Pi ðt ξÞ Ci 1 Φi ðt; ξÞ

136 5 Exchange and the Circulation of Entropy

þ

Integration of Pi ðt τÞ over the time-domain τ yields

8 ξ 9

< ð =

þ þ

Pi ðt ξÞ ¼ Pi ðtÞ exp pþ

i ðt τ Þdτ

: ;

0

preceding the latter formula, that

8 ξ 9

< ð =

1 Φi ðt,ξÞ ¼ 1 Φi ðt,ξÞ exp pþ

i ðt τÞ dτ

: ;

0

8 ξ 9

< ð =

φi ðt,ξÞ ¼ φi ðt,ξÞ þ pþ

i ðt ξÞ 1 Φi ðt; ξÞ exp pþ

i ðt τÞ dτ

: ;

0

φi ðt; ξÞ φi ðt; ξÞ

¼ þ pþ

i ðt ξÞ

1 Φi ðt; ξÞ 1 Φi ðt; ξÞ

or

ζ i ðt,ξÞ ¼ ζ i ðt; ξÞ þ pþ

i ðt ξÞ

ζ i ðt,ξÞ ¼ ζ i ðt ξÞ þ pþ

i ðt ξÞ (5.25)

The right side of this expression is a function of t ξ only. Hence the left side of

the expression must be a function of t ξ only. That is,

ζ i ðt ξÞ ¼ ζ i ðt ξÞ þ pþ

i ðt ξ Þ

Clearly, the probability ζ i ðtÞdt that an output bitpulse of Si originates in dSþ i

between time t and time t þ dt must exceed the probability ζ i ðtÞdt that an outflux

bitpulse of Si originates in dSþ

i dS0 between time t and time t þ dt . Else the

constraint of average price inflation within Si cannot be satisfied at current time t and

5.5 The Circulation of Output in the Inflationary Mode of Evolution 137

there would then be average price deflation rather than average price inflation. Thus

to satisfy the constraint for which (5.24) holds true, it is also required that

þ

pþ

i ðtÞ 0 conditional to PðtÞ Pi ðtÞ 0 (5.26)

Moreover we conclude from (5.25) that

ζ i ðt,τÞ ¼ ζ i ðt τÞ (5.27)

ðτ

lnf1 Φi ðt,τÞg ¼ ζ i ðt ξÞ dξ

8 τ0 9

< ð =

Φi ðt,τÞ ¼ 1 exp ζ i ðt ξÞ dξ

: ;

0

and 8 τ 9

< ð =

φi ðt,τÞ ¼ ζ i ðt τÞ exp ζ i ðt ξÞ dξ

: ;

0

dPi þ þ

¼ pþP

i i ¼ ζ i P P i for pþ

i 0 (5.29)

dt

þ

dPi =dt

pþ

i ¼ þ

Pi

Proof of theorem (5.29): Differentiate the expression (5.23) to time t. It follows that

þ ð

1 ð

1

dPi @ Pð t ξ Þ @ φi ðt,ξÞ

¼ φi ðt,ξÞdξ þ P ðt ξÞ dξ

dt @t @t

0 0

138 5 Exchange and the Circulation of Entropy

@ Pð t ξ Þ @ Pðt ξÞ

With ¼ and after partial integration of the first integral

@t @ξ

over the ξ- domain,

þ ð

1

dPi @ φi ðt,ξÞ @ φi ðt,ξÞ

¼ ζi P þ Pðt ξÞ þ dξ (5.30)

dt dξ dt

0

Let us first deal with the factor of the integrand between braces. In virtue of (5.11):

8 ξ 9

< ð =

φi ðt,ξÞ ¼ ζ i ðt ξÞ f in which the factor f ¼ exp ζ i ðt τÞdτ

: ;

0

Also

@ ζ i ðt ξÞ @ ζ ðt ξÞ

¼ i

@t @ξ

So,

@ φi ðt,ξÞ @ζ ðt ξÞ 2

¼ i f ζ i ðt ξÞ f

@ξ @t

and

@ φi ðt,ξÞ @ ζ i ðt ξÞ

¼ f þ ζ i ðt ξÞ ζ i ðtÞ ζ i ðt ξÞf

@t @t

These expressions may be inserted in (5.30). This yields after some elaboration:

þ ð

1

dPi

¼ ζi P Pðt ξÞζ i ðtÞφi ðt,ξÞdξ

dt

0

þ

The second term of the right side is ζ i Pi on behalf of (5.23), so that theorem

(5.29) is established. □

With (5.29) proven, the observation expressed in (5.26) has been verified to hold

þ

analytically. This implies that the constraint PðtÞ Pi ðtÞ 0, which marks and

defines the inflationary mode of evolution within Si (See Sect. 5.2), may just as well

be replaced by the constraint pþ i ðtÞ 0 . Thus the theory derived in the present

section holds under the constraint that pþ

i ðtÞ 0. □

5.6 The Circulation of Input in the Deflationary Mode of Evolution 139

To prove theorem (5.28) we will rely on theorems (5.24) and (5.29). It follows

from (5.24) and (5.29) that

þ þ

ζ i ðtÞPi Ci ¼ ζ i ðtÞ þ pþ

i ðtÞ Pi Ci

or

þ þ þ

ζ i Pi Ci ¼ ζ i Pi Ci þ ζ i P Pi Ci ¼ ζ i PCi

and

ζ i Viþ dt ¼ ζ i PCi dt

Recall from our exposition in Sect. 5.3.3 that ζ i PCi dt is the money outflux of Si.

In virtue of (5.28) we conclude that this is the equivalent of ζ i ðtÞViþ ðtÞdt . An

interpretation of the various outflows will be given in Chap. 6.

Evolution

We are here dealing with the deflationary mode of evolution. This implies that the

probability distribution Ψ i ðt,θÞ of excess lifetime θ of the input bitpulses exists and

that the probability distribution Φi ðt,τÞ of current lifetime τ of output bitpulses does

not exist.

In foregoing sections we have explained how the probability distributions

Ψ i ðt,θÞ and Ψ i ðt,θÞ of excess lifetime relate respectively to the rate of influx

circulation and to the rate of input circulation in this particular case. We shall

now bridge the connection between Ψ i ðt,θÞ and Ψ i ðt,θÞ. The relationship between

Ψ i ðt,θÞ and Ψ i ðt,θÞ is also closely related with the time-course of the unit price PðtÞ

of a bit of entropy. As we are here dealing with the annihilation of bitpulses within

þ

dS

i (i.e. including the transmission domain dS0 \ dSi ), for analysis to make sense

the deflationary mode of evolution can only apply.

Note that Ψ i ðt,θÞ ¼ Ψ i ðt,θÞ if P is a constant over the entire time-domain. Recall

also our discussion with respect to the deflationary mode of evolution in Sect. 5.2.

In this section we demonstrated that if the constraint Pi ðtÞ PðtÞ < 0 of average

price deflation applies, all entropy annihilation (entropy input) is in dS i (i.e. in

dS dSþ as well as in dS \ dSþ ). Financial entropy annihilation in dS \ dSþ

i 0 i 0 i 0

occurs in exchange for virtual entropy (money).

140 5 Exchange and the Circulation of Entropy

We shall now consider the structure of the probability distribution of the input

bitpulses subject to the above constraint of average price deflation. Meanwhile we

will solve how the average future unit price Pi ðtÞ of Si relates to the current unit

price PðtÞ, a question that we haven’t yet considered in Sect. 5.2.

We must follow the money value involved with the exchange of entropy. We can

look at that money exchange value from two perspectives: that of the money

liberated with the annihilation of influx bitpulses and that of the money liberated

with the sacrifice of input bitpulses. Irrespective of the perspective chosen the

money value liberated/exchanged cannot be different.

Let Ci ðt,ξÞ be the number of bitpulses residing in S0 at observation time t that will

annihilate in state i prior to time t þ ξ. Let further Vi ðt,ξÞ be the aggregate total of

the money value exchanged at time t in consequence of the annihilation of bitpulses

within Si before time t þ ξ.

þ

C

i ðt,1Þ ¼ Ci ðtÞ ¼ Ci ðtÞ ¼ Ci ðtÞ is capacity, the total of the entropy of

bitpulses, residing in S0 at time t and that will cease existence within Si in the

future, i.e. after time t (See Sect. 5.1). Mark also that Vi ðt,1Þ is the future money

exchange value of bitpulses, residing in S0 at time t and that will cease existence in Si

in the future, i.e. after time t. Clearly, Vi ðt,1Þ like Ci ðtÞ depends on time t only and

for this reason we may write

Recall that Vi ðtÞ6¼ Viþ ðtÞ for i 6¼ 0 and that V0 ðtÞ ¼ V0þ ðtÞ (See Sect. 5.1).

Let us next consider how C

i ðt,ξÞ and Vi ðt,ξÞ contribute to the gross expiration of

bitpulses and respectively to the money value for which they are being exchanged

on this infinitesimally small time-interval ðt þ ξ,t þ ξ þ dξÞ.

As C

i ðt,ξÞ ¼ Ci ðtÞΨ i ðt,ξÞ, the gross number @ξ Ci ðt,ξÞ of bitpulses annihilating

between t þ ξ and t þ ξ þ dξ is

@ξ C

i ðt,ξÞ ¼ Ci ðtÞψ i ðt,ξÞdξ (5.31)

On the other hand, as Vi ðt,ξÞ ¼ Vi ðtÞ Ψ i ðt,ξÞ, the money @ξ Vi ðt,ξÞ liberated in

dS

i with the sacrifice of these bitpulses between t þ ξ and t þ ξ þ dξ is

because ψ i ðt; ξÞdt is the gross chance that an input bitpulse is annihilating between

t þ ξ and t þ ξ þ dξ.

The bitpulses that cease existence in the sector Si are being exchanged for unit

price Pðt þ ξÞ at time t þ ξ. The money value exchanged is then:

i ðt,ξÞ (5.33)

5.6 The Circulation of Input in the Deflationary Mode of Evolution 141

Ci C

i ðt,ξÞ ¼ Ci 1 Ψ i ðt,ξÞ (5.34)

and

Vi Vi ðt,ξÞ ¼ Vi ½1 Ψ i ðt,ξÞ (5.35)

Herein Ci 1 Ψ i ðt,ξÞ is the entropy stock of the bitpulses that will cease

existence after time t þ ξ and Vi ½1 Φi ðt,ξÞ is the money exchange value of the

bitpulses that will annihilate after time t þ ξ.

It follows further from (5.33) and (5.31) that

@

V ðt,ξÞ ¼ Pðt þ ξÞCi ðtÞψ i ðt,ξÞ

@ξ i

ðτ

Vi ðt,τÞ ¼ Ci ðtÞ Pðt þ ξÞψ i ðt,ξÞdξ

0

If τ tends to infinity, we get the formula for the money exchange value Vi ðtÞ of

all the bitpulses that reside in S0 at time t and that cease existence in state i in the

future. That is,

ð

1

0

The quotient of Vi ðtÞ and Ci ðtÞ is the average bit price Pi per bit to be liberated/

exchanged within Si in the future as observed at current time t. It follows that

Vi ðtÞ

Pi ðtÞ ¼ (5.37)

Ci ðtÞ

Of course Pi ðtÞ is also a random function of time.

It follows further that

ð

1

Pi ¼ Pðt þ ξÞψ i ðt,ξÞdξ (5.38)

0

Pi ðtÞ is the average future unit price of the influx bitpulses stocked in S0 at time t

that will cease existence in state i in the future. This is the average unit price for

which these bits will be sacrificed in the future. Pi ðtÞ does not match the current

unit bit price PðtÞ. Mark Vi ðtÞ is not equal to the product of Ci ðtÞ and PðtÞ, because

142 5 Exchange and the Circulation of Entropy

the average future unit price to be sacrificed on influx bits in the future (after

observation time t) is another than the current unit price PðtÞ at time t.

As in Sect. 5.5.2 I shall derive two important theorems that relate the circulation of

the input bitpulses to the circulation of the influx bitpulses. The first theorem to be

derived is

ρi ðtÞ ¼ ρi ðtÞ þ p

i ðtÞ conditional to Pi ðtÞ PðtÞ 0 (5.39)

Mark that we claim (5.39) to be valid only if Pi ðtÞ PðtÞ 0, i.e. if there is

average price deflation within Si at current time t . This marks the deflationary

constraint for the specific sector Si .

Proof of theorem (5.39): The right side Vi ½1 Ψ i ðt,ξÞ of expression (5.35) renders

the money exchange value of input bitpulses that will cease to exist after time t þ ξ.

Now recall from (5.37) that Pi ðt þ ξÞ is the average price sacrificed per bit in the

future as observed at time t þ ξ. Further, the number of influx bitpulses that will

annihilate after time t þ ξ and that are still present at time t is Ci 1 Ψ i ðt,ξÞ . It

follows that Pi ðt þ ξÞ must also be the quotient of Vi ½1 Ψ i ðt,ξÞ and

Ci 1 Ψ i ðt,ξÞ . That is,

Vi ½1 Ψ i ðt,ξÞ ¼ Pi ðt þ ξÞCi 1 Ψ i ðt; ξÞ

The integration of Pi ðt þ θÞ over the time-domain θ yields

8ξ 9

<ð =

P i ðt þ ξÞ ¼ Pi ðtÞ exp p

i ðt þ θ Þdθ

: ;

0

preceding the latter formula, that

8ξ 9

<ð =

1 Ψ i ðt,ξÞ ¼ 1 Ψ i ðt,ξÞ exp p

i ðt þ θ Þ dθ (5.40)

: ;

0

8ξ 9

<ð =

ψ i ðt,ξÞ ¼ ψ i ðt,ξÞ p

i ðt þ ξÞ 1 Ψ i ðt,ξÞ exp p

i ðt þ θ Þ dθ

: ;

0

5.6 The Circulation of Input in the Deflationary Mode of Evolution 143

ψ i ðt,ξÞ ψ i ðt,ξÞ

¼ p

i ðt þ ξÞ

1 Ψ i ðt,ξÞ 1 Ψ i ðt,ξÞ

or

ρi ðt,ξÞ ¼ ρi ðt,ξÞ p

i ðt þ ξ Þ

ρi ðt,ξÞ ¼ ρi ðt þ ξÞ p

i ðt þ ξÞ (5.41)

The right side of this expression is a function of t þ ξ only. Hence the left side of

the expression must be a function of t þ ξ only. That is,

ρi ðt þ ξÞ ¼ ρi ðt þ ξÞ p

i ðt þ ξÞ

Clearly, the probability ρi ðtÞdt that an input bitpulse of Si annihilates in dS i

between time t and time t þ dt must exceed the probability ρi ðtÞdt that an influx

bitpulse of Si originates in dS þ

i dS0 between time t and time t þ dt. Else the constraint

of average price deflation within Si cannot be satisfied at current time t and there

would then be average price inflation rather than average price deflation. Thus to

satisfy the constraint for which (5.39) holds true, it is also required that

p

i ðtÞ 0 conditional to Pi ðtÞ PðtÞ 0 (5.42)

Moreover we conclude from (5.41) that

ρi ðt,θÞ ¼ ρi ðt þ θÞ (5.43)

ðθ

lnf1 Ψ i ðt,θÞg ¼ ρi ðt þ ξÞ dξ

0

8 θ 9

< ð =

Ψ i ðt,θÞ ¼ 1 exp ρi ðt þ ξÞ dξ

: ;

0

144 5 Exchange and the Circulation of Entropy

8 θ 9

< ð =

ψ i ðt,θÞ ¼ ρi ðt þ θÞ exp ρi ðt þ ξÞ dξ

: ;

0

dPi

dt ¼ p i P i ¼ ρ i P i P for p

i 0 (5.45)

dPi =dt

p

i ¼

Pi

Proof of theorem (5.45): Differentiate the expression (5.38) to time t. It follows that

ð

1 ð

1

dPi @ Pð t þ ξ Þ @ ψ i ðt,ξÞ

¼ ψ i ðt; ξÞ dξ þ Pð t þ ξ Þ dξ

dt @t @t

0 0

@ Pðt þ ξÞ @ Pðt þ ξÞ

With ¼ and after partial integration of the first integral

@t @ξ

over the ξ- domain,

ð

1

dPi @ ψ i ðt,ξÞ @ ψ i ðt,ξÞ

¼ ρi P þ Pðt þ ξÞ dξ (5.46)

dt dt dξ

0

Let us first deal with the factor of the integrand between braces. In virtue of

(5.15):

8 ξ 9

< ð =

ψ i ðt,ξÞ ¼ ρi ðt þ ξÞ f in which the factor f ¼ exp ρi ðt þ θÞdθ

: ;

0

Also

@ ρi ðt þ ξÞ @ ρi ðt þ ξÞ

¼

@t @ξ

5.6 The Circulation of Input in the Deflationary Mode of Evolution 145

So,

@ ψ i ðt,ξÞ @ ρi ðt þ ξÞ

¼ f fρi ðt þ ξÞg2 f

@ξ @t

and

@ ψ i ðt,ξÞ @ ρi ðt þ ξÞ

¼ f þ fρi ðtÞ ρi ðt þ ξÞg ρi ðt þ ξÞf

@t @t

These expressions may be inserted in (5.46). This yields after some elaboration:

ð

1

dPi

¼ ρi P þ Pðt þ ξÞρi ðtÞψ i ðt,ξÞdξ

dt

0

The second term of the right side is ρi Pi on behalf of (5.38), so that theorem

(5.45) is established. □

With (5.45) proven, the observation expressed in (5.42) has been verified to hold

analytically. This implies that the constraint Pi ðtÞ PðtÞ 0, which marks and

defines the deflationary mode of evolution within Si (See Sect. 5.2), may just as well

be replaced by the constraint p i ðtÞ 0 . Thus the theory derived in the present

section holds under the constraint that p

i ðtÞ 0. □

To prove theorem (5.44) we will rely on theorems (5.39) and (5.45). It follows

from (5.39) and (5.45) that

dPi

ρi ðtÞVi ðtÞ ¼ ρi ðtÞPi Ci ¼ ρi ðtÞ p

i ðtÞ P i Ci ¼ ρ i ðtÞP i Ci C i

dt

or

ρi Vi ¼ ρi Pi Ci þ ρi P Pi Ci ¼ ρi PCi

and

ρi Vi dt ¼ ρi PCi dt

Recall from our exposition in Sect. 5.3.4 that ρi PCi dt is the money influx of Si. In

virtue of (5.44) we conclude that this is the equivalent of ρi ðtÞVi ðtÞdt . An

interpretation of the various inflows will be given in Chap. 6.

Chapter 6

The Interpretation of the Economic Variables

Abstract Each differential subset of the Venn diagram is associated with a partic-

ular economic flow. The assignment differs dependent on whether the inflationary

or the deflationary mode of evolution applies. The inflationary and deflationary

modes of evolution are mutually exclusive. Only one of these two alternative modes

can apply within all the subsets of the economy simultaneously at a particular time.

It is demonstrated that the point of transition from the inflationary to the deflation-

ary mode (and conversely) is always in the turning point of evolution. In this point

there is absence of statistical dependence between input and output. Also HðX0 \ Y0 Þ

¼ 0 , H ðX0 Þ ¼ H ðY0 Þ ¼ 0 and the rate of economic growth is zero in this point.

Statistical dependence between input and output (which implies both that HðX0 \ Y0 Þ

> 0 and that there is a sufficient rate of price inflation) is crucial for evolution to

succeed and to go on. The absence of statistical dependence smothers evolution.

Positive evolutionary growth is impossible in the deflationary mode. This explains

that economies can only manifest themselves if there is a small but persistent positive

rate of price inflation on an average. Then a positive rate of capacity growth will be

maintained in case labor input probability exceeds consumption probability (labor

output probability). The general line is that to attain more positive economic growth,

investment must be stimulated relative to consumption.

It is further claimed that to maintain positive evolutionary growth all evolution-

ary systems must have a unit of exchange additional to the unit of selection (the bit

of entropy) that slowly revaluates relative to the unit of exchange.

produce goods for current consumption. People can choose

whether to spend time picking apples or planting apple trees.

In the first case there are more apples today; in the second

case, more apples tomorrow.

Steven Landsberg

Lecture Notes in Economics and Mathematical Systems 665,

DOI 10.1007/978-3-642-34056-7_6, # Springer-Verlag Berlin Heidelberg 2013

148 6 The Interpretation of the Economic Variables

between quite a number of different money flows and associated entropy flows. It is

only within a concise and consistent mathematical context that these economic

concepts can be given a precise meaning. The pursuit of such conciseness and

consistency is a fundamental aspect of the design of any scientific theory. I shall

here further be concerned with this subject. It covers the economic interpretation of

the output and input circulation rates ζ i and ρi of Si and the outflux and influx

circulation rates ζ i and ρi of Si in relation to the various entropy and money inflows

and outflows as considered previously in the text and in several Appendices and as

illustrated in various Venn diagrams and figures.

Before entering in these details let me first give the general summary of the

connection between the various entropy flows and the various differential subsets in

which the events of bitpulse origination and bitpulse annihilation occur:

• The outflux Y i ¼ ζ i Ci dt attached to the events in the differential subset dSþ

i dS0

• The influx Xi ¼ ρi Ci dt attached to the events in the differential subset dS þ

i dS0

þ

• The output Yi ¼ ζ i Ci dt attached to the events in the differential subset dSi

• The input Xi ¼ ρi Ci dt attached to the events in the differential subset dS i

entropy output ζ i Ci dt was already introduced in Sects. 1.6 and 1.7. Also the brief

symbolic notation Xi to denote entropy influx ρi Ci dt and Y i to denote entropy outflux

ζ i Ci dt was already introduced in Sect. 2.8. However in these sections we have not

yet drawn the distinction between different sorts of flows such as input, output,

influx, outflux, financial input and financial output. In Sect. 2.8 entropy influx was

still called a conditional entropy inflow and entropy outflux was still called a

conditional entropy outflow, which in essence they are of course.

Let us now first consider the context of outflux, output, influx and input in the

inflationary mode of evolution, for which the theory set out in Sects. 5.3.5 and 5.5

and the constraint pþ i 0 is applicable.

We have argued in the foregoing that in the inflationary mode of evolution (i.e.,

þ þ

for P Pi ) bitpulses originate within dS 0 \ dSi in exchange for virtual entropy.

On behalf of (5.28) we may then next ascertain that there is a money value of

φi ðt; 0ÞViþ dt ¼ ζ i ðtÞViþ dt of outflux bitpulses originating within Si during ðt; t þ dtÞ.

This is a money outflux of Si .

Further, on behalf of (5.3) there is a number of bitpulses originating within Si

during ðt; t þ dtÞ and equal to ζ i Ci dt. This is an entropy outflux of Si. It corresponds

with a money value ζ i PCi dt because the unit price of a bit is P during the selection

interval ðt; t þ dtÞ.

þ

The link ζ i PCi dt ¼ ζ i Pi Ci dt ¼ ζ i Viþ dt between entropy outflux ζ i Ci dt and its

money value ζ i Viþ dt was established by the proof of (5.28).

6.1 Outflow and Inflow in the Inflationary Mode of Evolution 149

(see Sect. 5.3.5). This is the entropy output of Si. These bitpulses have originated in

þ

the entire differential set dSþ i , either within the conditional differential set dS i dS0

þ

as entropy outflux ζ i Ci dt or within the intersection dSi \ dS0 as financial output of

Si in exchange for money. The expression for the financial output follows from

(5.24) for pþ

i 0, which characterizes the inflationary mode of evolution:

ζ i PCi dt ¼ ζ i PCi dt þ pþ þ

i PCi dt with pi 0 (6.1)

þ P

pþ

i PCi dt ¼ ζ i P Pi

þ

þ with pi 0 (6.2)

Pi

and

P

þ

Financial output ¼ pþ

i PCi dt ¼ ζ i P Pi þ dt

Pi

wish to express it in bits we must divide by the unit price P.

We have further that

ζ i PCi dt ¼ PZdt H dSþ and ζ i PCi dt ¼ PZdt H dSþ

i i dS0 (6.3)

and

þ

pþ H dSþ

i PCi dt ¼ PZdt H dSi i dS0 ¼ PZdt H ðYi \ X0 Þ

þ

pþ

i PCi dt ¼ PZdt H dSi \ dS0 ¼ γ μi PC0 dt (6.4)

þ þ

Expression (6.2) clarifies that pþ

i and P Pi share the same positive sign. P Pi

þ

is positive conditional to average price inflation. P Pi is also the positive financial

gain per bitpulse exchanged in Si on the selection interval ðt; t þ dtÞ . Therefore

pi þ PCi dt is to be conceived as part of the entropy output on ðt; t þ dtÞ.

From (5.28) it follows further that

þ

ζ i P ¼ ζ i Pi (6.5)

150 6 The Interpretation of the Economic Variables

þ

ζ i H dSþ

i dS0 ¼ ζ i H dSi (6.6)

þ þ

PH dSþ

i dS0 ¼ Pi H dSi

In accordance with (2.4) the evolutionary growth dCi of the sector Si is the net

result of two opposing flows: output Yi of Si and input Xi of Si :

In the inflationary mode of evolution Xi ¼ Zdt H dS is the sum of entropy

þ i

influx Xi ¼ Zdt H dSi dS0 and a virtual component Zdt H dS þ

i \ dS0 .

Note further that generally

λi

Zdt H dS þ þ

i \ dS0 ¼ λi Zdt H dS0 \ dS0 ¼ Zdt H dS þ

0 \ dSi

μi

λi þ

¼ p Ci dt

μi i

þ

Let us then define p

i and ρi as follows for pi 0, i.e., in case the inflationary

mode of evolution applies:

λi þ

p

i ¼ p for pþ

i 0 (6.7)

μi i

and

ρi ¼ ρi þ p

i for pþ

i 0 (6.8)

p þ

i Ci dt ¼ Zdt H dSi \ dS0 (6.9)

and

Xi ¼ ρi Ci dt ¼ Zdt H dS

i

Xi ¼ ρi Ci dt can be called entropy input, although it is partly virtual.

6.2 Outflow and Inflow in the Deflationary Mode of Evolution 151

þ

Finally recall from Sects. 5.2 and 5.3.4 that the entropy influx Zdt H dS

i dS0

of the sector Si is defined by

þ

Xi ¼ ρi Ci dt ¼ Zdt H dS

i dS0 (6.10)

Let us next consider the context of outflux, output, influx and input in the deflationary

mode of evolution, for which the theory set out in Sects. 5.3.6 and 5.6 and the

constraint p i 0 is applicable.

We have argued in the foregoing that in the deflationary mode of evolution ði:e:

þ

for P Pi Þ bitpulses annihilate within dS i \ dS0 in exchange for virtual entropy.

On behalf of (5.44) we may then ascertain that there is a money value of

ψ i ðt; 0ÞVi dt ¼ ρi ðtÞVi dt of influx bitpulses annihilating within Si during ðt; t þ dtÞ.

This is the money influx of Si .

Further, on behalf of (5.6) there is a number of bitpulses annihilating within Si

during ðt; t þ dtÞ and equal to ρi Ci dt. This is an entropy influx of Si . It corresponds

with a money value ρi PCi dt because the unit price of a bit is P during the selection

interval ðt; t þ dtÞ.

The link ρi PCi dt ¼ ρi Pi Ci dt ¼ ρi Vi dt between the entropy influx ρi Ci dt and its

money value ρi Vi dt was established by the proof of (5.44).

The number of all the bitpulses that annihilate in Si on ðt; t þ dtÞ is ρi Ci dt (see

Sect. 5.3.6). This is the entropy input of Si . These bitpulses will annihilate in the

þ

entire differential set dS i , either within the conditional differential set dSi dS0 as

þ

entropy influx ρi Ci dt or within the intersection dS i \ dS0 as financial input of Si in

exchange for money. The expression for the financial input follows from (5.39) for

p

i 0, which characterizes the deflationary mode of evolution:

ρi PCi dt ¼ ρi PCi dt p

i PCi dt with pi 0 (6.11)

P

p

i PCi dt ¼ ρi Pi P

with pi 0 (6.12)

Pi

and

P

Financial input ¼ p

i PCi dt ¼ ρi Pi P

Pi

152 6 The Interpretation of the Economic Variables

wish to express it in bits we must divide by the unit price P.

We have further that

þ

ρi PCi dt ¼ PZdt H dS and ρi PCi dt ¼ PZdt H dS

i i dS0 (6.13)

and

þ

p H dS

i PCi dt ¼ PZdt H dSi i dS0 ¼ PZdt H ðXi \ Y0 Þ

p þ

i PCi dt ¼ PZdt H dSi \ dS0 ¼ γλi PC0 dt

Expression (6.12) clarifies that p

i and Pi P share the same negative sign.

Pi P is negative conditional to average price deflation. Pi P is also the

negative financial loss per bitpulse exchanged in Si on the selection interval

ðt; t þ dtÞ. Therefore pi PCi dt is to be conceived as part of the entropy input

on ðt; t þ dtÞ.

From (5.44) it follows further that

ρ i P ¼ ρi Pi (6.14)

þ

ρi H dS

i dS0 ¼ ρi H dSi (6.15)

þ

PH dS

i dS0 ¼ Pi H dSi

In the deflationary mode of evolution Yi ¼ Zdt H dSþ is the sum of entropy

þ i

outflux Y i ¼ Zdt H dSi dS0 and a virtual component Zdt H dS þ

0 \ dSi .

Note further that generally

μi

Zdt H dS þ

0 \ dSi ¼ μi Zdt H dS þ

0 \ dS0 ¼ Zdt H dS þ

i \ dS0

λi

μi

¼ pi Ci dt

λi

i and ζ i as follows for pi 0, i.e., in case the deflationary

mode of evolution applies:

6.3 The Impacts of the Inflationary and Deflationary Modes of Evolution 153

μi

pþ

i ¼ p for p

i 0 (6.16)

λi i

and

ζ i ¼ ζ i pþ

i for p

i 0 (6.17)

pþ þ

i Ci dt ¼ Zdt H dS0 \ dSi

and

Yi ¼ ζ i Ci dt ¼ Zdt H dSþ

i

Yi ¼ ζ i Ci dt can be called entropy output, although it is partly virtual.

Finally

recall

from Sects. 5.2, 5.3.2, and 5.3.3 that the entropy outflux

Zdt H dSþ

i dS0 of the sector Si is defined by

Y i ¼ ζ i Ci dt ¼ Zdt H dSþ

i dS0 (6.18)

Table 6.1 presents a summary and glossary of the various flows, both for the

inflationary and deflationary mode of evolution.

Modes of Evolution

We have argued in Sect. 5.2 that the mode of inflationary evolution and the mode of

deflationary evolution in Si are mutually exclusive. That is, either pþ

i > 0 or pi < 0.

At first glance the dependence of these constraints on the state i might suggest

that the mode of evolution differs dependent on the sector Si we consider. However,

this is not the case.

To substantiate this claim, my task is here to demonstrate that the mode of

evolution is inflationary in the sector Si whenever it is inflationary in S0 and

conversely. Likewise my task is to demonstrate that the mode of evolution is

deflationary in the sector Si whenever it is deflationary in S0 and conversely.

Well, it is easy to see that if pþ þ

0 > 0 applies, it must follow that pi > 0 for any

state i.

For if pþ þ

0 > 0 , bitpulses can only originate in dS0 \ dS0 in exchange for

þ

“annihilating” virtual bits. Thus in any subset of dS0 \ dS0 , more specifically the

154

Table 6.1 The nomenclature of the flows and circulation rates of the sector Si of the economy

Inflationary mode of evolution pþ

i 0 Deflationary mode of evolution p

i 0

Virtual Virtual

Flow category Flow variable Yes or no Residence Equivalent Yes or no Residence Equivalent

Entropy output ζi Ci dt N dSþ

i ζi Ci dt ¼ ðζi þ pþ

i ÞCi dt Partly dSþ

i ζ i Ci dt ¼ ζ i μi p

i =λi Ci dt

Entropy outflux ζi Ci dt N dSþ ζi Ci dt N dSþ ζ i Ci dt

i dS0 i dS0

þ

Financial output p Ci dt

i

N dS0 \ dSþi Zdt H dS \ dSþ

i

Y dS0 \ dSþi μi p i Ci dt=λi

0

Entropy input ρi Ci dt Partly dS

i ρi Ci dt ¼ ρi þλi pþi =μi Ci dt

N dS

i ρi Ci dt ¼ ρi p i Ci dt

Entropy influx ρi Ci dt N dS dSþ

i 0

ρi Ci dt N dS dSþ

i 0

ρi Ci dt

þ þ

þ

Financial input p Ci dt

i

Y dS

i \ dS0 λi pþ

i Ci dt=μi N dS

i \ dS0 Zdt H dS i \ dS0

Money output ζi PCi dt N dSþ

i ζi PCi dt Partly dSþ

i ζ i PCi dt

Money outflux N N þ

ζi PCi dt dSþ

i dS0

ζi PCi dt dSþ

i dS0 P ζi Ci dt ¼ ζ i PCi dt

i

Money input ρi PCi dt Partly dS

i ρi PCi dt N dS

i ρi PCi dt

þ þ

Money influx ρi PCi dt N dS

i dS0

ρi PCi dt N dS

i dS0 Pi ρi Ci dt ¼ ρi PCi dt

Circulation rates

Input circulation rate dS

i ρi ¼ ρi þ p i dS

i ρi ¼ ρi p i

Output circulation rate dSþ

i ζi ¼ ζi þ pþ

i dSþ

i ζ i ¼ ζi pþ

i

Influx circulation rate ρi dS þ dS þ

i dS0 i dS0

Outflux circulation rate ζi dSþ dSþ

i dS0 i dS0

Capacity growth dCi Zdt H dSþ

i H dS

i Zdt H dSþ

i H dS

i

6 The Interpretation of the Economic Variables

6.3 The Impacts of the Inflationary and Deflationary Modes of Evolution 155

þ

subset dS 0 \ dSi , bitpulses can only originate in exchange for virtual money. And

hence pi > 0 if pþ

þ þ þ

0 > 0. That is, pi is positive whenever p0 is positive.

Likewise if p0 < 0, bitpulses can only annihilate in dS0 \ dSþ

0 in exchange for

þ þ

“originating” virtual bits. Thus in any subset of dS0 \ dS0 , e.g., the subset dS

i \ dS0 ,

bitpulses can only annihilate in exchange for virtual money. And hence pi < 0 if

p

0 < 0. That is, pi is negative whenever p0 is negative.

þ þ

Similarly if p0 gets zero, no longer bitpulses originate in dS 0 \ dS0 and no

longer bitpulses will originate in dS0 \ dSi . Hence it must follow that pþ

þ

i ¼ 0 if

pþ0 ¼ 0. Also if p

0 gets zero, no longer bitpulses annihilate in dS

0 \ dS þ

0 and no

þ

longer bitpulses will annihilate in dSi \ dS0 . Hence it must follow that p

i ¼ 0 if

p0 ¼ 0.

This implies that the evolutionary process can only alternate from inflationary

mode to deflationary mode of evolution or conversely after the rates pþ þ

i , p0 , pi and

p0 vanish altogether simultaneously. It follows that the mode of evolution is

inflationary in the sector Si whenever it is inflationary in S0 and conversely. And

it follows that the mode of evolution is deflationary in the sector Si whenever it is

deflationary in S0 . □

I shall call the time instance for which pþ

i and pi change sign the turning point of

evolution. Inflationary mode and deflationary mode can only exist together at a

moment of time t for which one of them vanishes for a particular index i. In that case

all pþ þ

i and pi vanish together, thus causing pi ðtÞ ¼ pi ðtÞ ¼ 0 for all i at that

particular time t.

And in case either pþ

i or pi vanish it is necessary that H ðX0 \ Y0 Þ ¼ 0 as one may

easily check.

Well, the circumstances for which H ðX0 \ Y0 Þ ¼ 0 are very special, but the

consequences are far-reaching. To get an idea of what is at stake when H ðX0 \Y0 Þ¼0,

I refer to the detailed expositions in Appendices F and G. It is demonstrated in Appendix

F that the case with H ðX0 \Y0 Þ¼0 and that the case of statistical independence of input

events and output events go hand in hand. That is, if there is statistical independence

between input and output, it must follow that H ðX0 \Y0 Þ¼0 and, if H ðX0 \Y0 Þ¼0,

it must follow that there is statistical independence between input and output.

Moreover, if HðX0 \ Y0 Þ ¼ 0, it is shown in Appendix G that H ðX0 Þ ¼ HðY0 Þ ¼ 0

as well and that labor output probability μ (consumption propensity) and labor input

probability λ must satisfy λ ¼ μ ¼ 1 and finally that economic growth is then totally

absent. Therefore H ðX0 \ Y0 Þ ¼ 0 marks the begin and the end of evolution as well

as the begin and end of evolutionary selection. It marks both the point of evolution-

ary take off and the point of ultimate evolutionary failure and extinction. This is

why it is a turning point of evolution. Thus, as the constraint pþ

i ¼ pi ¼ 0 is reached,

the economy has reached that very end of change or that very begin of change. Here

þ

the differential entropy H ðX0 \ Y0 Þ of dS 0 \ dS0 vanishes entirely and also all the

differential entropy H Xi \ Yj of the subsets dSi \ dSþ

j and the differential entropy

þ

of dSi and of dSi vanishes entirely.

156 6 The Interpretation of the Economic Variables

All in all it is not very likely for a modern economy to reach the turning point,

where in fact the economy lands in the middle of nowhere, in effect not a situation

of temporary economic stagnation but more likely a situation of definitive stagna-

tion and downfall.

Of course an economy may sometimes experience that the current price-level P

stops rising and P may even temporarily decline. This is a situation of temporary

deflation. That may reflect a very serious situation of economic stagnation, but the

economy need not yet be in the deflationary mode of evolution, which is much more

demanding because to reach the latter we have to get in the turning point of

evolution. Temporary deflation ðp < 0Þ does not immediately bring about the

average historic price inflation rate pþ i to get zero. On the contrary, due to price

increases in the past this will not happen lightly.

What these observations do reveal is that a deflationary fall of the current unit

price P will have serious devastating effects on the growth potential of any economy,

because it will then approach the turning point closer and closer. It is dangerous to

have the economy kept in a state of declining unit price P or a state of a very low

inflation rate. The longer it stays in such state, the closer it reaches a constant average

þ

historic price level P0 and the more dangerous it is for the economy to decline

further.

This is the main reason why our modern growth economies need a few percents

of average price inflation each year in order to enhance the realization of long term

growth.

Noticing the small probability of survival of an economy in the turning point of

evolution or in the deflationary mode of evolution, it is very likely that all modern

growth economies are in the inflationary mode of evolution. The deflationary mode

of evolution appears to be a very rare exception, a point that is also a point of

evolutionary take off. To analyze that further is interesting but rather irrelevant for

the study of the performance of our modern economies.

I shall therefore proceed in the sequel with analyzing the evolution of the

economy as staying in the inflationary mode of evolution.

The definition (6.7) of pi in the inflationary mode of evolution and the definition

(6.16) of pþ

i in the deflationary mode of evolution, can be condensed in a single

equation:

λ i pþ

i ¼ μ i pi irrespective whether pþ

i 0 or pi 0

whereas (5.21), (5.22), (5.23) and (5.29) are valid in the inflationary mode of

evolution and alternatively (5.36), (5.37), (5.38) and (5.45) are valid in the defla-

tionary mode of evolution.

6.4 Some Further Relationships of Price and Circulation Rates 157

X

pþ

0 C0 ¼ pþ

i Ci

i

X

p

0 C0 ¼ p

i Ci (6.19)

i

X X

ζ 0 C0 ¼ ζ i Ci ; ρ0 C0 ¼ ρi C i

i i

X X

ζ 0 C0 ¼ ζ i Ci ; ρ0 C0 ¼ ρi C i

i i

þ

ðζ 0 þ ρ0 ÞC0 ¼ Z H dSþ þ

0 þ Z H dS0 dS0 ¼ Z H dS0 [ dS0 ¼ Z H ðdS0 Þ

and

ζ 0 þ ρ0 C0 ¼ Z H dSþ þ

0 dS0 þ Z H dS0 ¼ Z H dS0 [ dS0 ¼ Z H ðdS0 Þ

Hence

ζ 0 þ ρ0 C0 ¼ ðζ 0 þ ρ0 ÞC0 ¼ ZH ðX0 [ Y0 Þ ¼ ZH ðdS0 Þ

and

ζ 0 þ ρ0 ¼ ζ 0 þ ρ0

ρi Ci ¼ λi ρ0 C0 , ρi Ci ¼ λi ρ0 C0 , ζ i Ci ¼ μi ζ 0 C0 and ζ i Ci ¼ μi ζ 0 C0

ζ i ζ i Ci ¼ μi ζ 0 ζ 0 C0 so that

p þ þ

i Ci ¼ λi p0 C0 and pi Ci ¼ μi p0 C0 (6.20)

It follows that

þ

p Ci ¼ γ μi C0 ¼ Z HðX0 \ Yi Þ

i

and

p Ci ¼ γ λi C0 ¼ Z H ðXi \ Y0 Þ

i

158 6 The Interpretation of the Economic Variables

þ

Substitution of i ¼ 0 in these expressions for p

i and pi in (6.20) results in

γ ¼ pþ

0 ¼ p0 (6.21)

Hence the transmission rate γ is the absolute value equivalent of the overall

average rate of historic price increase in the inflationary mode of evolution and it is

the absolute value equivalent of the overall average rate of future price decrease in

the deflationary mode of evolution.

On behalf of (1.1), (2.11), (3.2) and (3.3) we can reformulate the expressions for

ρi , ζ i , ρi and ζ i as

P P

λi Z λi log λi μi Z μi log μi

i i

ρi ¼ and ζ i ¼ (6.22)

Ci Ci

ρi ¼ and ζ i ¼ i (6.23)

Ci Ci

Like the variables Ci , Ci , Z, H ðXi jY0 Þ, H ðXi Þ, H ðYi jX0 Þ, H ðYi Þ, λi , μi and qij , the

transmission rate γ and all the circulation rates ρi, ρi, ζ i and ζ i are dynamic functions

of time t.

The sales volume of goods and services produced in the economy is summarized in the

economic concept of spending or output. To keep the production of output going input

is demanded. To that end agents deliver effort which involves wear and tear of their

capacity: physical in the form of labor, and rather more materially but not too strictly

so in the form of wear and tear of mechanical production capacity and production

facilities. From an evolutionary point of view the term spending is less appropriate to

reflect the production of goods and services. Perhaps the term procreation is more

appropriate to denote the productive output resulting from effort.

Procreation is then the output of the economy, effort is the input of the economy.

We can conceive input as the delivery of effort and output as procreation.

Procreation results by effort. In turn procreation feeds the effort delivering agents

in order to sustain the exertion of effort. Procreation is not restricted to apply only

to concrete material entities, neither is effort. Procreation and effort emerge in

physical goods, services, goodwill, patents and more generally in agents as well as

in thoughts, ideas, etcetera in the sense Hodgson and Knudsen describe the

properties of replicators. Financial flow is “stocked” within the transmission area

þ

dS0 \ dS0 .

6.5 The Two-Sector Economy 159

Let us next turn to what concrete meaning the flow variables dealt with in

Sects. 6.1, 6.2, 6.3, and 6.4 have for the two-sector economy of Fig. 2.4 consisting

of a consumption sector S1 and an investment sector S2 . We will here adopt the

division of the sample space dS0 in subsets A, B, C, D, E, F, G and U as given in

Fig. 2.4.

þ

Using this scheme we get: dSþ þ

1 ¼ B [ D [ E, dS1 dS0 ¼ B and dS1 \ dS0 ¼D [ E.

Here we shall use the terms GNP and gross national income (GNI) to denote the

gross national product and the GNI over the time-interval ðt; t þ dtÞ of selection

rather than over a year or quarter. A similar remark applies to all the other flow

variables of the economy.

Since the economy is closed it is necessary that the valueζ 0 PC0 dt ¼ PZdt H dSþ

0

of national output (GNP) balances the value of GNI.

Clearly GNP is total spending, the sum of consumption and investment:

consumption ¼ labor output ¼ Y1 ¼ ζ 1 C1 dt ¼ Zdt H dSþ

1

¼ Zdt H ðB [ D [ EÞ

investment ¼ entrepreneurial output ¼ Y2 ¼ ζ 2 C2 dt ¼ Zdt H dSþ

2

¼ Zdt HðA [ C [ FÞ

It follows that Y0 ¼ Y1 þ Y2 ¼ ζ 0 PC0 dt ¼ PZdt H ðA [ B [ C [ D [ E [ FÞ.

On the income side GNI is the sum of wages, entrepreneurial depreciation, labor

financial input and producer profit.

Wages represent the value of the labor effort delivered

byþ laborers. This value is

the equivalent of labor influx: ρ1 PC1 dt ¼ PZdt H dS1 dS0 ¼ PZdt HðGÞ.

Entrepreneurial depreciation is the value of the sacrifice of effort delivered by the

investment sector. This value equals ρ2 PC2 dt ¼ PZdt H dS dSþ ¼ PZdt HðUÞ.

2 0

is the financial

input of the consumption sector. This equals

p PC1 dt ¼ PZdt H dS \ dSþ ¼ PZdt H ðE [ FÞ.

1 1 0

Producer profit is a residual quantity. It is the surplus of the total PZdt H dSþ 0

of produced outputþover

the total production cost formed by labor financial

þinput

PZdt H dS1 \ dS0 and wages + depreciation ρ0 PC0 dt ¼ PZdt H dS0 dS0 . In

summary this residue of profit is equal to

PZdt H ðE [ FÞ PZdt H ðG [ UÞ (6.24)

160 6 The Interpretation of the Economic Variables

Herein the first term PZdt H ðA [ BÞ PZdt H ðG [ UÞ on the right side

is equal to the surplus of PZdt H dSþ dS over PZdt H dS dSþ . On

0 0 0 0

behalf of (2.18) this surplus is equal to the net

growth

dC 0 of overall

capital

of S0 .

It is also equal to the surplus of PZdt H dSþ 0 over PZdt H dS 0 , which is

the net growth dC0 of overall capacity C0 in accordance with (2.4) and (2.19).

The second

term on þ

the right, PZdt H ðC [ DÞ, is entrepreneurial financial input

PZdt H dS 2 \ dS 0 .

Producer profit

þ

¼ PZdt H dSþ þ

0 dS0 PZdt H dS0 dS0 þ PZdt H dS2 \ dS0

this producer profit of (6.24) we get indeed GNI to balance GNP.

That is,

flow, but it can also be done in a more hidden way by noting that

or

Herein PZdt H ðA [ BÞ is the money cost of total output at average historic unit

þ

production cost P0 rather than at market unit price P per bit. Further, PZdt H ðC [ DÞ

and PZdt H ðE [ FÞ are the respective entrepreneurial financial input and labor

financial input. Alternatively, PZdt H ðD [ EÞ and PZdt HðC [ FÞ are the respec-

tive labor financial output and entrepreneurial financial output.

Mark that on the input side the following terminology for the two-sector

economy has been employed:

labor input ¼ ρ1 C1 dt ¼ Zdt H dS

1 ¼ Zdt H ðE [ F [ GÞ

entrepreneurial input ¼ ρ2 C2 dt ¼ Zdt H dS

2 ¼ Zdt H ðD [ C [ UÞ

þ

labor influx ðwagesÞ ¼ ρ1 C1 dt ¼ Zdt H dS

1 dS0 ¼ Zdt HðGÞ

þ

entrepreneurial influx ðdepreciationÞ ¼ ρ2 C2 dt ¼ Zdt H dS

2 dS0 ¼ Zdt HðUÞ

6.6 The Growth of Capacity 161

Inflow Outflow

Set Input Influx Output Outflux

S1 Labor input Wages (labor influx) Consumption (labor Labor outflux

X1 ¼ ρ1 C1 dt X1 ¼ ρ1 C1 dt output) Y1 ¼ ζ 1 C1 dt

Y1 ¼ ζ 1 C1 dt

S2 Entrepreneurial Depreciation Investment Entrepreneurial

input (entrepreneurial influx) (entrepreneurial outflux

X2 ¼ ρ2 C2 dt X2 ¼ ρ2 C2 dt output) Y2 ¼ ζ 2 C2 dt

Y2 ¼ ζ 2 C2 dt

S0 Joint input Joint influx Joint output Joint outflux

X0 ¼ X1 þ X2 ¼ X0 ¼ X1 þ X2 ¼ Y0 ¼ Y1 þ Y2 ¼ Y0 ¼ Y1 þ Y2 ¼

¼ ρ0 C0 dt ¼ ρ0 C0 dt ¼ ζ0 C0 dt ¼ ζ 0 C0 dt

þ

Labor input Zdt H dS sum of wages (labor influx) Zdt H dS dS

1 is here the

1 0

and labor financial input PZdt H dS1 \ dSþ 0 . The idea behind this choice of

terminology is that labor realizes its financial input from the return on savings that

ultimately proceed from past wages. Thus labor input is more than wages alone, just

like entrepreneurial input is more than entrepreneurial depreciation alone.

A summary of the inflow and outflow terminology for the two-sector economy

has been given in Table 6.2.

Since dCi ¼ Zdt ½H ðYi Þ H ðXi Þ ¼ ðζ i ρi ÞCi dt, let us first observe that

c i ¼ ζ i ρi (6.25)

ρ i H ð Yi Þ ¼ ζ i H ð X i Þ (6.26)

X X

H ðYi Þ ¼ μi H ðY0 Þ ¼ μi μj log μj ; H ðXi Þ ¼ λi H ðX0 Þ ¼ λi λj log λj

j j

After substitution of these expressions for H ðYi Þ and H ðXi Þ in (6.26) we arrive at

X X

μ i ρi μj log μj ¼ λi ζ i λj log λj

j j

162 6 The Interpretation of the Economic Variables

P P

μi μj log μj þ λi λj log λj

j j

ci ¼ P ζi

μi μj log μj

j

P P

μi μj log μj þ λi λj log λj

j j

¼ P ρi (6.27)

λi λj log λj

j

P P

μj log μj þ λj log λj

j j

c0 ¼ c0 ¼ P ζ0

μj log μj

j

P P

μj log μj þ λj log λj

j j

¼ P ρ0 (6.28)

λj log λj

j

μ ¼ μ1 ¼1 μ2 :

X

λj log λj ¼ λ log λ ð1 λÞ logð1 λÞ ¼ QðλÞ

j

and

X

μj log μj ¼ μ log μ ð1 μÞ logð1 μÞ ¼ QðμÞ

j

c0 ¼ c0 ¼ ζ0 ¼ ρ0 (6.30)

QðμÞ Q ðλÞ

The function QðωÞ has been plotted in Fig. 6.1. QðωÞ has an absolute maximum 1

for ω ¼ 0:5 and two absolute minima 0 for ω ¼ 0 and 1.

6.6 The Growth of Capacity 163

0.9

0.8 Q( μ)

Q(ω) 0.7

Q( λ)

0.6

0.5

0.4

0.3

0.2

0.1

0

0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1

ω

μ λ

Fig. 6.1 The two-sector economy. The function Q(ω) as a function of ω. The absolute maximum is

Q(ω) ¼ 1 for ω ¼ 0.5. Furthermore Q(ω) ¼ 0 for ω ¼ 0 and ω ¼ 1. Z · [Q(μ) Q(λ)] ¼ dC0/dt,

the volume of capacity growth. This is positive for λ > μ

of the modern two-sector money economy fluctuates in the range μ ¼ 0.65 up till

0.80. Thus we can ignore the left side of Fig. 6.1 with ω ¼ μ and ω ¼ λ smaller than

0.5. To obtain positive economic growth the labor input propensity λ must exceed

consumption propensity μ (see Fig. 6.1).

In some applications it may be helpful to approximate QðλÞ QðμÞ by a power

series of the difference δ ¼ ðλ μÞ=2 as follows

1β δ2 1 δ3 1 2β

QðλÞ QðμÞ δ log þ þ 2

β 2 βð1 βÞ ln 2 6 β ð1 βÞ2 ln 2

with β ¼ ðμ þ λÞ=2. This third order expansion in δ offers very good approximations

for μ and λ in a 15 % vicinity around β between 0.65 and 0.80.

On behalf of (6.30) it can be shown that the common rate c0 ¼ c0 of capacity

growth and capital growth of the economy is mainly determined by the difference

ðλ μÞ. For λ > μ the rate of economic capacity growth is positive. For λ < μ it is

negative. The dance of that difference about its long run average in the course of

time explains the instantaneous fluctuations of the growth rate c0 of overall capacity.

In accordance with expressions (6.28) and (6.30) c0 is also equal to the growth rate

c0 of overall capital.

164 6 The Interpretation of the Economic Variables

from (6.1), (6.7), (6.8) and (6.25):

μi λi þ

c i ¼ ζ i ρi ¼ ζ i ρi þ pi , pþ

i 0

μi

In the deflationary mode of evolution ci follows from (6.11), (6.16), (6.17) and

(6.25):

λi μi

c i ¼ ζ i ρi ¼ ζ i ρi þ pi , p

i 0

λi

The growth rate of output Yi ¼ Zdt H ðYi Þ is equal to the growth rate of Yi ¼

ζ i Ci dt:

yi ¼ ¼ þ ci

Yi ζi

Likewise the growth rate of input Xi ¼ Zdt HðXi Þ is equal to the growth rate of

Xi ¼ ρi Ci dt:

xi ¼ ¼ þ ci

Xi ρi

change of the output circulation rate ζ i, respectively of the input circulation rate ρi in

the course of time. Together with the fluctuations of ci this is another source of

instantaneous fluctuations of the business cycle. Whereas the time-averages of

dζ i =ζ i dt and dρi =ρi dt will usually average out and vanish over the full business

cycle, ci need not vanish if a prolonged surplus of labor input propensity λ ¼ λ1 over

consumption propensity μ ¼ μ1 is realized. Ci is therefore a real source of economic

growth and evolution.

In accordance with (6.18) the net growth rate of outflux Y i ¼ Zdt H ðYi jX0 Þ ¼

ζ i Ci dt is

dY i =dt dζ i =dt

yi ¼ ¼ þ ci

Yi ζi

Likewise, on behalf of (6.10), the net growth rate of influx Xi ¼ Zdt H ðXi jY0 Þ ¼

ρi Ci dt is

xi ¼ ¼ þ ci

Xi ρi

6.7 Economic Growth and the Surplus of Output Over Input 165

with many new variables and exact relationships that each may be subject of

observation, measurement, consistent explanation and optimum prediction.

The surplus of labor output over labor input is equal to the net growth dC1 of labor

capacity C1 :

P P

As Y1 ¼ μ1 Y0 ¼ μ1 Zdt i μi log μi and X1 ¼ λ1 Y0 ¼ λ1 Zdt i λi log λi

this results in

h X X i

dC1 ¼ Zdt μ1 μ

i i

log μ i λ 1 i

λ i log λ i

We are interested in the surplus dC1 of labor output (consumption) over labor

input (wages + financial labor influx), how it depends on ðλ μÞ. The questions are:

Does the net growth rate c1 of labor capacity display a more or less similar behavior

like c0 as a function of ðλ μÞ? Is it necessary that labor input X1 (the income side of

the consumption sector) exceeds labor output Y1 (the spending side of the consump-

tion sector) to sustain a positive overall rate c0 of growth, i.e., if ðλ μÞ > 0 ?

Another question is: what happens with an eventual surplus of X1 over Y1 if c0 is

negative, i.e., if ðλ μÞ < 0?

To analyze this, the behavior of ωQðωÞ as a function of ω is decisive. The course

of ωQðωÞ as a function of ω has been plotted in Fig. 6.2.

Notice ωQðωÞ has a single maximum for ω ¼ 0:703506. The maximum value of

ωQðωÞ here attained is 0.616949. We shall discern between six different situations:

1. For μ < λ < 0:703506 we have that μQðμÞ < λQðλÞ: c0 > 0, consumption <

labor input and c1 < 0 moving in a direction opposite to c0 . Case of positive

overall economic growth, but negative growth in the consumption sector S1 .

2. For λ < μ < 0:703506 we have that μQðμÞ > λQðλÞ: c0 < 0, consumption >

labor input and c1 > 0 moving in a direction opposite to c0 . Case of negative

overall economic decline, but positive growth in the consumption sector S1 .

3. For 0:703506 < μ < λ we have that μQðμÞ > λQðλÞ: c0 > 0, consumption >

labor input and c1 > 0 more or less behaving like c0 . Case of positive overall

growth.

166 6 The Interpretation of the Economic Variables

0.9

0.8

ω Q(ω ) 0.7

0.6 0.616949

0.5

0.4

0.3

0.2

0.1

0

0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1

ω

0.703506

Fig. 6.2 The two-sector economy. The function ωQ(ω) as a function of ω. The absolute maximum

ωQ(ω) ¼ 0.616949 is attained for ω ¼ 0.703506

4. For 0:703506 < λ < μ we have that μQðμÞ < λQðλÞ: c0 < 0, consumption <

labor input and c1 < 0 more or less behaving like c0 . Case of negative overall

decline.

5. For μ < 0:703506 < λ it is uncertain whether consumption is greater or smaller

than labor input: c0 > 0 but c1 will often tend to be rather small, either positive or

negative.

6. For λ < 0:703506 < μ it is uncertain whether consumption is greater or smaller

than labor input: c0 < 0 but c1 will often tend to be rather small, either positive or

negative.

The economic growth in the investment sector of the two-sector economy is

determined by

(depreciation + financial entrepreneurial influx) is largely determined by ð1 ωÞQðωÞ

as a function of ω. We shall not plot this function here, because it is the horizontal

mirror image of the function ωQðωÞ around the vertical axis ω ¼ 0:5. ð1 ωÞQðωÞ is a

strictly decreasing function of ω in the right half plane 0:5 < ω < 1. Thus we conclude

from Fig. 6.2 that

6.8 Economic Evolution and Biologic Evolution 167

1. For μ < λ always ð1 μÞQðμÞ > ð1 λÞQðλÞ: c0 > 0, investment > entrepre-

neurial input and c1 > 0 more or less behaving like c0 . Case of positive overall

growth.

2. For μ > λ always ð1 μÞQðμÞ < ð1 λÞQðλÞ: c0 < 0, investment < entrepre-

neurial input and c1 < 0 more or less behaving like c0 . Case of negative overall

decline.

Thus we conclude that a substantial increase of investment is the best thing to do

in order to resume overall economic growth.

A very well developed system of money exchange distincts our modern growth

economies from evolutionary systems with much slower rates of entropy growth. It

has been shown in Appendices F and G that this must be attended with sufficient

statistical dependence between the output events and the input events. This in turn

demands that a moderate level of price inflation is sustained. In this manner

transmission Zdt H ðX0 \ Y0 Þ plays a substantial role and is of the same order as

output Zdt H ðY0 Þ and input Zdt H ðX0 Þ . The result is the attainment of the

considerable growth rates that our modern money economies characterize. On the

other hand an economy in a state with very low inflation rate is likely to demon-

strate poor positive or even negative growth. It will be in a state of economic

stagnation and decline.

Clearly then, money with a little but sufficient inflationary impetus is the

lubricant of economic performance. This raises the point how the primitive barter

economy has managed to realize economic growth. The conclusion we must draw

here is that economies of a (very) primitive state of development cannot have

survived without a sort of unit of exchange that slowly devalued in the course of

time. Well, the use of a unit of exchange (shells, beads, corn) in primitive

economies has a very old record. Due to the scarce availability of appropriate

units of exchange and the lack of ease of transportation and the limited acceptance

of their units of exchange, these barter economies achieved only small or very small

growth rates, at least much less than the rates of growth the modern economies have

realized and still manage to attain.

It must further be stressed that the prerequisite for any economy to possess a

moderately devaluating unit of exchange does not imply that always the same

unique entity should serve as the unit of exchange. The moment another suitable

unit of exchange appeared on the scene, that unit could take over the role of the

former unit of exchange. Moreover, more units of exchange have been used side by

side or alternately in one and the same economy. Nevertheless there were and there

are still important restrictions for the acceptance of a proper unit of exchange. That

unit ought to be sufficiently scarce and it must remain so in order to prevent the

supply of the exchange unit to rise abundantly beyond control. On the other hand it

168 6 The Interpretation of the Economic Variables

conditions caused by too much money scarceness. Clearly the difficulty to meet the

proper conditions for the usefulness of an exchange unit during prolonged periods

of time must have restricted economic growth of primitive economies considerably.

The ideal solution, a scarce and yet easily reproducible unit of exchange, has been

approximated most closely in the modern economies by an independent central

monetary authority that controls and restricts the monopolistic supply of money as

best as possible in the interest of the growth of the economy.

As I adhere to the idea that the theory of evolutionary selection should provide

for a universal common explanation of all manifestations of evolution, I can’t

escape the conclusion that exchange must be part of the biologic evolutionary

framework as well in order to warrant that biologic evolution will occur at all. At

first glance one is inclined to dismiss a biologic unit of exchange distinct from the

unit of selection as being an unrealistic suggestion. However, the rejection of the

idea might largely be due to a misconception of what must be understood by a

biologic unit of exchange. Nothing economic should be associated with it like

biologic entropy is completely different from economic entropy as well, save the

application of the universal validity of Boltzmann’s principle.

Note further that biologic replicators are also quite different from economic

replicators except for the fact that they carry entropy. The decisive point is that

there are two aspects associated with all evolutionary processes: exchange and

selection. In connection with this there are two units determining evolution: the unit

of exchange and the unit of selection. For economic evolution the unit of selection

is the bit and the unit of exchange is the money unit (Strictly speaking money unit is

the name that economists assign to the unit of exchange of the modern economy).

To seek out the corresponding pair of units of selection and exchange of biologic

evolution, it is easier to begin with the unit of selection. In economics selection is

the allocation of bits (samples) of entropy either in the subjective state of

consumers/laborers (state 1) or in the environmental state of entrepreneurs/

investors, the ecotope1 (state 2). I have argued before that the corresponding states

of selection of biologic evolution are the species (state 1) and the environmental

state of the biotope, the niche or habitat in which species prosper. This is the

phenotypical condition in which biologic selection takes place and it is linked up

with the genotypical condition. But genotypical conditions do not act directly on the

phenotypical adjustment of the environment. It is the entropy of environment (the

biotope) and the phenotype that appear to execute a continual selective dance.

However, the interaction of genotypic and phenotypic conditions takes care of

constantly supplying bits for a changing biologic unit price in the course of time.

Thus I claim that for biologic evolution the bit is the unit of selection and the

selection is between the phenotypic subjective state of the species (state 1) and the

biotopic state (state 2) in which the phenotype selects the significance it prefers.

1

I use the term ecotope on the analogy of the term biotope in biologic evolution.

6.8 Economic Evolution and Biologic Evolution 169

Darwinian evolution (see Sect. 1.6). Biologic evolution will not come about if it

would not be a key-stone of the evolutionary process. In the very first instance

genetic inheritance causes exchange to take place between the sectors so that

selection can pursue its course. Biologic evolution avails itself of exchange of

inheritable information to initiate and to sustain the process of selection. By

selection the gene pool adjusts itself in accordance with the conditions imposed

by the complete biologic system. However genes also function to exchange infor-

mation. They transport information for recombination. Like the various entities of

economic money value, we can split up the biologic entities just as well in even

units of exchange value (in a manner different from the phenotypic bits of selec-

tion), that we shall call quanta for convenience of description.

Thus we propose the bit as the unit of exchange and the quantum as the unit of

exchange of biologic evolution. Like in economics the unit of selection (the bit) is

the time-varying equivalent of PðtÞ units of exchange, we encounter in biologic

evolution the bit as the time-varying equivalent of PðtÞ quanta.

To understand why there must be a unit of selection additional to the unit of

selection, we should not seek for too much analogy between biologic evolution and

economic evolution, e.g., by a search for the monetary authority of biologic

evolution. That initiative does not have an eye for the variety of evolutionary

systems and the uniqueness of a specific class of evolutionary systems. Neither

the barter economy had a monetary authority.

What we should emphasize here is that biologic evolution is very much slower

than economic evolution and it is just the presence of the much smaller growth rates

of biologic evolution that explains why economic evolution is so different although

the mathematical descriptions of the evolutionary processes do not differ.

We should explain the pair wise existence of a unit of selection and unit of

exchange for biologic evolution from the opposite perspective. The very much

smaller growth rates of biologic evolution indicate that the surplus λ μ of input

probability λ over output probability μ for the two-sector system of biologic

evolution is often close to zero on an average over time, often momentarily positive

and also often momentarily negative. It is also not very unlikely that in the case of

biologic evolution both λ and μ will regularly be close to 1, i.e., close to the take-off

point and extinction point of evolution for which λ ¼ μ ¼ 1 and for which the

transmission H ðX0 \ Y0 Þ ¼ 0 (see Appendices F and G for the details). At that point

the unit of selection and the unit of exchange melt together. Only a single common

unit both for selection and exchange is left there but there is no biologic change

anymore if HðX0 \ Y0 Þ ¼ 0. Biologic evolution can only proceed when the trans-

mission H ðX0 \ Y0 Þ gets positive. As Zdt H ðX0 \ Y0 Þ ¼ pþ 0 C0 dt this implies that

þ

the average historic price inflation rate p0 must be positive in order for evolution to

proceed. This requires that there is a unit of exchange that is devaluating (slowly)

with respect to the unit of selection. The devaluation may be so slow in biologic

evolution that we cannot observe the distinct presence of these two processes of

selection and exchange. We only know that it must have gone that way as we

conclude retrospectively after many millennia that biologic evolution has occurred.

170 6 The Interpretation of the Economic Variables

Table 6.3 The core variables and core dimensional units of evolution

Equivalent evolutionary terminology

Core concepts of evolution Biologic evolution Economic evolution

Genotype Quantities of exchange Genes Entities

(article of of variable content each holding a each holding a variable

exchange) variable number number PHðSÞ of

of quanta money-units

Unit of exchange Quantum Money unit

Phenotype Quantities of variable Species/Biotope Subjects/Ecotope

(article of content and different each stocking a each stocking a variable

selection) state variable number number HðSÞ of

of bitpulses bitpulses

Unit of selection Suggested: Bitpulse

Bitpulse holding one bit of entropy

holding one bit of

entropy

Unit price of unit of P quantum units (P is P money units (P is a

selection a variable of time) variable of time)

etcetera are measurable, this seems hardly to be the case for biologic evolution. The

drawback is that the idea of a common explanation for all sorts of evolutionary

manifestation within our universe is hardly testable. Moreover there are a lot of

questions with respect to this issue still to be answered. Nevertheless it is worth-

while that—given the assumption that evolvodynamics provides for a universal

explanation of evolution—there need be no conflict between economic and biologic

evolution.

I have summarized the (suggested) corresponding terminology of economic

evolution and biologic evolution in Table 6.3.

Chapter 7

Money and Liquidity, Time, Work

and Effectiveness

Abstract The transmission Zdt H ðX0 \ Y0 Þ represents all the money-like entities

(expressed in bits) issued in the economy on the time-interval (t,t þ dt). This

justifies articulate mathematical definitions of money flow and money stock for

the economy as a whole and for its separate sectors.

Another line of investigation considered in this chapter is the role of time. We

can calculate outflow and inflow handling rates, the time duration of selective

attention involved per outflow bit respectively per inflow bit on the selection

interval (t,t þ dt). These handling rates assist to calculate the relative time gain

of input handling over output handling per unit of time per bit.

The product of this relative time gain and the circulation rate is a net rate of

capacity growth. Thus the relative time gain can be conceived as a total of work-

units per unit of time passage that goes into the growth of capacity during the

selection interval (t,t þ dt). This suggests a direct and unique relationship between

the stock Li ðtÞ of work-units of an economic sector Si that has accumulated in the

past until present time t and the capacity Ci ðtÞ, the entropy that has accumulated in

the past until present time t: Ci ðtÞ ¼ EðtÞ Li ðtÞ. Herein EðtÞ is the effectiveness of

production at present time t.

Milton Friedman

The basal condition for statistical dependence is the exchange of goods and services

for money. Money is the source of exchange required for facilitating selection. We

may consider money as the lubricant of economic selection. Without money, the

Lecture Notes in Economics and Mathematical Systems 665,

DOI 10.1007/978-3-642-34056-7_7, # Springer-Verlag Berlin Heidelberg 2013

172 7 Money and Liquidity, Time, Work and Effectiveness

a positive transmission HðX0 \ Y0 Þ is realizable as well as statistical dependence

between the events of entropy input within dS i and the events of entropy output

within dSþ i so that growth can result. It depends on the sign of ðλ μÞ whether

growth will be positive or negative (See the equations for the growth rate c0 in

Sect. 6.6).

HðX0 \ Y0 Þ need not vanish when there is virtual money exchange. Once

H ðX0 \ Y0 Þ vanishes, money exchange is powerless. The entropy incorporated in

þ

money manifests itself within the transmission domain dS 0 \ dS0 : We have

therefore called this the domain of financial entropy. H ðX0 \ Y0 Þ represents a

financial entropy flow. This is what Claude Shannon calls the rate of actual

transmission, the surplus of the rate HðY0 Þ of entropy production (output) over

the rate HðY0 jX0 Þ of uncertainty in terms of communication channel analysis. For

economic evolution the interpretation is different.

Let us consider the money outlays and receipts of the two-sector economy

consisting of a consumption sector S1 and an investment sector S2 .

Producers use production resources and hire labor to produce both finished

consumer goods and investment goods, the latter in last instance to facilitate the

production of consumer goods. There are two complementary ways to approach this

production process: one from the output side where we concentrate on what

is earned on output and one from the input side where we concentrate on what is

earned on input.1

We shall approach the economy from an overall producers’ output view. To keep

matters more surveyable we restrict the discussion to the two-sector economy.

Producers sell their production of investment goods/services and consumer

goods/services at the unit price P per bit. That is, the production of investment

entities is sold for ζ 2 PC2 dt money units on the market. And the production of

consumer entities is sold for ζ 1 PC1 dt money units on the market. However the

money outlay involved with producing these ζ 2 C2 dt bits of investment goods and

these ζ 1 C1 dt bits of consumer goods is the money value for which producers have

acquired them in the past, i.e. respectively for Pþ þ

2 and P1 money units per bit.

Hence

the net money earned by producers with the sale of all of their production is

ζ 1 P Pþ 1 C 1 dt þ ζ 2 P P þ

2 C2 dt . From an output angle of incidence, the net

money earned and received by producers on the selection interval ðt; t þ dtÞ is then:

ζ 0 P Pþ þ þ

0 C0 dt ¼ ζ 1 P P1 C1 dt þ ζ 2 P P2 C2 dt

together) in bits produced at a unit cost of Pþ

0 per bit and sold at a unit price P

per bit.

1

I use the term “earned” here just for comfort of description. Actually it is a net money amount

collected on input and a net money amount collected on output, which will be shown to balance in

the end.

7.1 The Role of Money and Transmission in Production 173

ζ i þ þ

ζ i P Pþ

i Ci dt ¼ p P Ci dt ¼ pþ

i PCi dt

ζi i i

Hence, the net money earned and received by producers on the selection interval

ðt; t þ dtÞ can also be restated as:

pþ þ

0 PC0 dt ¼ p þ

1 PC1 dt þ p 2 PC2 dt

pþ

2 PC2 dt is the money surplus received by producers with the sale of investment

goods over the money outlay involved with producing it and pþ 1 PC1 dt is the money

surplus received by producers with the sale of consumer goods over the money

outlay involved with producing it.

The burning question next is what producers do with this net money surplus they

receive. Clearly, they can put it on their bank account. However this is not what

they do only. On the contrary, the net money received is the money that consists of

the net surplus of sales over outlays involved with manufacturing it. This implies

that the original outlays, formerly put in entrepreneurial inventories, must

have reoccurred up to the former level of ζ 0 Pþ 0 C0 dt during ðt; t þ dtÞ . Else

producers are left with more money than the pþ 0 PC0 dt earned. Thus we have

actually assumed that producers have reallocated the same amount of money

value that they originally had tied up in capacity stock before they sold it on the

market. How might producers further have reallocated the amount pþ 0 PC0 dt of

money? Well producers reallocate their money resources in labor input ρ1 PC1 dt

and entrepreneurial input ρ2 PC2 dt. If we look at the money value flow process

from this side we analyze the production process from an alternative overall input

angle of incidence. This is the complementary way of analyzing the production

process. Let us see how this works out with respect to the money flows received by

producers. Producers use up production facilities reflected in entrepreneurial

depreciation and they use labor effort, reflected in the wages they pay, in order

to maintain production. They pay influx cost (wages; see Table 6.2) of labor and

incur influx cost (depreciation; see Table 6.2) of wear and tear of production

facilities at the unit cost price P per bit. That is, a total ρ2 PC2 dt of production

equipment and facilities (in money units) is being used up at a depreciation cost of

P money units per bit and labor is being hired for ρ1 PC1 dt money units on the

market also at a unit price P per bit. This is all the money going into the purchase

of non-financial resources: labor influx ρ1 PC1 dt and entrepreneurial influx ρ2 PC2 dt.

The rest of the money is the surplus of input ρ0 PC0 dt ¼ ρ1 PC1 dt þ ρ2 PC2 dt

over influx ρ0 PC0 dt ¼ ρ1 PC1 dt þ ρ2 PC2 dt . This goes into the remaining input

entries: the financial labor input p 1 PC1 dt ¼ ρ1 PC1 dt ρ1 PC1 dt and the financial

entrepreneurial input p 2 PC 2 dt ¼ ρ 2 PC 2 dt

ρ 2 PC 2 dt.

174 7 Money and Liquidity, Time, Work and Effectiveness

From this input angle of incidence, the net money received by producers on the

selection interval ðt; t þ dtÞ is:

p

0 PC0 dt ¼ p

1 PC1 dt þ p 2 PC2 dt

of which the financial influx p 2 PC2 dt is the money received by entrepreneurs/

producers and of which the financial influx p 1 PC1 dt is the money received by

consumers for the disposal of financial resources for the benefit of production.

In conclusion, the total money received by producers on the selection interval

ðt; t þ dtÞ is pþ

0 PC0 dt from the angle of incidence of output. And it is p 0 PC0 dt from

the alternative

þ angle of incidence of input. These flows are in equilibrium because

p ¼ p ¼ γ in accordance with (6.21).

0 0

We are thus led to the conclusion that p 0 PC0 dt ¼ Zdt H ðX0 \ Y0 Þ ¼ γPC0 dt is

all the money issued by the banking system during the time-interval ðt; t þ dtÞ of

selection.

Traditional accounts of economic theory define the money stock of agents as the

resources that can be liberated for exchange immediately or within a very short time

period. This depends on the quantity of money volume issued by the banks against

long term loans. The terms under which the loans are to be redeemed, the depen-

dence of these terms on economic performance and also the availability of other

forms of liquidity than issued by the central bank have an impact on the available

means of liquidity in the near future. To account for that, traditional economic

theory employs various definitions of the money stock. However, it appears that the

transmission Zdt H ðX0 \ Y0 Þ provides for a clear theoretical definition of

the entropy increase dM0 of the money stock M0 (measured in bits of entropy) on

ðt; t þ dtÞ. In the dimension of money units this increase is PdM0 :

samples during ðt; t þ dtÞ. The financial weight per sample is H ðX0 \ Y0 Þ bits, which

is a quantity between 0 and 1. This is the perfect measure to assess the extent of the

role of money within an economy.

Let us next consider how the total money flow dM0 is divided between the sectors S1

and S2 of the two-sector economy. In this regard the Venn diagram of Fig. 2.4 will

again be very helpful.

Let dMi denote the increase of the money stock Mi of the sector Si during

ðt; t þ dtÞ. Thus

7.2 The Liquidity Flux and Money Flows and Stocks 175

X X

dM0 ¼ dMi and M0 ¼ Mi

i i

More specifically for the two-sector economy, dM1 is the increase of the money

stock M1 of the consumption sector S1 during ðt; t þ dtÞ and dM2 is the increase of the

money stock M2 of the investment sector S2 during ðt; t þ dtÞ. Of course,

Mark that it costs the money wage ρ1 PC1 dt to produce consumer and investment

goods before bringing this production to the market for the money value ρ1 PC1 dt

during the selection interval ðt; t þ dtÞ. The net money realized on the utilization

of labor effort by producers for economic production is then ρ1 PC1 dt ρ1 PC1 dt ¼

p

1 PC1 dt ¼ PZdt H ðFÞ (See the Venn diagram of Fig. 2.4). As we have set out

before, this can be regarded to represent the financial input generated by the

consumption sector only. On the other hand the surplus of money sales ζ 1 PC1 dt

of consumer good production over the money cost ζ 1 Pþ 1 C1 dt thereof is

ζ 1 PC1 dt ζ 1 Pþ 1 C1 dt ¼

p þ

1 PC 1 dt ¼ PZdt H ð D Þ. As we have also explained before,

this surplus is the financial output realized on consumer good production. Clearly

the financial input p 1 PC1 dt ¼ PZdt H ðFÞ realized on the utilization of labor effort

does not match the net financial output pþ 1 PC1 dt ¼ PZdt H ðDÞ realized on

consumer good production. This is comprehensible because labor effort serves

also to bring forth investment good production. Furthermore consumer good

production will also require the cost of wear and tear of capital equipment. Neither

does the cost of labor effort, required for investment good production, balance the

depreciation cost caused by consumer good production only.

In conclusion it must follow that generally p 1 PC1 dt p þ

1 PC1 dt 6¼ 0.

p

1 PC 1 dt is the amount by which the money in stock of the consumption sector S1

increments during ðt; t þ dtÞ after all input costing obligations of that sector have

been met at time t þ dt minus the amount pþ 1 PC0 dt by which the money in stock of

the consumption sector p decrements during ðt; t þ dtÞ after all output spending

obligations of that sector have been settled at time t þ dt . It follows that the

difference p 1 PC1 dt p þ

1 PC1 dt is the remaining net flow of money that enters the

consumption sector S1 during ðt; t þ dtÞ.

Likewise p 2 PC2 dt pþ2 PC2 dt is the remaining net flow of money that enters the

investment sector S2 during ðt; t þ dtÞ. However, recall that

p þ

1 PC1 dt p

1 PC1 dt þ p þ

2 PC2 dt p

2 PC2 dt ¼ p þ

0 PC0 dt p 0 PC0 dt ¼ 0

Hence the surplus of money flow of the consumption sector is the deficit of

money flow of the investment sector or conversely. We have called this surplus of

money flow the liquidity flux of the consumption sector S1 and refer to its entropy

level by the symbolic differential notation dB1 (See Sect. 2.9). That is, on behalf of

(6.4) and (6.19),

176 7 Money and Liquidity, Time, Work and Effectiveness

dB1 ¼ p þ

1 C1 dt p 1 C1 dt ¼ Zdt ½H ðFÞ H ðDÞ

¼ Zdt ½H ðX1 \ Y2 Þ H ðX2 \ Y1 Þ

and

dB1 ¼ p þ

1 C1 dt p 1 C1 dt ¼ ðq10 q01 ÞZdt H ðX0 \ Y0 Þ ¼ γ ðλ μÞC0 dt (7.3)

formation of the money stock M0 of S0 , there is dB1 more money available for

the formation of the money stock M1 of S1 than available for the money stock M2 of

S2. Saying the same thing in different order, there is dB1 less money available for the

formation of the money stock M2 of S2 than available for the money stock M1 of S1.

Hence,

dM0 dB1

dM1 ¼

2

follows after some elaboration

dM1 ¼

2

and

1þλμ 1λþμ

dM1 ¼ Zdt H ðX0 \ Y0 Þ and dM2 ¼ Zdt HðX0 \ Y0 Þ

2 2

1þλμ 1λþμ

dM1 ¼ γC0 dt and dM2 ¼ γC0 dt (7.5)

2 2

Mark that dB1 and dMi are entropy contents. They are expressed in bits. PdB1 and

PdMi are the corresponding money flows in money units.

For the money economy γ > 0. Thus we see, on behalf of (7.3), that for the

money economy the liquidity flux dB1 is only positive if labor input probability λ

exceeds consumption probability μ. Recall that under this condition also positive

entropy growth of the money economy will sustain [see (6.30)]. Clearly, in the very

first incipient phase of evolution, positive entropy growth is necessary for evolution

to take off. Thus μ should tend to decline below λ at incipience time of economic

7.2 The Liquidity Flux and Money Flows and Stocks 177

evolution. It follows from (7.3) that the liquidity flux of the consumption sector will

be positive when economic evolution takes a path of positive entropy growth and

also that dM1 and dM2 will remain positive as long as economic evolution has

taken off and the money economy endures to exist. On the other hand the liquidity

flux of the investment sector remains negative because it is opposite to the money

flow of dB1 .

For any particular sector Si of the multi-sector economy the liquidity flux dBi in

bits of entropy is defined by:

dBi ¼ Zdt ½H ðXi \ Y0 Þ H ðX0 \ Yi Þ ¼ p þ

i p i Ci dt ¼ γ ðλi μi ÞC0 dt (7.7)

Ðt

We should be aware that the integral 1 PðξÞ dBi ðξÞ is the accumulated

money value of dBi over time. The money value of dBi at current time t is

ðt ðt ðt

PðξÞdBi ðξÞ ¼ p

i ðξÞPðξÞCi ðξÞdξ pþ

i ðξÞPðξÞCi ðτÞdξ

ξ¼1 ξ¼1 ξ¼1

or

ðt ðt

p

½i ðξÞ pþ

i ðξÞ PðξÞCi ðξÞdξ ¼ ½λi ðξÞ μi ðξÞ γ ðξÞ PðξÞC0 ðξÞdξ

ξ¼1 ξ¼1

Direct integration of the liquidity entropy flux dBi over the time-domain yields

the entropy stock Bi of the liquidity surplus in bits, which—as we have seen—may

be positive as well as negative.

The surplus dBi ¼ p i p þ

i Ci dt will only differ from 0 (for i 6¼ 0) in case

transactions are being settled in money units on the time interval ðt; t þ dtÞ of

selection. The following properties must always be awarded:

X X

dB0 ¼ dBi ¼ 0; B0 ¼ Bi ¼ 0

i i

178 7 Money and Liquidity, Time, Work and Effectiveness

Ðt

Furthermore the integral 1 PðξÞ dMi ðξÞ is the accumulated money value of

dMi over time. This differs from Mi . The money value of dM0 at current time t is

ðt ðt ðt

PðξÞdM0 ðξÞ ¼ p

0 ðξÞPðξÞCi ðξÞdξ þ pþ

0 ðξÞPðξÞCi ðτÞdξ

ξ¼1 ξ¼1 ξ¼1

or

ðt ðt

PðξÞdM0 ðξÞ ¼ 2γ ðξÞPðξÞC0 ðξÞdξ

ξ¼1 ξ¼1

increasing by dCi on ðt; t þ dtÞ. That is [see (2.4)],

dCi ¼ Zdt H dSþ

i Zdt H dS

i

dCi is the real growth of the economy. On behalf of (2.4) and (2.18) we have

It follows that

Further

7.4 The Handling Rate of Inflow and Outflow Selection and the Net Growth of. . . 179

and the Net Growth of Capacity and Capital

Xi ¼ Zdt H ðXi Þ bits and the output of Yi ¼ Zdt HðYi Þ bits. On an average each bit

of input demands dt=Xi handling time/per unit of time to reassemble in Si and each

bit of output demands dt=Yi handling time/per unit of time to reassemble in Si. I shall

þ

call σ

i ¼ dt=Xi the input-bit handling rate and σ i ¼ dt=Yi the output-bit handling

rate of Si . Clearly, on behalf of (6.22),

1 1 1

σ

i ¼ ¼ ¼ P

Z H ðXi Þ ρi Ci λi Z λj log λj

j

1 1 1

and σ þ

i ¼ ¼ ¼ P

Z H ðYi Þ ζ i Ci μi Z μj log μj

j

so that

X X

σ þ

i ρi ¼ σ i ζ i and σ i λi λj log λj ¼ σ þ

i μi μj log μj (7.8)

j j

bit of input and per bit of output, we have also the choice of dividing dt by the influx

Xi and by the outflux Yi and so to calculate the handling rate per bit of influx and

per bit of outflux. In that case each bit of influx demands a handling rate σ i ¼

1=½Z HðXi jY0 Þ to reassemble and each bit of output demands a handling rate σþ i

¼ 1=½Z HðYi jX0 Þ to reassemble. I shall call σ þ

i the influx-bit handling rate and σ i

the outflux-bit handling rate of Si . On behalf of (6.23) we obtain now

1 1

σ

i ¼ and σþ

i ¼

ρi Ci ζ i Ci

It follows that

σ ρi ¼ σþ

i i ζi (7.9)

For the two sector economy equation (7.8) assumes the form

λi QðλÞ σ þ

i ¼ μi QðμÞ σ i for N ¼ 2

180 7 Money and Liquidity, Time, Work and Effectiveness

Mark that the handling rate is the time required per unit of time to select a bit.

However, the total time to be distributed over inflow selection and outflow selection

is the same time length dt. Inflow selection and outflow selection occur simulta-

neously on ðt; t þ dtÞ. In fact it is all part of the overall selection experiment. Hence

when the selection of an input-bit is settled, the selection of an output-bit is

þ

concluded simultaneously. What then about the difference σ i σ i in handling

rates per bit between input-bits and output-bits. As the bit is our reference unit of

þ

real value, it is clear that there is a surplus σ i σ i of input-time per unit of time

over output-time per unit of time required to select a bit in the process of selection.

The relative time-gain realized per unit of time per bit during ðt; t þ dtÞ is

þ

σ

i σi

σ

i

To understand this more fully, let us write, with the help of (7.8), the rate

ci ¼ ζ i ρi of capacity growth as

ζ i ρi ρ σþ σi σþ

c i ¼ ζ i ρi ¼ ζi ¼ 1 i ζ i ¼ 1 i ζ i ¼ i

ζi

ζi ζi σi σ

i

It follows that

σi σþ

i σi σþ

i

ci ¼ ζ i ¼ ρi (7.10)

σ

i σþ

i

þ

þ

The expression on the right expresses time-gain σ i σi σ i relative to

output-bit handling time.

We see that the rate ci of capacity

growth isthe product of the output circulation

þ

rate ζ i and the relative time-gain σ

i σ i σ i per bit. Equation (7.10) can also be

stated as

σi σþ

i σi σþ

i

dCi ¼ ζ C

i i dt ¼ ρi Ci dt

σ

i σþ

i

or as

σi σþ

i σi σþ

i

dCi ¼ Yi ¼ Xi

σ

i σþ

i

Thus we conclude that the realized relative time-gain of each bit of output,

originating during ðt; t þ dtÞ, goes into the net growth dCi of capacity Ci during

ðt; t þ dtÞ. Here the unit of time acquires another meaning: the time of attention, the

7.4 The Handling Rate of Inflow and Outflow Selection and the Net Growth of. . . 181

work-time, spent to bring forth a bit of entropy per unit of time. In line with this we

must interpret capacity Ci as the stock in which all the surplus of work-time of the

sector Si has accumulated.

The explanation of the net growth rate ci of capacity Ci in (7.10) is concerned

with the net surplus of input-bit handling time over output-bit handling time

required per unit of time. We can explain the net growth d Ci of capital in quite a

similar manner, as a sort of net growth rate dCi =Ci based on expression (7.9) of

influx-bit handling rate and outflux-bit handling rate. Then the proper way of

explaining is to identify d Ci =Ci with

þ

dCi σi σþ

i ζ i dt ¼ σi σi ρi dt

¼ (7.11)

Ci σ

i σþ

i

þ

Herein σi σþ

i σi and σ

i σþi σi are the relative time-gains, respec-

tively measured relative to influx-bit handling time and relative to outflux-bit

handling time.

Equation (7.11) results in

þ

σi σþ ζ i Ci dt ¼ σi σi ρi Ci dt

dCi ¼ i

σ

i σþ

i

or as

σ

i σ þ σi σþ

dCi ¼ i

Yi ¼ i

Xi

σ

i σþ

i

Thus we conclude that the realized relative time-gain of each bit of outflux,

originating during ðt; t þ dtÞ, goes into the net growth dCi of the capital of Si during

ðt; t þ dtÞ.

I shall adhere to the following notation when denoting the various relative time-

gains.

þ þ

σ

i σi σ

i σi σ

i σ þ σ

i σ þ

η

i ¼ ; ηþ

i ¼ þ ; η

i ¼

i

; η

i ¼ þ

i

σi σi σi σi

þ

I shall call η ηi and η

i , ηi , i rates of relative time-saving. Clearly,

ci ¼ η þ η ηþ

i ζ i ¼ ηi ρi and ðd Ci =dtÞ=Ci ¼ i ζi ¼ i

ρi (7.12)

and

dCi ¼ η þ η ηþ

i Yi ¼ ηi Xi and d Ci ¼ i Yi ¼ i Xi (7.13)

182 7 Money and Liquidity, Time, Work and Effectiveness

þ

The pair of η η

i and ηi is very much related, like the pair of η

i and i :

η þ þ

i ηi ¼ ηi ηi and η ηþ

i η

i ¼ ηþ

i i

In this section I shall be concerned with the definitions of variables such as work

and effectiveness that play a role in circumscribing the role of labor and productiv-

ity of the production process. In economics employment and how employment can

be influenced by economic policy is a major issue. To deal with that issue I shall

initially define the concept of labor force in the following way:

L1 ðtÞ ¼ Labor force (also called labor), the number of employees actively

involved with delivering paid occupational labor at time t.

There are some doubts about the suitability of this definition. E.g. the definition

does not seem to weigh the role of part-time work properly. We shall not immedi-

ately go into that matter here, but later on we shall consider the issue from a more

general perspective.

The total time-effort delivered by the labor force during the production interval

(t,t þ dt) is of course proportional to the length dt of that interval. We shall call that

time-effort work or work-time:

L1 ðtÞdt ¼ Work.2

The labor force is part of the consumption sector, the conglomerate of agents of

S1 delivering work and building up reserves to maintain doing work. Thus so far the

above definitions apply to the sector S1 only. However for purposes of generaliza-

tion we will just as well consider cases with the index 1 of the consumption sector

replaced by the general index i denoting an arbitrary sector Si of the economy. That

is, Li ðtÞdt is defined as the total of work delivered by the sector Si during

the production interval (t,t þ dt). This implies there are Li ðtÞ work-producing

units in Si each delivering dt units of time-effort during (t,t þ dt). We wish to

stress here that we are primarily concerned with definitions here. The physical

nature of these work-delivering units is of no concern here at the moment. We will

discuss that subject later.

The quantity of work delivered is one aspect of economic activity; the other

aspect is the effectiveness, the productivity by which work is delivered. Thus we

must also provide for a definition of the concept of productivity.

2

I realize that the term work may call forth many different associations. Nevertheless I think it is

the best term to refer to the strict economic mathematical meaning that I have in view. It is not the

first time that science claims frequently used words of ordinary language to denote mathematical

strictly defined concepts. In physics the claims are on: energy, matter, force, power, charge, mass

and even work to mention only a few. Mathematically clear developed science needs such

restrictively defined concepts.

7.5 The Definition of Work and Effectiveness 183

input required to bring forth that output. The crux is then what orthodox theory

understands by output and what by input in this respect. The classical general idea is

that input is one of the real factors, labor or capital, of classical production

theory (See for instance Sect. 1.9). Further it is custom to identify output with

GDP, i.e. Y0 for the two-sector economy. For instance labor productivity is then the

quotient of Y0 and work L1 dt : Y0 =ðL1 dtÞ.

Since Y0 ¼ ζ 0 C0 dt, the classical definition implies that Productivity ¼ ζ 0 C0 =L1.

Then the productivity growth rate is

ζ_ 0

Productivity growthrate ¼ þ c0 l1

ζ0

I think it is a minor flaw that this formula for the productivity growth rate contains

an additional term ζ_ 0 =ζ 0 , which is the rate of change of the output circulation rate.

We might of course reason that it should be that way. The larger the circulation rate,

the faster the economic cycle moves around and the more output we get per unit of

time so that ζ_ 0 =ζ 0 should be one of the components of the productivity growth rate.

However there are very good reasons to refute that and to pursue a more systematic

line of argumentation for the definition of productivity. We shall present that

argument here below. I think it wise to avoid confusion with the classical meaning

of productivity and that is why I shall instead use the term effectiveness with the

similar intention to reflect the efficiency of production.

Let then Ei denote the effectiveness of production of the sector Si. Let us further

þ

recall the expressions (7.12) that relate the rates of relative time-saving η i , ηi ,

ηi

and ηi and the circulation rates to the rates ci and ðdCi =dtÞ=Ci of economic growth:

þ

ci ¼ η þ η ηþ

i ζ i ¼ ηi ρi and ðd Ci =dtÞ=Ci ¼ i ζi ¼ i

ρi ð7:12Þ

In Sect. 7.4 it has been explained that the rates of relative time-saving go into the

growth of capacity Ci (respectively the growth of capital of Si). E.g. ηþ

i is the relative

decrease of handling time to effectuate dCi relative to input-bit handling rate σ i .

The understanding that work-time is the determinant realizing the growth of

entropy on the production interval ðt; t þ dtÞ immediately suggests the notion that

the work-time stored in the entropy stock of Ci consists of Ci bits of entropy, that

each carries some work-units of time. However the number of these work-units

stored per bit differs dependent on the moment of time they have been added to Ci.

The entropy content per work-unit of the total stock Ci is not the equivalent of the

entropy content per work-unit of the currently [on ðt; t þ dtÞ] created “stock” dCi of

work-units. The reason is that the manner entropy is produced currently is more (or

less) effective than it was done yesterday. Hence, by definition,

Ci ¼ Ei Li (7.14)

184 7 Money and Liquidity, Time, Work and Effectiveness

number of work-units stored in the stock Ci of capacity. The number of work-units

stored per bit is Li =Ci ¼ 1=Ei. The more effective production is, the less work-units

stored per bit. Clearly Li is the total stock of work-units stored in Si .

It follows from (7.14) that

ci ¼ ei þ li (7.15)

Thus we see that economic growth can be made to increase in two alternative

ways:

1. By increasing effort through the rise of the work force Li effectuating a growth

rate li .

2. By increasing the efficiency of production through the rise of effectiveness Ei

effectuating a growth rate ei .

Note the differences between the general definition (7.14) of effectiveness and

the classical definition of productivity given by E1 ¼ ζ 0 C0 =L1. The factor ζ 0 has yet

to be omitted from the classical definition and C0 has to be replaced by C1 .

Well let us now revert to the question what actually Li stands for. The answer

begins with the critical aspects of the initially chosen definition L1 of the labor force:

the number of employees actively involved with delivering paid occupational labor

at time t.

The argumentation given in Sect. 7.4 clarifies that work-time per bit is the

equivalent of the time it takes per bit to effectuate the entropy growth as a result

of the overall selection process. This is the time during which the agents

involved attend the selection process. It appears then that the best measure of

work-time or work L1 dt is the number of hours actively worked by the labor

force during ðt; t þ dtÞ. Thus if we know the average number of hours employees

work per week, we must replace the calculation of work by the product of L1 dt and

the average number of hours per week employees are on duty, divided by the

constant number of 168 h that go in a week. Well instead of correcting the

calculation of work in that manner, I prefer to correct the calculation of L1 by

replacing it by the product of the labor force and the average numbers of hours per

week employees are on duty, divided by the constant number of 168 h that go in a

week. Thus we have a new definition of labor L1 rather than another definition of

work L1 dt.

We must next deal with providing a more concrete notion of the Li work-

delivering units of Si for i 6¼ 1, i.e. for effort delivered by sectors other than the

consumption sector S1 . The same question, restricted to the investment sector with

i ¼ 2 , is also an issue of classical economic theory. The neoclassical claim on

capital represents in fact the physical expression of all the production units of the

investment sector. For the investment sector S2 of the two-sector economy we might

identify L2 with an active stock of entrepreneurial production units capable of

delivering L2 dt time like units of effort such that C2 ¼ E2 L2 : Herein C2 is

entrepreneurial capacity and E2 is entrepreneurial effectiveness in accordance

7.5 The Definition of Work and Effectiveness 185

with (7.14). Well, despite the actual economic existence of factories, workshops,

retail shops, office buildings, assurance agencies, car dealers, building contractors,

showrooms, etcetera, etcetera, it is quite impossible to delimit the physical contours

of a uniform unit of entropy production within the investment sector. To approach

the problem from this side leads nowhere. The solution must be sought in what the

essence of entropy is. Before following that line of explanation, let me first give a

more classical answer.

Note that the sector S1 delivers L1 dt work-units during ðt; t þ dtÞ representing a

value of PL1 E1 dt money units. Similarly the sector S2 delivers L2 dt work-units

during ðt; t þ dtÞ representing a value of PL2 E2 dt money units.

However, if S2 would instead deliver the number L1 dt of work-units delivered

by S1 during ðt; t þ dtÞ, it would represent a value of PL1 E2 dt money units. If

PL1 E1 dt is smaller than PL1 E2 dt, there will be a natural tendency to replace labor

work-units immediately by entrepreneurial work-units. Or to put it in more

classical terms: then there will be a permanent natural tendency to substitute labor

for more advanced production technology. This implies that any disequilibrium be-

tween PL1 E2 dt and PL1 E1 dt cannot subsist. It is necessary that PL1 E2 dt ¼ PL1 E1 dt

and hence that E1 ¼ E2 or more generally that effectiveness cannot depend on

the state i:

Ei ¼ E (7.16)

sector at issue. Well, the weakness of this argument is in the presupposition that a

work-unit delivered by S2 is the economic equivalent of a work-unit delivered by S1.

Indeed it is. But the argument does not settle that. Apart from this consideration it

presupposes an intelligent collective of economic agents to exist with sufficient

information, insight and foresight to arrange equilibrium of E1 and E2 . One thing

must be clear at this stage of my exposition, such economic reasoning can no longer

be accepted.

A much better fundamental reason for (7.16) is that bits of entropy must be

everywhere similar in the economy as a matter of selection requirements. They

cannot differ in effectiveness, because then they cannot serve as equivalent units of

selection. In fact, here the same argument applies as given before to explain the

common unit price P of all bits of entropy (See Sects. 2.5, 3.4, 3.5, 3.6).

The crux of the argument is as follows: Any bit that has an effectiveness

different from all the other bits will be selected with a state probability π other

than 12 and as such its entropy will be log π, which must then differ from 1. Hence

that bit with state probability π represents no longer one single bit of entropy, but

more or less than that. This is a contradiction and therefore effectiveness cannot

differ dependent on state.

The equivalence of sector efficiency does not imply that efficiency is a constant

in the course of time or that capacity Ci is a constant multiple of Li or that all Ci are

186 7 Money and Liquidity, Time, Work and Effectiveness

equal as well. Efficiency is a stochastic function of time and keeps changing all the

time, just like Ci and Li .

Let us finally summarize the general definitions associated with work and

effectiveness of a sector Si :

Work-unit ¼ The effort delivered by an actively engaged unit of the work-force

per unit of time.

Li ¼ Work Force ¼ The number of work-units actively delivering work at time t.

Li dt ¼ Work, the work-time delivered by the work-force during ðt; t þ dtÞ.

E ¼ Ci =Li ¼ Effectiveness ¼ The productivity of delivering work.

The labor force L1 of an economy can be measured independently. Thus, if we

get an estimate of c1 from the study and analysis of the other variables of

the economy, we can calculate the rate of growth e of effectiveness. Then further,

if we get likewise knowledge of the various ci other than c1 from the study

and analysis of the other variables of the economy, we can calculate all the li

including l2 without bothering about the physical aspects of these entropy

producing units of sectors other than the consumption sector.

Additional to the variables of labor force L1 and effectiveness E, some other

variables play a role in the economics of employment and labor:

W1 ¼ Money Wage per work-unit, the average wage earned per work-unit of the

work force per unit of time elapsing.

_

L1 dt ¼ L1 W1 dt ¼ Money Wages, the total of money wages earned by the work

force during the production interval ðt; t þ dtÞ.

On the other hand money wages are also equal to PX1 ¼ PZdt H ðX1 jY0 Þ. Hence,

PX1 ¼

ρ1 C1 Pdt ¼ L1 W1 dt and

ρ1 C 1 P ¼ L 1 W 1

It follows that

_ ρ_ 1

_

p þ x1 ¼ l1 þ w1 ¼ l 1 and þ c1 þ p ¼ l1 þ w1 ¼ l 1 (7.17)

1

ρ

The first equation of (7.17) delivers a handsome way to calculate the rate of

_

growth x1 of labor influx (real wages) from the knowledge of the rate of growth l 1

of money wages and the rate of inflation p.

w1 p ¼ x1 l1 ¼ ρ_ 1 =

ρ1 þ c1 l1 is the rise of the wage per work-unit over

the rate of price inflation. In the long run the rate ρ_ 1 =ρ1 averages out.

From (7.15), (7.16) and (7.17) it follows that

ρ_ 1

w1 ¼ þeþp (7.18)

1

ρ

Chapter 8

Calculation

work of selection have revealed quite a number of relationships between the many

dynamic variables of an economy. Evolvodynamics explains a variety of economic

phenomena. In this study the impact is discussed only in a qualitative manner

although the theory is typically quantitative. Eventually quantitative confirmation

is the coping-stone of any scientific theory and so it is for evolvodynamics.

Measurements demand a definitional framework of variables that must be the

subject of those measurements and it is this for which evolvodynamics provides

the basis. The measurements often require sophisticated schemes of calculation.

These calculations are the touchstone of theory. All calculation schemes must be

based on derived evolvodynamics equations. It is not the other way around that

measurements determine how variables are defined.

Economic measurements are difficult to collect. Measurements of sufficient

accuracy can often only be obtained by intricate and laborious schemes of calcula-

tion. In this chapter I consider various calculation schemes, embedded in the

evolvodynamic framework.

Compartmentalization of entropy sets and of differential entropy sets is one of

the tools that may be used for calculation purposes.

Anonymous

The question that concerns us here is the measurement of the unit prices and their

rates of change. Thus far we have become acquainted with the unit price P of a bit

of entropy and its relative rate of change pðtÞ ¼ ðdP=dtÞ=PðtÞ per unit of time,

which is also called a rate of (price) inflation.

Lecture Notes in Economics and Mathematical Systems 665,

DOI 10.1007/978-3-642-34056-7_8, # Springer-Verlag Berlin Heidelberg 2013

188 8 Calculation

inflation. The current practice is primarily concerned with postulating practical

and workable formulas of price index calculation. By comparing the outcomes of

the different methods of price index calculation one gets an idea of the differences

of the various methods without knowing which is closest to the theoretically correct

one because traditional economic theory ignores to derive what the latter should be.

This is a dissatisfactory situation and therefore I set myself here to derive the

theoretically correct formulas of price index calculation. Once derived we have a

reference basis for studying the performance of various practical methods of price

index calculation such as Laspeyres’ index formula, Paasche’s index method,

Fisher’s index method and the Törnqvist index formula to mention only a few.

Let me sketch the contours of a theoretical basis for unit price calculation. Let Kj

ðj ¼ 0; 1; 2, 3 Þ be the number of categories of identical economic entities with

the same unit price Pj ðj ¼ 1; 2, 3, Þ stored in a sector Sj of a warehouse.

P The total

value of all the economic entities stored in warehouse is j Kj P j : Another

warehouse storing K0 hypothetical economic entities of unit price P0 stocks the

same aggregate money value if

X

K0 ðtÞP0 ðtÞ ¼ Kj ðtÞPj ðtÞ for all time t (8.1)

j

As there is equivalence of both sides of the equation all the time, we might call P0

the average unit price of all the entities stored in warehouse. However, there

is ambiguity in fixing K0 and P0 separately if only the product K0 P0 is known.

E.g. K00 ¼ 10 K0 with P00 ¼ P0 =10 will do equally well. Well, this is solvable as the

choice of a unit of dimension is free. Thus we can fix P0 at a constant at a particular

time. However there is still another problem with the application of (8.1), because it

does not work for non-differential sectors Sj. Presuming that Sj is non-differential, the

difficulty is that the economic entities of category j in stock of Sj at current time t have

accumulated in the past for varying unit prices dependent on the variable times for

which they have been acquired. The reason is that Pj varies in the course of time.

Recall that almost all of the stock of non-differential sets remains unselected during

ðt; t þ dtÞ. Price formation at time t will only be affected at the moments agents select,

i.e. within the differential sets of entropy creation and entropy annihilation rather than

within non-differential sets. Hence (8.1) must be rejected if the subsets Sj are non-

differential.

We can still apply (8.1) for price index calculation provided the subsets Sj are

differential. Recall that the entropy in the economy is accumulating from the

surplus of entropy output over entropy input. PðtÞ is the unit price per bit of this

surplus and we can use that property to calculate the average unit price of output

and input from the unit prices of the constituents of the output flow and of the input

flow during a very small time-interval ðt; t þ dtÞ on which time comes to a standstill.

P is an average price that is constant to first order degree of accuracy in dt during the

time-interval ðt; t þ dtÞ of selection. Hence let us then calculate P as an average of

8.1 Divisia’s Index Formulas for Output Calculation 189

the unit prices of all equally priced constituent portions of economic entities on

which the individual agents spend their money in dSþ dS during ðt; t þ dtÞ.1 Let

i 0

then Yi be the number of equally priced entities of unit price Pj that agents spend on

entities of the category j in dSþ

i dS0 during (t,t þ dt). It follows in accordance with

(8.1) that

X

Yi P ¼ Yij Pj (8.2)

j

Herein Yi is the joint entropy outflux of Si. We shall denote the subsector of Si in

which only the economic entities of category j are stocked by Sij. The subdivision of

Si in Sij as well as the subdivision of dSþ þ

i dS0 in dSij dS0 we shall call

compartmentalization. Mark Yij is “stocked” in dSij dS0 .

þ

As regards (8.2) we encounter the same ambiguity problem in fixing Yi and P

separately if only the product Yi P is known. We can however proceed with

differentiating left and right side of (8.2) to time t as (8.2) holds for all time t.

This results in

X

ðyi þ pÞ Yi P ¼ yij þ pj Yij Pj (8.3)

j

Appendix I,

yi ¼ ; p ¼ ;

y ¼ ; pj ¼

Yi P ij

Yij Pj

Mark that Yi P is the joint money outflux of the sector Si of the economy. It

includes here the outflux of Si only. Also note that Yij Pj is the money spent on

entities of the category j within the sector Si of the economy. Let us here adhere to

_ _

the notation Yij Pj ¼ Y ij and Yi P ¼ Y i so that we can restate (8.3) as

_ _

X Y ij X Y ij

yi þ p ¼ yi j _

þ pj _

(8.4)

j Yi j Yi

_

._

The quotients Y ij Y i are measurable quantities. They are often called the budget

index factors. We will denote them by fþ : ij

1

Mark that financial entropy is not part of the collection of economic entities. E.g. interest on

mortgage has an entropy content but it lacks a quantity content like books and cars have. Thus only

the contents of conditional differential sets are suitable for price and quantity index calculation.

190 8 Calculation

_

Y ij

fijþ ¼ _ (8.5)

Yi

X X

yi þ p ¼ yij fijþ þ pj fijþ (8.6)

j j

In the left side of (8.6) we encounter the sum of two terms: the relative rate of

quantity change yi and the relative rate of average price change p. Likewise we have

P

on the right side a quantity rate change component ij fijþ and a price rate

jy

P P

þ þ

change component j pj fij . It is tempting to equate p and j pj fij . Then

X X

yi ¼ yij fijþ and p ¼ pj fijþ (8.7)

j j

Equations (8.7) give us the means to calculate yi and p from the constituents yij

and pj. It presents two separate expressions for quantity index calculation and price

index calculation. These equations are known as Divisia’s quantity index and price

index formulas.

Divisia refrained from presenting a general proof of his quantity index and price

index formulas. When stating expression (8.7) the first expression of (8.7) was

justified by demanding the average relative price-level change p to vanish should all

pj vanish in (8.6). Similarly, the second expression of (8.7) was justified by

demanding the average relative quantity change yi to vanish should all yij vanish

in (8.6).

Indeed, under these restrictions (8.7) follows from (8.6). However, this argument

fails to establish a universal proof, because (8.7) has not been demonstrated to hold

also in situations were not all pj or all yij to vanish.

The correct argument for inferring (8.7) is as follows.

_

Let us express Y i , Yi and P in (8.2) as dependent variables of time:

_

Y i ðt þ dtÞ ¼ Yi ðt þ dtÞ Pðt þ dtÞ

Herein Yi ðt þ dtÞ is the number of outflux bitpulses originating in dSþ

i j dS0

during the time-interval (t,t þ dt). Pðt þ dtÞ is the average unit price of these

_

bitpulses. Y i ðt þ dtÞ is their money value. Likewise

_

Y i ðtÞ ¼ Yi ðtÞ PðtÞ

8.1 Divisia’s Index Formulas for Output Calculation 191

Yi ðtÞ is the number of outflux bitpulses originating during the time-interval

_

ðt dt; tÞ. PðtÞ is the average unit price of these bitpulses. Y i ðtÞ is their money value.

Clearly, the set of Yi ðt þ dtÞ outflux bitpulses originating on (t,t þ dt) is different

from the set of Yi ðtÞ outflux bitpulses originating on ðt dt; tÞ . Hence the

_

money value Y i ðt þ dtÞ, observed at time t þ dt, is the money value of a different

number Yi ðt þ dtÞ of bitpulses than the number of bitpulses associated with money

_

value Y i ðtÞ, observed at time t. The same number Yi ðtÞ would cost a money value of

Yi ðtÞ Pðt þ dtÞ at time t þ dt. The difference of Yi ðtÞ Pðt þ dtÞ and Yi ðtÞ PðtÞ is

then the rise of non-financial spending due to price change only. Thus

Yi ðtÞ Pðt þ dtÞ Yi ðtÞ PðtÞ ¼ Yi ðtÞ dPðtÞ

¼ The rise of non-financial spending due to price change only on (t,t þ dt).

_

The same argument applies to the money valueY ij ðt þ dtÞ ¼ Yij ðt þ dtÞ Pj ðt þ dtÞ,

spent on Yij ðt þ dtÞ outflux entities of the category j during (t,t þ dt) and the money

_

value Y ij ðtÞ ¼ Yij ðtÞ Pj ðtÞ, spent on Yij ðtÞ outflux entities of the same category j

during ðt dt; tÞ. That is

Yij ðtÞ Pij ðt þ dtÞ Yij ðtÞ Pj ðtÞ ¼ Yij ðtÞ dPj ðtÞ

due to price change only on (t,t þ dt)2

It follows that

X

Yi ðtÞ dPðtÞ ¼ Yij ðtÞ dPj ðtÞ

j

resulting in

X

pðtÞ ¼ fij ðtÞ pj ðtÞ

j

2

The application of this formula is correct for consumer commodities because consumption goods

and services represent only finished goods of which the relative change of unit prices is generally

known. This is different for the complete range of goods and services produced by the investment

sector. This contains also intermediate firm to firm deliveries of which the relative change of the

unit prices is difficult to determine.

192 8 Calculation

This completes the proof of Divisia’s price index formula of (8.7). The proof of

Divisia’s quantity index formula of (8.7) follows from the latter and expression

(8.6).3 □

A disadvantage of the Divisia price-index formula (8.7) is that it requires

continual updating of the budget basket and for that reason it is difficult to

implement in statistical routine calculations. Collecting appropriate budget data is

a time consuming occupation. To make the effort controllable, more practical

schemes have been devised to implement (8.7). Among these the Laspeyres’

index formula, Paasche’s index method, Fisher’s index method and Törnqvist

index formula are quite common. They should be put to the test by comparing

them analytically with Divisia’s index formulas. This is a subject we shall not

consider here.

Since it is impossible to measure output, outflux, input and influx over time-

intervals of infinitesimally small time-length dt, the first practical adjustment is the

numerical approximation of instantaneous output, outflux, input and influx by

measurements over finite time-intervals, e.g. monthly or quarterly.4 This is the

first source of inaccuracy of price and quantity index calculations. The relative error

(and bias) will depend on the statistical properties of the time-series of outflux and

influx (among these properties the frequency spectrum is the most important).

Much research has still to be done in this direction.

For price and quantity calculations in the investment sector Divisia’s price and

quantity index formulas are less suited. The price and quantity index formulas can

best be applied in the consumption sector S1 . To that end we must approximate

Divisia’s formulas by practical schemes.

Most common for calculating the consumer price index (CPI) is Laspeyres’

method. This method treats the budget index factors fiþj in the Divisia price-index

formula as constants. In actual practice the budget basket is periodically determined

by budget research studies extending over one particular year of consumer spend-

ing. Once determined the budget basket remains fixed for several years to come and

will only be revised after consumption patterns and habits have changed so much

that it must be updated in order to remain applicable. The set of budget factors will

therefore be revised once in about 5–6 years. The current intention is to revise the

consumption basket more frequently since modern consumption patterns tend to

change faster and computer technology constantly opens more possibilities to attain

3

Divisia’s index formulas are the only equations of orthodox economic theory that hold exactly,

although the proof here stated for Divisia’s index formula is not part of the orthodox legacy. The

validity of definitional equations of orthodox economic theory such as Y ¼ C þ I does not rest on

a derivation, but on common consent.

4

This is a common practical problem facing all differential quotients in the sciences. E.g. in

physics the measurement of instantaneous velocity v ¼ ds/dt, in which s represents distance and

t time as usual, is confronted with the same difficulties for ds and dt tending to zero. Accuracy of

measurements and observation is always limited irrespective of the domain of investigation. To

tackle the matter we need the powerful techniques of numerical analysis, which is not the subject

of the present treatise.

8.2 Compartmentalization and Influx Calculation 193

that. Another intention is to adjust the set of consumption budget factors each year

in accordance with the consumption pattern over the last period of 2–3 years. The

assumed constancy of the budget-index factors introduces an error-term in the

calculation of the rate of inflation.

Laspeyres’ method is widely used to calculate the rate of inflation of consump-

tion. It appears that it warrants the least error and bias because it is closest to

Divisia’s theoretical index formulas.

We will here not dive into the details of the pros and cons of the various methods

of price index calculation. The problem is one of econometrics. It appears that still

much can be done to improve the accuracy.

In the preceding section we have dealt with deriving Divisia’s index formulas of

which approximations have historically been successfully implemented and applied

to labor output (consumption). In principle Divisia’s scheme of index calculation is

applicable to other processes of economic flow: influx, input and output. However,

there are some serious practical limitations. Like Divisia’s formulas are difficult to

implement for the outflux Y2 of the investment sector, the obstacles that beset

the

implementation of Divisia-like index formulas for influx Xi ¼ Zdt H dS þ

i dS0

are often not less difficult to overcome than for entrepreneurial outflux. Like for

outflux Y2 , the great difficulty is to establish a reliable and practical scheme of

compartmentalization.

Fortunately, compartmentalization for labor influx (wages) X1 appears to be

within reach. As it helps to understand the mechanism of index calculation,

þ I shall

therefore sketch how this can be done for the influx Xi ¼ Zdt H dSi dS0 of the

sector Si .

To that end we shall first devise a general scheme of compartmentalization. All

forms of compartmentalization have in common that they divide up the non-

differential sector Si in non-differential subsectors Sij which do not overlap one

another. We have

[

Si ¼ Sij

j

compartmentalized. In this respect we discern between four different kinds of

compartmentalization:

1. The division of the differential set dSþ i in non-overlapping differential subsets

P

dSþ

ij . In this case Yij is the output of Sij with Yi ¼ j Yij .

2. The division of the differential set dS i in non-overlapping

P differential subsets

dS

ij . In this case X ij is the input of S ij with X i ¼ X

j ij .

194 8 Calculation

3. The division of the differential set dSþ

i dS0 in non-overlapping differential

P

subsets dSþ

ij dS0 . In this case Y ij is the outflux of Sij with Y i ¼ j Y ij .

þ

4. The division of the differential set dSi dS0 in non-overlapping differential

þ P

subsets dS

ij dS0 . In this case X ij is the influx of Sij with X i ¼ j X ij .

[ [ [ [

þ þ þ

dSþ

i ¼ Sþ

i j ; dSi ¼ S

i j , dSi dS0 ¼ Sþ

i j dS0 ; dSi dS0 ¼ S

i j dS0

j j j j

Pj ðtÞ is the average unit price of entropy within Si j at time t. This will generally

differ from the average unit price PðtÞ of entropy within Si. We introduce further Cij

and Cij to denote the capacity, respectively the capital, stocked in Sij .

The compartmentalization dealt with in Sect. 8.1 is a typical example of the third

kind of compartmentalization. þ

In the present section we shall deal with compartmentalization of dS dS in

þ

i 0

dSij dS0 such that Xi j is the influx of Sij. This is the fourth kind of compartmentali-

zation listed above and for i ¼ 1 it deals here with labor and wages. However,

although we shall do so in the sequel, we need not delimit the discussion to the case

i ¼ 1 only.

We have in the general case:

_ X_ X X

Li dt ¼ Li Wi dt ¼ Xi P ¼ Lij dt ¼ Lij Wij dt ¼ Xij Pj (8.8)

j j j

With i ¼ 1, PX1 is the total of money wages within the economy. Pj X1j is the total

of money wages within dS þ

1j dS0 . The basal idea is that generally the quotients, the

weighing factors

_

Pj Xij Lij

fij ¼ ¼ _ (8.9)

PX 1 Li

are measurable quantities and are fairly well to measure independently in the course

of time. Moreover it is assumed that the price inflation rates pj of the subsets Sij can

be measured with sufficient accuracy. After differentiating left and right side of

(8.8) to time t we obtain

X X

xi þ p ¼ xij fij þ pj fij

j j

8.2 Compartmentalization and Influx Calculation 195

X X

xi ¼ xij fij and p ¼ pj fij (8.10)

j j

Thus for i ¼ 1 this delivers a rather roundabout way to calculate xi from its

compartmentalized portions xij as well as another manner to determine the inflation

rate p. The relationship p þ x1 ¼ l1 þ w1 of (7.17) suggests to substitute l1 for x1, w1

for p in (8.10) and introduce the labor force L1j employed in S1j for X1j and the money

wage W1j dt earned per employee in S1j during (t,t + dt) for Pj in (7.17). Then for

i ¼ 1 (8.10) would transform into

X X

l1 ¼ l1j f1j and w1 ¼ w1j f1j (8.11)

j j

_ _

As PX1 ¼ W1 L1 dt ¼ L1 dt and Pj X1j ¼ W1j L1j dt ¼ L1j dt, we have

_ _

f1j ¼ Pj X1j =ðPX1 Þ ¼ W1j L1j =ðW1 L1 Þ ¼ L 1j L 1 (8.12)

confirming (8.9).

Well the crux is: Is (8.11) correct? Let us analyze this in much more detail in the

_

way we derived (8.7) in Sect. 8.1. With L1 dt ¼ L1 W1 dt being the total of money

wages earned within dS þ

1 dS0 during (t,t þ dt) we notice that

_ X

L1 dt ¼ L1 W1 dt ¼ L1j W1j dt (8.13)

j

_

Let us further express L1, L1 and W1 in (8.13) as dependent variables of time. We

have

_ _

L1 ðtÞ ¼ L1 ðtÞW1 ðtÞ and L1 ðt þ dtÞ ¼ L1 ðt þ dtÞW1 ðt þ dtÞ

1 of work-units

at time t. L1 ðtÞdt is the work exerted

during the time-interval t 2dt; t þ 2dt . W1 ðtÞ the average unit cost per unit of

1

_

time of this labor time-interval. L1 ðtÞdt is the money value of wages

effort over that

earned during t 12dt; t þ 12dt .

L1 ðt þ dtÞ is the average number of work-units

t þ dt. L1 ðt þ dtÞdt is the

at time

work exerted during the time-interval t þ 2dt; t þ 2dt . W1 ðt þ dtÞ is the average

1 3

_

unit cost per unit of time of this labor effort

over that time-interval.

L1 ðt þ dtÞdt is

the money value of wages earned during t þ 12dt; t þ 32dt .

196 8 Calculation

L1 ðtÞW1 ðt þ dtÞ per unit of time at time t þ dt. The difference of L1 ðtÞW1 ðt þ dtÞdt

and L1 ðtÞW1 ðtÞdt is then suggested to represent the rise of wages over (t,t þ dt)

due to an increase of the money wage per work-unit only. Thus

þ

¼ The rise of money wages in dS

1 dS0 due to the change of money wage per

work-unit only on (t,t þ dt).

Similarly,

þ

¼ The rise of money wages in dS

1j dS0 due to the change of money wage per

work-unit only on (t,t þ dt).

P

Well, does this result in L1 ðtÞdW1 ðtÞ ¼ j L1j ðtÞdW1j ðtÞ?

It definitely does not. What we forgot to take into account is that the effective-

ness is altering over a time-interval of length dt as well. An increase of effectiveness

enables to produce more outflow or to use less inflow in the course of time. The

work-force L1 is not a measure of an entropy stock and therefore L1 dt is not an

P

inflow of entropy during ðt; t þ dtÞ . Instead in Xi ðtÞdPðtÞ ¼ j Xij ðtÞdPj ðtÞ the

influx Xi is entropy inflow.

Recall that p þ x1 ¼ l1 þ w1 . This can be compartmentalized to hold for each

differential subset dS þ

1j dS0 . That is,

_

pj þ x1j ¼ l1j þ w1j ¼ l 1j

Herein pj is the inflation rate of the average unit price for which the influx X1j can

be produced. From (8.10) we obtain

X X

x1 ¼ l1j þ w1j pj f1j and p ¼ l1 þ w1 x1 ¼ pj f1j

j j

_

Mark that l 1 ¼ x1 þ p so that the first equation can be restated as

_ X X_

l1 ¼ l1j þ w1j f1j ¼ l 1j f1j (8.14)

j j

Note the subtle difference between (8.14) and the incorrect (8.11). The

coefficients f1j represent the relative weight of the wages by definition of (8.9)

and (8.12). Differentiation of (8.8) to time yields

_ _ X_ _

l 1 L1 ¼ l 1j L1j

j

8.3 Aggregation Properties of Capacity and Capital 197

_

Subsequent division by L1 yields (8.14). The relative rate e of effectiveness

growth is easy to calculate from the knowledge of w1 and p [consult (7.18) for help:

if there is additional knowledge about ρ_ 1 =

ρ1 ]. With the knowledge of the rate e of

effectiveness growth we can find x1 as the sum of l1 and e.

Equation (8.10) gives a correct scheme of index calculation of x1, but it is not the

most practical to calculate x1 . We have only used it to explain the theoretical

background of index calculation. Of course a more practical scheme for the

calculation of x1 is furnished by (7.17):

_

x1 ¼ l 1 p

Once we know x1 we have a basis to calculate X1 and, if we know Y1 as well, we

can also calculate dC1 .

section. Let dSþ þ

i j represent the compartmentalized subset of dSi . And let dSi j

represent the compartmentalized subset of dSi . Recall that Yij is the output of the

subset Sij and that Xij is the input of the subset Sij . Let further Cij be the capacity

stocked in subset Sij and Pj be the average price level of Sij . The following

aggregation formulas hold for money output and money input:

X X

Yi P ¼ Yij Pj and Xi P ¼ Xij Pj (8.15)

j j

X X

Yi dP þ P dYi ¼ Yij dPj þ Pj dYij

j j

X X

Xi dP þ P dXi ¼ Xij dPj þ Pj dXij

j j

X X

ðYi Xi Þ dP þ P dðYi Xi Þ ¼ Yij Xij dPj þ Pj d Yij Xij

j j

198 8 Calculation

The insertion of dCi for Yi Xi and dCij for Yij Xij delivers

X X

dCi dP þ P d2 Ci ¼ dCij dPj þ Pj d2 Cij

j j

X

d ðPdCi Þ ¼ d Pj dCij

j

Integration yields

X

PdCi ¼ Pj dCij (8.16)

j

must vanish because for vanishing dCij, the left side should vanish as well. Also for

P

P ¼ Pj , it is necessary that dCi ¼ j dCij and this can only be realized if the

constant vanishes.

PdCi in (8.16) is the money value of the net increase of capacity Ci . Expression

(8.16) provides for an additional index calculation formula:

X X

PdCi ¼ Pj dCij and PðYi Xi Þ ¼ Pj Yij Xij

j j

It might help to calculate dCi assuming that the data of Yij Xij , Pj and P are

available.

In the above we have derived the aggregation formulas for capacity. We may

follow the same approach for capital Ci with Yij representing the outflux of the

subset Sij and Xij the influx of the subset Sij. Let further dCij be the growth of capital

Cij stocked in subset Sij : The aggregation formulas for money outflux and money

influx are:

X X

Yi P ¼ Y Pj and Xi P ¼

j ij j

Xij Pj

Differentiation yields

X X

Yi dP þ Pd Yi ¼ Yij dPj þ Pj dYij

j j

X X

and Xi dP þ PdXi ¼ Xij dPj þ Pj dXij

j j

8.4 The Calculation of the Macro Variables of the Economy 199

X X

ðYi Xi Þ dP þ P d ðYi Xi Þ ¼ Yij Xij dPj þ Pj d Yij Xij

j j

The insertion of d Ci for Yi Xi and d Cij for Yij Xij delivers

X X

dCi dP þ P d2 Ci ¼ dCij dPj þ Pj d2 Cij

j j

X

dðPd Ci Þ ¼ d Pj d Cij

j

X

Pd Ci ¼ Pj d Cij

j

Let us recall the first equation of (7.13) dealing with the relationship between the

growth dCi of sector capacity and the relative saving of work-time:

dCi ¼ η

i Yi (8.17)

In (8.17) η0 s are rates of relative time-saving. This equation lends itself for

compartmentalization.

S That is, Si will be divided in separate small subsectors Sij

ð j Sij ¼ Si Þ that serve as entropy producing units with money input Pj Xij and

^

money output Pj Yij . Let us introduce the notation Xij ¼ Pj Xij for money input and

^

Y ij ¼ Pj Yij for money output of Sij . It follows that

^ X^ ^ X^

Xi ¼ Xij and Y i ¼ Y ij

j j

Each of the production units Sij produces its own contribution dCij to dCi in

accordance with

200 8 Calculation

dCij ¼ η þ

ij ζ ij Cij dt ¼ ηij ρij Cij dt (8.18)

þ

η

ij and ηij are the rates of relative time-saving of the subsector Sij . Further ρij

denotes the input circulation rate of Sij and ζ ij denotes the output circulation rate of

Sij .

Then, with Xij ¼ ρij Cij dt and Yij ¼ ζ ij Cij dt, we can restate (8.18) as

dCij ¼ η þ

ij Yij ¼ ηij Xij (8.19)

P

Mark that dCi ¼

6 j dCij because the unit prices of entropy of the subsets Sij differ

from one another. To arrive at variables that can be aggregated directly, we must

first multiply by the unit prices. The multiplication of (8.17) by its average price

^

level P results in PdCi ¼ η

i Y i and the multiplication of (8.19) by its average price

^

level Pj results in Pj dCij ¼ η

ij Y ij . P

Then, on behalf of (8.16), PdCi ¼ Pj dCij . Hence it must follow that

j

^ X ^

η

i Yi ¼ η

ij Y ij (8.20)

j

Herein

σ

ij σ ij Yij Xij σ

ij σ ij Yij Xij

η

ij ¼ ¼ and η þ

ij ¼ þ ¼

σ

i Yij σ ij Xij

þ

σ

ij and σ ij represent the input-bit handling rate, respectively the output-bit

þ

handling rate of Sij . They satisfy the equation σ

ij ρij ¼ σ ij ζ ij .

Equation (8.20) can be restated in the form:

^

X Yij

η

i ¼ η þ

i j fij with fijþ ¼ ^

(8.21)

j Yi

^

.^

In this equation the weighing factors fijþ ¼ Y ij Y i should not be confused with

the budget index factors fþ of (8.5). The coefficients f þ represent measurable

ij ij

quotients of money output rather than quotients of outflux. The scheme of (8.21)

requires another compartmentalization scheme. The focus is on the calculation of

η

i for which we need to know the rates ηi j of relative time-saving in the course of

production within Si j during ðt; t þ dtÞ. To do that separately for the production

of consumption ði ¼ 1Þ and the production of investment ði ¼ 2Þ is difficult if not

8.4 The Calculation of the Macro Variables of the Economy 201

nomic production in S0 ði ¼ 0Þ. In that case S0 is compartmentalized in subsets S0j .

The difficulties concentrate on the measurement of the rates η0 j . Mark that

η

0j ¼ ¼ ¼

Y0j Y0j Pj Y0j

To calculate this coefficient we must know the total money value added Pj Y0j of

the subsector S0j as well as its net money result Pj dC0j, the surplus of money output

over money input, which is the most difficult to determine sufficiently accurate.

The index formula (8.21) is not intended to include the entire collection of

subsectors S0j that together form the economy S0 . But it should include a represen-

tative collection of sample subsets S0j of the economy S0 large enough to average out

the errors in the determination of the coefficients η0 j, especially those due to errors

and bias in the measurement of the money results Pj dC0j .

η

Instead of calculatingP 0 by employing

P the index formula (8.21), we could just as

well calculate the totals j Pj Y0j and j Pj dC0j directly from the available samples

of S0j :

P

j Pj Y0j

η ¼P

0

j Pj dC0j

QðμÞ QðλÞ

η

0 ¼

QðμÞ

Further if we know also Y0 , (7.13) may be used to calculate dC0 ¼ η 0 Y0 .

Let us summarize our knowledge position of the two-sector macro-economy as

follows:

We suppose that we are in possession of sufficiently accurate measurements of

money consumption PY1, joint money output PY0 and money wages PX1. Thus also

money investment PY2 ¼ PY0 PY1 and μ ¼ Y1 =Y0 can be calculated.

Further we get from index calculation by (8.7) measurements of the variables p;

P, y1 and Y1 .

Let us further assume that η 0 has also been calculated so that we can calculate λ

from η 0 and μ with the help of

QðμÞ QðλÞ

η

0 ¼

QðμÞ

202 8 Calculation

Now that we have calculated λ we can calculate PX0 ¼ PX1 =λ and PX2 as the

difference of PX0 and PX1 .

Next we find PY0 from PY0 ¼ PY1 =μ and further PY2 as the difference of PY0 and

PY1 .

As P has already been calculated we can get all the entropy flows Xi, Xi, Yi and Yi

by dividing the corresponding money flows by P.

Net capacity growths dC0 , dC1 and dC2 follow from dCi ¼ Yi Xi . This will

assist us to calculate C0 , C1 and C2 as well as the growth rates c0 , c1 and c2 in the

course of time.

Also the financial influxes p

1 C1 dt , p

2 C2 dt , and p 0 C0 dt and the financial

þ þ þ

outfluxes p1 C1 dt, p2 C2 dt, and p0 C0 dt can now be calculated with the help of

p þ

i Ci dt ¼ Xi X i and p i Ci dt ¼ Yi Y i

þ þ

This in the knowledge of p1 , p2 , p1 , p2 and in the knowledge of

þ results

γ¼ p ¼ p . Then dCi follows from

0 0

Further H ðX0 Þ ¼ λ log λ ð1 λÞ logð1 λÞ and H ðY0 Þ ¼ μ log μ ð1 μÞ

logð1 μÞ can be calculated knowing λ and μ. Then Zdt follows from

X0 Y0

Zdt ¼ ¼

H ð X 0 Þ H ð Y0 Þ

1 1

qij log qij ¼ H ðXi Þ þ H Yj qij HðX0 \ Y0 Þði; j ¼ 1,2,3, ,NÞ (4.8)

N N

8.5 An Alternative Route to Calculate the Macro-Variables of the Economy 203

2H ðX1 jY0 Þ þ HðY0 Þ ¼ 2q11 log q11 2ðλ q11 Þ logðλ q11 Þ

After solving the latter equation for q11 , the other qij follow from q12 ¼ λ q11 ,

q21 ¼ μ q11 and q22 ¼ 1 λ q21 . P

This enables us to calculate HðX0 [ Y0 Þ ¼ ij qi j log qi j and further to find

H ðX0 \ Y0 Þ by H ðX0 \ Y0 Þ ¼ HðX0 Þ þ H ðY0 Þ H ðX0 [ Y0 Þ.

Subsequently H ðXi jY0 Þ and H ðYi jX0 Þ can be calculated.

This completes the calculation of the macro-variables of the economy.

It should be noticed that all the variables thus calculated are behaving as

dynamic stochastic variables of time t. The calculations do not stand the fundamen-

tal and essential properties in the way but respect them to the full as time and

economic events progress.

of the Economy

However, there is perhaps one exception. The labor outflux circulation rate ζ 1

applies to the circulation of labor. This rate is closely connected with the average

time employees are in service since they were recruited. This labor circulation rate

ζ 1 appears to be measurable after providing for some subtle but necessary

adaptations. Let us see how this can be done.

Recall from Sect. 6.6 that

ζ_

y1 ¼ 1 þ c1 (8.24)

ζ1

We shall assume that p and y1 have been determined by price and quantity

index calculation in the way set out in Sect. 8.1. We need next to calculate ζ 1 ðtÞ and

ζ_ 1 ðtÞ ζ 1 ðtÞ sufficiently accurate at observation time t.

Well ζ 1 is the labor outflux circulation rate, which is connected with the

probability density function φ 1 ðt; τÞ of current lifetime of the labor outflux bitpulses

as given by (5.11):

204 8 Calculation

8 τ 9

< ð =

1 ðt,τÞ ¼ ζ 1 ðt τÞ exp ζ 1 ðt ξÞ dξ

φ

: ;

0

Here τ is the current lifetime of outflux bitpulses. This differs slightly from the

current lifetime τ0 of work-units.

Current lifetime τ0 is the time elapsed at observation time t since the work-unit

has been recruited in S1 . Thus we must collect the data of the various initial times

t τ0 at which the work-units of S1 have been recruited for delivering effort. This

can be done by collecting all the initial times at which the employees of S1 have

been recruited while weighing these data appropriately for the effect of part-time

labor.

This will be used to determine the aggregate statistical circulation rate χ 1 ðtÞ of

the current lifetime τ0 of the work-units of S1. We shall not go into a discussion of the

technical details of how this can be done. It appears that it can be done quite

accurately.

However we must take into account that χ 1 ðtÞ is the outflux circulation rate of the

work-units L1 of S1. To get the outflux circulation rate ζ 1 ðtÞ of the outflux bitpulses

we need compensate for the change of the effectiveness E of the work-force L1

during ðt; t þ dtÞ as follows:

ζ 1 ðtÞ ¼

χ 1 ðtÞ þ eðtÞ

The problem is now that we have been able to calculate χ 1 ðtÞ, but we don’t know

ζ 1 ðtÞ and eðtÞ yet. However, (7.15) comes to our rescue:

c1 ¼ e þ l1

ζ 1 ðtÞ ¼

χ 1 ðtÞ þ c1 ðtÞ l1 ðtÞ

Furthermore, c1 ðtÞ can be eliminated from the latter equation with the help of

(8.24). This results in

_

ζ 1 ðtÞ þ ζ 1 ðtÞ ¼

ζ 1 ðtÞ χ 1 ðtÞ þ y1 ðtÞ l1 ðtÞ

Knowing χ 1 , y1 and l1 this differential equation can be solved for ζ 1 and ζ_ 1 ζ 1 .

Subsequently the growth rate c1 of labor capacity and hence dC1 can be

calculated. Also the growth rate eðtÞ of effectiveness follows from e ¼ c1 l1 .

The calculated dC1 and Y1 may then be used to determine η 1 on behalf of (7.13).

It can be shown that

8.6 Other Sources of Data Collection 205

η

1 ¼ and η

2 ¼

μQðμÞ ð1 μÞQðμÞ

This opens a way to calculate λ from the knowledge of μ and all the other

variables of the economy as discussed in more detail in Sect. 8.4.

If our expectation is confirmed that

χ 1 can be calculated sufficiently accurate, this

alternative route of calculation may be a very attractive one to implement.

We have concluded the latter two sections with particular schedules for calculating

all the statistical dynamic averages of the economy. However there are more ways

of how this can be done and much of that is still to be investigated given the many

newly derived equations that determine economic evolution.

One major issue is whether we can measure the transmission Zdt HðXi \ Yi Þ and

more specifically Zdt H ðX0 \ Y0 Þ directly. On behalf of (7.1) the total money dM0

(in bits) issued by the banking system during ðt; t þ dtÞ is equal to the latter

transmission. That is

change in the course of time and so to get an idea of the course γC0 takes in time.

Moreover, measurements on the increase of the money stocks of consumption

sector and investment sector in the case of the two-sector economy, may help to

determine λ μ, γ and C0 more accurately on behalf of (7.5).

Whereas in orthodox economic theory one is only concerned with the surplus of

outflow over inflow, evolvodynamics is also concerned with the addition of outflow

to inflow. Whether there will exist practical schedules to measure the transmission

sufficiently accurate is a question difficult to answer without further investigation,

but it must be mentioned here as a serious possibility.

Another matter is the eventual determination of the average historic price level

Pþ

i by calculating the integral given by (5.23), which holds in the common

inflationary mode of evolution:

ð

1

Pþ

i ¼ Pðt ξÞ

φi ðt,ξÞdξ (5.23)

0

The probability density function φ

bitpulses is given by (5.11):

206 8 Calculation

8 τ 9

< ð =

i ðt,τÞ ¼ ζ i ðt τÞ exp ζ i ðt ξÞ dξ

φ (5.11)

: ;

0

Thus if we have knowledge of the historic time-course of PðtÞ and ζ i ðtÞ for the

determination of φ i ðt; τÞ in accordance with (5.11), we can use that information to

calculate Pþ

i ðtÞ.

Chapter 9

Theory and Confirmation

Abstract The ins and outs of evidence and the interplay of evolvodynamics with

Keynesianism, monetary policy, Euro crisis and orthodoxy are discussed.

In science consistency and coherence of laws with explanations and observations

have top priority. Postulated principles and equations that derive from these

principles must be mutually consistent and coherent. If there is absence of evidence

for a theory or if our derivations from these principles lead to mutual conflicts and

contradictions, the premises of a theory are the first to be questioned and, only if

possible, reshaped and reformulated We must uncompromisingly stand up for these

scientific standards. Nevertheless it is possible to maintain a theory, in spite of its

failure in a general sense, if there is a well-defined region of its variables for which

the theory is still accurate. However no such orthodox economic theories are known

to exist.

A major obstacle to test for evidence, certainly for the discipline of economics, is

the limited accuracy by which we can do our calculations and measurements. We

must always take into account the inaccuracy of our measurements and insist on

improving the accuracy where we can, e.g. by improving our calculation schemes

or by introducing other schemes of calculation or by adjusting the way we collect

data. What we can’t tolerate is to adopt theories when measurements of sufficient

accuracy contradict what the theory asserts.

and it is simpler than it was before, then it is right.

Richard P. Feynman

Lecture Notes in Economics and Mathematical Systems 665,

DOI 10.1007/978-3-642-34056-7_9, # Springer-Verlag Berlin Heidelberg 2013

208 9 Theory and Confirmation

The equations of successful physical science are based on the principle of physical

homogeneity. This principle requires that the dimensions of each of the terms of the

equation on both sides of the equation are the same. The principle does allow

conversion of the scale of dimension in which a variable is expressed to another

scale of that dimension without affecting the validity of the equation.

The principle of physical homogeneity is in fact the equivalent of the principle of

evolutionary homogeneity that applies to the variables of economic evolution (See

Sect. 1.2).

The principle implies that the measure in which the content of a variable is

expressed is relative. Absolute variables do not exist, neither in physics nor in

economics. Without this principle physics is inconceivable and I claim that the

formulation of economic theory without this principle of homogeneity, focused on

time-dependent variables of entropy, money value and time, is just as

inconceivable.

The curious thing is that orthodox economics cherishes instead her definition of

homogeneity, which is quite different from the definition of homogeneity applicable

to physics and evolvodynamics. We shall state that definition here for completeness

sake with respect to an equation with one independent variable F and two dependent

variables x and y: The following equation involving the function F ¼ Fðx; yÞ is called

homogeneous of degree g if

The definition can be easily extended to cases with many independent variables

and many dependent variables.

To distinguish the evolutionary definition of homogeneity from the orthodox

definition of homogeneity we shall add the adjectives “evolutionary” and/or “physical”

to the first.

Core orthodox economic theories like neoclassical theory of production and the

Marshallian theory of demand, rely on the assumption that the equations are

homogeneous, e.g. of degree zero, degree one or degree 2.

I have great doubts about the admissibility of these orthodox homogeneity

assumptions. Neoclassical production functions are usually said to satisfy homoge-

neity of first or second degree. It appears to me that this is in direct conflict with the

principle of evolutionary homogeneity because output F is a flow (per unit of time)

and the inputs x (capital) and y (labor) are stock variables in accordance with the

neoclassical model.

This is a conflict of dimensions between the two sides of the equation that should

not be lightly accepted. I have already criticized the neoclassical theory of produc-

tion from another angle in Sect. 1.9 so that I shall not go into this matter further with

respect to neoclassical production theory. Instead I shall here focus on the signifi-

cance of orthodox homogeneity for mainstream demand theory.

9.1 Consistency, Yes or No? 209

The economist Keuzenkamp has written an interesting book on the latter matter

in which he confronts methodological considerations with the acceptance of ortho-

dox demand theory as an explanatory scientific device for explaining the demand

side of price-formation (Keuzenkamp 2004). As Keuzenkamp remarks, “The con-

dition of homogeneity of degree zero in prices and income of Marshallian demand

functions belongs to the core of micro-economic wisdom. Simply put, this condi-

tion says that if all prices and income change proportionally, expenditure in real

terms will remain unchanged.” (Keuzenkamp 2004, page 180).

The principle is more widely known as the principle of the absence of money

illusion. In this respect the state of mind by which economic agents might think to

effectuate a change in their real volume of expenditures consequent on a propor-

tional change of prices and income is considered to be an illusion.

Keuzenkamp investigates the validity of the absence of money illusion by

discussing the outcomes of the many tests that economists have carried out in

that respect. He begins with remarking that the homogeneity condition gives an

idealized picture of the world of demand. Whether it is valid, so he pursues,

depends on the validity of auxiliary assumptions [page 190].

Then he makes mention of quite a number of serious tests to verify demand

homogeneity of which almost all confirm that the empirical data are inconsistent

with the homogeneity property [pages 196–199]. Eventually Keuzenkamp had at

least to admit that “economists have tested these (homogeneity) conditions, and, in

many cases, have had to reject them statistically” [page 181]. Clearly then, the

results point in one conclusive direction: the hypothesis of homogeneous demand is

not more than a speculation on shaky ground.

Keuzenkamp is very detailed in enumerating the various testing attempts and

one should expect that he would have concluded with rejecting the homogeneity

property of functions of demand because of the lack of evidence. Well, this is not

what he does.

The principle of homogeneity of degree zero is definitely a pillar of orthodox

demand theory. To reject orthodox demand theory is manifestly a step too far to go

for Keuzenkamp. So, he devotes a considerable part of his book on discussing the

philosophy of scientific reasoning and, particularly, of econometric reasoning,

which he imputes a methodology distinctive of that of the exact sciences. In this

respect he pays much attention to contradict Popper’s realist philosophy of science

with its emphasis on consistency and falsification. What the connection of these

methodological considerations is with the subject is not very clear. It appears that

the oddity of ignoring the consequence of negative test results (i.e. to renounce

Marshallian demand theory) is concealed by sheltering behind the methodological

dust-cloud of a great many of partially conflicting views about the meaning and

significance of scientific theory formation. Notwithstanding Keuzenkamp’s

expositions on diverse schools of methodology, the matter is more likely an

exercise in propositional logic:

Let A be the statement that demand is homogeneous (of degree zero). Let B be

the statement that micro-economic demand theory is correct. For B to hold good it

is required that A is true. But evidently Keuzenkamp’s hope might be that this does

210 9 Theory and Confirmation

not exclude the possibility that B is true in some exceptional cases for which A is

false. However, it seems impossible to derive the properties of micro-economic

demand theory if A is false. Thus this is not a good escape. And we must then

conclude that if A is false, B must be false. The very last hope for Keuzenkamp is

then that there might still be exceptional cases for which A is true. However, this

reduces the validity of B to exceptional cases, not a very attractive prospect for a

scientific theory that is supposed to provide for explanations as widely universal as

they can be formulated.

Keuzenkamp avoids discussing the matter from this side. Instead he focuses on

what philosophers of science have to say about methodology and the truth status of

scientific laws.

Much what Keuzenkamp says looks reasonable in the passages devoted to

methodology: “I believe explanations serve a purpose: they are useful in

constructing analogies which may improve theoretical understanding.” [page

215]. He remarks that “explanations are not roads to truth”. Well that remark forces

an open door. What is truth? In the sense Keuzenkamp uses it, he seems to hint at

big truths, but why should scientific economic explanations have that status? Only a

convinced materialist or lop-sided scientist may identify an economic testresult or

theoretical derivation with a big truth. Let us remain modest in science but keep

demanding consistency and coherence and satisfying the principles of propositional

logic of our empirical findings and of our derived theoretical laws describing the

behavior and relationships of economic variables! No more and no less than that.

Keuzenkamp accepts the negative test results with respect to the homogeneity of

demand. In line with that he thinks also that money is an illusion: “In the form of a

penny or a dime money is pretty real, but its true value may be an illusion! And as

an aggregate, like M1, it is highly problematic.” [page 216]. He remarks further that

it has no real existence outside the context of a specific theory [page 216]. Does he

intend to suggest with the latter remark that—as far as money is illusive—it cannot

be described within a scientific framework? And that money is scientifically elusive

so that we can only analyze it scientifically if we render it reality and if we accept

the absence of money illusion contrary to what money actually is?

If this is what Keuzenkamp is hinting at, that does not make very much sense. It

implies that we do better to accept A as true although it is false because it is

otherwise impossible to formulate as good a theory as B is.

Or should we interpret his latter remark as an apology that economic science

cannot be done better than that?

According to Keuzenkamp econometrics is positivist. “It is characterized by an

emphasis on observation, measurement and verification. Furthermore, positivists do

not believe in the need to search for ‘true causes’ and tend to be sceptical about deep

parameters.” [page 258]. Well no problem, but why should that imply that we must

accept the negation of a core premise not to be of much significance for a theory that

is crucially based on that premise?

Keuzenkamp concludes that “the homogeneity condition survived thanks to its

strong prior support.” [Page 212]. After all falsification is not applicable to

9.2 Evolvodynamics and Keynes 211

(Keuzenkamp 2004, page 11).

Well, what is the benefit of a science if we are told to adopt it even if it is refuted

by the facts?

Can we perhaps understand why the orthodox principle of homogeneity is false?

Well, an economy can follow any path that is a solution of the equations of

evolvodynamics, because the economic system is not a determinist system with a

single unique solution. There are multiple dynamic solutions to the system of

equations. As the number of freedom of the system of equations is more than 1,

many different paths can be followed. We can nevertheless predict the most

probable course on the basis of as many measurements that we have gathered

over the past and as many policy initiatives that we plan (and succeed) to implement

in the future. The economic process is stochastic rather than determinist. There is

ample freedom of choice for an economy to deviate gradually from a particular path

and to take another dynamic course that satisfies the derived system of equations as

well. In fact with so much choice it is an illusion to think that demand will behave

according to a postulate of orthodox economic theory that is primarily accepted for

its convenience.

Today it is a little more than three quarters of a century ago that the great economist

Keynes introduced the consumption function as an explanatory device to demon-

strate the multiplier effect in response to increments of investment (Keynes 1936).

The model was appropriate to elucidate the argument that investment stimulation

was first and for all required to accelerate the growth of the economy. The fact that

consumption probability μ is nearer to 1 than ð1 μÞ is to 1 played a vital role in

Keynes’ explanation. The model illustrated that the larger μ is, the greater the

multiplier effect and the more the investment impulses will bring about the growth

of the economy. These investment impulses will ultimately work out that μ gets

reduced.

The great merit of Keynes’ consumption function theory was that it foresaw in a

descriptive explanation of the requirement to invest in order to get economic

recovery and to regain growth rather than to effectuate that by a reduction of

those and other expenses. The bad thing was that the argumentation was mathemat-

ically incomplete, even unsound and impossible to translate into a mathematically

adequate model. As far as it has been done, it has very often led astray and to a crisis

in policy implementation. I shall not discuss that in detail further here. Cognizance

and interpretation of the alternative theory of evolvodynamics explained in the

foregoing is enough because this delivers the correct dynamic relationships.

What I wish to emphasize here is that Keynes himself held a much more

complete idea of the economics of growth stimulation than the many mathematical

212 9 Theory and Confirmation

were and are capable to reflect.

When Keynes published his general theory he had no intention to state it in the

form of a system of mathematical equations. Although he bore the mathematical

scheme of the multiplier in mind, he was suspicious to work that out mathemati-

cally, assuming that the best explanation at hand was descriptive.

Let us, to keep matters simple, discuss the business cycle for the two-sector

economy only (That is: no export, no import, no government).

Recall that the general and exact explanation of the rate c0 of economic growth of

the two-sector economy is provided by (6.30):

c0 ¼ ζ0 ¼ ρ0 (6.30)

QðμÞ QðλÞ

notation.

Let us next see in what manner Keynes’ original ideas about the stimulation of

economic growth are reflected in these equations. For a qualitative analysis the

fluctuations of the circulation rates ζ 0 and ρ0 in (6.30) are immaterial to c0, because

ζ 0 and ρ0 are positive definite and relatively stable. On the other hand the relative

fluctuation ζ_ 0 =ζ 0 of the output circulation rate ζ 0 is much more sensitive to

fluctuations and this has an impact on the growth rate y0 of output.

As argued in Sect. 6.6 the rate c0 of net growth of the economy is mainly

determined by the difference ðλ μÞ. The growth rate c0 is roughly proportionate to

ðλ μÞ. The larger ðλ μÞ, the larger c0 . This implies that

that. Keynes’ central emphasis was on the stimulation of investment relative to

consumption. That this policy had to work, he motivated by referring to the

multiplier effect for which he put the consumption function upon the stage. But

that was only to underpin his argument. In the first place Keynes wanted the

stimulation of investment Y2 ¼ ð1 μÞY0 and hence μ to decrease and not to

increase. Further the increase of investment would induce entrepreneurs to employ

more labor so that wages would ultimately rise and production capacity would be

utilized more effectively. The rise of wages simultaneously with increased degree

of capacity utilization would also induce savings within the consumption sector to

step up with investment so that the process of growth acceleration could go on.

Keynes’ reasoning fits wonderfully well within the framework of (6.30). The

induced rise of money wages PX1 ¼ λP X0 simultaneously with increased capacity

utilization would cause labor input probability λ to rise if prices are held under

control. The joint effect of a decrease of μ together with an increase of λ will

increase ðλ μÞ and stimulate growth in a very effective manner.

9.2 Evolvodynamics and Keynes 213

Keynes’ plea for investment stimulation has often resulted in output stimulation

programs that also stimulate consumption. As the stimulation of consumption will

usually cause the output circulation rate ζ 0 to rise, it will often induce y0 ¼ c0 þ ζ_ 0 =ζ 0

to rise initially. As a result a policy of output stimulation that stimulates consumption

relative to investment will sometimes look successful in the short run.

E.g. if λ < μ < 0:703506, the situation discussed in Sect. 6.7 under number 2,

this will bring about growth in the consumption sector ðc1 > 0Þ, but nevertheless

overall economic decline ðc0 < 0Þ. Such policy may appear to work out reasonably

well in the short run, especially if ζ_ 0 =ζ 0 is positive such that y0 may remain slightly

positive for a while, which may convince policy-makers that they are on the right

track to reach recovery. However, the stimulation of consumption will likely cause

μ to rise so that the long-term condition μ < λ for economic growth will not be

reached. A prolonged increase of ζ 0 may extend the period of positive growth of Y0

and it may be very reasonable to achieve if ζ 0 were lagging much behind its normal

magnitude. But ζ 0 cannot rise forever and may even decrease again so that y0 will

not have increased in the end. Thus a policy that concentrates on consumption

stimulation rather than on investment stimulation will likely ultimately reach the

point where c0 is reduced and it will hence be unsuccessful in the end and often

postpone the recovery process.

However in case c0 is sufficiently large, y0 may nevertheless be too small or even

negative due to a negative growth rate ζ_ 0 =ζ 0 of output circulation. In that case

consumption stimulation is enough to eliminate the negative ζ_ 0 =ζ 0 and to restore the

growth of output Y0 again. Thus a policy of consumption stimulation may incidentally

or accidentally be effective to combat some stagnation. Such stagnations are usually

mild and relatively easy to overcome.

Keynes was of course unaware of (6.30), but he had a profound intuitive

understanding of the economic process. To endorse his views he used the consump-

tion function in combination with the multiplier effect. He did not intend to embed

it in a fabric of parametric mathematical equations like the following generation of

economists did. What happened afterwards was a mathematical consumption func-

tion fitted in a parametric model in which consumption probability was merely a

constant parameter so that the most sensitive component δ ¼ ðλ μÞ=2 of economic

growth could no longer theoretically change in response to changes of μ. Well, for

our quantitative engagements it can be done in that way, but it can also be done

much and much better.

The bottom line is that investment stimulation is the best policy to regain

economic recovery after an economic recession. However, how that must be

worked out and will work out for a particular economy depends strongly on the

state of growth the economy is in. The equations that determine the time-course of

economic growth demonstrate complicated relationships, not less complicated for

the two-sector economy, which in fact can only be properly analyzed with the help

of the calculating power of digital computers. However, some qualitative insight

can be gathered by considering four different growth-positions an economy can be

in and by analyzing the prospects of growth for each of these positions. This has

214 9 Theory and Confirmation

have been listed there. Two of the growth positions deal with economies with

negative growth. The worst is the growth-position number 4 characterized by the

conditions

It appears that the Dutch economy reached growth position 4 in 2012, although

the economic growth rate is only slightly negative.

should be done. It is not uncommon that the stimulation of consumption rather

than investment is advocated to restore economic growth. And indeed Keynes has

often been misinterpreted in this manner. On the other hand the many factors that

influence the course of the economy have also their impact and do not help to

understand what should be done.

In this respect the influence of the monetary factor is of considerable weight and

often not well understood. Therefore I shall here elucidate the role of money in

maintaining economic growth.

If the transmission H ðX0 \ Y0 Þ gets too small, the money stock declines, growth

will slow down, price inflation rates become small and deflation is on the look-out.

This is the salient eventual consequence that develops during the aftermath of a

typical credit/banking crisis as we experience in the western world economy since

the autumn of 2007. In those circumstances it will usually take much more time to

recover from the recession because massive government support has been supplied

and will still be required for some time to save the banks. Once arrived in that low

or negative growth-state of the economy and of large government budget deficits,

there is a natural inclination of an economy to dwarf near the turning point of

evolution and to stay close to it, especially since the policy makers often seek the

solution, wrongly but understandably, in jamming on the brakes by cutting govern-

ment expenses and convincing or prescribing the banks to hold on much greater

buffers than they held before the crisis. The immediate effect is the tightening of

credit rules by the banks and a fall of investments.

The present situation of the Euro credit crisis is a typical instance. With the start

of the Eurozone the Eurozone memberstates have refrained from embedding the

introduction of a common currency within the framework of a full fledged financial/

fiscal union. Without that fiscal union common fiscal discipline is nowhere and will

ultimately end up in economic and financial chaos. This is the lesson that history

has taught us many times.

9.3 Eurocrisis and Monetary Expansion 215

Current policy to combat the crisis, strongly and persistently advocated by the

Northern Eurozone-memberstates with a good budget record, stresses to restore

government budget equilibrium as the first and immediate thing to be done by each

of the memberstates. However, given the untenable critical state of budget

disequilibria combined with very high interest rates in some of the member states,

the fiscal union should be implemented without delay. Once the member states had

made the choice for a monetary union nearly two decennia ago, a political/fiscal

union was actually inevitable and it must therefore now be implemented without

delay to avoid persistent serious economic and political drawbacks within Europe.

This requires political wisdom and solidarity among the member states rather than

the play of nationalist populist sentiments, which has brought us only adversity in

the past and will bring us nothing else than that in the future if we don’t succeed to

dress up the political/fiscal union timely.

The absence of a political/fiscal union has not only led to a wide variation of

budget deficits among the memberstates but also to a wide variation in the interest

rates these memberstates pay. The good-record memberstates consider their low

interest rate as their own inalienable reward for their disciplinary budget behavior

of the past. However, that is only very partially so because they would certainly not

have borrowed money for such extreme low interest rates if each of the Euro

memberstates would have kept its own currency.

Moreover one should take into account that within a great economic zone like

the USA, like China or like the Eurozone there will always be regions performing

better and regions performing worse and some even much better or much worse.

This is inevitable and absolute solidarity within the system is a must to prevent that

the zone disintegrates, certainly if democracy is the basis of the cooperation.

The point is that a rigid policy to restore budget equilibrium by each country

separately will everywhere and immediately induce still greater differences in

interest rates between the countries, which does not help to solve the problem but

will only help to worsen it. It appears that a substantial part of the decline of the

interest rates of the good-record member states is connected with the sharp rise of

the interest rates for which the less-disciplinary memberstates borrow money.

All member states of the Eurozone, including the member states with good

budget record, must accept their common responsibility for the total of budget

deficits. As far as this acceptance will have a drawback on the economies of the

Northern member states, it is much more preferable than the serious drawback

caused by muddling on with our own national priorities. Moreover, all member

states should accept their individual responsibility for having contributed to imple-

ment a monetary union in the past without a backbone of sufficient political and

fiscal unification.

Once the Eurozone has established this political/fiscal union of common solidarity,

budget equilibrium can soon be reached by each of the member states. Presumably

interest rates for which the Northern member states borrow will rise, but it is rather

unlikely that it will rise very much because the overall budget state of the Euro zone is

more favourable than the American with its already low interest rate.

216 9 Theory and Confirmation

No doubt the political fiscal union has to be implemented with strict budget

rules. Solidarity between the member states implies that each of the member states

will strictly subscribe to the same budget rules.

The current credit crisis has primarily been caused by the banks and is also due to

insufficient control on the banks by the monetary authorities. The crisis reflects the

general pattern of the most severe recession an economy can go through. Therefore

I shall give it the necessary attention here. To begin let me first state where banks

are for.

The banking system is there to finance the economy. That is the only task banks

have. To that end banks have been granted the monopoly of money creation under

certain restrictions and under independent control of a central monetary authority.

The monopoly of money creation is not the exclusive property of banks. On the

contrary, it has been granted to the banking system by law with the mandate to

manage the financial needs of the economy as good as possible.1 Most important in

this respect are the financial needs of small and middle-sized firms. It is here where

new innovative ideas are brought to life within an economy, often with great

personal sacrifice of time and welfare of the entrepreneurs concerned. It is here

where the risks of financing may be greater than elsewhere (although I doubt it

whether this is really true), but where the economic rewards in the long run are the

greatest. In brief, this is pre-eminently the sphere of work for which the banking

system is first and for all needed and for which it was intended. The general rule

appears to be that economies without a middle class of entrepreneurs are always

stagnating. Nevertheless time and again banks have neglected this essential role of

their mandate and their curious reasons were always that small credit financing is

too costly for the banks and that the risks are too great relative to the risks in other

domains of financing, as if it were not a very special mandate they were endowed

with. But actually this is nothing else than the failure of banks to comply with their

mandate. Banks have been granted the monopoly of money creation to help finance,

not to withdraw from what they are supposed to do. And first and foremost to

sustain and bring forth economic growth is to provide for financing the middle class

of entrepreneurs.

Well banks often forget to stay with the special and very important task they

have been given literally as a gift. As they grow larger, their executives get to dream

of complementary financial activities and the banks begin to supply their customers

with all sorts of often superfluous financial (even usurious) products other than

lending money, just to increase their share of the national pie. Their executives get

the idea that they seriously contribute to (inter)national economic performance in

this manner, but what they achieve for the greater part is creating additional money

value, which is in fact merely a financial portion of the national pie snatched from

the non-banking sector. That is, the banking sector manages in effect to raise the

costs of financing and banking considerably beyond the level it should have in a

1

We should be aware that much of the current banking practice (such as investment banking and

the bonus-culture) does not accord with the intentions of a responsible banking mandate.

9.3 Eurocrisis and Monetary Expansion 217

normal competitive market. The financial share they take and redistribute among

their personnel and executives rises to unrealistic proportions.

As this process goes on and on, the capital actually accumulated by the banking

sector is primarily backed by paper claims on banks and third parties that the

banking/financial sector herself has issued. The accumulation of these paper claims

goes as far as it can go. The more it grows the relatively less the buffer capacity of

banks and the closer the limits are reached that the non-financial sector can cough

up. Thus the more vulnerable the banks get to hitches in the solvability of the non-

banking sector. If it keeps on growing in this manner, the entire system will

ultimately break down and—as a default of the banking system is a very inattractive

option—governments are forced to save the banks massively. In this manner banks

will not, but society will be confronted with the ultimate burden of their behavior.

In effect banks have misused their monopoly of money creation.

This is in a nutshell what happened since the turn of the century and even before

but then yet at a smaller scale.

To recover from this recession is not an easy matter. In the Netherlands mone-

tary and fiscal authorities have put rigid emphasis on reduction of government

expenses, paying off debts, raising bank buffers. This has effectuated credit restric-

tion in the private domain or at least affected businesses to delay their plans of

expansion. Well, clearly, government expenses must be reduced, debts must be paid

off, bank buffers must be raised all in the interest of recovery but such policy should

never accept credit financing to decline. Governments and banks have the bounden

duty to provide sufficiently for the financial needs of firms and businesses in order

to stay far enough off from the turning point of evolution with its very low inflation

rates and growth rates. Policy should have emphasized a different order: first and

foremost credit expansion and then the other policy objectives. Credit expansion

should have priority even if it leads to greater risks (Well, I doubt the risk is greater

because credit expansion will stimulate growth and diminish the risks of failure).

Actually rescuing the banks from default has costed and will cost a lot more,

certainly if we fail to change the rules the banks must accord to.

In the past the lack of sufficient financial means has often driven firms and

businesses into despair and time and again it has resulted in initiatives to found new

banks with the task to finance a specific sector of the economy that until than had

almost no access to the financial resources that banks control. Unfortunately, when

these newly founded banks grew more and more, they gradually withdrew from the

tasks they had been founded for and sooner or later the lack to provide for financing

the small and middle-sized business sector was again on the menu. This has been

too manifest in Europe. (In the Netherlands small banks are gradually disappearing

from the stage). The rules for the entry of newly founded banks have perhaps been

too restrictive and the market dominance of the large banks has outgrown far too

much.

Since the early begin of the current crisis, the business credit problem has popped

up with vehemence. For the investment sector credit limitation rather than credit

expansion became the current fate. Particularly starters’ businesses, small and

medium-sized enterprises were and still are the victim. These entrepreneurs began

218 9 Theory and Confirmation

willingness of banks to provide for the financial demands of the investment sector is

now a major cause of stagnation within the entire Eurozone and if nothing will

dramatically change in this respect, we may prepare for many years of stagnation

and very little growth.

The investment sector cannot invest sufficiently because of the restrictions in

financing. As a consequence economic transmission gets too small and the outlook

for the resumption of a reasonable rate of economic growth of the economy is

waning. It is here where governments should intervene without delay and assist, at

need oblige the banks to resume their responsible financing task in the way it should

be done.

over μ as we concluded from the consultation of (6.30) in Sect. 9.2. Stimulation can

only be affected by spending money in the right ways and it is therefore necessary

also to consider the monetary implications of the increase of the surplus λ μ. The

equations applicable here for the two-sector economy are (7.5) and (7.7):

1þλμ 1λþμ

dM1 ¼ γ C0 dt and dM2 ¼ γ C0 dt (7.5)

2 2

dB1 ¼ b1 B1 dt ¼ γ ðλ μÞC0 dt

dM1 is the increase of the money stock of the consumption sector during

ðt; t þ dtÞ. dB1 is the liquidity surplus of the consumption sector during ðt; t þ dtÞ.

Additional to its own money resources the investment sector employs the liquidity

surplus dB1 of the consumption sector S2 to realize its investment objectives during

ðt; t þ dtÞ. The larger the flow of dB1 the larger the availability of liquidity for S2 .

After differentiation of dM1 and dB1 to time we obtain

m_ 1 γ_ 2δ_ b_1 γ_ δ_

m1 þ ¼ þ þ c0 and b1 þ ¼ þ þ c0 (9.1)

m1 γ 1 þ 2δ b1 γ δ

In (9.1) we have adhered to the Newtonian fluxion-notation: m_ 1 ¼ dm1 =dt , γ_ ¼

dγ =dt, b_1 ¼ db1 =dt etcetera.

In the short run the terms m_ 1 =m1, b_1 =b1, 2δ_ =ð1 þ 2δÞ and δ_ =δ will play a role. In

the long run all terms of (9.1) play a role.

We shall restrict here our discussion to apply to the inflationary mode of

evolution only.

9.4 Evolvodynamics and Monetary Expansion 219

Let us first discuss the stationary growth solution. Under stationary economic

growth of an economy we understand an economy for which all λi , μi , and the

transmission rate γ remain constant in the course of time as well as the growth rates

ci of capacity. On behalf of (6.27) and (6.30) the maintenance of stationary growth

warrants that ζ i , ρi , ζ i and

ρi are time-independent constants as well.

For the stationary growth two-sector economy it follows thatδ ¼ ðλ μÞ=2,m1 and

b1 are independent of time. In that case (9.1) result in m1 ¼ b1 ¼ c0 . This is indeed

what might be expected: the liquidity stock and the joint capacity stock must share the

same growth rate under the condition of stationary growth. Moreover H ðX0 Þ, H ðY0 Þ

and transmission H ðX0 \ Y0 Þ become constants for stationary growth, whereas the

number Z of samples per unit of time, Zdt HðX0 \ Y0 Þ ¼ γ C0 dt, X0 ¼ Zdt H ðX0 Þ

and Y0 ¼ Zdt H ðY0 Þ share the same stable growth rate z ¼ m1 ¼ b1 ¼ c0. Further γ, λ

and μ behave as constants independent of time under stationary growth.

However, the condition of stationary growth is exceptional and it is entirely

inadequate for economic forecasts to rely on. The economic process is concerned

with stochastic time-series. Much more relevant is the general case for which every

variable is a dynamic stochastic variable of time. Non-stationarity reflects the

general condition of the economy, e.g. the circumstances we face in the time course

from top to bottom of the economic cycle and conversely. We must therefore

consider (6.30) and (9.1) in full ornate in order to draw sensible conclusions.

These equations are appropriate for getting a tentative general qualitative idea of

the effect of monetary expansion and contraction in the case of the two-sector

economy. Let us then assume that the initial condition of a two-sector economy is

stationary growth and that from then onwards a policy of monetary expansion is

pursued discontinuing stationarity and resulting in the increment of the transmis-

sion rate γ and of the transmission HðX0 \ Y0 Þ ¼ γ C0 =Z proportional to γ . The

question is then: what happens next?

Let us first conclude that in case of accelerated monetary expansion the

growth rates m1 and b1 of the money stock and B1 will increase and in particular

m_ 1 =m1 and b_1 =b1 will increase, even more the greater the amount of money injected

into the economy. In virtue of (9.1) γ_ =γ þ 2δ_ =ð1 þ 2δÞ þ c0 and γ_ =γ þ δ_ =δ þ c0

must increase as well. An increase of c0 will not be effectuated immediately.

The immediate effect of a change of m_ 1 =m1 and b_1 =b1 will have an impact on

γ_ =γ þ 2δ_ =ð1 þ 2δÞ and on γ_ =γ þ δ_ =δ.

As far as the change of m_ 1 =m1 and b_1 =b1 affects γ_ =γ, this will have the secondary

effect of raising inflation (in case the inflationary mode of evolution applies)

because γ ¼ pþ 0 ¼ p 0 on behalf of (6.21). On the other hand as far as the change

of m_ 1 =m1 and b_1 =b1 affects 2δ_ =ð1 þ 2δÞ and δ_ =δ, this will have the secondary effect

on the economic growth rate c0 on behalf of (6.30). Whether that raises c0 in the

longer run depends on the sign of δ. In Appendix H several scenarios have been

listed.

220 9 Theory and Confirmation

Consequent on a rise of 2δ_ =ð1 þ 2δÞ and δ_ =δ, c0 will eventually also rise. Hence it

seems at first glance that the change of m_ 1 =m1 and b_1 =b1 will likely to have more

effect on c0 þ 2δ_ =ð1 þ 2δÞ and on c0 þ δ_ =δ than on γ_ =γ. However, this conclusion is

too rash. Note that the changes in m_ 1 =m1, b_1 =b1, γ_ =γ, 2δ_ =ð1 þ 2δÞ and δ_ =δ are short

run changes and that the affected secondary effect on c0 manifests itself in the

longer run, when the short run changes of m_ 1 =m1, b_1 =b1, γ_ =γ, δ_ =ð1 þ δÞ and δ_ =δ may

have smoothed out. Moreover, as a secondary response to the initial rise of γ_ =γ, the

transmission rate γ will eventually rise as well in the longer run while γ_ =γ will then

smooth out. Thus,

In the short run : m_ 1 =m1 and b_1 =b1 effects γ_ =γ þ 2δ_ =ð1 þ 2δÞ and γ_ =γ þ δ_ =δ

In the longer run : m1 ; b1 ; pþ 0 ; δ and c0 rise

m_ 1 ¼ b_1 ¼ γ_ ¼ δ_ ¼ 0 and m1 ¼ c0

The success of realizing more economic growth in the longer run by an impul-

sive rise of m_ 1 =m1 and b_1 =b1 depends on how much λ_ =λ, 2δ_ =ð1 þ 2δÞ and δ_ =δ will be

affected separately. The growth-position the economy is in at the moment a

liquidity flux impulse is injected into the economy, has considerable influence on

that matter (See Appendix H). We should further be aware that the effect of the

impulse of m_ 1 =m1 and b_1 =b1 on λ_ =λ and μ_ =μ will be of the same order of magnitude

as the effect of m_ 1 =m1 and b_1 =b1 on γ_ =γ , 2δ_ =ð1 þ 2δÞ and δ_ =δ.

For a moderately growing economy, a monetary spending impulse will bring

about a rise of the rate of inflation as well as a rise of the rate of economic growth.

How the increase is divided between inflation and real growth depends on the state

the economy is in.

If the growth rate c0 is not affected simultaneously in the longer run, the price

inflation rate p must increase. Then accelerating inflation is our fate and eventually

this will lead to hyperinflation if we keep accelerating monetary expansion condi-

tional to an immovable c0. Hence accelerated monetary expansion is only effective

if it is accompanied by an accelerating growth rate c0 .

Observations on modern growth economies have taught us that usually a part of

m_ 1 =m1 and b_1 =b1 goes eventually into c0 and the remainder into γ_ =γ. The higher the

attainable growth rate c0 , the higher the inflation rate as well.

If monetary expansion is directed at economic recovery or at more growth, it is

necessary that it boosts an initial rise of δ ¼ ðλ μÞ=2 and ultimately a rise of c0 as

we have argued in Sect. 9.2. For that matter monetary policy must be accompanied

by stimulating investment relative to consumption (which decreases the propensity

μ to consume) as well as by keeping depreciation low relative to wages (which

increases λ). These incentives can best be realized if economic policy concentrates

on expansion investing rather than on replacement investing. The more monetary

9.5 Evolvodynamics and Orthodoxy 221

expansion is accompanied by such policy incentives, the less chance that money

expansion will leak away in the growth of the rate of price inflation p and in the

transmission term γ_ =γ of the right side of (9.1).

A policy of monetary restriction can be pursued to reduce inflation. However, its

effectiveness depends on how we succeed to avoid that δ ¼ ðλ μÞ=2 will not

decrease as a result of that policy. If we do not succeed so and δ will only decrease,

as a result, monetary contraction will have little effect on the rate of inflation.

Success can only be realized if investment is not reduced relative to consumption.

The nature of the above expositions of the present and preceding sections is

qualitative. The expositions demonstrate the feasibility and power of the theory of

evolvodynamics. It is of course possible to postulate an alternative system of

parametric equations that may more or less also provide for a qualitative explana-

tion of monetary expansion and economic growth.

However, these alternative systems of equations do not consistently provide for

a general explanation covering the entire time-domain and every economy. They

must be “repaired” continuously in the course of time by adjusting the parameters,

which demonstrates that the parameters are not time-independent despite the oppo-

site assertion by the proponents of those systems. Because of their lack of universal-

ity and their maltreatment of time it is very questionable whether these systems

provide for as good a dynamic explanation as the theory of evolvodynamics does.

The great merit of the equations of evolvodynamics is that they are universally

valid and fully dynamic and that they have been derived. Moreover these univer-

sally valid equations demonstrate that economic constants do not exist (as all

economists are actually aware of) and hence constant parameters cannot exist

either. The application of evolvodynamics is not restricted to qualitative

expositions but is appropriate for quantitative calculations to forecast with optimum

attainable accuracy. If performed without blemish, these calculations are reliable as

long as the few underlying principles of Darwinian selection keep their validity.

Our above qualitative exposition applies to the two-sector economy only. For the

N- sector economy ( N 3 ) the equations become so complicated that useful

qualitative expositions appear to be very difficult. We must then resort to quantita-

tive calculations. To analyze quantitatively rather than qualitatively, it is of course

necessary to oversee the complete system of evolvodynamic equations in detail and

to apply sophisticated tools of numerical analysis that need to be handled by digital

computers. Since the number of the degrees of freedom of the system of equations

is 3 (See Sect. 4.6), it is sufficient to collect the data of three different time-series for

the computation of complete forecasts of the economy.

evolutionary selection with Shannon’s theory of entropy/information has reached a

tentative though not definite completion. Many well-known economic variables and

222 9 Theory and Confirmation

several new ones have been fitted in a general definitional context and satisfy quite

many exact universally valid relationships, so far unheard of and unexploited in

orthodox economic theory.2 These relationships have not been postulated, but have

been derived from a very minimum of basic principles of Darwinian evolutionary

selection. Moreover, Shannon’s conception of entropy has been shown to represent

the inevitable proper measure of uncertainty, information and value: uncertainty

that agents face, information and value that agents gather and get rid of while

selecting.

It has also been demonstrated that economic behavior of agents is purposeful

rather than purposeless. Nonetheless the way economic agents behave is very

selective. Purpose manifests itself in the way economic agents avoid to select the

enormous bulk of potential variations that can possibly be chosen but that they

consider being useless. Instead they prefer to choose from a much and much smaller

set of typical variations deliberately. The latter set contains an infinite number of

equally meaningful opportunities to choose from. Clearly, this corresponds with our

human experience that as individual decision makers we have very great freedom to

choose between the things we consider meaningful to consume, and between the

things in which to invest purposefully and how to use them up, as well as to decide

between the jobs that we choose to do and to create.

This implies that orthodox economic models in which agents are programmed to

seek equilibrium and to optimize some postulated object function (production

function, output, input, profit, utility) are far from realistic. The purported equilib-

rium and/or optimization always results in a single or a very limited number of

possible solutions to choose from. Moreover it clings together very many

variegated individual decisions of individual consumers, investors, employees

and entrepreneurs as if there is only one decision maker per category that makes

the same consideration for that entire category.

These robot-like agents weigh the aggregate of consumption, the aggregate of

investment, the aggregate of economic resources and the aggregate of jobs as if it

were only a single grand item, or a single grand job. Time is often not considered to

change and if time is considered to change, it is always a poor model of deficient

dynamics.

Growth theories will usually reach not much further than describing theorems of

stable growth and the listing of some golden rules of accumulation.

This slavish conception of economic reality does not correspond with the

unrestricted dynamic freedom of behavior economic agents have and demonstrate

with respect to the way they spend on and choose between multifarious goods and

the way they select between the great variety of jobs under dynamically ever

changing economic conditions.

2

With the exception of Divisia’s index formulas.

9.6 Science, Premise and Prejudice 223

Notwithstanding its relevance and despite its anchorage in the logic of proper and

consistent scientific reasoning I foresee that there is a long way to go before the new

theory will meet some acceptance among economists. This is nothing to worry

much about. Let me in this respect reproduce a famous quote from James Lovelock:

“If you start any large theory, it takes about 40 years for mainstream science to

come around”. So if you may have stumbled on this quote while glancing through

this book, you may lay the book aside for 40 years before reading it.

A major obstacle is the prejudice with which generations of economists have

been educated as to what to understand by good and sound economic reasoning.

Ask any economist, accomplished in orthodox economic theory, what he thinks

about the existence and bearing of economic laws. He will certainly respond by

remarking that economic laws like the derivable type of laws in the physical

sciences do not exist (whether he has any real notion of the struggle by which

these physical laws have evolved, often from originally primitively formulated

parametric equations,3 is—to say the least—questionable). And he will certainly

stress that you cannot describe economic (human) behavior fully by equations

(since he seems to think human behavior is of some other and higher order exalting

far above the material laws that can only describe the dead world of physics. Why

he thinks so is a riddle. It has never been explained nor demonstrated. We are told to

believe it.). The idea that the methodology of scientific reasoning is a common one

for all sciences, he will reject as absurd and qualify as sheer nonsense, because it

conflicts with the prejudices he cherishes.

Well, in accordance with the standards of rational science, any conception,

premise or prejudice that is at the basis of the human pretention of scientific

explanation should be subjected to meticulous scrutiny. There have always been

two procedures to achieve that. Both of them must be well observed to warrant good

science in accordance with good methodology of science. The first is that the

forecasts of a scientific theory must be tested and confirmed by field

measurements.4 This is consistency of facts. The second is to subject the consecu-

tive steps of deductive reasoning to meticulous scrutiny and to compare whether all

the derived laws are consistent with one another as well as universally valid.5 This

is consistency of laws.

3

Ptolemaic astronomy is an example. Another instance is Planck’s derivation of the law of black

body radiation.

4

Mark that confirmation is always tentative, never definitive.

5

One might mention Occam’s razor here, which states that the less the number of basic postulates,

the better and more general the theory. But I think Occam’s razor is just as much a natural result of

the two procedures of scientific scrutiny. The greater the applicable domains of space (read here

also: economy) and time for which there is mutual consistency between the various laws derived

from the first postulates (the principles) of a theory and for which these laws remain sustained by

measurements, the more universal the theory is and the more probable it is that the number of basic

postulates will be reduced to a minimum. For if there are more postulates on which a theory is

224 9 Theory and Confirmation

heed is given to the second procedure of good science. It is not that economic

orthodoxy is not concerned with deductive reasoning. It certainly does. It is just that

orthodox economists are doubtful of the attainability and usefulness of very critical,

consistent, scrutinous, inference given their prejudice that economic behavior

cannot be fully described in such manner. The great riddle is then why they

theorize? Or is the answer in their failure to realize that scientific laws should be

foremost mutually consistent and cover as wide a range of phenomena as possible

without permanently changing these laws e.g. by continual adjustment of

parameters?6 Simply in consequence of the unlimited adaptability of parameters,

the orthodox models of economic explanation lose much of their relevance and

universality. Moreover there are many parametric equations that contradict each

other provided the comparison is pushed far enough, which is often neglected. Thus

it should be realized that—as regards the second procedure of science—the theory

of evolvodynamics expounded here is far superior to any orthodox model of

economic explanation because there are no parameters to be adjusted continually

whereas the various laws are consistent and since there is no contradiction between

any of them as far as I am aware of at the moment of writing this.

Unfortunately the prejudice of economists that no laws of economic behavior

exist other than parametric, which has been taught to them decennia after decennia,

stands in the way of considering the second procedure of good science as being

utmost relevant.

Human prejudices are very difficult and inert to overcome. That may be

connected with the survival chances in human evolution. Choose the common

generally accepted point of view and you will be most successful. There is no

exception, but rather confirmation of this rule as the evolution of human science is

concerned. Once a particular dogma has engraved itself on the human mind, it will

not soon be abandoned. The general rule is that for change one must await the dawn

of a new generation. A generation that has nothing to lose but only to gain.

One of the instructive examples of this mechanism is Ptolemaic astronomy.

Ptolemy lived from circa 100 until circa 170 A.D. He adopted the basic principles

that the earth is the center of the universe and that all celestial motions of the stars,

sun, moon and planets are reducible to circular motion. Thus he devised a system

that explained any orbit of a celestial body as a superposition of circular motions of

epicycles on a circular orbit around the earth. By adjusting the parameters of the

epicycles he foresaw in the required correspondence between the astronomical

based, there is greater chance that a law derived from one or a few of the postulates is inconsistent

(or incompatible) with a law derived from another postulate.

6

The following consideration clarifies the shortcomings from a Popperian perspective. While

neglecting the importance of the second procedure (the consistency of laws), practitioners of

orthodox science can propose infinite many parametric models as providing for a universal

economic explanation, because one can always add and adjust the parameters so that

measurements are always in harmony with what the model predicts. Thus there is no way to

refute the “laws” of economic orthodoxy.

9.6 Science, Premise and Prejudice 225

observations of the orbit and the calculated orbit predicted by the theory. The

Ptolemaic system was of course very accurate in explaining the motion of the

distant stars without the need to add any epicycle. Further to explain the orbit of

the sun, epicycles were also unnecessary. An eccentric circle was sufficient to

account for the sun’s orbit around the earth within reasonable limits of accuracy.

For the motion of the planets and moon more was required and here Ptolemy was

lavish in applying epicycles.

Like the parametric models of orthodox economics, it was necessary to adjust

the parameters regularly, those for explaining the orbits of the moon and the planet

Mars often, those for some of the other planets only after several decades. The

appraisal of the success of the Ptolemaic model depends considerably on how

accurate astronomical observations can be made. Science is of course concerned

with explaining the smallest differences that we can observe. Well, it has been

demonstrated that by introducing still more epicycles Ptolemaic astronomy can

explain away any smallest deviation between theory and observation, certainly with

the help of the calculating power of our computer technology age. However, we

must keep on adjusting the many parameters regularly and continually. Every

second of the world-time-clock has in fact its own system of Ptolemaic parameters

and we must recalculate these parameters every second so that unprecedented

accuracy of prediction will be realized for the next second. Well, does that affect

the extent of our scientific appreciation of the suitability of the Ptolemaic model?

Yes or no? Well, if we keep believing and preaching that we can’t replace the old

dogmas by deductive reasoning (like the dominating authority, the Church, did at

least until the year 1633 when Galileo was compelled to repeal his heliocentric

world view), it appears that we may definitely answer that question in the negative.

Indeed “no” is the answer of the orthodoxy! And it was the answer of all the

astronomers that practiced the science of astronomy for more than 1300 years after

Ptolemy, upon whose work the Church based her calendar and the improvements

thereof confirming that the idea of the earth as the immovable center of the universe

was a fruitful one. All well in accordance with the prejudices of that time.

That prejudices have a long lifetime is illustrated by the time it took to adopt the

heliocentric system. Copernicus published his revolutionary heliocentric world

view in the year 1543, also the year he died. It was immediately rejected almost

by anyone who took note of it with the exception of a few. True enough, there was

the difficulty that the Copernican system was still based on circular motion and

epicycles, which did not really contribute to improved accuracy of its predictions

and that did neither contribute much to the acceptance of the Copernican system.

Thus, when the leading Danish astronomer Tycho Brahe (1546–1601) made his

pre-telescopic celestial observations of unprecedented accuracy, he took the stand

that the Copernican system was definitely wrong. Instead Brahe kept working on his

own geocentric system of explanation without succeeding to complete it. It was the

more mathematically oriented Johannes Kepler who—since 1600 in possession of

the observations of Tycho Brahe—discovered that the planetary orbits around the

226 9 Theory and Confirmation

sun were elliptic7 (Crowe 1990; Dreyer 1953). His eight years older contemporary

Galileo was immediately convinced (Galileo 1954), but the latter was compelled by

the Church to recall his position in 1633 and to admit that a moving earth “is

contrary to Holy Scripture and therefore may not be defended or held” (Stillman

Drake 1980).

With Kepler’s publication of 1609 there was overwhelming evidence for

adopting the heliocentric world view. Kepler’s discovery of elliptical orbits implied

also the expulsion of time-dependent parameters from the model. This, I believe,

was the greatest scientific innovation of the new theory. No dynamic parametric

adjustments anymore in the course of time. Nevertheless it took still many years

before the Ptolemaic system with its parametric burden was definitely overthrown

by Isaac Newton and replaced by a general deductive theory of celestial mechanical

motion.8 The lesson is that prejudices have a long survival time. That our genera-

tion is less conservative than the generation of the seventeenth century is improba-

ble. Each generation cherishes its prejudices. The prejudice of orthodox economics

is the clincher that human behavior cannot fully be caught in a deductive theory. If

our belief in this principle is unshakable it places orthodoxy on the thrown of

authoritive inaccessibility like the Church in the dispute with Galileo in 1633.

In this respect we should realize that the idea of Darwinian selection is a

fundamental premise as well. It must permanently be subjected to meticulous

scrutiny just as well as other dogmas. We can’t prove the principles of Darwinian

selection by deductive reasoning. What we can do is to establish evolutionary laws

that derive from it and collect measurements to test the predictions of the laws and

phenomena following from it. If there is correspondence between measurements

and predictions this does not imply that we have proved the basic premise. We will

only be strengthened in our conviction—how much depends on the extent of the

evidence—that the premise of Darwinian selection offers a correct and effective

tentative description of the basic fabric of our domain of investigation as long as it

is not overthrown by a still more general explanatory theory.

That orthodox theory is offering a better testing record than the theory of evolvo-

dynamics does would be a false impression. In the practical situation of collecting

and predicting macro-economic statistics, orthodox economics offers only a frame-

work of unproved parametric equations. Sufficient correlation with test results can

only be sustained by adjusting the parameters all the time, like for the Ptolemaic

system. And even then economic predictions are not better than the predictions a

7

Kepler published his findings in the year 1609.

8

Newton devised his theory of mechanical and gravitational motion in the years 1665–1967 and

kept silent on the matter for many years. It was finally published in 1687.

9.7 Theory and Measurements 227

Thus economic orthodoxy does not provide for a unique and universal description

of economic performance, not in time, not per economy, not per economic institute

giving such predictions. Sufficient reason to conclude that there are no tests that

contribute to genuine verification of orthodox economic theories because we don’t

even know what theory is to be tested if we allow the parameters to vary in that

manner.

Well, this is the primitive way all science began but in economics we should now

reach a step further.

With the exposition of evolvodynamics in this treatise we must nevertheless be

aware that we are also still not in a position to draw more definite conclusions

about its capability of offering a reliable description of the domain of economic

phenomena. But at least there is a body of derivable equations ready for national

economic institutes to work on. In fact the exposition given in previous pages deals

mainly with the theoretical side of economic evolution. This exposition of the

theoretical side I consider as where my contribution in presenting the theory of

evolvodynamics ends. However, despite the power of deductive reasoning which

I have tried to expose in previous pages, we are far from completion. We must be

cautious in drawing definite conclusions given the pile of work of testing still to be

done. Deductively based theoretical analysis is necessary to create a theory as

reliable as possible that is ready for testing. Subsequent testing is needed to verify

its significance.

All aspects (theoretical and experimental) of the scientific enterprise demand the

deployment of diversified expertise. The current macro-economic forecasts of

governmental planning agencies are the result of the cooperative effort of two

specialisms: the expertise of econometric model-design and the expertise of data

collecting.

Each nation has its own system of parametric equations to describe the economy.

It reflects the compromise to which has been decided by that nation in a cooperative

econometric effort. Now and then the parameters and the system of equations will

and must be adjusted. We can’t conclude that such operational system of parametric

equations reflects the attainments of certain schools of orthodox economic thought.

In fact the present systems represent a mixture of ideas not so much the approach of

a particular economic mindset but rather a practical compromise that is currently

believed to give the best correlation with observations. No dogmatism but pragma-

tism prevails. However, there is no indication afterwards that the preferred model

does indeed produce the best correlation. Moreover there are often alternative

economic agencies within a country that employ a completely different system of

macro-economic parametric equations that produces forecasts of similar quality.

Clearly, there are many orthodox systems of equations of equal merit. This is of

course the typical problem of economic orthodoxy. With the formulation of the

theory of evolvodynamics the situation will be quite different: econometrists need

no longer be involved in constructing the applicable economic theory because only

a single theoretical system is available. Apart from extending and improving the

theory of evolvodynamics further, their task is different now.

228 9 Theory and Confirmation

The task of the scientific experimenter remains to verify and test the theoretical

forecasts against observations. This is a role that has to be fulfilled with respect to

the theory of evolvodynamics. Gathering the required data about macro-economic

time-series is a major enterprise. Many variables of the theory of evolvodynamics

are differential quotients. Their measurement demands an indirect approach.

Measurements always extend in time so that numerical procedures and filtering

techniques are required to prepare them for comparison with the theoretical

predictions. It is a classic problem of time-series analysis, also well known in the

physical sciences, communication and signal processing sciences. This is where

numerical analysis and the expertise of econometrists are badly needed. Thus

instead of composing a set of parametric equations, econometrists must take up

the classic role of the translation between the instantaneous variables of

evolvodynamics and the measurements of those variables by the experimenters

involved in data measurement.

In this respect the present practice of seasonal detrending by economists needs

critical reconsideration. Economic time-series contain information. One of the main

attainments of time series analysis is that data mutilation is fundamentally wrong,

e.g. by the application of the wrong filtering techniques. By filtering out seasonal

fluctuations information gets lost. As E.T. Jaynes remarks in the preface of his book

on probability theory, “this is happening constantly from orthodox methods of

detrending or seasonal adjustment in econometrics” (Jaynes 2004, page xxvii).9

The subject deserves the utmost attention in the process of implementing the

equations of evolvodynamics in numerical computational routines.

The seasonal fluctuations are of considerable importance and optimum use of

them in computational routines improves the interpolations and extrapolations of

the variables over longer periods of time. Economists should therefore be on their

guard with applying the right techniques to link the momentary flow variables, such

as money input PXi money influx PXi , money output PYi , money outflux PYi , the

price levels and circulation rates, to the observed averages over a fixed period T of

time. E.g. Xi ðtÞ respectively Yi ðtÞ is something different than

ð0 ð0

1 1

Xi ðt þ θÞdθ and Yi ðt þ θÞdθ

T T

T T

Ð0 Ð0

We cannot simply replace Xi ðtÞ by T1 T Xi ðt þ θÞdθ and Yi ðtÞ by T1 T

Yi ðt þ θÞdθ. That will cause a loss of information, the more so the larger T is. On the

other hand, some smoothing out over time is inevitable to assure that the zero-mean

errors of measurement smooth out. This is however not a typical economic prob-

lem. It is a common problem of time-series analysis with respect to all sorts of

quantitative scientific disciplines.

9

Neoclassicism is an example of an approach with a very substantial waste of information because

the tenets of neoclassicism do not hold in the short run as we have argued in Sect. 1.7.

Appendix A

Homogeneity

Let us consider two-sector input selection for the case that there are only Zdt samples

of which two thirds turn out to be in state 1 and one third in state 2 (See Fig. 1.2).

Then the probability of selecting a sample in state 1 is λ1 ¼ 23 and the probability of

selecting a sample in state 2 is λ2 ¼ 13. In accordance with Shannon’s formula (1.1) the

reassembled entropy input is Zdt HðX0 Þ ¼ Zdt ½ð1 λ1 Þ logð1 λ1 Þ þ λ1 log λ1

and it follows in this special case that Zdt H ðX0 Þ equals 0:9183 Zdt units of

value (u.o.v.).

Well there is a snake in the grass. Shannon’s formula (1.1) is an asymptotic

approximation, which is the better the more samples there are, i.e. the larger Zdt is.

In fact the formula is very accurate for Zdt sufficiently large but it is not if Zdt

remains quite small. The exact general expression for HðX0 Þ is

k!

Zdt H ðX0 Þ ¼ log with k ¼ k1 þ k2 (A.1)

k1 ! k2 !

in which k ¼ Zdt is the total number of samples (in state 0), k1 ¼ λ1 Zdt the number

of samples that turn out to be in state 1 and k2 ¼ λ2 Zdt the number of samples that

turn out to be in state 2.

Suppose then that the statistical experiment is chosen so that Zdt ¼ k is finite and

equal to 21 as for example is illustrated by the input sequence in Fig. 1.2. Calcula-

tion with the help of the exact formula (A.1) results in

u.o.v. (see Sect. 1.7). The difference between the two calculations is an error in the

Lecture Notes in Economics and Mathematical Systems 665,

DOI 10.1007/978-3-642-34056-7, # Springer-Verlag Berlin Heidelberg 2013

230 Appendix A

Table A.1 The reassembled information content of input selection for different numbers k ¼ Zdt

of samples

Number of Number of ReassembledP information

samples in state 1 samples in state 2 content Zdt λi logλi

Unit of value relative to i

standard u.o.v. λ1 Zdt λ2 Zdt in standard u.o.v.

Standard 14 7 16.827243

10 times as small 140 70 18.874421a

100 times as small 1,400 700 19.226624a

1,000 times as small 14,000 7,000 19.276793a

10,000 times as small 140,000 70,000 19.283304a

100,000 times as small 1,400,000 700,000 19.284105a

1,000,000 times as small 14,000,000 7,000,000 19.284200a

10,000,000 times as small 140,000,000 70,000,000 19.284211a

100,000,000 times as 1,400,000,000 700,000,000 19.284212a

small

a

To calculate these numbers I have used the following very accurate asymptotic approximation:

log[k!/(k1!k2!)] ¼ –[(1 – λ)log(1 – λ) + λlogλ]k – ½log[(1 – λ)λk] – ½log(2π) with λ ¼ λ1

Shannon calculation due to the circumstance that the number of samples is chosen

too small. The point is that Shannon’s theory is only applicable for Zdt sufficiently

large, i.e. in the limit Zdt should tend to 1. On the other hand Shannon’s formula is

compatible with the principle of evolutionary homogeneity, but the calculation of

16.827243 u.o.v. on behalf of (A.1) is not. The problem is however easy to manage.

We must choose the number of samples much larger and simultaneously adjust the

choice of the u.o.v. so that the outcome of Zdt H ðX0 Þ on behalf of (A.1) tends to the

outcome on behalf of Shannon’s formula (1.1). Thus all statistical experiments will

be so executed that the number Zdt of samples is increased by a sufficiently large

factor while simultaneously choosing the new unit of value inversely proportion-

ately smaller. The error between the outcome of the Shannon formula and the

outcome of (A.1) will vanish then. This is illustrated in Table A.1. In this table each

row reflects a particular choice of Zdt ¼ k and the u.o.v., starting with k ¼ 21 in the

second row. Each following row has 10 times as many samples and 10 times as

small units of value as the preceding row. E.g. in the third row of Table A.1 the

number Zdt ¼ k samples is fixed at k ¼ 10 21 ¼ 210 so that k1 ¼ 140 and k2 ¼ 70

with a new u.o.v. that is 10 times as small as the old one in the second row. A

calculation with the help of (A.1) yields Zdt H ðX0 Þ ¼ 188:74421 units in the new

u.o.v. This is 18.874421 units in the old unadjusted u.o.v. The error between the

Shannon measure (19.2842) and the correct outcome (18.874421) has declined

considerably. If the number of samples is multiplied once more by a factor 10

and the u.o.v. is reduced once more by a factor 10 we have k ¼ 2; 100, k1 ¼ 1; 400

and k2 ¼ 700 (See fourth row in Table A.1) and the new outcome is 19.226624 units

in the old unadjusted u.o.v. This is now very close to the Shannon measure 19.2842.

Appendix A 231

Note that the larger the number of samples and the proportionately smaller

the choice of the unit of value, the smaller the error in the calculation of the

reassembled information content. This illustrates that it is necessary to choose

the number of samples as large as possible together with the u.o.v. as small as

possible to attain evolutionary homogeneity.

There is of course still the question why economic selection should, by neces-

sity, take place against the background of a sufficiently (very) small u.o.v. and an

infinite sequence length.

I can think of two reasons for that:

• It is a necessity effectuated by the requirements of economic exchange. If the

unit of value is too large, exchange will be hampered and even obstructed,

because transactions between agents can then only be rounded off in a way

that injures one of the agents and benefits the other unnecessarily and against the

will of both. Hence noticing the exchangeability, fluidity and divisibility of

money, agents will seek and find ways to settle transactions in a smaller u.o.v.

• Agents will seek to reassemble as much entropy as they can. They will not leave

attainable knowledge (by selection) unexploited, thus maximizing the informa-

tion that they gather about input and output separately. As the data in the fourth

column of Table A.1 teach us: the smaller the unit of value, the larger the input

and output in terms of an invariable u.o.v. Hence agents will apply the smallest

unit of value in which to reassemble their samples.

Appendix B

The probabilities of input and output selection in sample space dS0 ¼ dS

0 [ dS0

based on the Shannon-inspired conception of Darwinian evolution are the

following:

• The probability λi that a sample annihilates in state i on (t,t + dt).

• The probability μj that a sample originates in state j on (t,t + dt).

• The probability λðij jÞ that a sample annihilates in state i on (t,t + dt) conditional

to another sample originating in state j on (t,t + dt).

• The probability μðjjiÞ that a sample originates in state j on (t,t + dt) conditional

to another sample expiring in state i on (t,t + dt).

• The unconditional joint probability qij that a sample annihilates in state i on

(t,t + dt) and a sample originates in state j on (t,t + dt).

The following general rules of probability calculus hold with respect to these

probabilities:

1. Any trial of a sample expiring in state i ði ¼ 1; 2, 3, ; N Þ and another

sample concurrently originating in state j ðj ¼ 1; 2, 3, ; N Þ will induce

the emergence/cancellation of entropy in overall sample space dS0 ¼ dS

0 [ dS0 .

See the discussion in Sect. 2.2. The event of expiration of a sample in state i is

statistically dependent on the event of origination of a sample in state j. This

þ

implies that the subsets of dS i and dSj overlap (See the Venn diagrams of

Figs. 2.2, 2.4 and 2.5) for any i; j ¼ 1; 2, 3, ; N.

2. The event of expiration of a sample in state i and the event of expiration of

another sample in state j are mutually independent. Likewise the event of

origination of a sample in state i and the event of origination of another sample

in state j are mutually independent. Such independent events are selected

sequentially, i.e. in the process of executing two successive singular trials, one

with the outcome in state i, the other in state j.

Lecture Notes in Economics and Mathematical Systems 665,

DOI 10.1007/978-3-642-34056-7, # Springer-Verlag Berlin Heidelberg 2013

234 Appendix B

representing the same

economy 3 times.

Circle on the left is aggregate

joint outflow Y0. Ellipse on

μ1

the right is aggregate joint

inflow X0.

Top configuration with the

probabilities of outflow

selection: μ1 + μ2 = 1. μ2

Center configuration with the Y0 X0

probabilities of inflow

selection: λ1 + λ2 = 1.

Bottom configuration with the

probabilities of transmission

selection. From (B.1) and

(B.2) of Appendix B:

q11 þ q21 ¼ q01 ¼ μ1 λ1

q11 þ q12 ¼ q10 ¼ λ1

Y0 X0

q21 þ q22 ¼ q20 ¼ λ2

q10 þ q20 ¼ 1

q01 þ q02 ¼ 1

Mark that

q21 q12 ¼ μ1 λ1 ¼ λ2 μ2 q11

q21

q22 q11 ¼ μ2 λ1 ¼ λ2 μ1 q12

q22

Y0 X0

The Venn diagram of Fig. B.1 gives a geometrical insight into the various

relationships between the entropy variables and the probabilities for the two-sector

economy.

I have extended the range of i and j to include also the state 0, the union of all the

other states of the multi-sector economy. That is,

X X X X

μj ¼ q0j ¼ qij ; λi ¼ qi0 ¼ qij ; q00 ¼ qi0 ¼ q0j ¼ 1 (B.1)

i j i j

The probabilities λi and μj and the conditional probabilities λðij jÞ and μðjjiÞ satisfy

the necessary partition requirements (Papoulis 1985, Chap. 15):

Appendix B 235

X X X

λi ¼ λ0 ¼ 1; μj ¼ μ0 ¼ 1; λðij jÞ ¼ λð0j jÞ ¼ 1;

i j i

X

μðjjiÞ ¼ μð0jiÞ ¼ 1

j

and it is also certain that a sample has originated in state S0 .

In accordance with Shannon’s definition the conditional entropy H ðY 0 jX0 Þ is

the average of the entropy Y 0 for each value of X0 weighted according

to the probability of getting that particular X0 . Likewise the conditional entropy

H ðX0 jY 0 Þ is the average of the entropy X0 for each value of Y 0 weighted according

to the probability of getting that particular Y 0 :

X X

H ðY 0 j X 0 Þ ¼ qij logμðjjiÞ and H ðX0 jY 0 Þ ¼ qij logλðij jÞ (B.2)

i;j i;j

qij qij

μðjjiÞ ¼ and λðij jÞ ¼ (B.3)

λi μj

X X

H ðY 0 jX0 Þ ¼ qij logqij þ qij logλi

i;j i;j

and

X X

H ðX 0 j Y 0 Þ ¼ qij log qij þ qij logμj

i;j i;j

We have

X

H ðX 0 [ Y 0 Þ ¼ qij log qij (B.4)

i;j

joint aggregate output Y 0 . Thus

X

H ðY 0 jX0 Þ ¼ H ðX0 [ Y 0 Þ þ qi0 logλi

i

and

X

H ðX0 jY 0 Þ ¼ H ðX0 [ Y 0 Þ þ q0j logμj

j

236 Appendix B

X

H ðX 0 j Y 0 Þ ¼ H ðX 0 [ Y 0 Þ þ μj logμj and H ðY 0 jX0 Þ

j

X

¼ H ðX 0 [ Y 0 Þ þ λi logλi (B.5)

i

X X

H ðX 0 Þ ¼ λi logλi and H ðY 0 Þ ¼ μj logμj (B.6)

i j

Herein H ðX0 Þ is the aggregate joint entropy input. H ðY 0 Þ is the aggregate joint

entropy output. It follows from the two expressions (B.5) and (B.6) that

and H ðX0 jY 0 Þ ¼ H ðX0 [ Y 0 Þ H ðY 0 Þ (B.7)

Mark also that H ðY 0 jXi Þ and H X0 Xj satisfy a related and more general

relationship:

HðY 0 jXi Þ ¼ H ðXi [ Y 0 Þ H ðXi Þ and H X0 Y j ¼ H X0 [ Y j H Y j

X

H ðXi jY 0 Þ ¼ λi H ðX0 jY 0 Þ ¼ λi qij logλðij jÞ;

j

X

H Y j j X 0 ¼ μ j H ðX 0 j Y 0 Þ ¼ qij logμðjjiÞ

i

We maintain further that:

X X

H ðXi Þ ¼ λi H ðX0 Þ ¼ λi λj logλj ; H Y j ¼ μj H ðY 0 Þ ¼ μj μi logμi

j i

It follows that

X X

H ðXi Þ ¼ H ðX0 Þ and H Y j ¼ H ðY 0 Þ

i j

Appendix B 237

Let us next consider the equalities following from the associated Venn diagram:

H X i [ Y j ¼ H ðX i Þ þ H Y j H X i \ Y j (B.8)

Herein H Xi [ Y j is the entropy of the union Xi [ Y j of Xi and Y j . H Xi \ Y j

is the entropy of the intersection Xi \ Y j of Xi and Y j . H Xi \ Y j is related to

H ðX0 \ Y 0 Þ by H Xi \ Y j ¼ qij H ðX0 \ Y 0 Þ. The easiest way to check that is with

the help of the Venn diagram of Fig. B.1. Mark that the probability of selecting both

a sample originating in state j and another sample annihilating in state P i is equal to

μj λðij jÞ ¼ λi μðjjiÞ. On behalf of (B.3) this is equal to qij. Note q00 ¼ i;j qij ¼ 1.

Hence

H Xi \ Y j

qij ¼ for i; j ¼ 0; 1, 2, 3 (B.9)

H ðX 0 \ Y 0 Þ

Likewise the probabilities λi and μj are given by

H ðX i Þ H Yj

λi ðt Þ ¼ ; μ j ðt Þ ¼ for i; j ¼ 0; 1, 2, 3 (2.11)

H ðX0 Þ H ðY 0 Þ

From (B.8) it follows that

H ðX 0 \ Y 0 Þ ¼ H ðX 0 Þ þ H ðY 0 Þ H ðX 0 [ Y 0 Þ

X X X

H ðX 0 \ Y 0 Þ ¼ λi log λi μj log μj þ qij log qij

i j i;j

Substitution of H ðXi Þ ¼ λi H ðX0 Þ and H Y j ¼ μj H ðY 0 Þ in (B.8) yields

H X i [ Y j ¼ λ i H ðX 0 Þ þ μ j H ðY 0 Þ H X i \ Y j

H Xi \ Y j can be replaced by qij H ðX0 \ Y 0 Þ on behalf of (B.9). It follows that

H Xi [ Y j ¼ λi H ðX0 Þ þ μj H ðY 0 Þ qij ½HðX0 Þ þ H ðY 0 Þ HðX0 [ Y 0 Þ

H Xi [ Y j qij H ðX0 [ Y 0 Þ ¼ qi0 qij HðX0 Þ þ q0j qij H ðY 0 Þ

238 Appendix B

economy, has been listed:

q11 þ q21 ¼ q01 ¼ μ1 , q12 þ q22 ¼ q02 ¼ μ2 , q11 þ q12 ¼ q10 ¼ λ1

q21 þ q22 ¼ q20 ¼ λ2 , q10 þ q20 ¼ 1 and q01 þ q02 ¼ 1

Appendix C

the literature of probability theory dependent on the vocabulary the author prefers:

the two sets SA and SB are called non-overlapping or disjoint or mutually exclusive or

non-concurrent if their intersection is the null set, i.e. if

In general we have

property of mutually exclusive sets. Note that Probf g is an elementary probabil-

ity. It is not a state probability (See Sect. 2.7). The elementary probability ProbfSg

of a set S is proportionate to the entropy H ðSÞ of that set. It follows from (C.2) that

statistical selection within differential sample space dS0 . Generally in differential

þ

sample space, dS i and dSj are mutually inclusive. They overlap in differential

sample space:

n o

dS þ

i \ dSj 6¼ and Prob dS

i \ dS þ

j 6¼ 0

Lecture Notes in Economics and Mathematical Systems 665,

DOI 10.1007/978-3-642-34056-7, # Springer-Verlag Berlin Heidelberg 2013

240 Appendix C

That general situation has been depicted in Figs. 2.2, 2.3, 2.4 and 2.5. In the

particular case that i ¼ j ¼ 0, we have also

dS þ

0 \ dS0 6¼

The surface area that a set occupies in the Venn diagram is proportional to the

entropy content of that set.

On behalf of Boltzmann’s principle it follows from (C.3) that for any two sets

SA and SB

HðSA [SB Þ HðSA Þ HðSB Þ HðSA \SB Þ

1 1 1 1

¼

2 2 2 2

PrfSA g: PrfSB g

PrfSA [ SB g ¼ (C.4)

PrfSA \ SB g

Equation (C.4) is a general statement regarding state probabilities.

We need to revert to elementary probabilities in order to deal with the concept of

statistical independence. Mutual dependence/independence is concerned with the

elementary probability of an event/outcome of a single trial of an experiment

conditional to another event or series of events being certain. Generally the

following axiom of probability theory applies with regard to two elementary events

εA and εB :

We use the notation ProbfεA \ εB g with the operator \ here, but we should

be aware that ProbfSA \ SB g with the same operator \ has a completely different

interpretation. In ProbfSA \ SB g we are concerned with the chance that a sample

is drawn from (or into) the common area of the subset SA and the subset SB . In

ProbfεA \ εB g we are concerned with the chance that both the event εA and the

event εB occur.

By definition two events εA and εB are statistically independent if their

elementary probabilities satisfy

Appendix C 241

Hence it follows from (C.5) that ProbfεA jεB g ¼ ProbfεA g and ProbfεB jεA g ¼

ProbfεB g are properties of two independent events εA and εB . If (C.6) is not satisfied

the events are statistically dependent.

From the above expositions it follows that the general concepts of mutual

exclusiveness of selection and statistical independence of selection differ markedly

in definitional respects. They should therefore not be confused with one another.

Appendix D

P

Derivation of H ¼ ωi logωi as the Measure of Information

i

Per Sample

F gA ¼ A FðgÞ with g ¼ W 1

tion to A we obtain

¼ ¼ g ln g ¼ FðgÞ

dA d ð gA Þ dA d ð gA Þ

It follows that

dFðgA Þ d ðgA Þ

ln g ¼ A

Fð g Þ g

A ln g d ln F gA ¼ d ln gA ¼ dðA ln gÞ

and

dðA ln gÞ

d ln F gA ¼ ¼ d lnðA ln gÞ

A ln g

This results in

Lecture Notes in Economics and Mathematical Systems 665,

DOI 10.1007/978-3-642-34056-7, # Springer-Verlag Berlin Heidelberg 2013

244 Appendix D

ln F gA ¼ lnðA ln gÞ þ ln η and F gA ¼ Aη ln g

follows that FðgÞ ¼ η ln g and hence that

F W 1 ¼ η ln W 1

F W 1 ¼ η ln W 1 to be proportional to Zdt ¼ k. Thus we will set η ¼ Zdt=ln 2 so

that

F W 1 ¼ Zdt log W

Appendix E

from a number of k ¼ k1 þ k2 bitpulses of which k1 bitpulses are in state 1 and k2

bitpulses are in state 2 (note that in the main text k ¼ Zdt). k is the number of

bitpulses in state 0, i.e. the number of bitpulses that is either in state 1 or in state 2.

The experiment will be continued until all the k bitpulses have been selected. Our

task is to determine the state probability of the selected sequence. We shall denote

the ensemble of the bitpulses that are in state i by Z i ði ¼ 0, 1 or 2Þ. Z 1 and Z 2 are

mutually exclusive. The sets Zi satisfy the rules:

Z0 ¼ Z1 [ Z2 and Z1 \ Z2 ¼

The determination of the selection probability of this experiment without

replacement is a standard piece of combinatorial analysis of probability theory.

So I could suffice here with stating the formula for the state probability Π and to

refer to textbooks on probability theory for its derivation. However, the details of

the derivation uncover the context and ins and outs of economic processes of

selection. Therefore I prefer to present here the individual steps of the argument

in full detail. Let us then carefully follow the steps by which the selection probabil-

ity is to be derived.

If a bitpulse drawn from Z0 happens to have the outcome of being in state 1, this

results—after selection—in the removal of one bitpulse from the number of

bitpulses in the current population of Z 1 that will reside in state 1. This implies

also that one bitpulse is removed from the current population of Z0 since Z1 is a

subset of Z0 . On the other hand, if the bitpulse that is drawn happens to have the

outcome of residing in state 2, that will result in the simultaneous removal of one

bitpulse from the current population of Z2, which happen to reside in state 2, and one

bitpulse of the number of bitpulses from the current population of Z 0 .

Lecture Notes in Economics and Mathematical Systems 665,

DOI 10.1007/978-3-642-34056-7, # Springer-Verlag Berlin Heidelberg 2013

246 Appendix E

Let us first sum up the various variables and elementary events that we shall need

for the derivation of the probabilities of the sequences that may be formed as

outcomes of the selection process:

• k1 ¼ The number of bitpulses of Z 0 in state 1.

• k2 ¼ The number of bitpulses of Z 0 in state 2.

• k ¼ The total number k ¼ k1 þ k2 of bitpulses in state 0.

• Λi The event that the selected bitpulse is in state 1 on the i-th draw.

• Γ i The event that the selected bitpulse is in state 2 on the i-th draw.

• u The number of bitpulses in state 1 that have been drawn.

Let us start the experiment by drawing the first bitpulse of Z 0 . The probability

ProbfΛ1 g that the first bitpulse being drawn is in state 1 is

k1

ProbfΛ1 g ¼

k

and the probability ProbfΓ1 g that the first bitpulse being drawn is in state 2 is

k2 k1

ProbfΓ 1 g ¼ ¼1

k k

The interpretation is crucial here. When the first bitpulse is drawn, all of the k

bitpulses that are currently present in the population are engaged in the selection of

this bitpulse. In a world of many uncertainties this engagement is properly

expressed in the two expressions above for ProbfΛ1 g and ProbfΓ 1 g.

Next we consider the probability ProbfΛ1 \ Λ2 g that the first two bitpulses are

selected in state 1.1 This requires the second draw to be performed conditional to

the event that a bitpulse in state 1 was selected with the first draw. That is,

this expression demands that the removal of a bitpulse in state 1 should be taken

into account. This yields

k1 1 k1 k1 1

ProbfΛ2 j Λ1 g ¼ and ProbfΛ1 \ Λ2 g ¼

k1 k k1

The interpretation is again crucial here. Since one of the bitpulses in state 1 has

been taken into account as having been selected on the first draw, it is removed from

1

Mark that ProbfΛ1 \ Λ2 g is the elementary probability that both the event Λ1 and the event Λ2

occur.

Appendix E 247

the current population and does not play a role anymore in the selection of a bitpulse

on the second trial and on successive draws thereafter.

In this manner we may proceed with the consecutive selection of bitpulses in

state 1 on the third, fourth etc. trial.

In the end we arrive at the probability ProbfΛ1 \ Λ2 \ Λ3 \ . . . \ Λu g of u

¼ k1 consecutive draws of bitpulses in state 1:

k1 ðk1 1Þðk1 2Þ . . . . . 3 2 1

ProbfΛ1 \ Λ2 \ Λ3 \ . . . \ Λu g ¼

kðk 1Þðk 2Þ . . . . . ðk2 þ 1Þ

k1 ! k2 !

¼ (D.1)

k!

Each time a bitpulse in state 1 is selected and taken into account, the number of

the remaining bitpulses in state 1 reduces by one and the probabilities of forthcom-

ing selections must be adjusted accordingly because, since the moment a bitpulse is

selected, it does not contribute to the forthcoming selection of bitpulses anymore.

After all u ¼ k1 draws of bitpulses in state 1 have been executed, all the k2

bitpulses in state 2 form the remainder population of Z 0 . From then on, the

continuation of the selection process has no secrets anymore.

Each time we select a bitpulse, we know it will be in state 2, i.e. it will be

selected with probability 1.

Hence, (D.1) gives the complete expression for Π ¼ ProbfΛ1 \ Λ2 \ Λ3 \ . . .

\Λu g:

k1 ! k2 !

Π¼

k!

Appendix F

We shall here discuss the crucial role of statistical dependence in evolution and its

relationship with the overlapping of input and output. To this end we shall prove

that both the transmission H ðX0 \ Y 0 Þ will vanish relative if the elementary events

of input and output are statistically independent. This implies that the overlapping

of input and output will vanish if there is statistical independence, but that

overlapping will be more the more statistical dependence between the events of

input and output there is. Moreover we will see that the complete absence of

overlapping, with H ðX0 \ Y 0 Þ ¼ 0, is the point where evolution begins or ends. It

need not imply that selection is totally absent at that turning point of evolution so

that always evolutionary development can return as a result of random processes of

selection. However if the transmission H ðX0 \ Y 0 Þ vanishes relative to input HðX0 Þ

and output HðY 0 Þ such that

k H ðX 0 \ Y 0 Þ

lim ¼ 0 with k representing the number of samples

k!1 log k

selection reduces to a determinist choice between only one single state and so

ultimately rules out selection to occur at all because we need at least two states to

select between. We are then leaving the free world of random occurrences to

replace it by a determinist world view.

For good order’s sake note that we are here concerned with the interaction

between the events of entropy origination in dSþ 0 , which are the output events,

and with the events of entropy annihilation in dS 0 , which are the input events.

Thus we are not considering the output events of dSþ0 relative to the inflow events of

dS dSþ . Neither do we consider the input events of dS relative to the outflow

0 0 0

events of dSþ dS .

0 0

Lecture Notes in Economics and Mathematical Systems 665,

DOI 10.1007/978-3-642-34056-7, # Springer-Verlag Berlin Heidelberg 2013

250 Appendix F

To demonstrate the above assertions with respect to the input and output events

we must take full account of the asymptotic bias error in (1.1) and (2.7). These

Shannon equations are based on expression (4.4), which is the first order asymptotic

approximation of (4.4) for k ¼ Zdt ! 1. However a more accurate second order

asymptotic approximation of (4.3) takes also in account the terms that are propor-

tional to log k in (4.3), so acknowledging that also log k is tending to 1. This implies

that the Shannon equations (1.1) and (2.7) should be replaced by

X

k H ðX0 Þ ¼ k λi log λi 12ðN 1Þ log k (F.1)

i

X

k H ðY 0 Þ ¼ k μj log μi 12ðN 1Þ log k (F.2)

j

X

k H ðX0 [ Y 0 Þ ¼ k qij log qij 12 N 2 1 log k (F.3)

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