## Monday, June 03, 2013

### A Continuous Time System Block Diagram For Nicholas Kaldor

 A System Block Diagram For A Business Cycle Model

In this model of business cycles, two state variables, Y(t) and K(t), represent national income and the value of the capital stock, respectively. These state variables are each specified by a differential equation. In the above block diagram, I have adopted a notation from Steve Keen. The triangles in the upper-right and lower right equate the integrals of their inputs, over time, to their outputs. In other words, the following differential equations obtain:

dY/dt = α[I(t) - S(t)]
dK/dt = I(t) - δK(t)

You can compare and contrast this continuous-time representation of a dynamical system with its analogous discrete-time version.

This is a multiplier-accelerator model that allows for the economy to normally be out of equilibrium. An economic interpretation1 of the model is that entrepreneurs have some sort of common opinion about the level of economic activity they expect in this nation's economy. And they have an opinion about the total value of capital stock that they believe is needed to sustain that activity. When these expectations are realized, this dynamical system is in an equilibrium. The model shows that when the economy has more activity than expected, entrepreneurs tend to increase the capital stock more rapidly, and vice versa for when activity falls below the expected level. This tendency is a non-linear relationship. Maybe, the more extreme the difference between the actual level and the expected level is, the less likely entrepreneurs are to expect the actual level to continue.

Neither interest rates nor prices are modeled here. Such modeling might be justified by the claim that the income effects in the model overwhelm the effects of prices. At any rate, this model does not contain an aggregate production function. Capacity can be operated either above or below the rate that was desired when the capital equipment being evaluated was installed. If the value of the capital stock falls below the expected level, entrepreneurs tend to increase investment, and vice versa for when the value of the capital stock rises above the expected level. (I think of the depreciation of the capital stock shown in the model as an accounting heuristic, not a physical decay.)

I am not putting forth grand empirical claims. To me, this model is of mathematical interest. It illustrates how non-linear economic dynamics can be generated endogenously. A source of continuous external shocks is not needed2.

Unlike in the discrete-time case, I do not see how the continuous-time model given here can generate chaos. Trajectories in the two-dimensional state space are smooth, with no gaps. They cannot intersect. So, I think, this continuous-time model can generate cycles, but not strange attractors3. Another difference between discrete-time and continuous-time systems revolves around the details of stability analysis4.

Anyways, the graphical specification of the Kaldor model, given in this post, is suitable for numerical exploration in Steve Keen's software, as I understand it.

Footnote
1. As I understand it, mainstream macroeconomists currently reject the rough-and-ready microfoundations I provide here. They insist on formal microfoundations, even though their preferred formal treatments are just nonsense.
2. Some more mainstream economists seem to be willing to make this points in Overlapping Generations (OLG) models. I am willing to explore the mathematics there, despite the absurdity of assuming investment is driven by intertemporal utility-maximization of consumption.
3. The logistic equation is an example of a one-dimensial, discrete-time, chaotic dynamical system. Off-hand, I cannot think of a continuous-time chaotic system with less than three dimensions.
4. In discrete-time systems, one analyzes the stability of a fixed point by analyzing whether the eigenvalues of the system, linearized around the fixed point, are inside or outside the unit circle in the complex plane. In a continuous-time system, one looks to see if the eigenvalues are to the left or the right of the complex axis, if I recall correctly.

Georg Trappe said...

Hello Robert,

a system capable of chaos has to have at least three (3) dimensions.
A two dimensional system, like the one you discuss here, is as far as i know, not capable to generate Chaos.
Three dimensions and one non linearity are the minimum rquirement.
If you are interested in the research for the most simple chaotic system, you may want to take closer a look at publications from J.C. Sprott.
http://sprott.physics.wisc.edu/pubs.htm

Alex Nelson said...

Your link to Keen's notation is broken (I think too many http:// prefixes are the problem...).

Robert Vienneau said...

Thanks for the comments. I have corrected the link. I thought that this system is unable to generate chaos.