Dannenberg, Alia Asha Estola, Matti Dannenberg, Anna
Year of Publication:
Economics Discussion Papers No. 2017-110
The main weakness in the neoclassical theory of economics is its static nature. By a static model one cannot explain the observed time paths of economic quantities, like the flows of production of firms, the flows of consumption of consumers, and the prices of goods. The error in the neoclassical framework is that economic units are assumed to be in their optimum state and thus not willing to change their behaviour. Therefore, in neoclassical models a static equilibrium prevails. In this paper, the authors change this assumption so that economic units are assumed to be willing to improve their current state that may not be the optimal one. In this way, one can explain economic dynamics where every economic unit is changing its behaviour towards improving its welfare. The authors define the economic forces acting upon the production of firms, the consumption of consumers, and the prices of goods are changing in time. They show that in this dynamic system, business cycles and bankruptcies of firms emerge in a natural way like in the real world.