Sunday, February 21, 2010

Supply/Demand and information


Standard supply/Demand curve

This chart assumes money, and price is a comparison between the firm inventory of cash relative to the firm inventory of goods.

If we want to go to entropy norms, and eliminate money, then price becomes "redundancy", the complement of entropy. Redundancy is lowest when the production chain delivers at the maximum channel rates, where the channel rate are all transactions along the supply chain. So quantity is the "bit" rate, where the bit is the smallest observable quanta of good for the supply chain.

The first observation is the Austrian one, supply and demand makes no sense until one talks abut the whole distribution channel. The way we bridge the gap is, in the case of the peach business, is assume that everyone in the peach supply business ultimately counts in units of peaches. So, in effect, the researcher must first verify that the chain of distribution does seem to obey the Quant requirements, if so, then Shannon channel analysis can be used.

The trajectory of redundancy would become a series of large and small exponentials as the supply chain goes through a Ramsey Search (the allocation of limited precision along the supply chain) to adjust lot sizes and transaction rates at each term. There really isn't a supply and demand side, because the inventory unit moves through the supply chain, each processing step being conceived of a buyer of input and seller of output. Only the household at the tip of the network buys the basic unit of good, at the highest transaction rate allowed.

When traditional economists see a shift in household demand, they see a shift in the relative ratio of household cash and good inventories. The Information theorist sees the household, instead, shift to large lots sizes at lower transaction rates, which triggers a deflation and Ramsey search of the entire supply chain of the good. The household changes the basic good quant, the smallest quanta of good observable.

Let us construct the Caplan/Twieg fear budget hypothesis as a Shannon Channel. When we fear large terrorist events, more often; we see a deflated terror network, fewer steps is the production of terror. This is a low information rate channel with high quantization error relative to other distribution channels. The goal of the military is to provide much more precision to the terror network. So, in 2001, the production of terror required a combined Taliban and Al Queda, and a two stage network. Today, the production of terror from that region requires many more steps because of the requirements of precision imposed by counter military actions. So, today, we understand the terror network much better, the observable total number of steps in the production of terror is greater; the terror network is forced to be more informative.

So rather than a fear budget, maybe we need a minimum knowledge precision about threats to keep us comfortable.

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