The Thermodynamic Foundation for Ecological, Evolutionary, and Institutionalist Economics

Abstract

Social and biological systems, as open dissipative systems, need to extract low entropy from the environment to compensate for continuous dissipation. This process can be represented by lognormal processes, with a deterministic representation of a thermodynamic equation. From here, we develop an analytic thermodynamic theory of social sciences. Most people agree that thermodynamic theory is a sounder foundation to describe living systems than Newtonian mechanics, which is the physical foundation of general equilibrium theory. As it is often the case, an analytical framework that is built on sounder physical foundation delivers more intuitive and simpler results. This theory, for the first time in economic literature, provides an analytic formula that explicitly represents the relation among fixed costs, variable costs, uncertainty of the environment and duration of a project, which is the core concern in most economic decisions. Since a thermodynamic equation is of first order in temporal dimension, social and biological systems as thermodynamic systems are intrinsically evolutionary. This analytical theory directly models the extraction of low entropy natural resources and the diffusion of high entropy environmental waste. It provides an analytical framework for ecological and environmental economics. From the second law of thermodynamics, it is far easier for a system to disintegrate than to maintain its structure. Only certain institutional structures, which developed effective ways to extract low entropy from the environment, can compensate the universal tendency of increasing disorder. Therefore the problems of institutions and industrial organizations naturally emerge as the central issue in the thermodynamic theory.

Keywords: Analytical framework, thermodynamic foundation of economics, variable costs, fixed costs, tradeoff between competitiveness and flexibility, non-equilibrium

JEL Classification: B41, N50, Q01