Tuesday, April 3, 2012

N Theory versus Supply and Demand Theory II

The approach to solving economic problems differs greatly between N Theory and Supply and Demand Theory. N Theory identifies the components of an effective economic system and then looks at the economic system a country is using and identifies the flaws. Imagine instead of an economy the N Theory technique was used to identify the problems in a golf swing.  First, N Theory would establish the features of a good golf swing: keeping your left arm straight, raising the club over your head, keeping your eyes on the ball, keeping your head motionless, and releasing your cracked wrist at impact. After a list is created the N Theory process evaluates each item on the list for proper functioning and then evaluates how each step coordinates with the other steps. This analytical approach reveals cracks in the whole process and focuses on strengthening the areas needing improvement.

Supply and Demand Theory is a mathematical model where prices and quantities of goods are compared. From this process of comparison certain trends are derived from past results. These past results are used to predict future results or the results of alternative inputs. The major difference between N Theory and Supply and Demand Theory is how human choice is involved. Supply and Demand Theory asserts price setting results from concrete factors: the number of goods for sale or the changes in the money supply. N Theory states prices are determined by human decision making on both sides: Buyer and Seller decisions. Supply and Demand Theory comes up with an absolute result that applies to all sales. N Theory states all price setting is potentially unique and one of a kind.

In N Theory the roles played by people: Buyers and Sellers is most important. In Supply and Demand Theory the quantity of products for sale and the quantity of money in the hands of Buyers are the most important factors.  N Theory does not ignore these quantity factors, but diminishes their importance. N Theory sees quantity factors as part of a long list of factors that affect and influence decision makers: Buyers and Sellers. Supply and Demand Theory by focusing on things (products and money) fails to explain financial events caused by rational or irrational human action. Supply and Demand Theory cannot predict panics. N Theory is based on the human factor that precipitates financial panic.

Jean Claude Trichet in a speech at Harvard indicated that economic models based on Supply and Demand failed to predict or suggest a way out of the Global Financial Crisis of 2008. The strategies employed by central banks throughout the world did little to restrain or reverse the economic slide caused by poor political leadership. Throughout the world political leadership followed the tenets of Supply and Demand Theory and as stated by Keynes: "control of interest rates is the best way to encourage market growth." The central banks immediately instituted policies to lower interest rates, but nothing happened. Why? The decision makers were not convinced. Business people did not invest and expand, but reduced staff and horded investment cash. Consumers did not rush out to buy capital goods because interest rates were low, but delayed making purchases and put money into savings accounts.

The Global Financial Crisis is a vivid example that the things policies of conventional economics does not work. The only effective policy is one based on the actions and expectations of people. That is exactly what N Theory purports to do, but more than that, it also suggests a regular economic check-up to ensure the components of commercial enterprise are working properly.

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