Feedback and the Free Market

The classic economic model of the free market dynamics


The "market dynamic" in the free market


Here the market fluctuation settles on a single steady state with a unique price value (where supply ~= demand).

High-tech products market

Within the 'high-tech' product market there exist technical requirements concerning compatibility between different products (ie: VHS vs. Beta, Mac vs. PC)

Also, high-tech products require large initial capital investments. These increase a company's chance (and incentive) to monopolise a market

Example: Aircraft engine

  • Huge initial investment; approximately $2→$3 billion to design/develop/certify and produce
  • Economy of scale; copies then cost $50→$100 million.
  • Increased knowledge; producing more units means gaining more experience in the manufacturing process and reducing cost even further
  • Improved products; more utility and less costs
  • More knowledge; to develop similar product

Positive feedback in high-tech market

  • High-tech products set up standards for later technological development (the locking-in effect)

Example: Light water nuclear reactor

A number of possible cooling systems existed for light-water nuclear reactors when they were first being developed. These included: heavy water, gas or liquid sodium.

  • Light-water cooling system was originally developed for submarines
  • The US Navy's involvement in early reactor construction in conjunction with the National Security Council's efforts to get a reactor (any reactor) on land meant that light-water reactors were locked-into technological development.

In the high-tech market a demand-supply equilibrium is not met.
Instead the market is governed by positive feedback mechanisms. There are multiple possible equilibrium states.

Positive feedback and the free market

There are a number of alternate models of the market dynamics which occur in a free market. Some of these include:

  1. Diminishing return: where the market quickly settles at an equilibrium
  2. Constant return: market will quickly settle at one of many equilibria; initial gain in market share has a significant influence on the final steady state. Final steady state can not be predicted.
  3. Increasing return: one or few of the competing technologies will eventually dominate the market. Initial gain in market share is critical in determining which technology will be "selected". The technology selected is not necessarily the best choice.

Polya processes (constant-return)

The analogy for this method of modelling is as such:

  • Imagine an urn with infinite capacity
  • We add two balls: one red, one white
  • We now repeat this process indefinitely:
    • Choose a ball from the urn at random
    • Return the ball to the urn along with an additional ball of the same colour

The result of this gedanken is:

  • In the first few steps the proportion of red:white wanders a little
  • It then settles on a specific value
  • This proportion does not change very much once it is established
  • The outcome cannot be predicted at the beginning of the process

Polya processes & high-tech industry spatial distribution

  • Industries are often clustered around certain centres
  • There are benefits to being closer to other industries; local supply, skilled labourers, local law services, face to face communication with customers / other companies…

Positive feedback is the driving force underlying such industries spatial distribution pattern. The presence of a company attracts other companies to settle around them.

  1. The spatial distribution fluctuates among regions for a while
  2. Once the number of business within a region crosses a threshold, that region becomes a centre attracting more businesses to settle there
  3. Early gain in one region will influence the final spatial pattern
  4. Once the pattern is established it does not change ver much
  5. Which region will become the dominant one is not predictable at the beginning

Polya processes (increasing-return)

  • The system will fluctuate for the first few trials
  • Will then quickly settle on one phase
  • The system stays where it is thereafter

Polya process and high-tech competing technologies

  • In the beginning there are a number of competing technologies (ie: water / gas / sodium cooling)
  • For some reason (or random choice) one of these is adopted
  • The technology is used in subsequent projects because of the knowledge / skills attained in developing the first
  • Once widespread adoption occurs the technology matures and it is used even more
  • This technology is locked-in for future development even if others were superior
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