# The Aguilar Convergence Problem - \$1000 Prize

#### Onion Eater

##### Well-known member
In my 1999 Simplified Exposition of Axiomatic Economics, I write:

Supply and demand curves are different depending on the time unit chosen. Mainstream economists provide no proof that their predicted prices are independent of their choice of time unit. For example, will thirteen predicted weekly quantities be the same as three predicted monthly quantities?

A large part of the problem with supply and demand is that it is used descriptively, but called predictive. It is easy to predict the past. Economists just observe the quantity produced one month and what it sold for and they put a little × over that spot. Then, by pure conjecture, they draw four tails on their × to fill their graph paper. Supply and demand has never been used predictively, not even to make bad predictions. × marks the spot is a purely descriptive technique. Since they are using the 20-20 vision of hindsight, they can do this for three months in a row and, to nobody’s surprise, the sum of the quantities is the quarterly quantity. In the real world, price is constant for years at a time but, for most companies, their weekly and monthly sales figures swing wildly and unpredictably, sometimes by several fold from one month to the next.

My \$1000 challenge:

I will pay \$1000 to any economist who can provide a formal mathematical proof that supply and demand curves intersect in exactly the same place regardless of whether the time unit is a day, a week, a month or whatever. Do not forget to mention elasticity, which is well-known to be a function of this time unit. To receive the \$1000, your proof must be published in a refereed journal. The idea is not to convince me, who has spurned supply and demand and went my own way, but to convince a journal editor so that I may take your arguments as representative of Neoclassical Economics.

The time unit is important because the differentials do not converge to the derivative. Economists use calculus freely, slavishly imitating physicists as though supply were just like velocity, but they do not have convergence. Doing calculus without convergence is like driving a car without a transmission.

For example, if the vertical axis is distance and the horizontal axis is time, then the graph above could represent the position of a golf ball and the slope of the tangent line its velocity. Where the graph is steep, the ball is quickly changing its position, that is, it has a high velocity.

If one wished to measure the ball's current velocity, one could take a picture of it now and then take another picture ten seconds later. The difference in position divided by ten is a measure of the ball's velocity. But it is a coarse measure of the ball's current velocity, as a lot may change before the second picture is taken.

A better measure of the ball's current velocity is to take a picture of it now and then take another picture one second later. Better yet, a video camera could be used which takes pictures every 30th of a second. With flash photography we can obtain quite fine accuracy, as with the photo below, but there is always some time delay before the second picture is taken. There is no “velocity meter” that gives us the current (instantaneous) velocity the way a camera gives us the current position.

How do we know where the ball was between photos? Intuition tells us that the ball was in points of space between where it was seen, but it may have darted off on a side journey, disappeared entirely or perhaps appeared momentarily on the dark side of the moon before re-joining our intrepid photographer.

We just do not know where the ball was between photographs. It is an axiom of physics that energy and momentum are both conserved. It is not a result. Darting off on side journeys would violate these Conservation Principles. Physicists are not prepared to forsake these long-held axioms because someone raises impertinent questions about where a golf ball was between photos. Brushing impertinent questions aside is the whole point of having axioms. If physics were not based on the axiomatic method, it would degenerate into a skittish empirical science like Post-Autistic Economics, where everybody has an opinion, just like everybody has an _______.

Supply is the economic version of velocity and economists do not have a “supply meter” any more than physicists have a “velocity meter.”

If one wished to measure a factory's current (instantaneous) output, one could take a count of their inventory now and then take another a year later and add sales to learn how many widgets they are supplying. But it is a coarse measure of the factory's current output, as a lot may change before the second count is taken. It is well-known that time is the most important determinant of elasticity. In a year's time, people can adapt: workers can be re-trained, special-order machinery can be commissioned, crops can be planted, etc.. Clearly, a year is too long for the time unit of supply. A better measure of the factory's current output is to take a count of the inventory now and then take another a month later. Better yet, one might do this every week, every day or even every hour.

But are these measures of supply really “better” in any sense? They do not converge. The hourly figures would be all over the chart depending on whether the experiment was conducted in the daytime or at night, while the machines were running smoothly or wracked by malfunctions, etc.. Prices exist at every instant, so let us take our instant to be 3:00 a.m. on Sunday morning. A price for widgets exists at this moment, for one can certainly go online and order one. But if economists had established an hour to be their time unit, when they go to construct their supply and demand curves, they would find that supply everywhere is zero. There are no factories running.

In my Simplified Exposition of Axiomatic Economics, I write:

Even if a factory is temporarily closed for a week or a month, the price of its product is hardly affected because the total amount of phenomena in existence is hardly affected. Yet during that week or month the supply is zero. Mainstream economics, which relates price to supply, is unable to explain why the price does not increase dramatically as inspection of the supply and demand curves predicts that it should.

So what should the time unit be? A week? A month? It has got to be one or the other and they produce different results. And the different results obtained by different time units do not converge to anything. There is no axiom in Neoclassical Economics equivalent to the Conservation Principles of physics that assures convergence.

In my Simplified Exposition of Axiomatic Economics, I justify my decision to abandon supply and demand in favor of my own axioms in a number of ways, but none more important than this one:

The method of mainstream economics really has a third variable which is never mentioned and that is the time unit for supply and demand. It is well known that elasticity is a function of this time unit and, if this is true, one calculates a different price depending on whether one speaks of weekly or monthly supply and demand. This is an inconsistency since there can only be one price and it is not dependent on the caprice of an economist when he decides how often to conduct his surveys. This is a point that is glossed over in mainstream texts. A detailed discussion of the time unit chosen for supply and demand is never given and many texts neglect to mention the need for choosing one at all. Yet in their chapter on elasticity, every textbook lists time as a factor, sometimes as the most important factor.

Clearly, there can only be one price and it is not dependent on the caprice of an economist when he decides how often to conduct his surveys any more than the velocity of a golf ball is dependent on how many frames per second the video camera I have purchased operates at. If my camera operates at 30 frames per second and yours at 24 frames per second and we stand side-by-side filming a golf ball sailing past us, we should report close to the same velocity. All of Neoclassical Economics will fall like the House of Usher if it is seen that the prices and quantities it predicts depend entirely on a parameter plucked out of thin air and not on actual market forces.

#### Missed AB

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"Check out my website to see how right I am", is the same logic as reading the bible for proof that God exists.

Lets assume that you are right, and EVERY OTHER PERSON IN THE WORLD IS WRONG. That your axium economic theory is the way the business transactions/price occur. What does it mean in the real world? How can this be used to make me money in my business, pick a stock and it's direction... it can't.

The flaw you have in your theory is that it does not account for human emotions. To put it another way since you like physics and the sciences. You can say it's 32f degrees outside, 0c outside, whatever that temperature is in kelvin, or you can say it's at the freezing point of water... All the math you have at your side, but you can't say it's cold out side. Just like in your axium theory you can't express buy, sell, or hold parameters.

Your theory is no different than a Rubp Goldberg machine to explain economics and does nothing to advance economics. You are making something very complex out of a rather simple theory. Regardless of supply, demand will be curbed by elevated prices.

Also you don't seem to understand that you can not rely on mathematical formulas to prove things such as human emotions.

It is well-known that time is the most important determinant of elasticity. In a year's time, people can adapt: workers can be re-trained, special-order machinery can be commissioned, crops can be planted, etc.. Clearly, a year is too long for the time unit of supply. A better measure of the factory's current output is to take a count of the inventory now and then take another a month later. Better yet, one might do this every week, every day or even every hour.
The flaw you show is that you also don't understand how widget units of stored stocked is accounted for. Your widget factory in fantasyland makes 100 widgets a day/hour/month/minute... it doesn't matter what unit of time you use, so long as the inventory cycle is measured in a practicle term AND the inventory cycle is measured by the CONSUMER DEMAND AND NOT THE PRODUCER. Whey they say there are 20 day's worth of widgets in supply, that means the consumers are buying that a pace which wil deplete the inventory in 20 days should your widget factory shut down, it does not mean that your company makes that many widges/20days. If you can't figure out how many widgets you need to make based on the demand then you are being inefficient and in your case ignorant. It would seem logical to trend orders and calculate what "new orders" are and how it effect current warehouse supply and then determin if production needs to be increased or decreased. Is the fade picking up pace or slowing down should the widget company make a new plant or go out of business.

If one wished to measure a factory's current (instantaneous) output, one could take a count of their inventory now and then take another a year later and add sales to learn how many widgets they are supplying. But it is a coarse measure of the factory's current output, as a lot may change before the second count is taken.
But are these measures of supply really “better” in any sense? They do not converge. The hourly figures would be all over the chart depending on whether the experiment was conducted in the daytime or at night, while the machines were running smoothly or wracked by malfunctions, etc.. Prices exist at every instant, so let us take our instant to be 3:00 a.m. on Sunday morning. A price for widgets exists at this moment, for one can certainly go online and order one. But if economists had established an hour to be their time unit, when they go to construct their supply and demand curves, they would find that supply everywhere is zero. There are no factories running.
To be worried aobut the above shows you really don't understand how a business runs. To suggest that numbers are picked out of "thin air" also shows you do not understand how prices are structured for a product.

You spent the better part of 3 threads you have started complaining, making challenges, etc. but you have done nothing to show the bennefit of your theory.

I can make a case that time does not exist, therefore everything that is based on time is flawed, but that will not get me out of a speeding ticket.

At the end of the day, if your theory is right, and the rest of the world is wrong. So what? How does that effect the price of IBM stock?

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#### Onion Eater

##### Well-known member
The flaw you have in your theory is that it does not account for human emotions.

the differentials do not converge to the derivative.

This is the crux of the matter.

Anyone who has taken a semester of college-level calculus has seen the derivative defined as the limit to a sequence of differentials.

All those deltas and epsilons sure look impressive. How very scientific! But, without convergence, they are meaningless.

In physics, thanks to the Conservation Principles, we do have convergence. But - alas! - in Neoclassical Economics, the differential do not converge. Every choice for the time unit produces a different result and those results are not converging on anything that we can call with confidence the "correct" answer.

#### Missed AB

Banned
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This is the crux of the matter.

Anyone who has taken a semester of college-level calculus has seen the derivative defined as the limit to a sequence of differentials.

All those deltas and epsilons sure look impressive. How very scientific! But, without convergence, they are meaningless.

In physics, thanks to the Conservation Principles, we do have convergence. But - alas! - in Neoclassical Economics, the differential do not converge. Every choice for the time unit produces a different result and those results are not converging on anything that we can call with confidence the "correct" answer.

Again, so what? What does this prove? and how can I use your theory to make money?

#### Onion Eater

##### Well-known member
how can I use your theory to make money?

I'll give you a dollar if you go away.

So what should the time unit be? A week? A month? It has got to be one or the other and they produce different results. And the different results obtained by different time units do not converge to anything. There is no axiom in Neoclassical Economics equivalent to the Conservation Principles of physics that assures convergence.

Economists do not take the calculus course that the mathematics department offers to engineering students. Instead, they take a watered-down calculus course offered by the economics department.

One of the differences (besides jettisoning all of trigonometry) is that economics majors do not learn the definition of the derivative. They are just told that the derivative of x^n is nx^(n-1) and are expected to memorize this formula long enough to regurgitate the information on their next exam. They have no idea why this formula holds, or under what conditions.

In sharp contrast, engineering majors are expected to derive this formula from the definition of the derivative. So, while freshman economics majors get to do "real life" problems a couple of weeks before engineering students are applying their knowledge of derivatives to real-life problems in their own field, the engineering students wind up with a solid grounding in calculus that will last them a lifetime.

Thus, since this is an economics and not an engineering forum, it behooves me to review the definition of the derivative. From Wikipedia we have:

The derivative of y with respect to x at a is, geometrically, the slope of the tangent line to the graph of ƒ at a. The slope of the tangent line is very close to the slope of the line through (a, ƒ(a)) and a nearby point on the graph, for example (a + h, ƒ(a + h)). These lines are called secant lines. A value of h close to zero gives a good approximation to the slope of the tangent line, and smaller values (in absolute value) of h will, in general, give better approximations. The slope m of the secant line is the difference between the y values of these points divided by the difference between the x values, that is,

This expression is Newton's difference quotient. The derivative is the value of the difference quotient as the secant lines approach the tangent line. Formally, the derivative of the function ƒ at a is the limit

of the difference quotient as h approaches zero, if this limit exists. If the limit exists, then ƒ is differentiable at a.

#### Missed AB

Banned
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I'll give you a dollar if you go away.
I am not a student. I want to understand your theory and how I can use it to evaluate trades or in my business. What does your theory tell me? How can I use it. What is the practical use for it? How can I test your theory in real life today?

#### Onion Eater

##### Well-known member
What is the practical use for it?

Axiomatic Economics competes directly against supply and demand and has the same application space.

how can I use your theory to make money?

I am not an investment guru. I do not teach people how to make money. If you are in the market for get-rich-quick schemes, then there are a ton of people on the internet who will scratch that itch for you.

#### Missed AB

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Axiomatic Economics competes directly against supply and demand and has the same application space.
If supply and demand are irrelevant, what are the forces which directly effect price? Is it only the agreed price of the object between seller and buyer? If so, how do competitive bids work with in the concepts of your theory?

I am not an investment guru. I do not teach people how to make money. If you are in the market for get-rich-quick schemes, then there are a ton of people on the internet who will scratch that itch for you.
Not looking for a get rich quick scheme. I've been evaluating stocks, companies, bonds, trends... for the better part of the past 20 years. But if I can find a theory that can help me better evaluate my options of buying or selling something, why would I not use it?

I am trying to figure out a way to use your theory. What is a practical use for your theory? Can you give me a small sample example of how to apply your theory. Price a bottle of coke.

#### Hicup

DP Veteran
Or a pack of gum..

The value of the data set of any evaluation on pricing indexes is correlative only. All things being equal, the data is correlative for a reason, and as you so rightly point out, MissedAB, that reason is that the variable of human emotion is uncontrolled for. There is no axiomatic math at ANY given time, that correctly predicts outcomes of Supply and Demand, or the price of stock in 3 months, 2 days, or a year. Even if one were to design a massive super computer that factored in all possible tangible conditions/variables surrounding a transactional economic system, one would still be surely guessing on the ticket the super computer spits out when it beeps that it has arrived at the answer

Tim-

#### Onion Eater

##### Well-known member
If supply and demand are irrelevant, what are the forces which directly effect price? Is it only the agreed price of the object between seller and buyer? If so, how do competitive bids work with in the concepts of your theory?

This is all explained in my Simplified Exposition of Axiomatic Economics. This 30-page document is as simplified as it gets. I cannot condense the explanation down to a 1000-word forum post. So the following explanation is incomplete, but briefly outlines my argument.

The graph of the distribution of points of indifference, c(m), can be pictured as an aerial view of the people who value a phenomenon assembled along a line marked "money", where they are asked to stand by the number of monetary units that are equal to a unit of that phenomenon. If more than one person has the same valuation, they stand behind the corresponding number. The stock of that phenomenon naturally tends toward the high end, as anyone who possesses a unit of it who sees his neighbor to the right without one will sell it to him. Only use value and expected exchange value in other markets not represented on this graph are counted because, though one may value a phenomenon greatly in anticipation of exchanging it at a high price, if one fails to get that price, one has to lower one's asking price until it eventually equals the value of keeping that phenomenon for one's personal use. While money has very little use value, it does have expected exchange value in other markets not represented on this graph, and it is with this in mind that people withhold their money from this market if the price rises too high. The expected exchange value of money is historically derived from its use value. If it were a function of today's prices, we would have a contradiction because we are now deriving today’s prices from the demand distribution, c(m), which includes expected exchange value.

My theory relates stock and price, not supply and demand. The stock associated with a particular price is the integral of the demand distribution from that price out to infinity.

The image of the demand distribution as an aerial view is helpful. Initially, the stock is scattered throughout the distribution, but it migrates to the right due to the people towards the right side valuing it more and buying it from those to their left. In the same way that water in a glass all migrates towards the bottom as water molecules push air molecules aside, the phenomenon all migrates towards those who value it.

The forces which directly affect price are the parameters of the distribution, which determine its shape. There are three: mu, importance; sigma, substitutability; and u(s), diminishing utility.

I am trying to figure out a way to use your theory. What is a practical use for your theory? Can you give me a small sample example of how to apply your theory. Price a bottle of coke.

Have you tried using my software simulation? The screenshot below is for the default parameters, but it is instructive to try other parameters to see how the shape of the demand distribution changes.

The horizontal axis is price. The purple line is the demand distribution. Imagine the area under the purple line filled with people, each valuing the phenomenon equal to the price they stand above. If they need more than one unit, they send an agent to stand at that price, which (because of diminishing utility) is to their left.

If all of the phenomena have migrated to the right of the vertical yellow line, then it marks the price associated with that stock. People to the right are the haves, people to the left are the have-nots. The vertical yellow line can be thought of as the surface of the water in a glass, except that gravity pushes downward and value pushes rightward.

So every stock has an associated price. But there is one price and stock that is special (called the saturation price and stock) and that is the one where the area of the yellow rectangle is equal to the area under the purple line from the vertical yellow line out to infinity.

I provide existence and uniqueness proofs for the saturation price and prove two theorems about it which, together, are referred to as the Law of Price Adjustment. But these theorems are beyond the scope of a forum post.

Even if one were to design a massive super computer that factored in all possible tangible conditions/variables surrounding a transactional economic system, one would still be surely guessing on the ticket the super computer spits out when it beeps that it has arrived at the answer

You don't need a massive super computer, you can run the Java Applet on your laptop. I have even provided source code if you wish to write your own software.

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#### Hicup

DP Veteran
How does your modeler work for consumables? Actually nevermind, it doesn't.

I'd like for you to show me ANY proof that successfully predicts an outcome based on even the simplest transactional variables. I'll even let you pick the variables..

Go.....

Tim-

#### SFLRN

DP Veteran
How does your modeler work for consumables? Actually nevermind, it doesn't.

I'd like for you to show me ANY proof that successfully predicts an outcome based on even the simplest transactional variables. I'll even let you pick the variables..

Go.....

Tim-
Thank you for stating the obvious. Onion Eater, I understand that there are inconsistencies in neoclassical economics, but what real impact/advancement is achieved by spending all of one's time dissecting these mostly esoteric, and ultimately theoretical inconsistencies accomplish? Has your theory provided more accurate predictions of economic behavior than neoclassical models? It seems like you're more or less hung up (like many of the European-educated members of this board) with disproving neoclassical economics instead of providing better predictive models. I don't see the point in just throwing out a set of economic theories due to certain inconsistencies within the theory without showing that those inconsistencies lead to models with less predictive power (or at least I don't see the point in doing so for the duration and to the degree you have).

#### Missed AB

Banned
DP Veteran
I cannot condense the explanation down to a 1000-word forum post. So the following explanation is incomplete, but briefly outlines my argument.
First, thank you for taking some time to briefly outline the thesis. This is a controversial theory for most people, so I'm sure you have seen some heated debates in the past. I will try to keep my tone in check as I attempt to work through some things I would like to know more about.

The graph of the distribution of points of indifference, c(m), can be pictured as an aerial view of the people who value a phenomenon assembled along a line marked "money", where they are asked to stand by the number of monetary units that are equal to a unit of that phenomenon.
Your thoughts are clearly more analytical than most (me included here), so some of what I am asking is to make sure I am understanding the theory... There are parts that I don't agree with, but there are parts of what I have read that I do agree with. I am very astute at understanding the psychology of the market, but since some of what you are describing in math terms does match with some of my analysis... this I am interested in best understanding your theory.

For sake of wording "phenomenon" is the item being purchased, yes? The graph, the sin curve and it's changes represents the number of people who value the item at that price. The more people who value the item at that price, the higher the amplitude on the sin curve, yes?

If more than one person has the same valuation, they stand behind the corresponding number.
How is this represented in buy/sell terms? For example, I own IBM, and I sell it for 120. Am I the one who has the value of 120 or is the person who buys it the one of value of 120, for we each agree it is 120? I ask this because for every buyer there is a seller. However that buyer and seller does not have to be a real buyer or seller as there are market makers who are basically middle men that collect on the stock spread over time.

The stock of that phenomenon naturally tends toward the high end, as anyone who possesses a unit of it who sees his neighbor to the right without one will sell it to him.
Is it fair to compare the theory you have to stocks in the stock market, since that is what most people will buy and sell with the aim of making money?

In an ideal world this is how the transactions would happen, but most "investors" have an amazing ability to NOT sell to the right, but rather to the left. How is this reflected in your theory and program?

The expression "Buy into fear, and sell into euphoria" is the opposite of what most people do. That is why there are things like bubbles, and why most people don't make money in the stock market.

Only use value and expected exchange value in other markets not represented on this graph are counted because, though one may value a phenomenon greatly in anticipation of exchanging it at a high price, if one fails to get that price, one has to lower one's asking price until it eventually equals the value of keeping that phenomenon for one's personal use.
Many will sell due to price squeezes. For example, a bubble either up or down can last much longer than I can remain liquid if I were to be on margin. I may seek to get out of my position if I feel that the market will continue on a downward trend, and then I will get back in at a lower price.
and it is with this in mind that people withhold their money from this market if the price rises too high.
MOST people prescribe to the above theory, but in practice, most people buy high and sell low. Take the recent stock market correction when the DOW was in the process of dropping to around 6500, who was buying? A few months earlier at 12,000, who wasn't buying?

The expected exchange value of money is historically derived from its use value. If it were a function of today's prices, we would have a contradiction because we are now deriving today’s prices from the demand distribution, c(m), which includes expected exchange value.
This is how I see the world... Your money has it's value because I want your money. I want your money because I can use that money to buy other things I want. I will sell you my products, in exchange for your money, because of the expectation that I can then use that money to aquire things I want and need. If merchants stopped wanting my money, then I would be stuck with my money and I would have to exchange other goods or services for the item I desired. That money can be US backed, EU backed, or Disney bucks. The easier the exchange of that money for services, the more demand for that currency. Disney bucks to USD are 1:1 in disneyland, but the further you get from that place of exchange, the less real value that DB holds... because my plumber can't go to home depot to buy my new sink with DB... because HD doesn't want DB, they want USD. It is that coninued demand for the dollar which does give it it's value.

Without using jargon, distribution curves, or other abstract ideas, can you explain maybe give an example of why the above demand, how I see the world, is outside the paradigm you theorize?

While money has very little use value, it does have expected exchange value in other markets not represented on this graph, and it is with this in mind that people withhold their money from this market if the price rises too high.
If people were rational and withheld purchases of stocks with high P/E, bad fundamentals... then how do bubbles form? It is the pesimism which keeps the optimism in place. If one side becomes too heavy, then there is increased volitiality which will then be corrected as sentiment changes. For example if everyone who owned a stock was bullish on that stock, who would sell it? That bullishness, greed, demand for that stock pushes the price upward to a point where people are willing to part with the stock, this triggers a BUYING signal for the masses, not a SELLING signal as you describe above. People historically will put their money into appreciating assets, not depreciating assets. As the stock increases in value, more people will be attracted to it pouring more money into it and inflating the price due to increased demand for that stock... Go GOLD.

I tend to invest in undervalued assets or depreciating assets as they tend to be at the low end of the cycle and have no place to go but up. This works for me because most people don't invest this way. For the most part, I buy low, and sell higher.

This is a purely a very short term technical analysis view of support and resistance points. It is important to understand that support (low end) does not have to hold, and resistance (high end) can be broken through too. With each move through and resistanc/support point, this then alters the the support and resistance points. For example, what was once tought of as resistance, now becomes support on the way up, and what was once thought of as support now becomes resistance on the way down.

The image of the demand distribution as an aerial view is helpful. Initially, the stock is scattered throughout the distribution, but it migrates to the right due to the people towards the right side valuing it more and buying it from those to their left. In the same way that water in a glass all migrates towards the bottom as water molecules push air molecules aside, the phenomenon all migrates towards those who value it.
This is common to how most people think the stock markt works, but it doesn't work that way.

Stock prices are set by market makers. Assume I am the market maker, I want to make money. IBM trades at 120, and someone sells me IBM. I know you do not agree with supply and demand theory, but the market makers do... So their supply went up, so they need to decrease the price of IBM. As more people sell IBM, the market makers collect more supply of stock IBM, and continue to lower the price. For the market makers to continue they need to further lower the stock price under selling pressure to lower their average cost per share. As the market selling pressure continues, margin calls, stop losses, and some people who wish to protect their profits find themselves selling the stock (not to the people to the left of to the right, but to a middle man). At some point the stock bottoms the selling pressure stops, and the price starts to turn around around. Early on in a recovery, most people do not jump in and buy because of fear that the floor has not yet been found and this may just be a "dead cat bounce". As the stock gains more momentum people realize what the new "resistance point is" and now they fear that they will miss the run up. They then put money into the market and start buying more and more IBM (Ironically this increased bullishness normally signals the topping of the market). As the market maker sells more IBM, they have to raise the price because of the increased demand. The more the demand, the higher the gap up. Now the market maker is selling the stock back to the people who it bought it from...

The market makers make money both on the spread and the change in direction of the market/stock.

Imagine I, the market maker, had 2 accounts. One accont I was short IBM and the othe account I was long IBM. I would never sell to myself. For sake of simplicity in this example I will use whole numbers. I would have IBM listed at sell 3Kshares @ 120 and buy 3Kshares @121. As you make offers I am either adding or subtracting from my position of short/long. When my available shares at that price point reaches 0, I need to move my price targets. MY SUPPLY vs YOUR DEMAND sets the market price.

#### Onion Eater

##### Well-known member
Missed AB-

I have fundamental disagreements with supply and demand, as outlined in the OP. However, most of the issues you have raised in your most recent post are uncontroversial, either because they touch on common ground (like marginal utility) or because you are asking something of me that supply and demand does not provide you with either.

For sake of wording "phenomenon" is the item being purchased, yes? The graph, the sin curve and it's changes represents the number of people who value the item at that price. The more people who value the item at that price, the higher the amplitude on the sin curve, yes?

Yes. When I say “phenomena” I mean anything that is bought and sold. I eschew the term “goods” because it implies only tangible objects and because the singular term “good” is also an adjective.

The demand distribution is not a sine curve. It is actually logrithmico-normal, though for the purpose of this discussion you do not have to know the formula.

The graph of the distribution of points of indifference, c(m), can be pictured as an aerial view of the people who value a phenomenon assembled along a line marked "money", where they are asked to stand by the number of monetary units that are equal to a unit of that phenomenon. If more than one person has the same valuation, they stand behind the corresponding number.

Distributions are widely used in probability theory. For instance, the Gaussian (normal or bell-shaped) distribution is familiar to most people. If the demand distribution were normalized to unity, the area under it would also represent probability. The area from a to b would be the probability of randomly selecting someone off the street and finding that he values the phenomenon in question more than a but less than b.

How is this represented in buy/sell terms? For example, I own IBM, and I sell it for 120. Am I the one who has the value of 120 or is the person who buys it the one of value of 120, for we each agree it is 120?

If you buy a share of IBM for \$120, this implies that you value it more than \$120. If you sell a share of IBM for \$120, this implies that you value it less than \$120. Neither of you value it at \$120. The sale is made, not because you and your trading partner agree on the value of the item, but because you disagree.

The price is less than the point of indifference of the last person who possesses a unit of the phenomenon or he would sell it, and it is greater than the point of indifference of the first excluded individual or he would buy.

The only people who would disagree with this are Marxists, and I know that you are not a Marxist (though you received a “thank you” above from our resident Marxist) so I will not belabor this point.

Is it fair to compare the theory you have to stocks in the stock market, since that is what most people will buy and sell with the aim of making money?

In my lexicon, stock means the total amount of some phenomenon in existence. This is in contrast to supply, which is the amount created in some specified time unit, e.g. widgets per week. The word stock also means a share of ownership in a company, e.g. IBM stock. I never use the stock market in my examples because:

1) It confuses people to see the word stock used in two different ways.

2) The stock market is more sophisticated than markets for more mundane things and it has its own terminology (like “market maker”) that confuses people dealing in manufactured items and such.

3) There are a lot of people with formulas that take as input statistics about a company and output advice to buy, sell or hold. My theory is more general, competing directly against supply and demand, and I do not want to be mistaken for an investment guru.

Nevertheless, if people would agree to call it the equities market instead of the stock market, I would be happy to use it to illustrate the applicability of my theory, for it is clear that there is no supply. Unless we are describing how Bugsy Siegel financed the construction of the Flamingo, then there is no analog to widgets per week; IBM is not printing out and selling x new shares every week. There are a fixed number of IBM shares in existence and that number should be called the stock. It is too bad that people refer to individual shares as stock because the two uses of the word just confuse them.

In an ideal world this is how the transactions would happen, but most "investors" have an amazing ability to NOT sell to the right, but rather to the left. How is this reflected in your theory and program?

The expression "Buy into fear, and sell into euphoria" is the opposite of what most people do. That is why there are things like bubbles, and why most people don't make money in the stock market.

It is impossible to sell to the left. At any given moment everybody puts some value on the phenomenon and, if they see someone who values it more than they do, they sell him one. You would never sell something to someone who values it less than you do because the money he offers is less than your indifference point.

What I think you mean by “selling to the left” is that people's valuations are based on stupid reasoning that they will later regret. They currently are standing on the right side of the graph, expressing a high value for the phenomenon, but sober reflection will soon make them aware that this position is a mistake. But that is another day. My theory is about the trades that take place at this moment in time and is based on people's current valuations.

The same is true of supply and demand. It takes people's current valuations as a given. Nothing in a microeconomics textbook tells you how to predict the future. For instance, suppose it is 1984, you are in the women's clothing business and leg warmers are all the rage. Is this a style that will survive into the 21st century? Or will it be replaced by something else? If so, what? You can read your micro textbook from cover to cover and it isn't going to answer these questions for you.

So it is unfair to ask Axiomatic Economics to help you predict the future if your existing theory is not helping you with this. Most of the rest of your post is about predicting future price movements, specifically in the stock market. I can't help you with that, but neither can supply and demand, so it is a wash. Being a visionary and mastering economic theory (either Axiomatic or Neoclassical) are just different things.

This is similar to how there are two types of books about Texas Hold'em: Books by mathematicians that explain why, for instance, one should never draw to an inside straight; and books by psychologists that describe “tells” like facial quirks and explain how being ahead or behind on money affects one's bluffing. The successful poker player must master both skills. There is no reason for any animosity between the authors of the two types of books.

One final note: Your discussion of why people value money, illustrated with a comparison of U.S. Dollars and Disney bucks, is reasonable. I have a paper on my website that discusses the origin of money and compares the U.S. Dollar to the chips issued by Las Vegas casinos.

Critique of Stephen Zarlenga on the Origin of Money

#### Missed AB

Banned
DP Veteran
However, most of the issues you have raised in your most recent post are uncontroversial, either because they touch on common ground (like marginal utility) or because you are asking something of me that supply and demand does not provide you with either.
Like I said earlier, it is something that I do wish to better understand as some of what you have written I do agree with, and some I do disagree with. The cornerstone for me is to try to fully understand the theory and applications.

My investing techniques are a bit of a hybrid of philosophies that I find work, and often times it is what I refer to as the "contra-trend" that may make the least psychological sense, but the most profit... like buying depreciating assets with strong fundamentals.

If the demand distribution were normalized to unity, the area under it would also represent probability. The area from a to b would be the probability of randomly selecting someone off the street and finding that he values the phenomenon in question more than a but less than b.
So your curve would be an example of who values that item at that moment at that price? The oscillating curve your program produces may show that a given event may have more people value it at 100 and at 130 than at 115? Am I following so far?

In my lexicon, stock means the total amount of some phenomenon in existence. This is in contrast to supply, which is the amount created in some specified time unit, e.g. widgets per week. The word stock also means a share of ownership in a company, e.g. IBM stock. I never use the stock market in my examples because:
In the future I will say shares to avoid any confusion.

3) There are a lot of people with formulas that take as input statistics about a company and output advice to buy, sell or hold. My theory is more general, competing directly against supply and demand, and I do not want to be mistaken for an investment guru.
No worries. What intrigues me about your theory is that the possibility to gauge value at a given moment. If I can figure out how to write the program and what the different input variables are (in lay-mans terms, and how to read the output), then it is one more tool I can use to examine if the "probability" for the stocks move will be upward or downward.

I am not a chart technician, and I feel that reading the lines is a lot like reading tea leaves. Without knowing how the curve ends the same start could be a handle - leading to run up, or a reverse head and shoulders - leading to a stocks decline.

However, if there was a way to measure the "value" at a given time for the shares, that is a really nice tool to have.

I would be happy to use it to illustrate the applicability of my theory, for it is clear that there is no supply. Unless we are describing how Bugsy Siegel financed the construction of the Flamingo, then there is no analog to widgets per week; IBM is not printing out and selling x new shares every week. There are a fixed number of IBM shares in existence and that number should be called the stock. It is too bad that people refer to individual shares as stock because the two uses of the word just confuse them.

Generally speaking, there are a fixed number of shares for a company, but there is also a fixed number of houses in a subdivision. The way I see supply is not the total outstanding shares, or the number of houses, rather the number of shares available for purchase at a given price point, or the number of houses listed on MLS.

As with equity shares, some of the pricing is on fundamentals, other is strictly based on market makers, but once the opening bell starts, the trades are "placing votes" on the value of that share. The market makers however need to flex the price depending on how many shares people are buying or selling.

If I am a market maker. My ladder is as follows buy 55 sell 56. I am a middle man. I make money on the spread from the buy and sell portion of the transaction and I care very little about the actual price. I buy your shares, or I sell you shares that someone just sold to me (or I short sell). I need to remain neutral in my ownership. as more people sell than buy I need to lower my price point to reach equilibrium. Then as people "see" the value as a bargain and start buying up the shares, I need to raise my price point to again reach a point of equilibrium. The point is not that the physical supply of shares has changed, but the available number of shares does change. If more people are chasing fewer shares the price will need to reflect that with an increased price. If more shares are looking to find a new owner than there are people willing to own the shares, then the price needs to reflect that as well because the market makers will drop the price in the face of increased supply on their books. Likewise if the price for IBM was fixed at 30/share the market makers would not have any shares to sell because the demand at todays price would be far to great. By raising the price in the face of demand, this will help curb demand, and allow the market to reach equilibrium. As demand for those shares at a price point changes, the price point also changes. The "Micro Crash" this past summer happened when a mutual fund company "dumped" billions of dollars worth of shares into the market in a very short period of time.

The reason I find your theory interesting is because I have studied how the price alters even though the fundamentals have not changed and the theory you are introducing also shares this common interest.

The 2 points I am trying to understand in your theory are how is the way I see the workings of the equities market and described above outside of supply and demand theory/or how is the above outside of the theory you support? Second, if this is not used to "predict" outcomes, then what exactly is the probability showing?

What I think you mean by “selling to the left” is that people's valuations are based on stupid reasoning that they will later regret. They currently are standing on the right side of the graph, expressing a high value for the phenomenon, but sober reflection will soon make them aware that this position is a mistake. But that is another day. My theory is about the trades that take place at this moment in time and is based on people's current valuations.
Correct that was my rasoning for the wording I chose. I have a hard time understanding how at a given momeny people will value the shares at different levels, and within those levels there is no linear relationship. If share A is 100 how is there less support for it at 110 than at 143 in that single moment?
One final note: Your discussion of why people value money, illustrated with a comparison of U.S. Dollars and Disney bucks, is reasonable. I have a paper on my website that discusses the origin of money and compares the U.S. Dollar to the chips issued by Las Vegas casinos.
Funny, I was considering gift cards, and poker chips before I settled on Disney bucks.

#### Onion Eater

##### Well-known member
So your curve would be an example of who values that item at that moment at that price? The oscillating curve your program produces may show that a given event may have more people value it at 100 and at 130 than at 115? Am I following so far?

Yes. There may be more people with an indifference point at 100 or 130 than at 115. The oscillations are more pronounced at the low end of the demand distribution. And they increase with decreasing substitutability. If you reduce sigma (substitutability) much below 0.1 you will get a graph that looks like the seismograph reading during an earthquake.

With these very small sigmas, there may be more than one relative maxima, which raises the possibility that gradual changes in the parameters will result in an abrupt jump from one relative maxima to another rather than just following the maxima that the market has already found as that price/stock combo changes gradually in response to the gradual changes in the parameters.

But the Simplified Exposition makes a simplifying assumption that allows for a uniqueness proof. Dealing with the possibility of multiple relative maximas requires much more advanced math and is relegated to Chapter IV of my book, which assumes a familiarity with real analysis.

The oscillations were initially a surprise to me. I had worked out all the equations on paper but, until I wrote a computer program to graph the function, I did not realize that it was going to oscillate like that. However, on reflection, I decided that the oscillations were consistent with observations.

The 2 points I am trying to understand in your theory are how is the way I see the workings of the equities market and described above outside of supply and demand theory/or how is the above outside of the theory you support? Second, if this is not used to "predict" outcomes, then what exactly is the probability showing?

1) Let's go back to the analogy of the glass of water.

The image of the demand distribution as an aerial view is helpful. Initially, the stock is scattered throughout the distribution, but it migrates to the right due to the people towards the right side valuing it more and buying it from those to their left. In the same way that water in a glass all migrates towards the bottom as water molecules push air molecules aside, the phenomenon all migrates towards those who value it.

A sale is like a water molecule pushing an air molecule aside as gravity draws it downward. When the glass is quiescent, there are no instances of water molecules pushing air molecules aside because the water has all already settled on the bottom. The water has a smooth surface that defines a sharp boundary between the water and the air. It is only if the glass is shaken that water molecules find themselves above air molecules and push them aside in their effort to re-fill the bottom of the glass.

Similarly, if all the stock has found its way to those who value it most, as shown in my graph, there are no sales.

If all of the phenomena have migrated to the right of the vertical yellow line, then it marks the price associated with that stock. People to the right are the haves, people to the left are the have-nots. The vertical yellow line can be thought of as the surface of the water in a glass, except that gravity pushes downward and value pushes rightward.

The computer printout is of a quiescent market where nobody is selling anything to anybody. If the market has been shaken, possibly because some or all of the participants have come to the realization that their previous position was foolish, then there are people who possess some of the stock who do not want it as much as others who have none. Like the water molecules that suddenly found themselves above air molecules, a sale is made so the have-guy and the have-not-guy reverse roles. When the market is quiescent again, all the stock will have found its way to the right side of the demand distribution just as all the water will eventually find its way to the bottom of the glass.

2) There are two ways that my theory can be used for prediction:

First, it tells you what will happen to the market after it gets shaken up.

As demand for those shares at a price point changes, the price point also changes. The "Micro Crash" this past summer happened when a mutual fund company "dumped" billions of dollars worth of shares into the market in a very short period of time.

For instance, in your example, some of the market participants (the mutual company) came to the realization that their previous position was foolish and they did something about it: The moved leftward on the graph. So the shape of the demand distribution changed, becoming fatter on the left and thinner on the right. This is like if you have a plastic water bottle and suddenly give the bottom a squeeze, splashing water up and leaving a new bottle shape, one that is fatter on top and thinner on the bottom.

As I said before, I am not a visionary. I cannot predict that this mutual fund will suddenly have a forehead-slapping moment and decide to change their position. What I can predict, during the resulting turmoil, is where the price and stock will settle, provided that I can estimate the changes in the parameters that have occurred. (In the same way, I can predict the new water level in the bottle you squeezed if I can estimate the changes to its shape.) And that is a useful skill. The equities market is sophisticated and settles down quickly, but other markets may take weeks or months to settle down and profits can be made in the interim if one knows where it is settling towards.

Second, it is possible to prove theorems that are always true but are not intuitive.

For instance, ever since the first caveman constructed a bow and arrow, people have known that arrows follow a curved path through the air. But it was not then and it is still not intuitive that this path is a parabola. (For simplicity, we will ignore air resistance in this discussion.)

Newton's innovation was to state three axioms, his three laws of motion, which are intuitive and then to prove using those axioms alone, theorems like the one about the parabolic path, which are not intuitive. Using logic alone, he was able to go on to describe things completely outside our intuition, like the elliptic path of missiles that achieve orbit or the hyperbolic path of missiles that escape into outer space.

This is also a type of prediction. Based on a theory that had been worked out entirely in the form of algebraic equations, and which had been confirmed only in the easily observed case of parabolic trajectories, Victorian-era scientists were able to predict the path of missiles that would not be built for another hundred years, not until chemists came up with fuels powerful enough to propel a missile into orbit.

Similarly, I have stated three axioms which are intuitive and, based only on those axioms, I have proven theorems that always hold true and yet are not at all intuitive. Specifically, I proved the Law of Price Adjustment.

You will have to read my Simplified Exposition to see what the Law of Price Adjustment is about. It is too complicated to explain in a forum post.

#### Missed AB

Banned
DP Veteran
Yes. There may be more people with an indifference point at 100 or 130 than at 115. The oscillations are more pronounced at the low end of the demand distribution. And they increase with decreasing substitutability. If you reduce sigma (substitutability) much below 0.1 you will get a graph that looks like the seismograph reading during an earthquake.
In the case of the equities market, how does one determine sigma? Is it based on similar equities ie tech stocks IBM HPQ MSFT, energy stocks... Is it based on the total number of possible equity symbols in that market? Does the lower sigma indicate just higher volitility, or easier liquidity, or wider share price spreads? I am still trying to wrap my head around this theory, sorry again for the questions.

Similarly, if all the stock has found its way to those who value it most, as shown in my graph, there are no sales.
This is the part of the theory that has me wanting to understand it the most. Over the summer I was writing a program myself. I write in Action Script not Java. The program I was writing was different than yours. It was very dynamic with the ability to change interst rates, gdp, inflation, energy demand/consumption... but the part I had similar to your conclusion in your theory I termed bulls vs bears. As long as there was not too much weight on one side or the other, the effect was minimal. As the Bulls gained strength, this would add to momentum. At the same time it would add to the reluctance to sell the shares. The lack of sellers further drives up the price, making a reversal sharp and painful. a lot of the daily price flucuations were random with gentle upward or downward pressure from various variables. I built the program to examine 2 counter points to make money. DIA and DOG. DIA the ETF tracks the DOW30 and DOG which is the DOW short. The premise was if you sell the out performing stock to buy the underperforming stock, money would be made on the trend reversal and would always lead to buying low and selling high... In reality it is not as accurate because of the cost associated to hold shorts on the books, but in theory was quite good at producing returns. I never finished the program, but it is workable.

First, it tells you what will happen to the market after it gets shaken up.
Today the market has been shaken a bit by the news out of the EU regarding Ireland's debt problems (nothing new, I don't know why it's so shocking...) How would I set up a calculation using your program and the ETF "DIA". What would be the input variables for importance, difficulty, and common ratio... and the outputs, what number tells me where I land after the shake up and how do I read the outputs? I am not looking for exactness to "test" the theory. I looking to learn the how the theory can best used by me.

For instance, in your example, some of the market participants (the mutual company) came to the realization that their previous position was foolish and they did something about it: The moved leftward on the graph. So the shape of the demand distribution changed, becoming fatter on the left and thinner on the right. This is like if you have a plastic water bottle and suddenly give the bottom a squeeze, splashing water up and leaving a new bottle shape, one that is fatter on top and thinner on the bottom.
This redistribution in your program can be used to set out of the money puts in place to in the event of a shake up, yes? This is a cheap form of insurance to protect growth, and take advantage of sharp down turns. I don't know when I will get into a car accident, but I want to make sure I have air bags when it happens. having an idea on where the floor will be in the event of a shake up would help me set if I need insurance, and if I did, what the put price would be.

I will be reading the simplified exposition... I hope you're ready for another round of questions after that reading.

#### oldreliable67

DP Veteran
After a bit of a shaky start (IMO, YMMV), this thread has turned quite good. Lots of good back and forth discussion without rants, rancor or egos. Kudos to all who have contributed.

#### Onion Eater

##### Well-known member
How does your modeler work for consumables? Actually nevermind, it doesn't.

My theory works just fine for consumables.

Supply never means anything in economics, though sometimes (for non-durable phenomena) it can pass for stock.

It is just that consumables are the one area where supply and demand also kind of works – unlike the other 99% of the business world where it does not work at all.

On page 95 of Axiomatic Theory of Economics, I write:

250 years ago, when economics was first studied systematically, supply and demand made more sense. The only organized market was for agricultural products and, even there, the market did not operate continuously. Once a week, everybody came to town to attend church and to buy and sell food products. Without refrigeration, nothing lasted from one week to the next and so supply coincided with stock. Since the market was only held once a week, economists were not trying to be deceptive when they shortened “weekly quantity” to “quantity”. Perfect competition, as the term is used by mainstream economists, was fairly descriptive. After the industrial revolution, supply and demand no longer worked. Industrial products are durable and it is their stock, not their supply, that is related to price. Unfortunately, economists continued to use their theory and to label the horizontal axis of their graphs “quantity” (but to mean weekly quantity) even though markets now operated continuously and the week was an arbitrary time unit. Late into the industrial revolution, tiny villages surrounded by family farms were still very common. As long as economists chose their examples carefully, it was not immediately apparent that they had gone astray. Today, it is apparent to everybody who gives the subject some thought. It is truly appalling that, as I write these words, the 21st century approaches and supply and demand is still the undisputed theory of mainstream economics.

For instance, the price of eggs is based on the stock of eggs; that is, all the fresh eggs in existence at this moment. However, since all of these eggs will have either been eaten or spoiled by next week, the stock is actually the same thing as the weekly supply; that is, how many eggs are hatched and delivered to the grocery stores every week.

Because Neoclassical Economics overlaps sound (axiomatic) theory in this one area, mainstream economists can maintain a semblance of respectability by carefully restricting all of their textbook examples to consumables, doing axiomatic economics and then just saying “supply” when they really mean stock. In this way, stupid people will be convinced that the theory of supply and demand is still relevant 250 years after it became irrelevant.

But it should be clear to all intelligent observers that it is really stock, not supply, that is important in the egg market. For instance, suppose that there is a power outage and all the housewives in the city must throw out the dozen or two of eggs that they possess, but the egg farmers are unaffected as they have backup generators for air conditioning their hen houses. Neoclassical economists would attempt to describe this situation by saying that demand has increased as all those housewives converge on the grocery stores to replenish their stocks of eggs.

But, clearly, demand has not increased – people want the same number of eggs for their breakfasts whether the lights are on or not. For simplicity, we are here assuming that the housewives all have gas stoves, so the power outage does not affect their ability to make omelets. If some of them have electric stoves, demand for eggs has decreased (because stoves and eggs are complementary phenomena), just the opposite of Neoclassical economists' claim that demand has increased.

Axiomatic economists count both the eggs in possession of professionals (farmers, grocers, etc.) as well as those in possession of consumers (housewives) toward their measure of stock. No distinction is made between an egg in my refrigerator and one in the grocer's refrigerator – both just count as one more egg in the stock. So the power outage is easy to describe: stock went down, demand remains the same.

The great advantage of the equities market (as a textbook example) is that the stock, the total number of a company's shares in existence, is much easier to determine than the total number of eggs in existence. It is a lot of work to poll the hundreds of farmers surrounding a city and the dozens of grocery stores in that city to find out how many eggs there are x days away from spoilage. And you would still not have a complete estimate of stock without polling the thousands of housewives in the city to see how many dozens of eggs each one has in her refrigerator.

But the concept of stock in the equities market is much easier to get a handle on. Unless we are talking about the Flamingo, which Bugsy Siegel sold 300% of and still managed to retain a controlling interest in, all of the shares in existence add up to 100% of the ownership of a company. The availability of hard numbers for crucial statistics is always a positive when choosing one's examples.

#### Onion Eater

##### Well-known member
In the case of the equities market, how does one determine sigma? Is it based on similar equities ie tech stocks IBM HPQ MSFT, energy stocks... Is it based on the total number of possible equity symbols in that market? Does the lower sigma indicate just higher volitility, or easier liquidity, or wider share price spreads? I am still trying to wrap my head around this theory, sorry again for the questions.

Today the market has been shaken a bit by the news out of the EU regarding Ireland's debt problems (nothing new, I don't know why it's so shocking...) How would I set up a calculation using your program and the ETF "DIA". What would be the input variables for importance, difficulty, and common ratio... and the outputs, what number tells me where I land after the shake up and how do I read the outputs? I am not looking for exactness to "test" the theory. I looking to learn the how the theory can best used by me.

I do not want to talk about current events, like the problems among Irish banks, because I am trying to avoid the image of the investment guru and, even with disclaimers, people would read my post as advice to buy or sell particular equities.

So, let us consider a made-up example: Suppose that President Obama is beating the war drums, trying to rally the public around a preemptive strike on Iran. And suppose that our intrepid investor has decided that this is the right time to buy shares of weapons makers.

Disclaimer: This is not a political post. If anyone has a strong opinion on the likelihood or advisability of a U.S. attack on Iran, they should start their own thread in a military forum. Also, it is not an endorsement or indictment of any of the named companies. Any decision to buy or sell equities should be made on the basis of one's own analysis, not forum posts.

Sigma (substitutability)

Sigma is a measure of substitutability and this is determined by how many other companies meet one's criteria. Here, our criteria are arms dealers who will benefit from bellicosity, in contrast to lentil farmers, who will be hurt by the president's decision to make war, not peas.

If one's criteria for what defines a weapons maker is loose (anything that goes “bang” and kills people), then one will have prohibitively many companies to analyze, but their substitutabilities will high and the graphs of their demand distributions smooth.

One might consider tightening one's criteria. For instance, if one assumes that it is political suicide to send ground troops into Iran, one might reject the makers of military vehicles, small arms, etc., and focus on the makers of stand-off weapons.

Tightening one's criteria lessens one's work load by reducing the number of companies one must analyze, but it makes their analysis more difficult because lower sigma values increase the oscillations on the low end of the demand distribution.

So, it is a balancing act.

If one's criteria are too loose, the wheat and the chaff are both getting the same analysis, which is not only time consuming but gives weight to companies with good fundamentals that are not actually affected by the upcoming war. For instance, if it is clear that Raytheon is going to get mucho government contracts, it may be wise to invest in it even if it is run by idiots, while Beretta (maker of the 9mm sidearm) may be fundamentally sound, but it is pointless to even include it on the list if the war is going to be waged entirely from carrier battle groups in the Persian Gulf.

If one's criteria are too tight, the oscillations in the demand distributions for equities in the few companies that meet that criteria make analysis difficult.

The oscillations are more pronounced at the low end of the demand distribution. And they increase with decreasing substitutability. If you reduce sigma (substitutability) much below 0.1 you will get a graph that looks like the seismograph reading during an earthquake.

With these very small sigmas, there may be more than one relative maxima, which raises the possibility that gradual changes in the parameters will result in an abrupt jump from one relative maxima to another rather than just following the maxima that the market has already found as that price/stock combo changes gradually in response to the gradual changes in the parameters.

This actually came as a surprise to me. I had worked out all the equations on paper and proven the uniqueness of the saturation point in the restricted case described in my Simplified Exposition, but it was not until I wrote a program in QBasic (source code) that I noticed this effect. At the time, it was not the equities market that I thought of as an example, but the market for fine art. Suppose an artist has come up with a new style (like Picasso did with cubism) but then dies prematurely. Nobody else has mastered this style and those who are trying are seen as weak imitators, so there is really no substitute for an original oil by the master.

Indeed, the market for fine art becomes increasingly erratic as one moves away from the generic paintings sold to people who just want an original oil by a competent artist and into paintings by famous dead guys with a style all their own. When a Picasso goes up for auction, even the most astute aficionados cannot guess the price it will sell for within an order of magnitude.

u(s) (diminishing utility)

Big ticket items like stealth bombers have a much steeper diminishing utility than bulk items, like rifle cartridges. As Sun Tzu said, one tiger can prevent a hundred deer from crossing a river. So one stealth bomber can make every military officer in Iran nervous because they all know that their air defenses are useless against it and, with typical human pessimism, they will assume that it is their unit that will be targeted. But a second or third of these pricey bombers is of much less value.

Diminishing utility, u(s), can be any function that meets the conditions of Axiom #2

2) Marginal (diminishing) utility, u(s), is such that:

i) It is independent of first-unit demand.

ii) It is negative monotonic; that is, u'(s) < 0.

iii) The integral of u(s) from zero to infinity is finite.

The exponential function is the most obvious and tractable function that satisfies this axiom, and that is the one used in my Java Applet. The common ratio must be a number strictly between zero and unity. In our example of attacking Iran, small numbers represent things like stealth bombers, large numbers represent things like conventional iron bombs, and middling numbers represent things like guided (smart) bombs, which are expensive enough that they must be conserved but not so much that mid-level officers are not given considerable discretion in their use.

Mu (importance)

This is a measure of how much people value something. It is the most volatile, as it reflects human emotions, but it is the easiest to analyze, because it does not change the shape of the demand distribution but just stretches it out.

Basically, you play with these parameters until you find ones that accurately predict the price and stock observed in the past. Then you try to estimate how those parameters will change in the future and see what the new price and stock will be.

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#### Missed AB

Banned
DP Veteran
I do not want to talk about current events, like the problems among Irish banks, because I am trying to avoid the image of the investment guru and, even with disclaimers, people would read my post as advice to buy or sell particular equities.
Fair enough. Can we work out something reflective of recent past events like the Crash of 08 into 09 with the ETF DIA. I would like to see a working example so I can understand the outputs as well as the inputs.

Also, if the numbers worked in the past for the ETF would they also work in the future for the ETF?

So, let us consider a made-up example: Suppose that President Obama is beating the war drums, trying to rally the public around a preemptive strike on Iran. And suppose that our intrepid investor has decided that this is the right time to buy shares of weapons makers.... If one's criteria for what defines a weapons maker is loose (anything that goes “bang” and kills people), then one will have prohibitively many companies to analyze, but their substitutabilities will high and the graphs of their demand distributions smooth.
There are a finite number of military arms suppliers to the US government. Instead of tracking each company individually, there are ETF's which will do that hard work for you. PPA and ITA are 2 examples of such ETF's. How would I use them in your example you provided to examine their rise or fall. Often times after the initial "shake of the bottle" as you call it, the equites do not go in the direction you expect. After 911, the next day the stockmarket was open was a disaster for almost the whole market regardless of defense contracts.

Tightening one's criteria lessens one's work load by reducing the number of companies one must analyze, but it makes their analysis more difficult because lower sigma values increase the oscillations on the low end of the demand distribution.
This seems like fundamental equity analysis and not the work of a mathematic formula.

Sigma is a measure of substitutability and this is determined by how many other companies meet one's criteria. Here, our criteria are arms dealers who will benefit from bellicosity, in contrast to lentil farmers, who will be hurt by the president's decision to make war, not peas.
Lets say on a given day in history, we were able to look in the past and advances to declines were 2/9. Is that an easier way to calculate the risk to benefit ratio? Can the volitilty index be used here as well (how strongly the equity prices will move).

Indeed, the market for fine art becomes increasingly erratic as one moves away from the generic paintings sold to people who just want an original oil by a competent artist and into paintings by famous dead guys with a style all their own. When a Picasso goes up for auction, even the most astute aficionados cannot guess the price it will sell for within an order of magnitude.
Which is why I am interested in equities I can calculate P/E, projected earnings, volitility, and a general feel for where the economy is going... Pricing art is not something I am trying to calculate.

Basically, you play with these parameters until you find ones that accurately predict the price and stock observed in the past. Then you try to estimate how those parameters will change in the future and see what the new price and stock will be.

Will this predict both a run up and down, or will it show the one direction as the bubbles settle out once it is shaken.

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#### Onion Eater

##### Well-known member
How would I set up a calculation using your program and the ETF "DIA".

Can we work out something reflective of recent past events like the Crash of 08 into 09 with the ETF DIA.

You have asked repeatedly about DIA. I suspect – just a wild guess – that you lost your shirt in 2008. “Oops,” as they say in the business.

First, some background for the general reader following this thread as to what an ETF is.

Instead of tracking each company individually, there are ETF's which will do that hard work for you.

That is not really true. If you want someone to do the hard work for you, then you should invest in a mutual fund. The fund manager has wide discretion as to what equities, bonds, commodities, etc. he will purchase withing the broad confines of his fund's investment objective. And his portfolio is not transparent, like an ETF, so he can move large blocks of assets without other market participants knowing what he is doing until it is too late for them to act on that knowledge.

Basically, when you invest in a mutual fund, you have hitched your wagon to someone (the fund manager) whom you feel is more knowledgeable than you are. This is not a bad assumption for most working people. Working people need to focus on their own jobs and they just don't have the time or the inclination to research individual companies whom they are considering investing in. So, for a fee, they let the fund manager do this work for them.

But this is not the case with an exchange-traded fund (ETF). From Wikipedia:

Most ETFs are index funds that hold securities and attempt to replicate the performance of a stock market index. An index fund seeks to track the performance of an index by holding in its portfolio either the contents of the index or a representative sample of the securities in the index.

. . .

In 1998, State Street Global Advisors introduced the "Sector Spiders", which follow the nine sectors of the S&P 500. Also in 1998, the "Dow Diamonds" (NYSE: DIA) were introduced, tracking the famous Dow Jones Industrials Average. In 1999, the influential "cubes" (NASDAQ: QQQQ) were launched attempting to replicate the movement of the NASDAQ-100.

An ETF fund manager does not have wide discretion as to what equities he will purchase. He is basically married to the index that his fund is tracking.

The DIA, in particular, is an index fund that replicates the performance of the most famous equities market index of all, the Dow Jones Industrial Average. The Dow tracks the performance of thirty of the biggest, most stable companies in America and is thus meant to be a measure of the equities market as a whole with all the risk filtered out. Broader indexes, like the Russell 2000, include many small companies of varying riskiness, and cannot be viewed as representative of Wall Street as a whole because it is never clear how much risk is being averaged in to it.

So, by investing in DIA, you have basically hitched your wagon to the overall fate of Wall Street. And Wall Street, as we all know, took a drubbing in 2008. The Dow fell by half, from over 14,000 to less than 7,000.

But the whys and wherefores of this brush with a second Great Depression is a macroeconomic question. And this thread is about microeconomics. My theory competes directly against supply and demand – microeconomics.

So don't bother me about the ETF DIA anymore, please. We are talking about microeconomics, which considers things like the supply of eggs to a city or, in the case of equities, the decision to buy Raytheon or Beretta. I have written extensively on business cycle theory elsewhere, but this isn't the thread for that.

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#### Missed AB

Banned
DP Veteran
You have asked repeatedly about DIA. I suspect just a wild guess that you lost your shirt in 2008. Oops, as they say in the business.
It was the most profitable year I ever had. If I remember correctly, I had about 40% return.

I use DIA SPY and QQQQ as my hedges. I use deep long term out of the money puts as my cheap insurance policy. If your program was able to show where the price would land after shaking the bottle, that would help me narrow down my hedge price.

And his portfolio is not transparent, like an ETF, so he can move large blocks of assets without other market participants knowing what he is doing until it is too late for them to act on that knowledge.
Most fund managers do a horrible job. Very few funds "beat the market" averages. If you want to invest without really doing any of the work, buy and ETF SPY, DIA, or QQQQ. There are virtually no overhead costs compared to a MF and better overall performance.

If you want someone to do the hard work for you, then you should invest in a mutual fund. The fund manager has wide discretion as to what equities, bonds, commodities, etc. he will purchase withing the broad confines of his fund's investment objective.
Not true. The fund objective may handcuff the manager from participating in specific sector movements. Many funds are also not allowed to participate in options trading.

Basically, when you invest in a mutual fund, you have hitched your wagon to someone (the fund manager) whom you feel is more knowledgeable than you are.
I'm not in that boat.

An ETF fund manager does not have wide discretion as to what equities he will purchase. He is basically married to the index that his fund is tracking.
It does not have to be an INDEX. It can be any market sector. Defense, bonds, currency, metals, gold, shipping, energy, and yes index related funds.

So, by investing in DIA, you have basically hitched your wagon to the overall fate of Wall Street. And Wall Street, as we all know, took a drubbing in 2008. The Dow fell by half, from over 14,000 to less than 7,000.

All of your knowledge and you don't see how the 2 are tied to the hip? What happens to the cities egg supply when the depression hits? Did the depression hit before the Dow hit 6500? No, it was after clearing the answer of which came first the collapse, or the depression. One predicted the other (or caused).

So if your program can't handle DIA, but it can handle eggs, how about golden eggs, or just gold? How can I set up your program to see where gold will land when the cork comes out of that shaken bottle?

#### Onion Eater

##### Well-known member
So, by investing in DIA, you have basically hitched your wagon to the overall fate of Wall Street. And Wall Street, as we all know, took a drubbing in 2008. The Dow fell by half, from over 14,000 to less than 7,000.

So if your program can't handle DIA, but it can handle eggs, how about golden eggs, or just gold? How can I set up your program to see where gold will land when the cork comes out of that shaken bottle?

Not to put too fine a point on it, but most of the people who invest in the DIA (not, apparently, you with your 40% return in 2008) are rubes. They do this for two reasons:

1) The Dow is the only business statistic that they are familiar with, it being the only one routinely reported on ESPN. Plus, it comes with a cool graph on the business page, unlike all that fine print one must wade through to get stats on individual companies.

2) These are the same people you see at NASCAR races wearing orange "Union 76" jackets. They don't actually work at a gas station, they mailed \$49.95 to Union 76 and got the jacket in the mail. They pay to advertise someone else's business, just the opposite of the racers who only advertise businesses who have paid them endorsement money. Similarly, rubes buy DIA because it associates them with the 30 biggest companies in America, not because any sort of analysis predicted that DIA would go up.

Gold (as a textbook example) has one point in its favor and and one against:

The good thing about analyzing gold is that it is easy to get an estimate of the stock of gold in the world. Unlike base metals (tin, copper, etc.), nobody ever loses gold coins. If a Krugerrand was minted in 1967, you may not know who owns it today, but you can bet it is still in somebody's grubby little hands.

Wikipedia said:
Through 2008, Krugerrand coins containing 46 million ounces of gold have been sold.

The bad thing about analyzing gold is that the market is driven by fools.

Jeffrey Tucker said:
All political truth can be found in a coin shop.

My book is heavy on theory and light on examples. In fact, it is all theory - definition, lemma, theorem; definition, lemma theorem; page after page - without any examples. However, I'll see if I can come up with a real-world example. It'll probably take a few months to do the research, especially with the holidays coming up, so don't hold your breath.

#### Missed AB

Banned
DP Veteran
Not to put too fine a point on it, but most of the people who invest in the DIA (not, apparently, you with your 40% return in 2008) are rubes. They do this for two reasons:
There are a lot of good reasons to own the ETF's such as DIA. It is one that I do not own - except in terms of options - but not because of the reasons you describe. Speaking of returns on investment, the DIA is the easiest way to capture the movement of the market as a whole. There are very few days that the S&P500, Russel1000, or any sector is up a significant amount when the DIA is down.

Secondly it provides a monthly income dividend distribution. This is a nice way to enjoy income better than most 5 year CD's and allow for capital appreciation without having the money tied up. Buying DIA is as foolish as buying IBM, MSFT, CAT, MMM, GE, KO.... It makes a lot more sense to buy that basket than a mutual fund "large cap" which is tied to those same names but has high expense ratios.

The Dow is the only business statistic that they are familiar with, it being the only one routinely reported on ESPN. Plus, it comes with a cool graph on the business page, unlike all that fine print one must wade through to get stats on individual companies.
The point I hope you would agree with is that DIA is still a better option than most mutual fund options for the average person. Earlier you used the same rational to support mutual funds...

The good thing about analyzing gold is that it is easy to get an estimate of the stock of gold in the world. Unlike base metals (tin, copper, etc.), nobody ever loses gold coins.
To further that point, any gold that was ever around still exists. It does not degrade, oxidize, or have half lives.

The bad thing about analyzing gold is that the market is driven by fools
This is true for most markets, as gold is not isolated here.

In fact, it is all theory - definition, lemma, theorem; definition, lemma theorem; page after page - without any examples. However, I'll see if I can come up with a real-world example. It'll probably take a few months to do the research, especially with the holidays coming up, so don't hold your breath.
That is what makes it very hard for me to conceptulaize. I am a lot better understanding theory from examples than than just theorem. The nice thing about having examples is it allows you to back test the theory for degree of accuracy. I look forward to seeing some real world examples as a starting point for me to work at understanding your theory. Take your time and enjoy the holidays.