Musings on Economics

Sunday, April 11

The second law of thermodynamics and the law of supply and demand

The most basic example of economic equilibrium is, to judge from popular accounts of economics, the law of suppy and demand, namely that the higher the price of a
good, the larger the supply and the smaller the demand, and that actual prices are determined by the equilibrium between supply and demand.

The mention of equilibrium recalls—to my physicist's minds—the concept of thermodynamic equilibrium. The second law of thermodynamics can
be formulated by saying that


When two systems at different temperatures are put in contact, heat flows naturally from the hotter to the colder system.

Does this have an analogue in economics? Thinking about the supply/demand system, I have come up with the following dual forms of the principle:

  • Market share "flows" from the supplier with the higher price to the supplier with the lower price.
  • Products "flows" from the market providing the lower profit to the market providing the higher profit.

The point of this observation is that the equilibrium of supply and demand is not the most natural analogue of thermodynamic equilibrium: thermodynamic equilibrium has more to
do with competition.

We also have the principle that a thermodynamic system is stable if pouring heat into it raises its temperature. The analogues of this in economics are

  • A supplier is stable if increasing demand for its product increases the price of the product.
  • A market is stable if increasing supply of certain goods decreases the price they command in the market.

I would be interested in knowing of any actual examples of producers or markets which are unstable in these ways. Of course, such instabilities cannot persist for long periods
of time.

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