and analyzing the results of political and economic decisions.

by
Lars Olert
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updated 17
October, 2006
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The method of Economic Circular Flows can show the structure of an economic system, display historical data and simulate scenarios for a hypothetical future. An economic system is described as sectors of the society and flows of payments, good and services between them. The models consider both static and dynamic feed-back in the system. The flows are located in different layers of the models, the simplest models have only one layer for payment flows, the more advanced have a second layer for real flows such as work, goods and services. Price relations connect the different layers, dashed lines in illustration above.

No method can be used to make forecasts for the future. This method shows where decisions of economic actors act on the system, I call it decision centers. The decisions act on the model as input signals that can not be modeled.

The method presented here is founded in 100 years of engineering
tradition with notions and methods that are used for calculating
currents in electrical circuits, steam and water flows in thermal
power plants etc. It would not have been possible to design electrical
networks, power plants, process industries and electrical equipment
without these calculation methods. The method is similar to the
theory for Input-Output models, with the difference that some
parts of control theory have been added. The notion of **state
variables** has been added and the more advanced models can
describe a trajectory in time, so called dynamic systems.

The models are from the beginning designed to include the whole society: e.g. households, private sector, public sector and foreign countries. The models can calculate the immediate impact from political decisions, e.g. if a certain tax rate is changed. The ambition has not been to foresee decisions taken by actors on the market to counteract the first decision. The user of the programs must add the second decision himself to see the result of the combination.

At the moment, there are three static models
and two dynamic models. The method of constructing models is general
in the meaning that arbitrary networks can be built and extensions
added as desired. The theoretical background and the individual
models are described in a **report**
that is appended. The report also includes diagrams with historical
data and comparisons with the basic theory of political economy.
I am just developing the dynamic theory, see part 2, and making
a computer program for interactive design of economic models.

Economic model S3. The figure shows the flows of payments in Sweden 1994 (billions of Swedish crowns per year). With these flows as a starting point, new flows can be calculated when e.g. the tax rate is changed. |

All models are made with the Microsoft Excel program. The figures
are drawn with Visio Express for Mathcad. **Excel
calculus and figures** showing the
different models are found **here**.
If you do not succeed to download the Excel calculus, please contact
me and I will send them by e-mail.

The development of economic theory follows essentially two lines.
The oldest line is **qualitative** and uses little mathematics.
The pioneers in this field were the liberal economist Adam Smith
with the book "The Wealth of Nations" (1776) and Karl
Marx with the book "The Capital" (1:st edition 1867).
A **quantitative** economic theory was first developed during
20:th century. The theory for Input-Output models was formulated
by Wassily W. Leontief. He was awarded the Nobel Prize in Economic
Sciences in the year 1973.

Quantitative models can be used for mathematical simulations and economic forecasts. Economic forecasts requires that all influences from the surroundings on the system (exogenous variables) are known and are in principle impossible to make if one also wants to predict political and economic decisions. The result also depends upon the assumptions built into the model. Many models are limited to only depict one part of the society, especially the private enterprises and domestic and foreign trade (the market economy).

There are a number of professional models used by the governments and authorities of the Nordic countries. I have studied them briefly. When my models are more developed and I have an opinion of my own, I will go deeper into a comparison. My primary goal is to create smaller models that can be made public and be used for basic studies of macro economics.

The KOSMOS model is used by the Swedish National Institute of
Economic Research (Konjukturinstitutet)
in current forecasting work. The model is briefly described in
Appendix 1 of The Long Term Forecast, LU90, Långtidsutredningen
1990. In parallel, the calculation system FIMO is used for income
formation and financial savings in domestic sectors (the state,
old age pension *AP-fonden*, municipalities, households and
enterprises).

Statistics Denmark (Danmarks Statistik) have elaborated the macro economic model ADAM (Annual Danish Aggregated Model). It is a model with great detail. The first version came in 1972.

Who can tell me what can be found in Norway? The ADAM document
mentions that the Norwegians "since long have been doing
modeling work".

Model 1 (only in Swedish) is an older model that I wrote in 1996. It showed that the idea worked and gave me a good reason for elaborating a general method for designing models.

In the beginning of 1996, I wrote a project description that still is valid. It will take five years work to do everything. Therefore, I invite anyone who is interested to participate, maybe write a university thesis. An interdisciplinary project could be started with both economists and engineers/mathematicians as members.

I have also written contributions to the debate on economic issues.

- The two economic loops, about unemployment and the causes to the crises.
- Recipe against unemployment
- How to build an economy
- The misunderstood growth
- Effect from reduced working hours
- Look out for the working time
- All benefit from taxes
- Uniform taxes for enterprises

Statistics with background materials.

- Increasing production, less employment
- Employed according to branch of production
- Mixed statistics from Statistical Yearbook of Sweden, SCB
1996, Excel calculus

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