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Archive for November 16th, 2010

A computer simulation: Why the Rich get Richer and the poor – lose everything

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The rich get richer and the poor get poorer. You’ve heard that before. It is a maxim so often repeated, and so often confirmed by experience, that it begins to sound like a law of nature, as familiar and irresistible as gravity. And indeed perhaps there is some physical or mathematical rule governing the distribution of wealth in the world…  – American Scientist – Follow the Money

How the World Works

There are at least two ways to find out how the world works.  The first is to go out there and test it using real stuff.  The second way is to build models and simulate how the world works – as close as you can for the relevant area of interest – and see what happens. 

So, lets say you have designed a new jet fighter and want to see how it flys.  You could get a test pilot and let him/her try to fly it – “Here, try this out.  If you crash, let us know.”.  Another way, the preferred way, is to build a model and run a simulation.  This latter alternative is preferred by test pilots and those funding these ventures.

How about investments and trading?  Do you go out there, risking your treasure, to see “what happens” with real money?  Or, can you run a simulation first, testing various investment and trading strategies, without risking financial capital?

Sound too abstract and irrelevant?  How about the simple example of a  Yard Sale?  Everyone has been to one.  Can you create a computational model of a yard sale, test various scenarios to see what happens under different trading rules and participant behavior?  Sure, it’s all about rules, the model, and how people behave in the model.

Economics of Trade – Yard Sale Computational Simulation

Even slight departures from perfect pricing bring a new dynamic to the yard-sale model. If I buy your rusty wheelbarrow and pay more than it’s worth, I am left slightly poorer after the transaction, and you are a little richer. Conversely, if I pay less than fair value, I gain a little, and you lose.

In either case there has been a transfer of wealth, typically a small fraction of the price paid. These transfers are where the action is in the modeled economy; as a matter of fact, the model can ignore the transaction itself—there’s no need to talk about toasters and wheelbarrows—and simply consider the net transfer of wealth.

The question is: What happens when this process is repeated many times? If some of the traders are shrewder than others, you would certainly expect them to do well in the long run; likewise the perennial suckers are going to lose their shirts. But suppose that everyone is equally skillful, so that who wins and who loses is purely a matter of chance. The amount of gain and loss is also determined at random—but it’s always less than the total wealth of the poorer agent, so that traders never risk losing more than they own.

Before reading on, you might try to predict what will happen in such an economy. If everyone starts out with the same bankroll, how will the assets be distributed after many random exchanges?  Will the levels of wealth remain uniform? Perhaps the system will evolve toward a Gaussian distribution, with most people having a middling amount of money, while a few are very poor and a few are rich?

Here is the answer given by the computer experiment: If trading continues long enough, essentially all the wealth winds up in the hands of one person…

Hands-on.  Try it for yourself

While looking for something else related to modeling and computational simulation I came across these two easy-to-use simulation of simple investment choices and a simple Yard Sale model.  There are a number of inputs that can be dialed-in to set various parameters.  After dialing-in the rules of trading game you can run the scenario and see what happens.

If you spend some time with these models , you can find those scenarios (rules and choice people make) where clearly, the rich get richer and the poor – well, lose everything.

You can run the simulations off of a web page at the links below

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Written by frrl

November 16, 2010 at 6:05 pm

Posted in Uncategorized

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