Role of Intensive and Extensive Variables in a Soup of Firms in Economy to Address Long Run Prices and Aggregate Data

TL;DR

This paper explores how extensive and intensive variables influence long-term prices and aggregate data in an economy with many firms, using thermodynamics analogies and a toy model for aggregation.

Contribution

It introduces a thermodynamics-inspired perspective on economic variables and proposes a method for aggregating extensive quantities in a multi-sector economy.

Findings

Wages and rates of return act as intensive variables in economic systems.

Aggregation of extensive variables can be modeled using a toy model within neoclassical framework.

Thermodynamics analogy explains the equality of wages across sectors.

Abstract

We review the production function and the hypothesis of equilibrium in the neoclassical framework. We notify that in a soup of sectors in economy, while capital and labor resemble extensive variables, wage and rate of return on capital act as intensive variables. As a result, Baumol and Bowen's statement of equal wages is inevitable from the thermodynamics point of view. We try to see how aggregation can be performed concerning the extensive variables in a soup of firms. We provide a toy model to perform aggregation for production and the labor income as extensive quantities in a neoclassical framework.