Most people agree that human activities are consistent with physical laws. One may naturally think that sensible economic theories can be derived from physical laws and evolutionary principles. This is indeed the case. A newly developed analytical thermodynamic theory of economics provides a much more realistic and intuitive understanding of economic, social and biological phenomena than the mainstream economic theory. The theory was first systematically presented in a 2005 book, The Physical Foundation of Economics: An Analytical Thermodynamic Theory. A recent update is presented in a new book, The unity of science and economics: A new foundation of economic theory. In the following, we will give a brief description of the theory.

The entropy law states that systems tend toward higher entropy states spontaneously. Living systems, as non-equilibrium systems, need to extract low entropy from the environment to compensate for continuous dissipation. This process is the most fundamental property of life. It can be represented mathematically by lognormal process.  From the entropy law, the thermodynamic diffusion of an organic or economic system is spontaneous.  The extraction of low entropy from the environment, however, depends on specific biological or institutional structures that incur fixed or maintenance costs. Higher fixed cost systems generally have lower variable costs. We derive the thermodynamic equation that variable cost of a production system should satisfy, determine the initial value and solve the thermodynamic equation to derive an analytic formula that explicitly represents the relation among fixed costs, variable costs, uncertainty of the environment and the duration of a production system, which is the core concern in most economic decisions. This analytical representation of various factors in production processes enables us to directly compute and analyze the returns of different production systems under different kinds of environment in a simple and systematic way.

Social sciences are about conscious decisions of human beings. To understand social sciences, we must understand human mind, which is an organ of computation engineered by natural selection. We find that some psychological patterns, such as conservatism, reflect the constraint of entropy laws. Others, such as framing and herding, are evolutionary adaptations to enable the efficient processing of information, which is the reduction of entropy. Still others, such as overconfidence and loss aversion, are mental attitudes that help us survive the constant dissipation endured by all non-equilibrium systems. The entropy theory offers a unified understanding of the patterns of human mind. It provides an alternative theoretical foundation to rational expectation theory, which does not fit well with empirical evidences.

Human activities are predominantly economic activities, which are chiefly regulated by the exchange value of different economic commodities. The current value theory does not provide a measurable quantity to value. Since all human activities represent extraction and transformation of low entropy from the environment, it is natural to relate economic value to low entropy. From the properties that the value of commodities should satisfy, we derive that the only mathematical formula to represent value, as a function of scarcity, is the entropy function. This is parallel to that the only mathematical formula to represent information, as a function of probability, is the entropy function. The entropy theory of value offers a unified understanding of physical entropy, information and economic value. It provides a quantitative measure of value that is highly consistent with our intuitive understanding. Just like the entropy theory of information provided a clear understanding of the fundamental problems in communication theory, the entropy theory of value provides clear understanding of the fundamental problems in social activities.

Modern science was germinated from astronomy, which Wiener termed as an ideally simple science. Finance, which studies prices changes under uncertainty abstracted from all the intrigues of social and organizational complexities, is indeed an ideally simple social science. It is usually in simple subjects that original insights and methodologies are developed and applied with great effectiveness. It is from finance the new theory germinates. In the process, we also build a new foundation of finance.

We have applied the theory to understand many fundamental problems in social sciences. All the problems are analyzed with the unified methodology.  This is in sharp contrast to analysis based on general equilibrium theory, where many different models are developed for different problems.

We are at the dawn of a scientific revolution. Most new theories are first circulated through informal channels. My papers on SSRN also generate more than eighteen thousand downloads. I hope we can work together to greet this exciting new era.