Financial resources have different properties than physical resources. We can borrow money to buy something that we want to have now and pay it back –-with interest--in the future. If everybody expects a company will be successful the stock price will go up. Some people will even benefit from a dramatic downward trend in stock prices if they had bought options to sell stocks at high prices, which then enables them to buy those depressed stocks cheaply and sell them once they regain their value.
The economic and financial crises in recent years showed unexpected behavior in our economy’s performance that was not predicted by traditional economic models. In this chapter we will discuss two examples of using agent-based models to understand economic systems. The first example is about a bank that gives loans to people. How much money does a bank need to have in available cash to do their business and how do rules on how much reserves are required affect income inequality? In this example we also discuss the Gini coefficient, a measure of inequality.
The second example focuses on herding behavior in financial markets. Newspapers report on bubbles in financial markets. What are these bubbles and where do they come from? We show that herding behavior, people buying when other do, leads to bubbles.
The two examples we discuss in this chapter illustrate how models can help us to provide some understanding on phenomena in economic systems by exploring the consequences of some rules on interactions in markets.