Economic theory still rests on century-old notions of equilibrium, diminishing returns, and the single optimal outcome—concepts that were useful in the bulk manufacturing and agrarian economy of the 1800s, but that fail to illuminate the dynamics of today’s technology-intensive industries. Writing originally in Scientific American, W. Brian Arthur, Dean and Virginia Morrison Professor of Population Studies and Economics at Stanford University and Citibank Professor at the Santa Fe Institute in New Mexico, describes an alternative economics based on increasing returns, which can significantly affect the way today’s companies are organized and operated.

Conventional economic theory is built on the assumption of diminishing returns. Economic actions engender a negative feedback that leads to a predictable equilibrium for prices and market shares. Such feedback tends to stabilize the economy because any major changes will be offset by the very reactions they generate. The high oil prices of the 1970s encouraged energy conservation and increased oil exploration, precipitating a predictable drop in prices by the early 1980s. According to conventional theory, the equilibrium marks the "best" outcome possible under the circumstances: the most efficient use and allocation of resources.

Such an agreeable picture often does violence to reality. In many parts...