2.7 Conclusion: How good is the model?

In Chapter 1, we learned how to use game trees to understand stories like the interaction between the people of Kellogg, Idaho, and their employer, the Bunker Hill Company.

We used a game tree to see how Bunker and the Worker would split the gains from cooperation, with each earning an economic rent (a payoff greater than their next-best alternative). But the Worker, and others like them, would have seen that the outcome of the initial game was unequal: Bunker got a much larger share of the gains from cooperation than the Worker did. In this chapter, we explored how the Worker might try to change the rules of the game—for example, through democratic action and regulating the company’s emissions—so that the outcome favors the Worker rather than Bunker. We also saw that Bunker, anticipating this action, might choose to offer a fairer outcome to the Worker.

Having examined these different institutional arrangements, we turned to the question of environmental inequality, investigating how people with different backgrounds and different levels of income are exposed to different levels of emissions or environmental degradation. We saw, too, that regulations like the Clean Air Act can help to overcome inequalities and improve environmental outcomes for all. The evidence about improving air quality reflected the importance of democratic participation that we highlighted at the start of the chapter with the Fair Labor Standards Act: people engage in collective action and exercise power to change the rules of the game. By changing the rules of the game, people can change the outcomes of interactions in which they participate.

In Chapters 1 and 2, we used a model of two players to understand how institutions shape who captures the gains from cooperation, and how changing the rules of the game can shift that distribution. That model is powerful but small-scale: it tells us how Bunker and the Worker bargain, not how the economy as a whole came to look the way it does today. In Chapter 3 we zoom out to the historical and empirical record. We ask: what kind of economic system produced the dramatic improvements in living standards since 1800—and at what environmental and distributional cost? The tools change from game trees to graphs of centuries of data, but the core questions carry over: who gains, who loses, and what institutions make the difference.

Skill and learning objectives

  1. Reading an analytical graph
  2. Changing a game tree
  3. Seeing how institutions change game outcomes
  4. Defining terms
  5. Reading an empirical graph (and its terms)
  6. Reading comprehension (difficult material)

Concepts to be learned

  1. Economic actors and doing the best you can
  2. Choices and opportunity costs
  3. Rents and gains from cooperation (exchange)
  4. Conflicts of interest
  5. Institutions as rules of the game
  6. Power
  7. Economy as a social system in the biosphere

Seeing the Principles in Action

Principle Example Everyday Economics
Interdependence principle Economic outcomes depend on strategic choices people make in different parts of the economy (shown in Figure 2.7 and the game trees throughout the chapter). Identify outcomes in your life that depend on other people, such as an employer, colleague, or classmate. How does what they do affect the outcome you can achieve? How does what you do affect the outcome they can achieve?
Doing the best you can principle People make choices that will result in the best outcome for them given what they anticipate others will do in response—like Bunker when the Worker becomes mayor, or the Worker when Bunker makes different choices about its emissions levels. Think about what actions you take to do the best you can in everyday life. What happens when a situation changes and you can’t adopt the same actions you may have adopted previously?
Rules of the game principle The rules of the game—institutions—govern what people can and cannot do, such as the workers engaging in collective action to elect one of them the mayor of the town. Have you engaged in actions to change the rules of the game in interactions with other people? Maybe you’ve met with housemates or family members to discuss who does chores or engaged in organizing or collective action. Why did you structure things the way you did?
Trade-offs and opportunity costs principle People evaluate what they do in comparison to their outside option, which captures the opportunity cost of one action compared to another; changing the Worker’s outside option affects the trade-offs they are willing to make for their job. Think about a time in your life when the opportunity cost of one set of actions changed compared to another. For example, maybe you found out that a job you applied for had a better (or worse) salary than you anticipated compared to a job you already had. How would that affect your actions? Why?
Principle of gains from cooperation and conflict of interest Cooperation can lead to greater benefits for everyone, but also to competition and conflict over the benefits. Even when who goes first changes, Bunker and the Worker both benefit from interacting. Have you (or a friend) been in a job where you started as a worker, but then ended up as a manager—for example, starting as a server then working as a shift manager? How did the change in position affect how you/your friend viewed the gains from cooperation with your colleagues? Explain.
Principle of individual and societal interests When people do the best they can, they may make choices that do not lead to the best outcomes for everyone or for the environment, which can happen when either player (Bunker or the Worker) chooses an allocation that is highly unequal. Consider situations when you or someone you know may have interacted with other people, but where you (and they) ended up worse off than expected. Why did that happen? Were you each doing the best you could? Think about interactions with housemates, work on team projects, or similar examples from your own life.

References

Currie, Janet, John Voorheis and Reed Walker. “What Caused Racial Disparities in Particulate Exposure to Fall? New Evidence from the Clean Air Act and Satellite-Based Measures of Air Quality.” American Economic Review 113, no. 1 (2023): 71–97.