Based on this information, how many workers will wear ties? To begin answering this, we need to specify an equilibrium condition. An equilibrium exists when the system is at rest and has no further tendency to change. The logical equilibrium condition in this model is that there will be no further changes in behavior when expected behavior is the same as actual behavior. When actual behavior is different from expected behavior, we expect some adjustments to be made so the system will not be at rest. To determine where the system will be in equilibrium, the information in the table above can be reorganized to yield the table below. This table says that if no one expects to wear a tie, then no one will. If everyone expects two people to wear a tie, then only one person (Adams) actually will. He will not be happy with the result because when he sees that he is the only one wearing a tie, he will find that his expectations were not realized, and that he made a mistake.
By trying various possibilities, one discovers that there are two situations that can sustain themselves and, thus, in more technical terms, are positions of equilibrium. If no one else is expected to wear a tie, no one will, and no one will be disappointed with that result. If everyone else is expected to wear a tie, everyone will wear a tie, and again no one will be disappointed with this result. But if three other people are expected to wear a tie, three (Adams, Benson, and Carter) will. Adams will be happy with the situation, but Benson and Carter will find that only two others are wearing ties, so they will be unhappy with the outcome. If we add the assumption that people who are unhappy will change their behavior, three will not be a position that will sustain itself; that is, it will be a position of disequilibrium.
Let's dig a bit deeper by noting that this little story is made up of several parts. One part, given in the first table, is a statement or assumption about how people act. As with most economic theories, this model makes assumptions about how individuals act but is interested in group results. A second part of the model is a condition of equilibrium. Implicit in our discussion above is a third part, an adjustment process. An adjustment process explains how a system moves from a position of disequilibrium to one of equilibrium. The adjustment process in this model depends on how expectations are formed. For example, people might expect others to continue acting as they did the day before. You can act out what happens with this assumption. If five people are given cards with instructions similar to those in the first table (instead of wearing ties, the instructions might say, "Raise your hand." or "Sit down."), a small group can experiment with various starting points and see what happens.
If a system is bumped away from an equilibrium and the system has a tendency to come back to that equilibrium, then the equilibrium is stable. It is possible for an equilibrium to be unstable. This means that any small divergence away from equilibrium will take the system increasingly far from it.1 The picture of an egg balanced on its end illustrates an unstable equilibrium. It is at rest with no tendency to move, so it is in equilibrium. But if anything disturbs it, it will not return to this original position. Filling the bottom of the egg with plaster would make this equilibrium stable. Then any disturbance would rock the egg, but it would return to its original position.
Models of contingent behavior can be more complex than this discussion has made them. What if, for example, not everyone has the same initial expectations or they adjust to new expectations in a variety of ways? However, because our reason for looking at this model was only to introduce some concepts that will be of use later, we will not pursue those complexities.
There are a number of economic situations that contingent behavior may help explain. The prices of fine art, stamps, rare coins and other collectibles seem in large part determined by what people expect others to be willing to pay. People are willing to spend $5000 or more (and often much more) for a postage stamp because they are confident that they can resell it at the same price or a price close to it. Contingent behavior also may explain the wide price fluctuations in some speculative markets, such as that for gold. It even explains why people consider paper money valuable. Everyone is confident that others will accept it.
The one place where a model of contingent behavior has been developed and used in economics involves the Keynesian theory of national income, which was for many years the primary way economists thought about how unemployment and total production were determined. In this theory, people's spending depends on what they expect their income to be, and income in turn is the same as spending (because whatever one person spends, another receives as income). Equilibrium in this model exists when people receive the income they expectotherwise, they change expectations and behavior. There is also a multiplier effect in this model. When one person changes his behavior, it affects others who change their behavior in turn. This model was the focus of early macroeconomic textbooks and remains an important topic in recent textbooks.
Next we visit a frontier, the production-possibilities frontier.
1 The plural of equilibrium is equilibria. The word comes from Latin.
Copyright Robert Schenk