E. Applied Systems
E.2 Economics and Strategic Interaction
Course description
Microeconomics starts with supply and demand: how the two curves set a price, and how elasticity measures the response of quantity to a price change. Consumer choice theory (utility subject to a budget) and the firm's problem (costs and profit) are constrained optimization, the calculus of B.1 applied to people and companies. Work through the standard market structures: perfect competition, monopoly, oligopoly. OpenStax's Principles of Microeconomics is free and adequate; Mankiw's textbook is the common paid alternative. Smith's Wealth of Nations (1776) rewards reading in the original: Book I, chapter 1 on the pin factory states the gains from division of labor, and the single "invisible hand" passage in Book IV is narrower than its later fame suggests, a comment on foreign versus domestic investment, not a general theory of markets. Derive Ricardo's comparative advantage by hand once; it shows why trade helps both parties even when one produces everything more cheaply.
Macroeconomics works at the level of the whole economy: GDP and what it does and doesn't measure, unemployment, inflation, growth, the business cycle. The AD-AS model organizes short-run fluctuations; Solow's growth model does the same for the long run. Monetary policy (interest rates) and fiscal policy (spending and taxation) are the two levers; the Keynesian-stimulus-versus-austerity debate is the live disagreement over how hard to pull them. Blanchard's Macroeconomics or OpenStax's Principles of Macroeconomics cover this ground.
Behavioral economics reconnects this section with the psychology in D.1: real choices deviate systematically from the rational-actor model. Tversky and Kahneman's 1974 paper on heuristics and biases is the founding document; Richard Thaler's Misbehaving tells the field's history. Read it alongside B.2 on replication: some nudge interventions show a real if modest effect, others vanish once publication bias is corrected for; the gap between those results is a case study in publication bias.
Game theory formalizes strategic interdependence: what to do when the right choice depends on what someone else, reasoning the same way, will do. Start with dominance, Nash equilibrium, and mixed strategies, then backward induction and how repeated interaction changes the incentive to cooperate. John Nash's 1950 paper defining the equilibrium fits on two pages; read it once the basics are in hand, following the argument even if the fixed-point theorem it relies on is new to you. Ben Polak's Yale lectures are free and the standard self-study route. Robert Axelrod's The Evolution of Cooperation reports tournaments pitting strategies against each other in the iterated prisoner's dilemma, where tit-for-tat's success surprised the field. Elinor Ostrom's Nobel lecture argues that real communities often manage shared resources without either markets or the state, and lays out the design principles that let them. Thomas Schelling's The Strategy of Conflict (1960) adds commitment and credible threats. Game theory reaches into evolutionary biology (C.3), Cold War deterrence (D.3), and E.3's agent-based models.
Checkpoints
Each checkpoint is tagged with the stage of the cycle it tests.| Stage | Checkpoint | Attempts |
|---|---|---|
formalism | Find all pure and mixed Nash equilibria of the prisoner's dilemma, chicken, and matching pennies, and solve a three-stage game by backward induction. | Post the first attempt |
formalism | Build a two-country numerical example showing why trade helps both even when one produces both goods more cheaply. | Post the first attempt |
formalism | Write an iterated prisoner's dilemma tournament with six or more strategies, including tit-for-tat, and compare results with Axelrod's. | Post the first attempt |
skepticism | State Ostrom's design principles and describe one real commons that has not collapsed. | Post the first attempt |
abstraction | Explain a recent central bank rate decision with the AD-AS model, and say what it leaves out. | Post the first attempt |
skepticism | Say which behavioral findings have held up under replication and which have not. | Post the first attempt |
Discussion
Proposed edits
Found an error, a missing idea, or a better source? Propose a change. A moderator reviews each proposal.Sources
- "Supply and demand." Wikipedia.
- Smith, Adam. An Inquiry into the Nature and Causes of the Wealth of Nations (1776).
- Tversky, A. & Kahneman, D. "Judgment under Uncertainty: Heuristics and Biases." Science 185, 1124–1131 (1974).
- Nash, John F. "Equilibrium Points in n-Person Games." PNAS 36(1), 48–49 (1950).
- Polak, Ben. ECON 159: Game Theory, Open Yale Courses (2007).
- Axelrod, Robert. The Evolution of Cooperation (Basic Books, 1984).
- Ostrom, Elinor. "Beyond Markets and States: Polycentric Governance of Complex Economic Systems." American Economic Review 100(3), 641–672 (2010); Nobel lecture.