1.5 The Interdependence Principle
Nerida’s restaurant is doing well, and she’s thinking about opening earlier so that she can also serve lunch. She’s aware that the likely success of the lunch shift—and hence whether it’s worth pursuing—depends on a range of other factors. First of all, it depends on her other decisions. Nerida has also been thinking about offering cooking classes, but she doesn’t have enough bandwidth to succeed at both new projects. Second, it depends on the decisions made by others within her market. If the other Italian restaurant in town opens for lunch, it’s unlikely that there will be enough customers for her to break even serving lunch. As such, her best choice depends on the choices of her rivals. On the flip side, if more people eat out rather than bringing lunch from home, then perhaps it will be profitable. And so her best choice also depends on the choices her potential customers make. Third, it depends on developments in other markets. If Amazon opens a new regional headquarters nearby, that will mean more foot traffic, and more potential lunchtime customers. On the flip side, she’ll have to compete with Amazon for workers, and so it might also mean that she’ll have to pay higher wages. Fourth, it depends on her expectations about the future. She expects the economy to expand next year, and that means more customers with more money in their pockets, which could potentially make her lunch service very profitable.
As Nerida thinks harder about all of this, she sees that the economy—and indeed, her life—is rife with interdependencies. Her best decision depends on many factors, and as these other factors change, so does her best course of action. Indeed, all choices are interdependent, and they both shape—and are shaped by—the choices that you and others make, both now and in the future.
This is the interdependence principle, which recognizes that your best choice depends on your other choices, the choices others make, developments in other markets, and expectations about the future. When any of these factors changes, your best choice might change. There are four types of interdependencies you’ll need to think about:
Dependencies between each of your individual choices
Dependencies between people or businesses in the same market
Dependencies between markets
Dependencies through time
These four different types of interdependencies can be illustrated by thinking about how you choose your classes. First, if you take an economics class, you won’t be able to take some other class that is scheduled at the same time—perhaps it means that you can’t take “The Simpsons and Philosophy.” (Don’t laugh; it was an actual class at U.C. Berkeley!)
Second, if another student takes the last spot in a popular class, then you will have to take a different class. That is, your decisions about which classes to take also depend on the choices of others in the same “market.”
Third, if you believe (as I do!) that the falling cost and increasing capacity of data-crunching computers means that the skills you learn in introductory economics—which include how to interpret those data—have become more valuable, then your best decision in one market (which class to take) depends on outcomes in other markets (the growing availability of data).
And fourth, your decision to study economics today changes the set of classes you have met the prerequisites for, affecting the courses you can take next year. For example, completing introductory economics will enable you to take more advanced economics courses in the future, whereas those classes wouldn’t be an option if you didn’t take this class. Thus, the best course to take this year depends on what classes you expect to take in the future.
The broader point is that the best choice for you—such as which classes you take this semester—will depend on many other factors. If any of these other factors change, then your best choice might change, too. Let’s explore these four different types of dependencies in greater detail.
Interdependency One: Dependencies Between Your Own Choices
Since you have limited resources, every choice you make affects the resources available for every other decision. This interdependence follows from the many different constraints you face. Consider the following examples:
You have a budget constraint due to limited income, and so the amount of money available to spend on entertainment depends on how much you spend on food.
You have limited time because there are only 24 hours in a day, and so the amount of time available to study for economics depends on how much time you spend studying psychology.
You have limited attention, so the amount of attention you give your economics lecture depends on whether you allow yourself to be distracted by your smartphone.
You have limited production capacity because you only have one factory, and so the number of production lines available to produce hybrid cars depends on how many are producing minivans.
You have limited wealth to invest, and so the amount you invest in a new startup depends on how much you invest in stocks and bonds.
How you spend your limited attention will affect your grades.
In these cases, the interdependence follows from limited income, time, attention, production capacity, and wealth. Before moving on, ponder how other constraints, such as limited energy, limited cognitive capacity, and limited willpower will create other interdependencies between your choices.
Interdependency Two: Dependencies Between People (or Businesses)
The choices made by other economic actors—people, businesses, governments, or other groups—shape the choices available to you. In many cases, this arises because you’re competing for society’s scarce resources. The more others get, the less that’s left over for you. Consequently, your best choice depends on the choices that others make.
When people compete for scarce resources, they typically do so in a market. And so you’ll more easily see these interdependencies by focusing on how buyers or sellers compete. For instance, if Microsoft hires the best computer programmers in Seattle, it will be hard for a Seattle-based startup to find talented employees. And so a startup’s hiring outcomes depend on those made by Microsoft, because they’re competing buyers in the labor market. Alternatively, if your classmate is hired by Microsoft, that’s one less job for you to get. In this case, your outcome depends on your classmate’s because you’re competing sellers in the labor market.
To get a sense of these interdependencies, it’s useful to start by identifying the relevant market. It’s an approach that applies well beyond traditional markets, as the following examples show:
Your ability to date the most interesting person in your class depends on the other people they might date in your class.
You’re competing “buyers” in the dating market.
Whether your vote sways the next election depends on whether my vote offsets yours.
We’re competing “sellers” in the market for votes.
Whether your parents attend your younger brother’s Tuesday evening choir recital depends on whether they’re attending your sister’s Tuesday evening soccer game.
Your siblings are competing “buyers” in the market for parental attention.
Whether the school board adopts your new policy proposal depends on whether they prefer my alternative proposal.
We’re competing “sellers” in the marketplace of ideas.
Understanding these interdependencies between competitors in a market is a critical first step. In the next chapter, we’ll push these ideas further, analyzing the forces of supply and demand in greater detail.
Interdependency Three: Dependencies Between Markets
Choices are also interdependent across different markets. In particular, changes in prices and opportunities in one market affect the choices you might make in other markets. For instance:
Rising interest rates in the credit market make it more expensive to get a mortgage, which might lead you not to buy a home.
Your choice in the housing market depends on the credit market.
When demand for housing falls, entrepreneurs often convert existing homes into something else, such as child-care centers, making it easier for you to find child care.
Your choice in the child-care market depends on the housing market.
If you live in an area with many high-quality, low-cost child-care options, you may be more likely to return to work soon after becoming a parent.
Your choice in the labor market depends on the market for child care.
When both spouses work, households are more likely to need two cars.
Your choice in the car market depends on the labor market.
So you can see that there are dependencies running all the way from the credit market to the housing market, to the child-care market, to the labor market. If you ignore the interdependence principle, you could be tempted to just consider each market in isolation. But as these examples demonstrate, this can risk missing a large part of the story, because changes in these other markets shape your costs and benefits, and can thereby change which option is your best choice.
Interdependency Four: Dependencies Over Time
As a consumer, you always face the option of buying something tomorrow, rather than buying it today. And similarly, as an executive, you get to choose when to produce goods and when to bring them to market. Likewise, investors, employers, and workers all get to decide when to invest, hire, and work. These alternatives mean that your choices always reflect a trade-off across time: Is it better to act today or tomorrow? As expectations about the future change, the terms of this trade-off change, and so your best choice might change.
Your choices are also linked through time by the investments you make. For instance, if you invest in a new factory, in your education, or in getting fit, this expands your choices in the future, as these investments give you the opportunity to produce more, get a better job, or enjoy better health, respectively. Because your future depends so heavily on the choices you make today, you need to be sure to take account of these connections. And so the investment choices you’ll want to make today depend on your expectations about the future.
What Else?
The big idea behind the interdependence principle is to ask, “What else?” And this leads to two types of “what else?” questions. The first asks: What else might my decision affect? Every decision has ripple effects, and you’ll need to assess them all in order to count the full set of costs and benefits that’ll follow. The second “what else?” question asks: What else might affect my decision? The answer will help you figure out all the ways in which your costs and benefits—and hence your best choice—might change if other factors change.