Models of strategic interaction are common in the economic growth literature, as well as in many other fields. For example, in human capital spillover models of economic growth, your incentive to acquire human capital depends on the human capital of others. If spillovers take place within neighborhoods, then strategic interactions affect neighborhood formation, human capital of different ethnic groups, and overall inequality (Borjas 1993, 1996, Benabou 1993, 1996, Durlauf 2002, 1999, 1996). These models often feature multiple equilibria and sensitivity to initial conditions. Although the theory is well developed, there has been only limited empirical testing of strategic interactions and sensitivity to initial conditions.
One of the most famous models of strategic interaction in economics is Thomas Schelling’s (1971) elegant model of racial segregation (see its coverage in Dixit and Nalebuff 1991, for example). He shows how only a modest preference of whites to live next to other whites could result in nearly complete residential segregation, because of the instability of intermediate points where one agent’s residential location depends on the actions of other agents in the neighborhood. In this model, even a relatively small fraction of nonwhites could cause the neighborhood to “tip” from completely white to completely nonwhite. The fraction at which this happens is called the “tipping point.”
Segregation outcomes might seem to reflect segregationist preferences by whites, but in the Schelling model the degree of segregation exceeds what all but a small minority of the white population desires. If there are differences in average human capital between whites and blacks, and there are spillovers within neighborhoods, then residential segregation has important implications for black-white income differences. Card and Rothstein (2007) find that the black-white test score gap is higher in more segregated cities. Hence, Schelling’s model is potentially one of the important building blocks in understanding inequality (Durlauf 2002 cites it in this context).
The tipping view of neighborhood change had been around long before
Schelling’s piece. Schelling (1971) says he was inspired by articles from the 1950s, where the tipping process was described as universal, as was the instability of mixed neighborhoods. Once a neighborhood had begun to change from white to black, there was rarely a reversal. The process was very nonlinear. An article in 1960 defined it thus:
Although the movement of whites out of the area may proceed at varying rates of speed, a “tipping point” is soon reached which sets off a wholesale flight of whites. It is not too long before the community becomes predominantly Negro.
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Empirics of Strategic Interdependence: The Case of The Racial Tipping Point
