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African-Americans have experienced high levels of residential segregation from the racial majority for at least a century (Massey and Denton 1993, Cutler, Glaeser, and Vigdor 1999). Over the same time period, black socioeconomic outcomes have persistently lagged behind those of the majority, even as other initially disadvantaged ethnic and racial groups have experienced convergence (see Figures 7.1 and 7.2). Social scientists have developed and tested two causal explanations linking the former trend with the latter. First, the spatial mismatch hypothesis, proposed by John Kain in 1968, posits that residential segregation introduces a physical separation between blacks and centers of employment, which in turn adversely affects black outcomes. Empirical tests of this hypothesis (see Kain 1992, Ihlandfeldt and Sjoquist 1998 for recent reviews) have provided varying degrees of support for the hypothesis. Second, recent literature emphasizing the importance of neighborhood effects, peer groups, and social interactions proposes that segregation negatively affects blacks by separating them from positive role models, high-quality local public goods, or other important inputs into the human capital production function (Wilson 1987, Case and Katz 1993, Cutler and Glaeser 1997).
A natural question to ask upon examining this previous research is whether residential segregation per se has negative effects on socioeconomic outcomes, or whether the relationship between segregation and outcomes depends on specific factors, such as the proximity of ghettos to employment centers or the collective human capital of the segregated group.
Why are there stock market crashes? Why is France overwhelmingly Christian and Thailand overwhelmingly Buddhist? Why did the Great Depression occur? Why do crime rates vary so much over time and space? Why did the adoption of hybrid corn follow an s-shaped curve? Why is there racial segregation? Why do mass cultural phenomena like the Hula Hoop and Harry Potter occur?
This bizarre juxtaposition of questions is bound together by one common element. Over the past 30 years, economists have suggested that models of social interactions provide the answer to every one of these questions. In most cases, the relevant social interactions are nonmarket interactions, or interactions between individuals that are not regulated by the price mechanism.
Many models of nonmarket interactions exhibit strategic complementarities, which occur when the marginal utility to one person of undertaking an action is increasing with the average amount of the action taken by his peers. Consequently, a change in fundamentals has a direct effect on behavior and an indirect effect of the same sign. Each person's actions change not only because of the direct change in fundamentals, but also because of the change in the behavior of their neighbors. The result of all these indirect effects is the social multiplier. When this social multiplier is large, we expect to see the large variation of aggregate endogenous variables relative to the variability of fundamentals that seem to characterize stock market crashes, religious differences, the Great Depression, wildly different crime rates, and the Hula Hoop.
Everyone knows that economists have always studied prices, trade, markets, and money. Not everyone knows that they are now also researching topics like marriage, fertility, religion, politics, fads, crime, and punishment. These areas might seem intrinsically non-economic, and so inaccessible to economists. They are part of the field, however, when we have a broad and complete understanding of what economics is.
Contemporary economists believe that economics is not defined by its subject matter but by its method. Economists try to understand and explain the world by assuming that the phenomena they observe are the outcomes of people's purposeful decisions. Individuals try to achieve their objectives, given their limitations — limited time, money, and energy — that is to say, they optimize. The interactions of individuals will determine aggregate social outcomes — that is, market equilibrium.
This broader approach needs a more comprehensive definition of prices, goods, and markets. Markets are places where goods are exchanged and prices for those goods are paid. For economists, goods are just things we want to obtain. They can be resources like oil, manufactures like cars, or intangibles, such as esteem of one's colleagues, peaceful relations between countries, or a quiet evening at home. Some goods cannot be “purchased” only with money.
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