You may not have realised, but this week, you have seen economic theory in action at a pure level.
At last, the US and China have signed a deal to slow the world’s climate change crisis.
As the planet’s largest polluters, both countries had to sign, but one would not agree without the other taking the same action because governments feared their industries spewing out clouds of smoke and gases would be harmed.
That’s where the Nash Equilibrium came in.
John Nash was awarded a Nobel Prize in 1994 for devising his theory.
How the Nash Equilibrium works
In simple terms, he explained how individuals and groups come to decisions.
The example put forward is the police interrogation of two murder suspects.
If they both admit the killing, they both face a long imprisonment.
If neither admits, they get off on a minor charge.
But if one confesses and the other does not, the prisoner who makes the admission is freed and the other faces life imprisonment.
The theory goes that not confessing is best for the group, but the individual cannot rely on the other taking the deal to get off, leaving the other to face a life in jail.
Economics and the Kyoto Protocol
If neither ratified the treaty, life goes on.
If one ratified the treaty and the other didn’t, the ratifier would face a disadvantage because they would have to spend billions reducing harmful emissions while the other carried on polluting as before and benefitted from cheaper production costs.
If they both ratified the treaty, they both face bills of billions but their industrial output remains on the same footing.
The best decision for the world was to ratify the treaty, but one government could not rely on the other to do the same, so until now the individual decision was not to do the deal.
The treaty still has a long way to go as eight of the G20 most industrialised nations have yet to announce they will sign, but now the US and China can both bring enormous political pressure to bear on them.