Abstract
A central organizing principle in contemporary economic theory is the notion of equilibrium: all individuals make plans that are optimal, given beliefs that are mutually consistent. The equilibrium method is effective in generating sharp predictions, but it sidesteps important questions about how equilibrium can be attained, optimality assessed, and available alternatives enumerated. This chapter describes an alternative approach in which the process of adjustment is a central theme. Individuals adapt to changes in their environment by making incremental changes in their behavior. These changes alter the environment faced by others, which leads to further dynamic adjustments. Trajectories may eventually converge to an equilibrium, but this is not inevitable. Even when convergence does occur, it may be to one of several conceivable equilibria, so that the dynamics operate as an equilibrium selection device. These ideas are explored primarily through the example of homophily in social interactions, with other potential applications also briefly considered.
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