INTRODUCTION TO INSTITUTIONAL ECONOMICS

1. The Big Picture 

Framework for analysis of connection between choice-coordinating institutions

and the performance of the economy. Alternatives range from the market with

alternative property and contract rules to government enterprise and commands.

Role of formal and informal institutions.

Property as Power an as Econo!i"ingInstitutions as constraints and as

enabling. How paradigms aect what you see! what you "uestion.

 #ggertsson! $hrainn! #conomic %ehavior and Institutions. &1''()! *h. 1. Also see

Foreword and +reface.

,. Institutions # Organi"ations  rgani/ations &0rms)! Institutions and

%oundaries

b. imon! H. rgani/ations and 2arkets! 3. #con. +erspectives! 45,4-66 &1''1).

&Available from 3$R)

c. Hodgson! 7. #volutionary 8 *ompetence-%ased $heories of the

Firm! Evolution and Institutions! &1''')! ,69-,94.

$% Institutiona& Change

a. :orth! ;. Institutions! Institutional *hange and #conomic +erformance! &1''()

b. %owles! *hs. 11-1< &optional! see study notes)

'% CAN (E PREDICT T)E CONSE*UENCES +PER,ORMANCE- O,

ALTERNATI.E INSTITUTIONS/

E0peri!enta& Econo!ics

.ernon S!ith won the :obel +ri/e for his work on e=perimental economics. In

his article! $heory! #=periment and #conomics! J. Of Economic Perspectives!

<&1)5 141->' &1'?') &3$R) he contrasts what can be learned in 0eld and

e=perimental tests@ n p. 146! he argues the advantage of e=periments over

0eld data. Are you convinced@

Institutions matter. 14> $his is the main message of these e=periments. $his

may e=plain why mith has attached the #conomic cience Association meetings

to those of the +ublic *hoice ociety.

mith suggests three parts to a theory so that it might be tested5 environment!

institution and behavior &14<). His conception of environment includes all agents

characteristics! and for him this is primarily preferences whose essence is

e=pressed in willingness to pay or accept. +references are 0=ed and not learned

in the conte=t of the game. ;oes this 0t what we know about how the brain

works@

 

His conception of institutions include the language of communications--e=amples

of language include bids! oers and acceptances. Institutional rules specify when

a communication is converted to a contract. &I dont think he is referring to the

amount of the bid itself which he categori/es as behavior.) Also included in his

category of institutions are the characteristics of the commodity! which he seems

to include implicitly &see below on H#* and HI*). $his seems a strange mi=ture--

are not institutions something that is a variable open to human choice while the

characteristics of a commodity are 0=ed by physics and biology@ He also includes

rules under which messages become contracts and thus allocations. If the legal

foundations of an economy were so simple we wouldnt have much to do. $he

order in which economic agents move sounds so innocent.

%ehavior is concerned with agent choices of messages or actions given the

agents characteristics &environment) and the practices &institutional rules)

relating such choices to allocations. He wants to test the assumptions of

ma=imi/ation of utility! risk aversion! and %ayesian learning &as opposed to

bounded rationality! gamblers! and selective perception in the face of cognitive

dissonance@).

mith categori/es behavior as the agentss choices of messages or action. $he

e=amples of utility ma=imi/ation and risk aversion make sense. %ut I do not

understand him when he illustrates behavior as including the transaction costs

of thinking! deciding! acting. 2akes sense if it refers to the acts of cognition.

$heories of behavior make predictions about messages &bids! oers)... 2aybe

he uses the term transaction costs "uite dierently than Billiamson or chmid.

He includes /ero transaction costs as part of behavior though this seems a part

of the environment-characteristics of the good rather than an attribute of people.

His classi0cation seems appropriate in the conte=t of observing that double

auctions come to e"uilibrium faster than ascending price auctions. He see that

bidders and sellers learn more about the others demand or supply schedules

faster with the double auction and in that sense transaction costs are less with

one institution rather than another. For mith! transaction cost and the institution

seem to be the same thing rather than one separable thing interacting with

another. Bhy is the conceptuali/ation of separability important@ If an institution

creates the cost! then change the institution and the cost is gone. %ut if the cost

is independent of the institution! then the institution may not abolish the cost!

but only change who bears it or who bears the conse"uences of the cost.

*onsider the cost of traders discovering the demand and supply schedules of the

other person. If these schedules were written on their foreheads the cost would

be cheap! but they are not. &It reminds me of the dierence between blood and

shirts--information on blood "uality is harder to determine than for shirts.) o the

information cost seems inherent in nature. Bhen this HI* situation is then

combined with dierent institutions such as ;utch or #nglish auctions we can

observe how "uickly both parties learn these schedules and reach a trading

agreement. mith observes that the type of auction makes a dierence.

 

ince time is money! a better institution is one that saves money by reducing a

cost. %oth parties may gain though one may gain more than another. A reduction

in transaction costs may be +areto-better! but one must be careful to assume

than all transaction cost is like friction and that all gain by its reduction.

He seems to assume here that all messages are bids &e=its) rather than voice.

Footnote < is worth studying carefully for how value is induced. $he subCect is

made to have a well ordered preference map &demand schedule)! whether that is

the way the person usually thinks or not. mith controls for commodity

characteristics by making the good featureless and abstract. miths induced

value approach means the game is for money only--there can be no attachment

to the commodity or any divergence between reservation and bid price.

#=perimental subCects are assigned to be buyers or sellers. #ach demander is

given a schedule indicating the redemption value of each unit ac"uired in a

market period. For e=ample! if the demander ac"uired one unit! the e=perimenter

would give the buyer .>(! .4( for the second unit! .6( for the third! etc. #ach

seller is charged for any units sold according to a schedule. e.g. the cost

schedule might be .,( for the 0rst unit! .6( for the second! and .>( for the third!

etc. o for instance! if at the end of the trading period! the buyer of one unit

could redeem it for .>( and be credited with the dierence between the

redemption value and what she paid! assume .64. $hus .>( - .64 D .14 net credit.

 $he net credit possibility provides the incentive to trade advantageously. $his is

the way that characteristics of the commodity are controlled. For this to work of

course! it is implied via the payo schedules that this is not a H#* good--you

cant get a payo without trading. Eike all auctions! it is assumed the goods

already e=ist. $he problem is not one of investment and decisions involving

immobile assets.

2uch of the e=perimental literature is guided by nothing more sophisticated

than the static theory that markets will clear. &144) Bhat does this mean when

we observe that a lot of markets do not clear &labor markets being an obvious

case at the moment)@

mith says most people dont have to calculate to act in a way consistent with

calculation. 2arket competition means that either &1) those who randomly fall

into the right behavior survive and others do not. &,) a few who do calculate

force the others to appro=imate their behavior. How s"uare this with Frank who

observes that people who are non-opportunistic &non-calculation of advantage)

are sought by business partners insuring their survival. How relate to Heiner who

suggests because of the *-; gap! the 0rm with the ma=imi/ation calculation may

actually make more mistakes@ How relate to fact that the people making

mistakes are part of the environment of the smart calculating 0rm and cause the

calculation to go wrong@ mith attacks haneman and netsch and their

observations of people regarding market clearing behavior as unfair.

#ven if mith is right on the producing 0rm side! there is nothing e"uivalent on

the part of consumers. *onsumers who choose fair producers! who try to Custify

sunk costs! and regard opportunity cost as dierent from out of pocket costs do

 

not perishG they Cust dont consume as many goods &even if they might have

more utility and wind up less often in mental hospitals).

ernon miths :obel +ri/e acceptance speech is *onstructivist 8 #cological

Rationality in #conomics! AER! '<&<)56>4!4(? &,((<).