Summary Institutional Economics
Lecture 1 Introduction
What is institutional economics?
Institutional economics (IE) (specifically new institutional economics) = an integration of economic
theories of organizations, information, property rights and transaction costs.
Institutional economics shows why and how institutions matter but is not about institutions strictly
Why institutional economics?
• How people / actors behave in standard model
- Utility maximization under constraints
• Three components
1. Preferences & utility function (U)
2. Constraints (budget) (C)
3. (Relative) prices (P)
• Behavior B = MaxUC,P
Institutional economics (IE)
• Economic actors are embedded in particular
institutional environments
• What do institutions do? Govern (economic)
exchange
– Economic transactions: Albert Heijn
• Non-economic transactions: Dowry, bride price
• Why do we need governance of economic exchange?
– Exchange is not easy or frictionless
Transaction costs (TCs) (language is also a transaction cost)
What are institutions? Definitions - - >
1. “Rules of the game” (Douglass North) rules that provide how we need to live/behave
2. Social structures enabling meaningful social interaction
– Notably economic exchange
• Reduce so-called transaction costs (TCs)
3. Act as incentive structure of a society
– What type of behavior is “profitable”?
Transactions (broadly defined) as key unit of analysis
• Transactions matter!
– Exchange specialization welfare
• Division of labor / Adam Smith’s pin factory
• Under what circumstances do certain transactions come about?
– Some goods easily transacted
• Oil, corn
– Some goods never transacted
• Organs
– Some goods never produced
• Public goods
,Study of transaction costs (TCs)
• TCs↑ # transactions↓
• Welfare↓
• TCs as dependent variable (DV)
– Why / when TCs are high or low
• TCs as independent variable (IV)
– How TCs affect various forms of (economic) behavior and outcomes
• Individuals, firms & societies as a whole
• Comparative perspective
More on TCs as independent variable
• Level effects vs. probability effects
– Macro focus vs. micro focus
• Macro implications of TCs
– E.g., levels of economic performance of countries
• Micro implications of TCs
– TCs affect chosen modes of governance of exchange
• E.g., governance mode X more/less likely when TCs are high
– Governance mode Y more/less likely when TCs are low
• Logical question: How nature of transactions affects TCs?
How nature of transactions affects likelihood of adoption of particular
governance modes
Neoclassical economics (NE)
• Actors are hyperrational
• Markets always exist & never fail
– Pareto optimal
• Prices reflect only relevant information
– Identity of buyer / seller immaterial
– No transaction costs
• IE adds realism
– IE can even explain absence of real-world phenomena
• Markets in / existence of certain goods
• Deviations from NE assumptions have vital welfare implications
Summary of today
• Economics is about the optimal allocation of scarce resources given these resources’
alternative uses
• Optimal allocation requires exchange
• Exchange is not frictionless
• From preferences, constraints and prices to actual real-world exchange
– Why? Because X. Why x? Because Y? Why Y?
NE is the adult
IE is the child
,Lecture 2 Property rights
Recap of Lecture 1
• Profiting from specialization requires exchange
• Neoclassical economics (NE)
– Exchange always happens and is frictionless
• Institutional economics (IE)
– Transactions need to be studied
• IE adds realism
– Deviations from NE assumptions have vital welfare implications
Property rights theory
2.1 classic PRT
Classic definition of property rights (PRs):
"The right of individuals to use resources… supported by the force of etiquette, social custom,
ostracism, and formal legal rules enacted by the states' power of violence or punishment" (Alchian
1965)
You own a good if all these 3 rights belong to you:
1. Right to use good
2. Right to earn income from good
3. Right to transfer good to others
Tangible products have no problem with exchange or transfers.
Non-tangible than it is really complex, knowledge for example.
- Patents
- Copyrights
- Right of portrayal
Unpaid invoices incasso agency is buying the right to collect on these unpaid invoices.
Leaseback sale-and-leaseback): selling an asset and leasing it back for the long term
o Philips leasebacked its patents to/from Rabobank in the early 1990s
Legal claims (US)
o Rights to sue tobacco industry
NOT allowed to transfer organs or children.
As soon as there is ownership, there are conflicts.
, 2.2 Difficulty establishing property rights
See the case with hunting the fox in the powerpoint
we don’t define property by effort
How to protect property rights?
o Not owning anything
o Invest in protection
Physical resources such as fences
Own time
o Time not spent on productive activities trade off
o Institutionalized protection of property rights
Third-party authority with right to use violence = state / government
o Trust / trustworthiness (culture, social norms)
Dogs and modern society train dogs to protect property
Property’s not always simple to protect:
• Protection of non-tangible assets?
– Physical resources such as fences
– Own time
– Often non-rivalrous
• A chair = rivalrous ; Knowledge = non-rivalrous
• Excludability: Possibility of preventing non-owners from using a good
– Parks, natural resources
• Non-excludable & rivalrous = common-pool resource (anything that has to do with the environment)
• Non-excludable & non-rivalrous = public good
Four basic types of ownership:
1. Free use / access
– Clear property rights do not exist
2. Private property
– Individual or organization has right to use, earn income and transfer
3. State or government property
– State or government has right to use, earn income and transfer
4. Common property
– Group composed of individuals has right to use, earn income and transfer
It is easier to establish ownership of tangibles than of intangibles.
AGREE OR DISAGREE?
Agree I think.
Lecture 1 Introduction
What is institutional economics?
Institutional economics (IE) (specifically new institutional economics) = an integration of economic
theories of organizations, information, property rights and transaction costs.
Institutional economics shows why and how institutions matter but is not about institutions strictly
Why institutional economics?
• How people / actors behave in standard model
- Utility maximization under constraints
• Three components
1. Preferences & utility function (U)
2. Constraints (budget) (C)
3. (Relative) prices (P)
• Behavior B = MaxUC,P
Institutional economics (IE)
• Economic actors are embedded in particular
institutional environments
• What do institutions do? Govern (economic)
exchange
– Economic transactions: Albert Heijn
• Non-economic transactions: Dowry, bride price
• Why do we need governance of economic exchange?
– Exchange is not easy or frictionless
Transaction costs (TCs) (language is also a transaction cost)
What are institutions? Definitions - - >
1. “Rules of the game” (Douglass North) rules that provide how we need to live/behave
2. Social structures enabling meaningful social interaction
– Notably economic exchange
• Reduce so-called transaction costs (TCs)
3. Act as incentive structure of a society
– What type of behavior is “profitable”?
Transactions (broadly defined) as key unit of analysis
• Transactions matter!
– Exchange specialization welfare
• Division of labor / Adam Smith’s pin factory
• Under what circumstances do certain transactions come about?
– Some goods easily transacted
• Oil, corn
– Some goods never transacted
• Organs
– Some goods never produced
• Public goods
,Study of transaction costs (TCs)
• TCs↑ # transactions↓
• Welfare↓
• TCs as dependent variable (DV)
– Why / when TCs are high or low
• TCs as independent variable (IV)
– How TCs affect various forms of (economic) behavior and outcomes
• Individuals, firms & societies as a whole
• Comparative perspective
More on TCs as independent variable
• Level effects vs. probability effects
– Macro focus vs. micro focus
• Macro implications of TCs
– E.g., levels of economic performance of countries
• Micro implications of TCs
– TCs affect chosen modes of governance of exchange
• E.g., governance mode X more/less likely when TCs are high
– Governance mode Y more/less likely when TCs are low
• Logical question: How nature of transactions affects TCs?
How nature of transactions affects likelihood of adoption of particular
governance modes
Neoclassical economics (NE)
• Actors are hyperrational
• Markets always exist & never fail
– Pareto optimal
• Prices reflect only relevant information
– Identity of buyer / seller immaterial
– No transaction costs
• IE adds realism
– IE can even explain absence of real-world phenomena
• Markets in / existence of certain goods
• Deviations from NE assumptions have vital welfare implications
Summary of today
• Economics is about the optimal allocation of scarce resources given these resources’
alternative uses
• Optimal allocation requires exchange
• Exchange is not frictionless
• From preferences, constraints and prices to actual real-world exchange
– Why? Because X. Why x? Because Y? Why Y?
NE is the adult
IE is the child
,Lecture 2 Property rights
Recap of Lecture 1
• Profiting from specialization requires exchange
• Neoclassical economics (NE)
– Exchange always happens and is frictionless
• Institutional economics (IE)
– Transactions need to be studied
• IE adds realism
– Deviations from NE assumptions have vital welfare implications
Property rights theory
2.1 classic PRT
Classic definition of property rights (PRs):
"The right of individuals to use resources… supported by the force of etiquette, social custom,
ostracism, and formal legal rules enacted by the states' power of violence or punishment" (Alchian
1965)
You own a good if all these 3 rights belong to you:
1. Right to use good
2. Right to earn income from good
3. Right to transfer good to others
Tangible products have no problem with exchange or transfers.
Non-tangible than it is really complex, knowledge for example.
- Patents
- Copyrights
- Right of portrayal
Unpaid invoices incasso agency is buying the right to collect on these unpaid invoices.
Leaseback sale-and-leaseback): selling an asset and leasing it back for the long term
o Philips leasebacked its patents to/from Rabobank in the early 1990s
Legal claims (US)
o Rights to sue tobacco industry
NOT allowed to transfer organs or children.
As soon as there is ownership, there are conflicts.
, 2.2 Difficulty establishing property rights
See the case with hunting the fox in the powerpoint
we don’t define property by effort
How to protect property rights?
o Not owning anything
o Invest in protection
Physical resources such as fences
Own time
o Time not spent on productive activities trade off
o Institutionalized protection of property rights
Third-party authority with right to use violence = state / government
o Trust / trustworthiness (culture, social norms)
Dogs and modern society train dogs to protect property
Property’s not always simple to protect:
• Protection of non-tangible assets?
– Physical resources such as fences
– Own time
– Often non-rivalrous
• A chair = rivalrous ; Knowledge = non-rivalrous
• Excludability: Possibility of preventing non-owners from using a good
– Parks, natural resources
• Non-excludable & rivalrous = common-pool resource (anything that has to do with the environment)
• Non-excludable & non-rivalrous = public good
Four basic types of ownership:
1. Free use / access
– Clear property rights do not exist
2. Private property
– Individual or organization has right to use, earn income and transfer
3. State or government property
– State or government has right to use, earn income and transfer
4. Common property
– Group composed of individuals has right to use, earn income and transfer
It is easier to establish ownership of tangibles than of intangibles.
AGREE OR DISAGREE?
Agree I think.
