, Lecture 1
Introduction to Institutional Economics
Why institutional Economics?
* To complement to neoclassical economics and reduce failures of neoclassical economics
* Methodological individualism and reductionism => we look at individuals and than
aggregates
* Exogenous preferences => Individual preferences are given, doesn’t change
* Instrumental Rationality => Perfect rationality, all behave in certain way, maximizing utility!
* Perfect information => To make this perfect cost/bene t analysis
Perception of institutions in neoclassical economics:
* Static equilibrium, institutions not needed/external to economic system
Neoclassical Economics:
* Actors are hyper rational
* Markets always exist & never fail
* Prices re ect only relevant information (no transaction costs)
* Individuals try to maximize under certain constraints
* Everything will be sorted out by the market
* Everything besides markets are irrelevant!
* Standard Macro: investment > capital accumulation > productivity > growth + development
* BUT… countries have di erent developments and growth
* So, neoclassical economics not enough to understand complex reality…
Institutional Economics: Context matters! To understand complexity of real-life exchange
* In reality …
* Economic actors are embedded in particular institutional environments
* Not perfectly rational
* Free markets are far from being perfect
* Not fully rational => Bounded rationality
* Not all prices re ect only relevant information, also Transaction Costs
* Developing and changing world, not just static
* It is about social relations between individuals with di erent preferences/values/interest …
* Markets cannot manage everything, we need governance of exchanges and thus institutions
So, what are institutions?
* Institutions are Systems of man-made rules that structure behavior and social interaction…
* All banks, government, rms, university, rules and laws …
* As North says… ‘The Rules of The Game’
* Institutions are social structures enabling meaningful social interaction
* Institutions act as incentives structure of a society
* Institutions are shaping human constraints and structure human interactions !
* There are Political + Economic + Value institutions
Formal Institutions:
* Public rules of behavior that …
* Are designed by a public authority with legislative power
* Are enforced by a public authority with executive power
* Are a judiciary power that has the right and power to penalize an individual or organization for
breaking the rule
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