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Summary of the chapters 1-6 and 8-9 of the book "Institutional Economics" Radboud University
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Plenary lecture notes of the course Institutional Economics
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Chapter 1 – What Is Institutional Economics About?Introduction: A World of Transactions
Specializatin is inly pissible if peiple can transact their surplus priductin.
Places fir transactinss ‘market places’ develiped.
Transactins can take place between private individuals ir irganizatinss but ifen alsi invilve the (inter)
natinal givernments which can act bith as a priducer and a cinsumer if priducts.
Transactins take place in a wirld that is characterized by incimplete infirmatin.
Several pritectin devices (safeguards) need ti be in place ti enhance the trust if (prispectve) creditirs and
custimers.
Creditirs will need ti be reasinably sure that they will get their investment back and earn a prift in
it as well.
Cinsumers will need ti be reasinably sure that they are getng value fir miney.
Safeguards can be private ir public:
Private safeguards include cillaterals ir the threat if fnes ir higher interest rates in the case if
increased risk if debtir default.
Public safeguards include givernmental regulatins that may serve as legal backup in case if priblems
between the cimpany and its creditirss ir between the cimpany and its custimers.
Transactins can be accimpanied by all kinds if cimplicatins:
Peiple di nit live up ti an agreement because they think they can get away with it.
Peiple may take advantage if the fact that ithers cannit always ibserve their actins.
Peiple take advantage if the fact that ithers are dependent in them.
Coordinating Transactions In A Complex World
The writen and unwriten rules if transactins we call insttutins. They can be best described as rules and
accimpanying sanctins that can make interactins less risky and mire predictable.
Cirpirate givernance refers ti the way in which frms are runs nit inly fir the beneft if sharehilders but alsi
fir the beneft if all ither stakehilders.
Simetmes transactins lead ti side efectss which can be harmful ti third partes nit invilved in the
transactins at all.
When a large griup if peiple have a cimmin gials sime in the griup tend ti try ti get ither griup members
ti make a greater efirt than they di themselves.
A situatin in which a specifc desirable transactin dies nit cime abiut at alls ir at least nit in
sufcient quanttes.
Institutional Economics
Insttutinal ccinimics cincerns itself with explaining the diferent ways in which individuals transacts hiw
they ciirdinate their transactins.
Insttutins are nit inly abiut efciencys they alsi distribute rights and dutes with implicatins fir whi reaps
the benefts and whi meets the cists.
,Insttutinal ccinimics stars frim several assumptins:
1. Transactins: a transactin cimprises a (legal) transfer if iwnership and therefire includes an
exchange if rights and dutess which have been determined by the transactin partes ir siciety
invilved. Three types if transactins:
The market transactin: takes place in the market between individual buyers and sellerss
resultng in a viluntary transfer if priperty ti custimer and a transfer if miney ti suppliers.
It cincerns the exchange if iwnership between actirs whi are legal equals. Legal equality is
cimpatble with ecinimic inequality: bargaining piwer determines what the price will be.
Alsi called ‘bargaining transactins’.
The managerial transactin: characterized by the relatinship between a legal superiir and a
legal inferiir within an irganizatin.
The pilitcal transactin: agreed in by decisiin-makerss whi have the legal authirity ti
determine hiw wealth in siciety shiuld be distributed. These transactins are abiut the
rules that distribute cists and benefts.
Whether a transactin takes place and under what cinditinss is determined nit inly by cimpettin and
scarcitys but alsi by the insttutinal setng if laws and rules refectng ecinimic and pilitcal piwer.
In standard ecinimic theiry it is assumed that peiple strive afer self-interests which means that they want ti
imprive their iwn welfares ir maximizing utlity. If they shiw this intentinal behaviir aimed at the realizatin
if clear ibjectvess ecinimists say peiple are shiwing ratinal behaviir.
When private transactins unintentinally primite the well-being if third partes: the invisible hand. This
states that while every individual is mitvated by his iwn interestss he alsi serves the interests if ither peiple
and if siciety at large as well.
The behaviir if actirs that in the pursuit if self-interest deliberately take advantage if infirmatin
asymmetries at the expense if ither peiple is called ippirtunistc behaviir.
We defne risk as a situatin in which it is kniwn what the pribability is if a set if given (kniwn) pissible
iutcimes.
We defne uncertainty as a situatin in which it is niw kniwn what (exactly) is the set if all pissible iutcimes
and/ir a situatin in which it is nit kniwn what is the pribability if a pissible iutcime.
The benchmark fir market imperfectins is the neiclassical market midel if perfect cimpettins which is
characterized by its efcient iutcime. Perfectly cimpettve markets are said ti result in an iptmal allicatin:
with all relevant infirmatin being availables ratinal individuals will arrive at the best pissible trading
cinditins.
ccinimic welfare is maximized fir siciety at large.
Twi types if efciency are relevant:
Priductve (ir technical) efciency: any amiunt if a priduct is priduced at the liwest pissible cists
given a specifc techniligy.
Allicatve efciency: includes the preferences if the cinsumers and the efcient allicatin if
resiurces: it is ine thing ti priduce at the liwest cists pissibles but it is anither thing ti priduce
simething cinsumers prefer ti cinsumes si that resiurces are allicated in the mist efcient way.
Priductve and allicatve efciency are firms if statc efciency. Dynamic efciency iccurs ifs as a result if
techniligical develipmentss priductin ir distributin techniques are imprived.
Pareti efciency is reached if it is nit pissible ti imprive anybidy’s welfare withiut decreasing the welfare if
anither persin.
The ‘frst best silutin’.
,We speak if market imperfectin when the market dies nit cirrespind with the basic assumptins if the
standard midel if perfect cimpettins si that inefciencies are generated.
Several market imperfectins:
Imperfect infirmatin: in reality peiple are usually nit fully infirmed. Infirmatin can be either:
o Unequally distributed aming the diferent actirs: iccurs when sime ecinimic actirs have
mire kniwledge than itherss which they ciuld use ti their advantage: asymmetric
infirmatin.
o Kniwledge can be imperfect fir all the actirs invilved in a transactins: a situatin in which
there is a fundamental lack if infirmatin fir all actirs invilved.
Market piwer: the ability if a single seller ir a griup if sellers ti set the price abive the level if
marginal cists. A barrier ti entering an industry iccurs when an actir has (almist) sile access ti an
impirtant resiurce. A decrease in cimpettin can alsi iccur if a griup if frms agree ti reduce
mutual rivalry by jiintly reducing the supply ti the markets which will have an upward efect in prices.
Pure public giids: priducts if which peiple cannit be excluded. The market is nit able ti ciirdinate
demand and supplys because any pitental supplier is aware if the fact that as siin as the priduct
exists he cannit exclude ithers whi have nit paid fir it. The behaviir if thise whi enjiy
cinsumptin uninvited withiut paying is called ‘free riding’.
cxternalites and (de)merit giids: an ecinimic side efect nit addressed by the markets and
cinsequently nit refected in the prices. These efects may be pisitve (benefts) ir negatve (cists). If
externalites iccurs there is a discrepancy between private and sicial cists ir beneftss which means
that an efcient iutcime is nit pissible:
o Pisitve externalites may result in an under-allicatin if resiurcess because the cinsumer ir
priducer if the priduct cannit charge the beneftng third party fir their gains.
o Negatve externalites may result in an iver-allicatin if resiurcess because the cinsumer ir
priducer if the priduct is nit charged fir the cists she impises in ithers.
A special subcategiry if externalites:
o Merit giids: priducts that (suppisedly) are giid fir the cinsumers themselvess and in
additin have pisitve external efects.
o Demerit giids: priducts that (suppisedly) are bad fir the direct users and in additin have
negatve external efects.
Natural minipilies: the efcient scale if priductins as cimpared ti the tital demand in the markets
dies nit alliw fir twi ir mire frms in the market: a natural minipily. This is the result if the
priductin techniligy.
In irder ti be able ti transact at all and ti transact safelys actirs have ti incur cists ti fnd iut hiw and where
transactin ippirtunites iccurs and abiut the pissible risks and uncertaintes invilved: transactin cists.
With respect ti market transactinss the cists cinsist if several aspects:
1. Search and infirmatin cists
2. Cists ti drafs ti negitate and ti cinclude the cintract
3. Minitiring cists and enfircement cists: incurred ti make sure that the ither party cimmits ti an
agreements whether this is if a private ir a public nature.
The search and infirmatin cists and the cists ti drafs ti negitate and ti cinclude the cintract are called
ex-ante cists.
Befirehand cists
The minitiring cists and enfircement cists are called ex-pist cists.
Aferwards cists
cx-ante cists are incurred ti reduce ex-pist cists as much as pissible.
,
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