Institutions and Economic Interactions

Institutions and Power

• Institutions are written and unwritten rules governing interactions and distribution of economic rents.
• Institutions determine power, i.e., the ability of individuals to get what they want in interactions with others.
• Property owners may have bargaining power when they set terms, bargain with multiple workers, or impose costs on others.

Institutions and Distribution of Rents

• In capitalist systems, property can confer power, such as employers having power over workers.
• Historical examples: shifts in supply and demand for labor, emergence of trade unions, and right to vote increased wage earners' bargaining power.
• Monopolists can have power over consumers, as seen in the British East India Company's exclusive rights to import goods to Britain from India.

Evaluating Institutions and Outcomes

• The outcome of an economic interaction is an allocation, describing individual contributions, products, and distributions.
• Institutions are evaluated based on efficiency and fairness.

Evaluating Efficiency

• Efficiency in economics does not mean the most sensible or profitable way of doing something.
• An allocation is Pareto efficient if there is no alternative allocation that makes at least one person better off and no one worse off.
• Pareto inefficiency occurs when an allocation is not efficient.

Vilfredo Pareto

• Vilfredo Pareto (1848-1923) sought to make economics and sociology fact-based sciences.
• Pareto's law states that a small group of people always own most wealth (e.g., 80-20 or 90-20).
• Pareto argued that people fight over their share of wealth.