Institutions and Economic Interactions

Institutions are a set of written rules only.

Employers have bargaining power over workers only when there is a surplus of labor.

Monopolists have no power over consumers in a free market economy.

Institutions exist to promote coercive exchange and limit individual freedom.

The outcome of an economic interaction is always an optimal allocation.

An allocation is considered Pareto efficient if it makes at least one person worse off and no person better off.

Pareto efficiency is a concept that measures the profitability of a business venture.

Vilfredo Pareto was an economist who only focused on the concept of fairness in economics.

A Pareto improvement occurs when a change from an initial allocation of goods makes at least one person worse off and nobody else better off.

Poverty is considered an efficient allocation in economics.

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.

Understanding institutions and their impact on economic interactions, including bargaining power and distribution of economic rents. Learn how property owners set the terms of exchange and bargain with multiple workers.