Institutional and Behavioral Economics

1. Institutional and Behavioral Economics Peter Boettke Econ 881/Spring 2005 25 April

2. Another Look at Economics Narrowing of economics from classical political economy to mathematical formalism --- 1940-1970. Broadening of economics from mathematical formalism to post-classical political economy – 1990---

3. Institutions as Constraints • Property Rights • Control Rights • Cash Flow Rights • Transaction Costs • Information • contracting

4. Choice, Constraints, and Predictable Behavior All other goods As the relative price of candy bars falls, the budget constraint will rotate and the utility maximizing position will change. Utility Candy Bars Q2 Q1

5. Choice, Constraints and Predictable Behavior in Economic History • Institutions work their impact through changes in the relative price of a particular behavior and then lead to changes in the general pattern of behavior • Plague’s impact on the relative price of labor and the rise of free labor • Women entering the work force after WWII and the change in workplace norms, etc.

6. What Exactly Are Institutions? • Rules of the Game • Formal • Informal • Enforcement of the Rules • Contractual monitoring • Third-party enforcement • Self-policing through norms and conventions

7. From Constraints to Frames of Reference • North’s change of perspective • Institutions are important because they structure the incentives that are in operation in any society • E.g., Marginal Revolution cite to the FT article on Levitt • Saying that people respond to incentives doesn’t say anything until you can address how individuals represent those incentives in their own mind • E.g., meanings that individuals attribute to belief systems

8. Cognitive Dimension in Institutional Analysis • Economizers on information processessing --- rules of thumb • H. Simon and satisficing • Predictability in a world of uncertainty • Uncertainty of the world is minimized so that reasonable action can be predicted • Heiner on behavior rules, and Rizzo on law • Embodiment of ideology • Belief systems • Denzau and North • The move from constraint to inside the utility curve

9. Cognition, Economy and Society • The contributions of Timur Kuran • Private Truths and Public Lies --- the dilemma of social action • Homo-economicus • Max utility subject to constraints • Homo-sociologicus • Max reputation with peers • Homo-psychologicus • Max self-satisfaction with choices • The Contributions of Mark Granovetter • Embedded nature of individual action and market exchange • Markets are omnipresent but come in a variety of forms

10. Vernon Smith and the economics as an experimental science • Efficiency • Model of perfect and imperfect competition • Market failure theory • Cooperation • Das Adam Smith problem • Prisoners’ Dilemma

11. Where Do Institutions and Cognition Fit In Austrian Economics? • The point to stress is that institutions and cognition permeate the school of thought from Menger to today • Menger – designed and undesigned institutions • Bohm-Bawerk – applied microeconomics • Mises – institutional prerequisites of monetary calculation • Hayek – spontaneous order and the legal/political framework of a liberal order • The sensory order • Rothbard – the institutional framework of libertarian society • Kirzner – channeling entrepreneurship

12. Conclusion • The hour-glass metaphor is highlighted by the changing status of institutions in economic analysis • Bator – institutionally antiseptic • Hayek, Buchanan, Coase, North, Smith, Shleifer, Glaeser, Acemoglu, etc. • The mind is the filter through which all human action takes place • Interpretation, judgment, action • Imperfection in our knowledge • Cognition, Economy and Society • Broadening economic science to accommodate a changing intellectual universe • Boulding --- there is no such thing as economic science only social science applied to economic questions