ABSTRACT
In this chapter, we develop at length three central elements of the institutional approach. The first is the notion of institutions, the so-called rules of the game that individuals must abide by in real life. Institutions govern economic activity and are themselves influenced by changes in economic conditions. However, they tend to evolve slowly because they are subject to path dependence. Transaction costs provide a crucial caveat to unrestrained use of markets to allocate resources, with implications for both efficiency and equity. As the famous Coase Theorem states, when transaction costs are high, market outcomes may not be efficient and who bears legal liability for costs inflicted on others matters a great deal, both for efficiency and equity. The chapter concludes with a discussion of property rights, another foundational concept in institutional economics. Within the context of property rights, the discussion establishes three important factors that determine the magnitude of transaction costs: number of affected parties, asymmetric information, and difficulties in property rights enforcement.
