7 - The logic of economic organization

Summary

Introduction

In Chapter 6, we studied the economics of organizational forms in the firm. The firm was broadly defined as a nexus of contracts, but the interlocking webs of contractual relations made it impractical to nail down a more precise definition. Our subject thus became the economics of contracts. In Chapter 7, we go beyond questions relating to the nature of the firm and apply transaction-costs analysis to various organizational forms and market practices. The coverage is not exhaustive. Rather it serves as an illustration of Neoinstitutional Economics in action. We hope to demonstrate, through our examples, that the relative economic advantage of alternative contractual forms is rooted in transaction costs and cannot be explained in terms of frictionless neoclassical economics.

The topic of endogenous social and political institutions is reserved for the fourth and last part of the book. In the present chapter, the community's legal framework and social conventions are taken as given, and in most cases the framework is Demsetz's laissez-faire economy: the neoclassical competitive market plus transaction costs.

In Section 7.2, we begin our exploration of market practices by looking at the problem of measuring the quality of goods and services. Various market arrangements are seen as ways of minimizing measuring costs and lowering the effective price to buyers. The examples are drawn mostly from the market for consumer goods, but the basic analysis applies to all types of exchange.