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Lecture 16 Understanding and Analyzing Institutions: Coordination and conflict.

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1 Lecture 16 Understanding and Analyzing Institutions: Coordination and conflict

2 Types of Institutions (Ellickson 1991)

3 Types of Institutions (Vatn 2005)

4 The Grammar of Institutions (Crawford and Ostrom 1995)

5 Institutions and problem situations Source: Vatn (2005, p. 83)

6 Coordination and Conflict - Game Theory Games (coordination vs. conflict, non-cooperative vs. cooperative) Player (individual and collective actors) Strategies (set of conditional actions) Payoffs (benefits and costs, individual vs. social) Rules (intended or unintended, imposed or negotiated)

7 Assumptions in Games Theory Player Results (Payoffs) Actions Rules Environment Third player (Referee)

8 Changing the terms Actors Allocation, Distribution Interactions Institutions Environment Third party (e.g. court)

9 Simple game theoretic modeling Two players A and B Each player has two strategies i and j The payoffs are a function of the interactions (combinations of strategies) AiBi, AiBj, AjBi,AjBj Each player chooses the strategy the maximizes her/his expected utility, max E(U (AiBi, AiBj, AjBi,AjBj)) Each player build expectations about the behavior of the other player, she/he assigns probabilities p and 1-p to the other players strategies, max U (pAiBi + (1-p) AiBj, pAjBi + (1-p)AjBj)

10 Actor constellations (Scharpf 2000) Cooperation vs. Conflict Pure coordination Pure conflict A B i j ij B ij

11 Analysis of strategies and equilibrium Each player builds expectations about the behavior of the other player and assigns probabilities p und 1-p to the strategies of the other player, max U (pAiBi + (1-p) AiBj, pAjBi + (1-p)AjBj) Each player choose the strategy that maximizes her/his utility, max U (AiBi, AiBj, AjBi,AjBj) Example: A: U A i(p3+(1-p)0), U A j(p0+(1-p)0) -> Strategy i B: U B i(p3+(1-p)0), U B j(p0+(1-p)0) -> Strategy i Nash-Equilibrium: where no player has anything to gain by changing only his or her own strategy. If each player has chosen a strategy and no player can benefit by changing his or her strategy while the other players keep theirs unchanged, then the current set of strategy choices and the corresponding payoffs constitute a Nash equilibrium. Social Optimum: Sum of the individual utilities U A +U B Coordination: Nash-Equilibrium is social optimum Conflict: no single social optimum in a zero-sum game

12 Prisoners Dilemma and Chicken Games (cooperation games) Prisoners Dilemma Chicken Game B ij B ij A i j

13 Analysis of strategies and equilibrium II Prisoners Dilemma (Assumption: p, 1-p = 0,5) A: U A i(0,5*2+0,5*0)=1, U A j(0,5*3+0,5*1)=2 -> Strategy j -> don’t pay B: U B i(0,5*2+0,5*0)=1, U B j(0,5*3+0,5*1)=2 -> Strategy j -> don’t deliver Nash-Equilibrium is not a social optimum, social Optimum is pay and deliver, trade (cooperation)

14 Institutions, Games and Enforcement Prisoners Dilemma Prisoners dilemma with sanctions s B ij B ij A i j

15 Institutions and Enforcement II Comply with the rules or not Sanction non-compliance or not C ij A i j l – loss from non-compliance sc – sanctioning costs f - fine

16 Rules or convention may also emerge spontaneously, example: At a crossroad two drivers may stop or continue to drive For each driver it is beneficial to continue to drive while the other stops The worst case is that both drivers continue and cause and accident A convention right before left of left before right may emerge spontaneously Emergence of Conventions - the Crossroad Game (evolutionary game theory

17 Vatn's Example: Housing Rules I Prefer Common Style Prefer Individual Style

18 Vatn's Example: Housing Rules II Prefer Common Style

19 Vatn's Example: Housing Rules III Prefer Common Style Prefer Individual style Side payments require: (1) accepted property rights and (2) transaction costs lower than 15 units.

20 Whose rights should be protected? Transaction costs lower than 15 units: protection of rights effect the wealth of actors Transaction costs higher than 15 units: protection affects the resource allocation and the wealth of actors

21 Main Positions within Institutional Economics

22 Political Environment Institutional Context Acteurs Orientations and capacities Action situa- tion Forms of inter- action Pro- blems Political decision Games real actors play Actors-oriented Institutionalism (Scharpf)

23 A Framework for Institutional Analysis (Ostrom 1998) Attributes of Physical World Attributes of Community Rules-in-use Action Arena Action Situations Actors Patterns of Interaction Outcomes Evaluative Criteria: Social Auditing Cost-Benefit Equity Environment

24 Case Study: Littering Increased fines to crack down on littering 01/07/2003 The fixed penalty fine for littering today increased from £25 to £50. The Executive announced the increase in fixed penalty fines on the 27 th of March. These new powers come into force today and fulfill the Partnership Agreement to increase and encourage enforcement of penalties for litter. Environment Minister Ross Finnie today joined Edinburgh City Council environmental wardens on patrol. The Minister said: "Too many communities throughout Scotland are blighted by litter and the environmental problems it causes. Edinburgh City Council and their team of wardens have done excellent work to crack down on this environmental menace. This work sets an example to many Local Authorities across Scotland. "The Scottish Executive is committed to tackling the scourge of littering. Through the consultation paper 'Putting Communities First' launched last Thursday we are looking to tighten enforcement of litter laws. "Littering is unnaceptable. Doubling the fixed penalty fine shows we are cracking down on this anti-social behaviour." The Environmental Protection Act 1990 provides a. that littering is an offence and b. powers to local authorities allowing them to issue notices offering the offender the opportunity of discharging any liability to conviction for the offence by payment of a fixed penalty. The Litter (Fixed Penalty) (Scotland) Order 2003 increases the fixed penalty fine for littering from £25 to £50 and came into effect on Tuesday, 1 July The Scottish Executive announced the intention to increase the fixed penalty fine for littering on March , following the review of litter and flytipping legislation. Increasing the level of fine to £50 matches the level already in place in England and Wales.

25 Littering Rules in Georgia, USA

26 Nanjing, China

27 Literature and Sources Fehr, E. and Gächter, S. (2000) Cooperation and Punishment in Public Goods Experiments. American Economic Review 90(4), Scharpf, Fritz (1998) Games Real Actors Play. Actor- centered Institutionalism in Policy Analysis. Ostrom, Elinor (2005). Understanding Institutional Diversity. Princeton: Princeton University Press. Institut f ü r Empirische Wirtschaftsforschung (

28 Lecture 3 Transactions and Transaction Costs

29 What is a Transaction? I (1) „A transaction occurs when a good or service is transferred across a technological separable interface. One stage of activity terminates and another begins.“ (Williamson 1985, p.1) A transaction is an elementary coordination problem connected with the question how to solve this problem institutionally (and technically) Example: Somebody wants to get a transfer of 1000 Euro. What’s the problem? How can it be solved?

30 (2) A transaction is the „alienation and acquisition between individuals of the rights of future ownership of physical things.“ (Commons 1935, S.58) A transaction is a transfer of property rights Example: Somebody acquires the right to get 1000 Euro transferred. What’s the problem? ÜHow do both perspectives differ? What is a Transaction? II

31 What is a transaction? III aiai a i+1 I1I1 I2I2 Technological - separable Interface Transfer Property Rights Over a good or service Goods or services Definition of Property Rights of I 1 over a i Definition of Property Rights of I 2 over a i+1 Source: Beckmann (2000)

32 Markets vs. Hierarchy I1I1 I2I2 I2I2 I2I2 I4I4 I3I3 I3I3 Flow of goods Money flow Market Hierarchy

33 Centralized vs. Decentralized Resource Management Source: JAHAN et al (undated)

34 Transactions Costs Costs of running the economic system (Arrow 1969) „Cost of establishing, using, maintaining and changing institutions...“ Richter und Furubotn 1996, S. 49 Resources spend on initiating, negotiating, safeguarding, monitoring, enforcing and adjusting transactions Utility losses due to imprecise arrangements, inefficient safeguarding, monitoring, enforcement or adjustment

35 Types of Transaction costs I Search and information costs –Cost of searching for suppliers, customers, products, technologies, etc. –Information about qualities, prices, etc. ÜFunction of the distribution of information and the information and communication technology Negotiation and decision making costs –Negotiation, balancing diverse interests –Decision making costs, time and resources spend on decision making, cost of wrong decisions (bounded rationality) ÜFunction of differences in preferences, number of people involved and the decision making rule

36 Types of Transaction costs II Monitoring- and Enforcement Costs –Costs of monitoring, identification of non-compliance with the rules –Costs of enforcement, sanctioning non-compliance ÜFunction of the measurability and verifiability of activities and the monitoring and enforcement technology Adjustment costs –Costs of adjusting the rules to changing environmental circumstances –Costs of maladaptation ÜFunction of the environmental uncertainty and the flexibility of rules

37 Categories of Transaction Costs I Sunk and running transaction costs –Sunk: lost inputs, no opportunity costs –Running: inputs for which opportunity costs exist Fixed und variable transaction costs –Fixed – not depending on the size and the frequency of transaction –Variable - depending on the size and the frequency of transaction Ex-ante and ex-post transaction costs –Ex-ante costs: before the contract has been made –Ex-post costs: after the contract has been made

38 Categories of Transaction Costs II Market transaction costs –Costs of market organization –Searching, preparation, agreement, supervision, monitoring, controlling, enforcement, adjustment Transaction costs in firms –Costs of firm organization –Instruction, controlling, enforcement, adjustment Political transaction costs –Costs of the establishment and maintenance of a political order –Decision making, implementation, administration, enforcement

39 Modeling effects of transaction costs I Market transaction costs II X - quantity P - price S – supply without TC D – demand without TC S+TC XX+X+ p p+p+ Source: Furubotn and Richter (2000) D-TC

40 Modeling effects of transaction costs II Transactions costs inside the firm Z - Input Y - Output Y =F(Z) Y =F + (Z) B A E F D 0 Source: Furubotn and Richter (2000)

41 Modeling Causes and Effects, Optimality I Transaction and production costs 0 Division of Labor MTC MPC MC MC-Marginal Costs MTC-Marginal Transaction Costs MPC-Marginal Production Costs

42 Modeling Causes and Effects, Optimality II Optimal monitoring frequency Monitoring frequency (MF) Costs Monitoring costs Utility losses MF*

43 Institutions and Enforcement II Comply with the rules or not Sanction non-compliance or not C ij A i j l – loss from non-compliance sc – sanctioning costs f - fine

44 Modeling Causes and Effects, Optimality III Optimal searching activities Search activities S Costs Search costs Utility loss S*

45 Modeling Causes and Effects, Optimality II Transaction costs and institutional choice I 1 and I 2 differ with regard to fix and variable transaction costs 0 TC Frequency I1I1 I2I2

46 Modeling Causes and Effects, Optimality II Transaction costs and institutional choice Alternatives differ with regard to fix and variable transaction costs and utility losses 0 TC UL Expected utility losses (UL) No sanctioning system Introduce sanctioning system

47 Emergence of hierarchical firms Team-Production number of communication channels N(N-1)/2 N-1 Peer GroupHierarchy

48 25. September 2006Volker Beckmann - Asia-Link RECREATE 48 Transactions costs of the internal organization of firms TC Number of worker Peer Group Hierarchy

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