Lin-Az Listening Exam 03 – Level B2
Jan/2015
Prof. Peter Cullen
Text
The cost of making transactions reflects the overall complexity of formal and informal
institutions that make up an economy, or, on an even greater scale, a society. This overall
structure ultimately shapes the cost of transacting at the individual contract level, and
when economists talk about efficient markets, they have simply taken for granted an
elaborate framework of constraints. The cost of capital, for example, was in part
determined by an elaborate structure of financial intermediaries whose interconnections
among consumer credit and mortgage markets, stock markets and bond markets were
constrained by a complex structure of governmental constraints and regulatory agencies,
from (in the United States) the Federal Reserve System to state laws and regulatory
agencies dealing with everything from branch banking to interest rate ceilings. Moreover,
behind the supply of and demand for capital are still other institutions and organizations
such as title insurance and credit rating agencies. Probing still more deeply into the
institutional structure reveals political institutions that define formal constraints. The
interconnections between the political and economic institutions and organization is
apparent in governmental committees that are concerned with the capital market and a
host of lobbying organizations reflecting interested (and organized) groups in the capital
market. The web of interconnections extends to the executive branch of government as
well as to specific regulatory agencies. All of this, of course, has been fuel for the new
political economy in its attempt to spell out and provide an artificial framework for the
institutional structures of the legislature and other branches of government in the US.
When we compare the cost of transacting in a “so called” Third World country with that in
an advanced industrial economy, the costs per exchange in the former are much greater –
sometimes no exchange occurs because costs are too high. The institutional structure in
the Third World lacks the formal structure (and enforcement) that underlies efficient
markets. However, frequently underground economies in Third World countries attempt to
provide a structure for exchange. Such structure comes at high costs, however, because
the lack of formal property right insurances restricts activity to personalized exchange
systems that can provide self-enforcing types of contracts. As well as high transaction
costs, the institutional framework tends to perpetuate under-development.
Companies come into existence to take advantage of profitable opportunities which will be
defined by the existing set of constraints. With insecure property rights, poorly enforced
laws, barriers to entry and monopolistic restrictions, the profit-maximizing firms will tend to
have short-time horizons and little fixed capital, and will tend to be small scale. The most
profitable businesses may be in trade, redistributive activities or the black market. Large
firms with substantial fixed capital will exist only under the umbrella of government
protection – hardly conducive to production efficiency.
1
Lin-Az Listening Exam 03 – Level B2
Jan/2015
Prof. Peter Cullen
___________________________________________
Name, Date, and Registration Number
Questions: Answer all 5 of the following questions. SIMPLE AND CORRECT IS
BETTER THAN COMPLICATED AND WRONG. USE SHORT PHRASES AND
SENTENCES.
This exam requires interpretation and analysis. It is designed to test your ability to
apply what you hear to possible discussion areas.
1. What shapes transaction costs at the level of the individual contract?
2. What influenced the cost of capital? (assuming the United States as the author’s
point of reference)
3. How is the government involved in the complex set of relationships that create the
cost of capital?
4. Are transaction costs higher in the so-called Third World countries or in
industrialized countries?
5. What reasons can you give for your answer to question 4?
2
Lin-Az Listening Exam 03 – Level B2
Jan/2015
Answer Sheet
Prof. Peter Cullen
1. What shapes transaction costs at the level of the individual contract?
The cost of making transactions reflects the overall complexity of formal and informal
institutions that make up an economy, or, on an even greater scale, a society. This
overall structure ultimately shapes the cost of transacting at the individual contract level
2. What influenced the cost of capital? (assuming the United States as the author’s
point of reference)
The cost of capital, for example, was in part determined by an elaborate structure of
financial intermediaries whose interconnections among consumer credit and mortgage
markets, stock markets and bond markets were constrained by a complex structure of
governmental constraints and regulatory agencies
3. How is the government involved in the complex set of relationships that create the
cost of capital?
The interconnections between the political and economic institutions and organization is
apparent in governmental committees that are concerned with the capital market and a
host of lobbying organizations reflecting interested (and organized) groups in the capital
market. The web of interconnections extends to the executive branch of government as
well as to specific regulatory agencies. All of this, of course, has been fuel for the new
political economy in its attempt to spell out and provide an artificial framework for the
institutional structures of the legislature and other branches of government in the US.
4. Are transaction costs higher in the so-called Third World countries or in
industrialized countries?
Yes
5. What reasons can you give for your answer to question 4?
The institutional structure in the Third World lacks the formal structure (and enforcement)
that underlies efficient markets. However, frequently underground economies in Third
World countries attempt to provide a structure for exchange. Such structure comes at high
costs, however, because the lack of formal property right insurances restricts activity to
personalized exchange systems that can provide self-enforcing types of contracts. As well
as high transaction costs, the institutional framework tends to perpetuate underdevelopment.
3