Prof. Phillip J. Bryson
Marriott School
Brigham Young University
Market in Istanbul, Turkey
 Markets
are
institutions of buying
and selling on the
basis of voluntary
exchange.
 Can
you draw one?
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2
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S
1
0
0
8
0
6
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4
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Q
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Supply shows what sellers wish to do, Demand shows what buyers
wish to do, and both express the freedom of economic agents to
pursue their own interests. Prices and quantities reflect social
forces and leave no need for government planning or intervention
accept where citizens vote their desires to limit certain markets,
such as vice markets. This is the portrait of a free society.
 Hierarchies
are
institutions
designed to
allocate resources
without the use of
markets.
 They use strict
lines of authority
Transactions and Efficiency
The fundamental unit of analysis is the
transaction.
 Routine transactions don’t require much
organization. (Where parties must bargain
particular terms, higher transactions costs are
incurred).
 In both markets and hierarchies, resource
allocation should be performed with little waste,
so efficiency is an important criterion of
success.
 What is the goal of markets and hierarchies?
The greatest possible happiness of the people.
(To maximize society’s “utility” or satisfaction.)

Why Efficiency is Important
 Consider
the economic notion of
efficiency. Usually, for a given collection
of resources, numerous efficient
allocations will be possible. (Efficiency
doesn’t require a unique outcome.)
 Alternative resource allocation activities
offer diverse outcomes. “Pareto
optimality” is achieved in the social
situation where, given some distribution
of incomes or resources, no individual
can be made better off without making
someone else worse off.
Economic Systems
 An
economic system, e.g., capitalist or
socialist, must allocate scarce resources
through markets or through a central
planning agency.



Who was the spiritual
father of this hostility?
Karl Marx.
Lenin’s .
Contrast to bargaining
mentality or to a western
sales mentality.
Who gains in the normal
transaction?

Do both gain, or is one
party always the sucker,
the exploited participant?
The Socialist Dilemma
The Dilemma is to achieve efficient allocation
without markets.
 All goods need to be produced at the lowest
possible cost,
 The right mix of outputs must be forthcoming
for the benefit of consumers,
 the right levels of savings and investment must
be provided, and, in general,

The Socialist Dilemma
there must be no way to increase consumer
satisfaction by any reallocation of society’s
resources.
 Computing an efficient allocation for a complex
modern economy is clearly not feasible.


Even with only two people, it may be impossible to
determine how to arrange their activities to help one
without hurting the other.
The fundamental planning problem: destroy
markets so the property and power (to set
prices) is taken away from the capitalists
 Insufficient information for planners to deal
with the tremendous complexity of the
economy. How get it? From enterprises.
 Principle/agent problems. Incentive
compatibility problems.
 Establish quotas: gross output target.
(Objective of enterprise: secure soft target.)

The Gross Output Target
 The
primary
objective: “bury”
the capitalists.
 Frenetic pursuit of
growth results in:
 No quality
dimension,
 No innovation,
 Environmental
degradation.
The Information Problem in Central Planning
Material Balances, the
committee approach to
allocation.
 Half the committee works
on sources, the other half on
distribution.
 Send letters to suppliers and
buyers for quantities.
 Make plan and inform
enterprises. Hear their
problems and revise.
 7-13 iterations should do.

The Information Solution
Input-Output Analysis.
Wassily Leontief (St.
Petersburg, Nobel 1973)
 In a matrix of inputs
(columns) and outputs (rows)
all industries are listed.
 Invert the matrix to solve for
precise planning quantities.
 But Leontief was promoting
bourgeois doctrine. Wait for
Kontorovich and linear
programming.

Planning’s failure to achieve consistency and
productive results led to private efforts to meet
needs.
 Extensive growth was possible, especially early
on, but intensive growth was not. Productivity
stagnation was the nightmare of Brezhnev.
 Private efforts to manage resources began with
the enterprises sending out their Tolkach
(expediter, “pusher”) to find the resources the
plan had misdirected.
 From this the second economy developed, and
it was huge.

How Would You Organize?
Let us assume that 2,000 Saints moved to a
newly discovered and unpopulated island in the
Puget Sound region to start a new life and
establish Ytopia?
 Could this be done even without a government
to pass laws?
 Who would tell the people what to do, what to
produce? Without a government and economic
plan, why would anyone want to produce
anything?

How Would You Organize?
If whole economies can’t be organized
efficiently, can individual economic
organizations function efficiently?
 Some corporations are also extremely large with
multiple divisions and widely diverse activities.
Like those corporations, an economic
community would face the tasks of
coordination and motivation.
 Specialization is the key to societal material
wealth. Adam Smith and pins. Milton
Friedman and pencils.

How Would You Organize?
To coordinate effectively, widely dispersed
information must be available for planning.
Either collect it from lower hierarchical levels of
the organization or let those individuals who
have it use it with decentralized decision
powers to produce and buy, sell and consume.
 Prices summarize all knowledge and
information.
 What incentives are available to motivate people
to act on their information? Adam Smith’s
“invisible hand.”

Transactions Costs
A creative new approach to
economic analysis suggests
that economic activity and
organizations are arranged to
minimize transactions costs.
 Why are some transactions
conducted through markets
while others are not.
 Ronald Coase (Nobel, 1991)
pointed out that transactions
costs depend on the way a
transaction is carried out.

Transactions Costs
Coase taught that transactions agents will tend to
adopt institutional arrangements that minimize
transactions costs. Generally, they are the costs of
running the system, of coordinating and
motivating.
 Coordination costs. It is necessary to determine
prices and other details of transactions, to locate
and negotiate with potential buyers and sellers.
Producers must research buyers’ tastes and
determine market demands. Buyers must search
for the best prices and characteristics of goods.
 Transactions costs also include the benefits lost
when buyer and seller matching is non-optimal or
when worthwhile transactions don’t come about.

Transactions Costs
Motivation Costs.
 First, informational incompleteness and
asymmetries can cause transactions costs.
 Second, imperfect commitment causes them
when parties are unable to commit themselves
to follow and implement the contract.
 When agents must decide whether to follow
through on threats and promises they would
like to make, but which, having made, they
would later like to renounce, transactions costs
must be incurred.

Attributes of Transactions
The specificity of required
investments. High specificity
means the investment can’t be
Thuan Phuoc Fish Market
used in other transactions.
 The frequency with which
transactions occur and their
duration.
 The complexity and the
uncertainty (about the
transaction’s required
performance).
 The difficulty of measuring
performance
 The connectedness of the
transaction to other transactions

Viability of the Theory
The theory that economic
activity and organizations
are designed to minimize
transactions costs is
helpful conceptually,
problematic in two ways.
 First, Production costs =
f (technology, inputs)
Transactions costs =
f(organization of
transactions). But both
depend on organization
and technology;
separating and measuring
the two is difficult.

Viability of the Theory
Second, the notion that firms will organize so
as to minimize transactions costs (as Coase
suggests) is problematic.
 Why should employers minimize total
transactions costs rather than those costs
which they themselves must bear? (The
standard answer is that employees costs will
be taken account of where competition forces
employers to do so. But that greatly reduces
the range of application of the theory.)
