Transaction Costs

The neoclassical model of economics has proven to be a powerful tool for understanding the volume and terms of trade. However, in that model, the rules of the game do not matter. Phrased another way, the neoclassical model is incapable of explaining why institutions exist and vary across time and locations. Furthermore, the neoclassical model cannot explain why prices are not always used, as in firms and families where a decision maker simply directs resources. Nor can it explain why prices do not automatically adjust to equilibrium levels, as in cases of long lines of customers or unemployment.

Still, economists are interested in these questions, and rather than abandon their neoclassical foundations, they have modified the model to accommodate them. The key to understanding institutional detail ...