The Institutional Structure of Production

This article is about the importance of the working of the economic system of what might also be termed as Institutional structure of production. The various concepts like Free market theory, Coarse theorem, Transaction costs and its fundamentals, Externalities related to the production and Negotiations.

Types of Economic system

There are four types of economic systems; traditional, command, market and mixed economies. A traditional economic system focuses exclusively on goods and services that are directly related to its beliefs and traditions. A command economic system is characterized by a dominant centralized power. A market economic system relies on free markets and does not allow any kind of government involvement. Finally, a mixed economic system is any kind of mixture of a market and a command economic system. [1].

Price Theory

The theory of price is an economic theory whereby the price for any specific good or service is based on the relationship between supply and demand. The theory of price posits that the point at which the benefit gained from those who demand the entity meets the seller's marginal costs is the most optimal market price for the good or service.

Understanding Supply and Demand and the Relation to Price Theory

Supply denotes the amount of products or services the market can provide. This includes tangible goods, such as automobiles, or intangible goods, such as the ability to make an appointment with a skilled service provider. In each instance, the available supply is finite in nature. There are only a certain number of automobiles available, and only a certain number of appointments available, at any given time.

Demand applies to the market’s desire for the item, be it tangible or intangible. At any time, there is also only a finite number of potential consumers available. Demand may fluctuate depending on a variety of factors, such as whether an improved version of a product is available or if a service is no longer needed. Demand can also be impacted by an item's perceived value, or affordability, by the consumer market.

To achieve equilibrium, the goal is to locate a price point that allows the number of items available, referred to as the supply, to be reasonably covered by potential customers. If the price is too high, customers may avoid the good or service, resulting in excess supply. In contrast, if a price is too low, demand may significantly outweigh the available supply. Economists use price theory to find the selling price that brings supply and demand as close to the equilibrium as possible.

Transaction Cost

Transaction costs are expenses incurred when buying or selling a good or service. Transaction costs represent the labour required to bring a good or service to market, giving rise to entire industries dedicated to facilitating exchanges. In a financial sense, transaction costs include brokers' commissions and spreads, which are the differences between the price the dealer paid for a security and the price the buyer pays.

Concepts of Externalities

Voluntary exchange will only take place if both parties perceive are better off, this sometimes causes externalities. Now What is Externality? Externality are the cost or benefits, not transmitted through prices to other parties than those involved in the transaction when they are beneficial they are positive externalities and the rest if they are non-beneficial or costly they are negative externalities.

Let’s talk about negative externalities at the first place. Let us assume a practical situation. Imagine a corn farmer and consider the things which he need to support his growth of corns, they might be things like fertilizers, water, Sunlight etc. Suppose a river is flowing to the side of his cropping’s and some of his fertilizers are drowned and are leaked into the waterbody, often times this results in the large fish kill which in turn impact the fisherman, recreational and the landowners and they undergo the negative externalities as for fisherman the fishes are the source of income and as they are killed he will have the negative impact on his economic condition, not only him the end consumer will also face the effect of negative Externalities. These externalities can be broadly categorized into three categories

1. Taxation-We can impose the tax on production, that will reduce the amount of goods produced which will automatically reduce the negative externalities. However, the difficulty is monitoring as how much production is done and if the high production is not done then why the supply is constant and whether people are buying on the high prices.
2. Regulations

• Technology specific methods- This is where the government requires producers to use the certain technology to reduce pollution or emission. The benefit is that monitoring cost are quite low. You don’t need to have somebody out there to monitor the amount of emissions until that technology is working and present. The introduction of the latest technology has somewhat reduced the negative externalities. For example-Use of electronic precipitators in place of the manual ash collectors or hoppers has tremendously reduced the pollution level and the ash content in the atmosphere but again the underlying problem is it reduces the chances of innovative ways which company can use to still reduce the pollution content because there would be no immediate need.
• Restricting Quantity of Goods or pollution produced-The benefit of this is of course is now firms has the reason to find innovative ways to reduce the pollution but the drawbacks that the monitoring cost is quite high. So, the best way to counter the negative externalities is the property right solution.
• Property right solution-This proposes that if the property is world defined, divisible and defendable and negations cost or transaction costs are low, simply by assigning the property right we can overcome the externalities. The three characteristics which you must have in order to have fully functional property right solutions.

Then comes the concept of 3D’s

• Well Defined-What is the object on which the owner has rights. In what manner, the owner exercises his or her rights.
• Divisible-Are these rights separable? And whether they can be traded or not.
• Defendable-Are these rights enforceable? Are these rights recognized either by the custom, by the community or by a government agent?

Let’s assign the property rights in the above taken example-Let’s suppose the farmer doesn’t change his or her behaviour and continuous to leak fertilizers in the river but this time the fisherman can now trade with the farmer to reduce the amount of fertilizers that he lays on the field. This would reduce the amount of fish death downstream. We could also conversely define the property rights to the fisherman whom we may initially think to stop farmer to use the fertilizer on the land, however now the farmer has the knowledge to negotiate it’s the fisherman downstream. A fisherman will allow some amount of fertilizer but not as much as before in each scenario we come to a solution which overcomes the externalities. The fisherman and the farmer now know the cost of the externality and are in a state to negotiate in order to overcome it. There are also the initiative for both the parties to find the ways to contribute to the social welfare

Coarse theorem minimises these monitoring cost by providing the required information’s.

Learnings and Reflection

Finally, I got to know that how two concepts, which is Transaction cost and property rights talked by Coarse are connected. Basically, what course pointed out in this remarkable paper was that the problem with external benefits and external cost is not they are external but rather that property rights in these cases are uncertain and vague and that the transaction cost is high.