Neoinstitutional Economics and the theory of production and exchange

We are concerned in this book with recent attempts to extend and generalize the theory of price and apply it to economic and political institutions. Our focus is on a certain propensity in human nature, which Adam Smith pointed out – “the propensity to truck, barter, and exchange one thing for another” – and on the consequences of these activities for the use of scarce resources and the creation of wealth.

The economic outcomes of production depend in an important way on the social and political rules that govern economic activity and society in general. In his pioneering contribution to economics, Adam Smith sought to demonstrate how one specific set of rules contributes more to the wealth of nations than any other. The structure that Adam Smith recommended was one whereby individuals have exclusive private rights to economic assets.

In the more than 200 years following Adam Smith's contribution, the mainstream of research in economics has involved primarily an examination of a single set of idealized rules governing market exchange. In spite of this simplification, the approach has been fruitful: In terms of both analytical power and empirical relevance it overshadows all other theoretical systems in economics and the social sciences. The theory of price (microeconomic theory) has provided valuable insights into the fundamental nature of exchange and resource allocation in decentralized markets and also tools that enable us to predict how equilibrium outcomes are affected by changes in the constraints that individual decision makers face.