An Economic Theory of Institutional Change: Induced and Imposed Change

This article draws on recent progress in economics—especially in the economics of information, property rights, transaction costs, induced innovations, household production, and the theory of the state—to analyze the functions and choices of social institutions, and to consider the mechanism of institutional change. My purpose is to show that institutions provide useful services and that institutional choices and changes can be analyzed within the demand and supply framework. Special attention will be given to the role of the state in the process of institutional change. The study of institutions and their evolution is one of the focal points of Marxist economics. In contrast, conventional neoclassical economics takes the institutions of the modern Western economies for granted (Sweezy 1970). In the construction of economic models, well-defined property rights, perfect information, and frictionless transactions are in general implicitly assumed. With some additional assumptions about the characteristics of production and utility functions, which are termed the “classical environment,” the two wellknown optirnality theorems of welfare economics are shown to be attainable in the market economy. First, if there is perfect competition, the allocation of resources is Pareto-optimal. Second, any spec-