The new institutional economics and the theory of the firm

Concepts of importance in the literature of the New Institutional Economics, such as transaction costs and bounded rationality, have been used to extend the standard neoclassical model of the firm, but the hybrid models created have failed to provide adequate explanations of enterprise behavior. An alternative, “neoinstitutional,” model of the firm is developed in the paper that differs from the pure neoclassical model and hybrid models in respect to both the nature of the solution it yields and the process by which it reaches a solution. The neoinstitutional firm cannot be expected to achieve either the hypothetical allocative efficiency promised by the frictionless neoclassical model, or the relatively efficient (constrained Pareto optimal) solutions predicted by the largely frictionless hybrid models. The orthodox marginal rules of neoclassicism can only be used to solve lower-level problems that appear within the firm.