Artificial markets and the theory of games

Abstract

The concept of transaction costs is a common theme in most analyses of the phenomenon of market failure. Few economists would disagree with the abstract proposition that if there exist gains to be made from exchange, then in the absence of transaction costs private bargains will take place and exhaust all potential gain from trade. This proposition serves not only as a characterization of an ideal state of affairs, but as a guide to means by which specific cases of market failure could be remedied. It suggests, in particular, that reduction in transaction costs should be examined as a potential remendy. Since the nature and extent of transaction costs depend crucially on the institutional structure in which private bargains take place, the analysis of the relationship between institutions and transaction costs becomes a primary concern of policy for dealing with market failure.