"Incentives are the essence of economics," (Eddie Lazear). This phrase sums up the focus of this course. In the Neo-Classical world of standard economics classes, incentives are irrelevant because all actions are completely specified and perfectly induced by the price mechanism. In the real world, however, things are not so simple. In the real world, actions cannot be completely specified or completely monitored, promises can be reneged upon, people can become overwhelmed by information so desired coordination fails to occur, etc., etc. As a result, people may "distort" their behavior in order to exploit advantages that arise due to these problems. And, consequently, others will "distort" their behavior in order to avoid being the subject of exploitative behavior. This means that we are no longer in a world in which value-maximizing actions always occur, and are now in a world of inefficient, sub-value maximizing behavior. In such a world, it becomes important to give people proper incentives to engage in value-maximizing behavior rather than exploitative or defensive behavior.

"Transactions costs economics" is the name of the branch of economics that analyzes how information, commitment and coordination problems can lead to inefficient behavior, and how contracts and/or organizations are fashioned to counteract this phenomenon. Thus the major principle behind this course is the analysis of how contracts and organizations are structured in order to promote value-maximizing behavior. Transactions costs economics is a fairly advanced branch of economics, and an area in which much active research is taking place. This course will give you a thorough overview of the analytics of transactions costs economics. It will, as well, require that you apply the insights from the analytics to real-world case studies. The purpose of this is to both give you an idea of how good economic modelling must translate reality into mathematics and back, as well as to provide motivation for the often-times complex models. Thus the course will at times be fairly demanding in both microeconomic modelling aptitude and in reading load. On the other hand, this course will most likely provide more real-life insight than you have previously experienced from an economics course (or most other courses, for that matter).

The prerequisite for the course is 14.03. This course assumes a good grounding in intermediate microeconomics, including basic probability and utility theory, as well as notions of strategic gaming. The course is structured to cover much of the theoretical models in the first half of the course, and the second half of the course will be largely devoted to applications.

A schedule of the daily topics and required readings is found here. The required textbook is Milgrom and Roberts, Economics, Organization and Management, Prentice Hall, 1992. (The book suffers at times from an excess of concepts and applications, but just persevere. I am happy to explain any questions in class or office hours.) There is also a required reading packet.

There is a fair amount of required reading in this class, and it is important that all the assigned materials are read before class. To that end, part of your grade will be based upon class participation. You will be credited for comments and questions that reflect an understanding of the economic concepts and that moves the analysis of the case material along by identifying the economic principles that underlay them. Unless I specifically ask for them, you will get relatively little credit for comments that simply establish known facts from the case or that repeat previous comments. You are also encouraged to volunteer information on things that you have experienced or read about which are germane to the concepts in the class. There will be an in-class midterm on March 17th, six exercises to be handed in, and a take-home final exam to be done during the last week of classes. The grading breakdown is as follows:

1. Midterm: 35%

2. Six Exercises Total: 18% (3% each)

3. Take-Home Final Exam: 40%

4. Class Participation: 7%

The exercises and the take-home final are to be done on an individual basis. You are welcome to ask me clarifying questions about them, but you are to receive no other assistance on them. The exercises will be handed out in class and their due dates are indicated on your schedule.

My office is E52-262C, my phone number is (25)8-9491, and my email address is rewells@mit.edu. My secretary is Linda Woodbury, who is in E52-251, and her phone number is (25)3-8885. The TA for the course is Jonathan Dworak. He will give you details on his office hours on the web-site.