reprinted hereafter. From this period onwards, several generations of students in microeconomics and
related fields have come to understood economics as a science of rational choice between given
alternatives and given individual preferences. Only later, macroeconomics had been made fully
compatible with neoclassical economics with the introduction of microfoundations. In this way, the
working of economies and trade are deduced from individual optimising behaviour of firms and
consumers.
Neoclassical theory provides predictions based on the concept of equilibrium. In its most general way,
i.e. in microeconomics, macroeconomics and game theory alike, an equilibrium state (or steady state) is a
state in which all individuals have no incentive to change their plans or actions. A change in model
variables, or sometimes parameters, leads agents to change their plans or actions such that they find
themselves in a new equilibrium. It follows that predictions can be derived from comparative static
analysis of two equilibrium states, with the precise process leading the economy from one to another
equilibrium state, in real time, left unspecified. A well-known example of such a comparative static
analysis, is the derivation of technological substitution that will take place if relative factor prices change
(criticised at an early stage, on neoclassical grounds, by Atkinson and Stiglitz 1969).
The main explananda of neoclassical economics, at least where micro and macroeconomics is
concerned, are prices and quantities on either individual markets or in the economy as a whole,
determining the allocation of economic goods and surpluses. In these analyses, neoclassical economics
distinguished between different competitive settings (perfect, imperfect, monopoly) or informational
settings (e.g., principal-agent). There is no need for further specification of a specific institutional setting
in which actors operate, though implicit to the analysis are institutions like private property rights (Edquist
and Johnson, 1997). The analysis of institutions is dealt with within the framework of game theory, which
in its basic form shares utility maximization and equilibrium analysis (backward induction). It should be
stressed, however, that recent developments in game theory, or experimental economics more broadly,
tend to relax the assumption of utility maximization.
Another recent development, as indicated by the ‘new’ in new trade theory (Krugman, 1985), the new
economic geography (Krugman, 1991) and new growth theory (Romer, 1986; Lucas, 1988), is the use of
assumptions other than that of perfect competition and constant returns to scale. In the new economic
geography and new trade theory, for example, increasing returns related to geographical clustering cause
industries to locate or grow in ways different from the predictions based on the standard theories of
comparative advantage. Still, it is fair to say that these new approaches or still in line with the two basic
tenets of neoclassical theory: the assumption of utility maximizing actors and the derivation of model
predictions by equilibrium analysis.
2.2 Institutional economics
Although ‘institutionalism’ has been influential in early twentieth century American economic
thought (Hogdson 1998), institutional economics has never developed into a coherent, systematic
paradigm. Rather, it is better described as a collection of approaches that share a common interest in
explaining particular phenomena (Samuels, 1995). For most scholars adhering to institutional economics,
the methodological and theoretical pluralism does not reflect incoherence. On the contrary, pluralism is to
be encouraged, and is at the heart of methodology, at least if one accepts institutional economics as an
interdisciplinary and contextual science (Hodgson, 1988). In its most stringent form, institutional