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Institutional economics, known by some as institutionalist political economy, focuses on understanding the role of human-made institutions in shaping economic behaviour. The institutional economists were typically critical of American social, financial and business institutions. What is now called new institutional economics, is a very different creature politically, but still focuses on the role of institutions in reducing transaction costs. Heterodox institutional economics emphasizes a broader study of institutions and views markets as a result of the complex interaction of these various institutions (e.g. individuals, firms, states, social norms). Law and economics has been a major theme since the publication of the Legal Foundation of Capitalism by John R. Commons in 1924. Behavioral economics is another hallmark of institutional economics based on what is known about psychology and cognitive science, rather than simple assumptions of economic behavior. Institutional economics focuses on learning, bounded rationality, and evolution (rather than assume stable preferences, rationality and equilibrium). It was once the main school of economics in the United States, including such famous but diverse economists as Thorstein Veblen, Wesley Mitchell, and John R. Commons. Some institutionalists see Karl Marx as belonging to the institutionalist tradition because he described capitalism as a historically bounded social system; other institutionalist economists disagree with Marx's definition of capitalism, instead seeing defining features such as markets, money and the private ownership of production as indeed evolving over time, but as a result of the purposive actions of individuals. "Traditional" institutionalism [1] rejects the reduction of institutions to simply tastes, technology, and nature (see naturalistic fallacy). Tastes, along with expectations of the future, habits, and motivations, not only determine the nature of institutions but are limited and shaped by them. If people live and work in institutions on a regular basis, it shapes their world-views. Fundamentally, this traditional institutionalism (and its modern counter-part institutionalist political economy) emphasizes the legal foundations of an economy (see John R. Commons) and the evolutionary, habituated, and volitional processes by which institutions are erected and then changed (see John Dewey, Thorstein Veblen, and Daniel Bromley.) The vacillations of institutions are necessarily a result of the very incentives created by such institutions, and are thus endogenous. Emphatically, traditional institutionalism is in many ways a response to the current economic orthodoxy; its reintroduction in the form of institutionalist political economy is thus an explicit challenge to neoclassical economics, since it is based on the fundamental premise that neoclassicists oppose that economics cannot be separated from the political and social system within which it is embedded. Some of the authors associated with this school include Robert Frank, Warren J. Samuels, Mark R. Tool, Geoffrey Hodgson, Daniel Bromley, Jonathan Nitzan, Shimshon Bichler, Elinor Ostrom, Anne Mayhew, John Kenneth Galbraith and Gunnar Myrdal, but even the sociologist C. Wright Mills was highly influenced by the institutionalist approach in his major studies. Thorstein Veblen (1857-1929) wrote his first and most influential book while he was at the University of Chicago, on The Theory of the Leisure Class (1899). In it he criticised materialistic culture and wealthy people who conspicuously consumed their riches as a way of demonstrating success. Conspicuous leisure was another focus of Veblen's critique. In The Theory of Business Enterprise (1904) Veblen distinguished production for people to use things and production for pure profit, arguing that the former is often hindered because businesses pursue the latter. Output and technological advance are restricted by business practices and the creation of monopolies. Businesses protect their existing capital investments and employ excessive credit, leading to depressions and increasing military expenditure and war through business control of political power. These two books, focusing on criticism first of consumerism, and second of profiteering, did not advocate change.
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