Optimal design of trade institutions

We model an economy with social institutions that facilitate trade and induce three types of costs: establishment costs, access costs, and use costs. Use costs are specific transaction costs related to the use of these trade institutions. We assume that a trade institution is economically completely determined by the costs it imposes and by the effects on the trades it facilitates. We extend the Pareto efficiency concept to include various modes of organization of social institutions: the costs and benefits of these organizations are expressed in the trades they facilitate.Within this setting we discuss a valuation equilibrium concept, in which all agents use a common conjectural price system that assigns to every trade institution the price vector that would prevail under it. This feature of the equilibrium is important in securing the second welfare theorem, and is new to the analysis of economies with costly trade. Since the use costs can be nonlinear, there are non-convexities that prevent the second welfare theorem from obtaining in a finite economy, but we show it for large economies.Received: 3 April 2002, Accepted: 30 April 2003, JEL Classification: D59, D70, H49Robert P. Gilles: donewhile visiting the Center for Economic Research, Tilburg University, Tilburg, The Netherlands. Financial support from the Netherlands Organization for Scientific Research (NWO), grant B46-390, is gratefully acknowledged.Dimitrios Diamantaras: Part of this research wasSupport from Temple University via a Fuller research fellowship is gratefully acknowledged.The authors would like to thank Suzanne Scotchmer, Andreu Mas-Colell, Marcus Berliant, Shlomo Weber, Hans Haller, Dhanajay Gokhale, Julian Manning, and two anonymous referees for their valuable comments and discussions of previous drafts of this paper. A previous version of this paper was circulated as Equilibria of economies with costly trade.