Local coordination under bounded rationality: Coase meets Simon, finds Hayek

• Main Author: WOODARD, C. Jason
• Format: text
• Language: English
• Published: Institutional Knowledge at Singapore Management University 2010
• Subjects: Complex networks; Bounded rationality; Institutional economics; NKC model; Databases and Information Systems; Numerical Analysis and Scientific Computing; Strategic Management Policy
• Online Access: https://ink.library.smu.edu.sg/sis_research/7046; https://ink.library.smu.edu.sg/context/sis_research/article/8049/viewcontent/Local_Coordination_under_Bounded_Rationality__Coase_Meets_Simon.pdf
• Institution: Singapore Management University

This paper explores strategic behavior in a network of firms using an agent-based model. The model exhibits a tension between economic efficiency and the stability of the network in the face of incentives to change its configuration. This tension is to be expected because the conditions of the Coase theorem are violated: the boundedly rational firms in the model lack the ability to discover efficient network configurations or achieve them through collective action. In computational experiments, as predicted by theory, firms frequently became locked into inefficient outcomes or endless cycles of mutual frustration. However, simple institutional innovations such as property rights and side payments dramatically improved outcomes, even for severely myopic firms. The results are consistent with Hayek’s observations about the surprising effectiveness of local coordination in the economy at large, but the mechanism involved is different. Instead of prices, firms in the model exploited the fact that their incentives are partially decoupled by the structure of the network. This finding contributes to the growing body of theory on “loosely coupled” interactions in real-world networks.