INTRODUCTION

Social activity involves human interactions on two levels. The first level concerns the development, modification, and specifications of institutions. Institutions define the basic framework within which people interact with one another; we can refer to them as the rules of the game. The second level of social activity concerns human interactions within the prevailing institutional arrangements; we can refer to this level of activity as the game itself. The two levels of social activity are interrelated. By constraining the scope and contents of human interactions, the rules help interacting individuals to predict each other's behavior, or, to put it another way, the rules lower the transaction costs of playing the game. Of course, lower transaction costs mean a higher level of economic activity. By implication, a change in the rules changes both the way the game is played and the level of economic activity.

The institutional framework consists of formal and informal rules, all of which create their own behavioral incentives. Formal rules are constitutions, statutes, common law, and other governmental regulations. They are enacted, enforced, and changed by governmental authorities. Informal rules include traditions, customs, religious beliefs, and all other norms of behavior that have passed the test of time and that bind the generations. The enforcement of informal rules takes place by means of sanctions such as ostracism by friends and neighbors, loss of reputation, or alienation (expulsion) from the community.