Essay About Market Design Economics And Transaction Costs

Bop and Market Design Economics
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{Acknowledgment}Professor Dr. Peter Knorringa arises the question of how economists can contribute to the emerging field of Bottom of Pyramid. This question motivates me to write this paper. {Abstract}Theory of bottom of pyramid without doubt is one of the most influential theories in business literature the past decades. More than 4 billion people live in poverty. Prahalad suggests; “large-scale and wide-spread entrepreneurship is at the heart of the solution to poverty eradication”. This paper suggests that economic theory can contribute to BOP literature.  This paper utilizes two influential economic theories; transaction costs and market design economics, to further enrich BOP literature.section{Introduction}Prahald introduces new tool for poverty reduction. In his book “Fortune at the Bottom of Pyramid” he notes that; BOP (the 4 poor billion people) can and must involve in market as a customer and as a part of production process . The poor not only should not be excluded from market but they should be included in the market as a profitable customer class and active participants of value chain. He provides examples of companies that successfully enter to the BOP market; such as Casa Bahia, CEMEX, The Annapurna Salt Company, HLL Shakti, Jaipur Foot, ICIC Bank, ITC e-Choupel. These companies approach the poor as consumers and create win-win situation. That is, by selling to the poor companies gain profit and the poor get access to the products that contribute to their wellbeing. An example is Annapurna Salt Company that by selling idolized salt to the poor decreases IDD among the poor in India. \Technological advancements decrease production costs and make products affordable for middle and low economic classes. An example is reduction in the cost of agricultural products in the past decades due to the technological achievements. Nonetheless, the Prahalad raises the question of how companies can reduce cost of products by changing the management system. That is, decreasing the cost with the assumption of stagnant technology. \Prahalad , and BOP literatures, briefly answer to the aforementioned question. Nevertheless, economic theories discuss extensively the ways that firms can reduce products’ costs, given technology stay constant. Hence, economic theory provides robust theoretical framework for explaining how firms can extend their market to BOP cite{1}. \Institutionalists economists introduce two types of costs that determine the final price of products: primo, transformation cost which is cost of transforming raw materials to the final products. Secundo, transaction costs; as north define it; “all those costs incurred in operating an economic system”. An example of transaction costs is lack of trust in a market to the poor. The result is that the interest rate for the poor is by far more than normal interest rate. \Technology reduces transformation costs, however, economic theories has focused on decreasing transaction costs. The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel has been awarded to the topic of transaction economics. The reason for that is the important implications of transaction cost economics in several fields.\Market design economics is an emerging field in economics that creates a rigorous mechanism for tackling with transaction costs. This field utilize gamethory, mathematics, and IT to find solutions for market failures and transaction costs. Market design economics resuscitates several markets that severely suffered from transaction costs; kidney exchange market, high school admission, working position for new doctors and so on.\This papers link economics theories; explicitly transaction costs economics and market design economics, with BOP literature. This connection can further enrich both fields and contribute to life of the poor. section{Bottom of Pyramid at the Glance}Since the early 1950s developed countries have provided financial aids to developing nations. The common believe has been that capital is the main obstacle for development and providing financial capital is the main path for poverty reduction and development (Foreign Aid: Its Defense and Reform, page 24). The idea of financial aid as the path for poverty reduction become a dominant idea among majority of the agencies who aimed at helping the poor people; such as international organizations, NGOs and so on. \Graph1\ includegraphics[scale=0.4]{11}\Financial aid has increased from $41 billion in 1970 to $107 billion in 2005. That means an average of 3.1\% growth per year. Furthermore, in Monterrey consensusfootnote{