Friday, September 5, 2008

Institutions Shape Markets

Lately, I find one of the more interesting aspects of economics to be the study of institutions (rules, beliefs and organizations) and how they shape the choices we make; and how this ends up being reflected in the marketplace.

The thinking is that the rules of the marketplace, whether they are formal nactments by governmental bodies, or informal beliefs adopted by individuals or cultures, help to define the choices we make. These choices ultimately help shape the marketplace, and may even generate an opportunity for an entrepreneur or group of entrepreneurs to add value where little or none existed before.

Today's issue of The Wall Street Journal offers just such a story. "Have Knife Will Travel" tells about farmers on Lopez Island in Washington who had a problem, saw an opportunity, and crafted a solution - and became a cutting edge (pardon the pun) idea in animal slaughtering and meat packing. And it offers a lot of opportunities to tie to your economics class.

The farmers on Lopez Island had to ship their animals 150 miles to the nearest
slaughterhouse that was USDA-approved, if they wanted to sell their product on the island. This took time, added cost, and (for those of us trying to be "green") added to the carbon footprint. "What to do?"

Several of the farmers recognized there was a burgeoning desire to eat locally-grown produce. "Why not duplicate that with meat?" Enter the first USDA-sanctioned mobile slaughterhouse. A truck makes the rounds on the island, and a professional butcher slaughters, and cuts and packages the meat. That meat is then delivered to grocers and other markets in the area. It's fresher and it has the panache of being "locally grown and produced".

The market for locally-grown food is growing. The desire for these products affects how people choose to buy food. (There's an example of an informal institution.) Examining the impact of this new institution, the entrepreneur (or in this case a group of them - the farmers) saw a new process - a new way of producing a good or service. This "new way" is, according to economist Joseph Schumpeter, what being an entrepreneur is all about. They got funding for their idea. They got the clearance from the USDA (the rules governing sale of slaughtered meat are another example of an institution - a formal one). And they set up the business.

The mobile slaughterhouse is also an example of adding value to the consumer. In this case, the consumer (of the slaughterhouse service) is the farmer. Consumers seek utility when they purchase a good or service. And some economists will talk about form, place and time utility. In this case, the mobile unit doesn't do anything unique in the way of form utility. But it does add time and place utility to the meat. Time utility is added by making the meat fresher when it hits the stores. Place utility is added by bringing the service to the farmer, as well as allowing them to advertise their product as locally grown and processed.

Can you think of other ways to use this story in your economics classes? I suspect there are even more ideas that just haven't crossed my mind yet. I look forward to your comments.

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