The economic theories could never be applied to the situations of the real social world, because economic theorists such as North primarily assume that human minds function rationally – which is not always the case. The basis of these economic assumptions is that humans behave in such a fashion that would maximize the resources they have because they are clearly aware of the scarcity of goods on earth and the competition towards another human being for them. They use their minds to cognitively process and calculate the utility each good would give them, and estimate whether attaining such goods would satisfy them. However, each cognitive process requires a certain amount of information from the actor.
This information comes from human interaction, from which we generalize the behavior of the people in the society and form institutions from these taken for granted realities. After all, humans are in need of institutions in order to lubricate social interactions, to develop patterns in how we should act, and in North’s case, how we act as consumers of the world.
However, we should keep in mind that despite the objectivity (the process of becoming objective) of these institutionalized practices, humans and social interaction are subjective and are open to changes. One may not necessarily have the same preferences from the other, and their preferences changes over time, making the social system flexible and hard to contain in one-sided economic theories. It is good to point out that economic theorists are not sociological theories. They are mainly used as models in order to explain the behavior of the market and find answers to questions regarding supply and demand.
Going back, such inaccuracy of information due to the variety and constant changing of social interactions make it impossible for humans to act “rationally” all the time as the way economic theorists expect them to. Humans are more complex, and North’s perspectives do not honor the real human nature because North views man as a being with definite preferences that he acts upon, when in fact this isn’t true. Thus, information has a higher price more than any good, because it transcends which goods would objectively satisfy humans. The level of information you have also determines the costliness of your transactions. For example, in a story of Benjamin Franklin entitled The Whistle, he bought a whistle when he was young for an insanely expensive price, but he did not know it because having a whistle itself satisfied him. But when someone pointed out that he actually paid too much, the utility the whistle initially bought decreased. Being ignorant of prices and utilities makes humans pay too much for certain goods.
In macroeconomics, perhaps the more sociological application of economics, the types of exchange and each corresponding transaction cost varies. In North’s view, it is classified as personalized, impersonal and impersonal with a third party enforcer. The last two classifications involves other institutions such as the state and the legislative and judicial system. As I have mentioned above, these institutions lubricate human interaction, which means that the two parties are more or less much secure to transact, depending also to the way these institutions function.
Institutions function in an objective-subjective fashion. They are subjective but are formed and exist objectively. They minimize deviance from the norm be it formally (such as in laws and policies) or informally (such as culture).
While economic theorists do not precisely predict human behavior, they provide the awareness of the information humans need in order to maximize resources and also elaborate the importance of properly functioning institutions.
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