An Equilibrium Model of Hierarchy

This paper presents a general equilibrium model which formalizes the tradeoff between economies of specialization in producing goods and transaction costs and the tradeoff between economies of specialization in producing transaction services and transaction costs in delivering such services. The comparative statics of the equilibrium, based on comer solutions, indicate that the equilibrium will shift between several market structures as parameters have reached some critical values. As the transaction cost coefficient of transaction services falls and/or as the degree of economies of specialization increases, the level of division of labor in producing goods and transaction services and the number of layers of a hierarchical structure of division of labor and transactions will increase. A small number of layers of the hierarchy emerges from the division of labor with partially specialized production of goods and transaction services. A larger number of layers of the hierarchy emerges from a higher level of division of labor between wholesale and retail middlemen and between specialist producers of goods.