Wednesday, March 7, 2012

Assumptions of the transaction cost theory

In the last blog, we looked at Williamson's TCT formulation. In the current blog we look at the 2 essential assumptions about economic actors engaged in a transaction.
1. Bounded Rationality
2. Opportunism

Bounded Rationality is a term that we have used multiple terms thus far and essentially means - those who are engaged in a transaction are rational but have a limit to this rationality. What does this mean? I helps us realize that we would in the absence of such an assumption be writing contracts that would have unlimited complexity. Economic actors involved in the transaction simply cannot envision all the possible outcomes in an exchange relationship and there for formulate contracts for all eventualities.

Opportunism refers to incomplete or distorted information disclosure towards misleading or confusing partners in the exchange. It would be highly complex to assume that all actors are always opportunistic, however it would be easier if we begin with the assumption that actors may behave opportunistically and it is extremely costly to make the distinction who is opportunistic and who is not - this is what TCT assumes. It is this threat that in the world we deal with much more than merely the promises.

These two are important considerations - firms and people should always safeguard to avoid being victimized by the others.

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