UNIT IV

Theory of Co-operatives
 Agency Theory
• Agency relationship arises where one party (the
principal) delegates decision-making authority or
control over resources to another (the agent).
– Exemplified by relationship between stockholders
and senior managers

• Agency relationships also exist within the

organisation
– e.g. between top managers, who delegate decision-
making authority and control to business unit
(divisional) managers
 Agency Theory
Advantages:
• Easy to run a big organisation.
• Professional Management
• More Productive
• Easy Decision Making
Disadvantages:
• Delegation of Authority
• Credibility of agent
• Performance of agent
 Introduction to Game Theory

• Models the interaction of two or more players

• Occurs in the presence of uncertainty and
information asymmetry
• Game theory a complex decision theory
 Types of Games

• Many different types of games

– Classified as cooperative or non-cooperative
• Cooperative game: parties can enter into a binding
agreement.
• Non-cooperative game: an oligolopolistic industry is an
example of a non-cooperative game
 Contracts
A contract is a legal agreement which defines the
conditions of an exchange or series of exchanges.
Examples: Bank loan, futures contract, marriage, etc.
 Theory of contract
• The State of Nature: A pre-social condition.
• The Social Contract: An agreement between
• (a) members of the community or
• (b) members of the community and the Sovereign.
 Transaction Cost Theory
• Transaction costs: the costs of
negotiating, monitoring, and governing
exchanges between people
• Transaction cost theory: a theory
that states that the goal of an
organization is to minimize the costs of
exchanging resources in the
environment and the costs of managing
exchanges inside the organization
Transaction Cost Theory
 Types of Transaction Cost
Transaction costs can be divided into three broad categories:

(i) Search and information costs are costs such as those incurred in determining that
the required good is available on the market, which has the lowest price, etc.
(ii) Bargaining costs are the costs required to come to an acceptable agreement with
the other party to the transaction, drawing up an appropriate contract and so on.
(iii) Policing and enforcement costs are the costs of making sure the other party sticks
to the terms of the contract, and taking appropriate action (often through the legal
system) if this turns out not to be the case.

For example, the buyer of a used car faces a variety of different transaction costs. The
search costs are the costs of finding a car and determining the car's condition. The
bargaining costs are the costs of negotiating a price with the seller. The policing and
enforcement costs are the costs of ensuring that the seller delivers the car in the
promised condition.
 Welfare Economics

• To include society’s value of commodities under alternative

resource allocations directly involves welfare economics
– Study of all feasible allocations of resources for a society
– Establishment of criteria for selecting among these allocations

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 Welfare Economics
• Economic theory attempts to reconcile individual
decentralized resource allocation with overall social values of
a society
– May be accomplished with a social-welfare function
• Requires a cardinal measure of individual consumer preferences
• We maximize welfare function subject to a utility possibilities
frontier based on individual consumers’ preferences
– Then we specify and compare alternative egalitarian social-welfare
functions

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 Social-Welfare Function
• Using broad definition of social welfare as a level of happiness
for society as a whole
– Measurement for this happiness is needed to determine
socially optimal allocation of resources
• Such a measurement for determining how well off
agents are in a society requires a set of welfare criteria

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 Social-Welfare Function
• Efficient allocation of resources is a necessary condition for a social
optimum.
• To investigate a social-welfare function, a comparison of individual
consumers’ utilities is generally required.
• Individual needs to be satisfied.
• Security should be give to the individual in the society.

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