Tce Assumptions

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In my post entitled 'Introduction to transaction cost economics', I spoke about the roots of transaction cost economics by referring to Coase and by recognising transaction costs as the costs of using the market. As insightful Coase's contributions were, no serious development was made on transaction cost economics until 1975, when Williamson (who was awarded the Nobel Economics prize in 2009 together with Ostrom) tried to build on Coase's original theory to build a more cohesive theory to explore the dimensions explaining transaction costs and contractual forms. Williamson's contribution, extended in the 1980s and 1990s by Williamson and others, has currently become the quintessential and orthodox transaction cost economics theory. Let me briefly outline the assumptions of Williamson's theory in this post. I will discuss Williamson's tce dimensions (asset specificity, uncertainty & frequency) and contractual forms in a further post.

In developing TCE, Williamson assumes 2 key assumptions: bounded rationality & opportunism. These assumptions were borrowed by Williamson from behavioural economics developed in the 1950s by economists like Simon, Cyert and March. The assumption of bounded rationality (see storybook and McNutt's book) represents a departure from the neoclassical assumption of rationality. Behavioural economists, and Williamson, contend that individuals must act within the limits of their own knowledge. They may try to be as rational as they can in making decisions, but this rationality is limited by the fact that there is imperfect information and complexity... Our decisions may not be fully rational because we do not have full information, but even if we did, we have cognitive limitations, i.e. our assimilation power is limited. The storybook provides a good example when it refers to the game of chess. In theory, there is perfect information in a game of chess but it is impossible for every player to work out all potential countermoves their moves may trigger...

The second assumption is opportunism, which Williamson defines as ' self interest seeking with guile' and refers to situations where one party to a transaction may try to be opportunistic at the expense of the other party. Opportunism may stem from situations where there is asymmetric information, i.e. different parties to a transaction have different levels of information. The more informed party may use asymmetric information to her advantage. You may remember the example of the purchase of the second hand car mentioned in the storybook and in my earlier post... The concept of opportunism is extremely