Transaction Cost Economics - Essay Example

Running Head: Economics Transaction Cost Economics and New al Economics s Economics Economics is a social science that mainly deals with production (supply) and consumption (demand) of commodities. It has been a popular subject for 100s of years. Like every other subject, it has been evolving since its birth. Today, new institutional economics are widely accepted as compared to the old institutional economics. To understand the differences and similarities between the different approaches of economics, first we will look at what is management accounting. We will also go through with transaction cost economics and new institutional economics. Later, we will try to draw a conclusion from this discussion. Relation with Management Accounting In order to fully comprehend the phenomena of transaction cost and/or evolutionary economics, it is imperative that the concept of management accounting be fully understood as well. Management accounting may be defined in various manners. It is basically related to the use of accounting information by managers of organizations. It helps them in making prudent and timely decisions to run their businesses in an efficient and effective manner. Transaction Cost Economics "Transaction Cost Economics concerns itself with markets and hierarchies as alternative governance mechanisms for completing a set of transactions. Market forms of governance tend to rely on prices, competition, and contracts to keep all parties to an exchange informed of their rights and responsibilities it is based on two assumptions about economic actorseconomic transactions are intendedly rational, but only limitedly so and economic actors seek self-interest with guile." (http://findarticles.com/p/articles/mi_qa3933/is_199811/ai_n8812605/print) According to Williamson (1996), this type of economics is basically related to the, "governance of contractual relations" and it consists of three levels which can be easily understood by means of the schematic diagram shown below: Stage # 1 Stage # 2 Stage # 3 The institutional environment helps us to understand and define that "rules of the game". This includes all those factors that may influence or result in a change in the "comparative governance costs leading to a reconfiguration of economic organization". Williamson has basically defined governance to be of three types; market, hybrid and hierarchy. The individual basically is a, "result of the strict assumption of opportunism (i.e., self -interest seeking with guile) and human cognition is subject to bounded rationality (i.e., "intendedly rational, but only limitedly so"). In addition, TCE views governance as the means, "by which to infuse order, thereby to mitigate conflict and realize mutual gains the key purpose of organization on which transaction cost economics focuses is that of adaptation, of which two kinds were distinguished: autonomous adaptation in response to changes in relative prices, and cooperative adaptation accomplished through administration. Not only do transactions have differing "needs" for adaptations of these two kinds, but governance structures have differing capacities to supply autonomous and cooperative adaptation". (Williamson 2000, pp. 12, 19-20) New Institutional Theory Oliver Williamson is popularly known as the founder of the New Institutional Theory (also called the Evolutionary Theories of Economics) and he also coined the term "institutional economics" in 1975. However, its origins can be traced back to the works of Coase (1937), Hayek (1937, 1945), Chandler (1962), Simon (1947), Arrow (1963), Davis and North (1971), Alchian and Demsetz (1972), Macneil (1978), Holmstrm (1979) and others. Various definitions for the new institutional theory can be found in literature. Rosenberg (2000,p. 70) has defined it as, "a mechanism blind variation and natural selection that operates everywhere and always throughout the universe." "The new institutional economics (NIE) is an interdisciplinary enterprise combining economics, law, organization theory, political science, sociology and anthropology to understand the institutions of social, political and commercial life. It borrows liberally from various social-science disciplines, but its primary language is economics. Its goal is to explain what institutions are, how they arise, what purposes they serve, how they change and how - if at all - they should be reformed. This essay surveys the wide-ranging and rapidly growing literature on the economics." (Klein 1999, pp. 456) Moreover, it is believed that "The new institutional economics is a body of economic theory which ascribes an important role to ideas and ideologies. It provides scholars with a means of dealing rather more rigorously with the issue of distinguishing between the real world and individuals' and groups' perception of it. It is an attempt to incorporate a theory of institutions into economics. However, in contrast to the many earlier attempts to overturn or replace neoclassical theory, the NIE builds on, modifies and extends neoclassical theory". (http://cniss.wustl.edu/workshoppapers/richterpaper.pdf) This type of economics is based on four diverse levels of study. Each level profoundly influences the other and is more commonly referred to as the "rules of the game". The schematic diagram shown below helps to explain the relationship between the different levels. The upper-most level is called is known as the social theory. It includes informal institutions, customs, traditions, norms, and religion. The second-next highest-level is the institutional environment. The third level is governance, which includes transaction costs to align governance structures with the nature of transactions. The fourth level is resource allocation and employment. This level also includes neoclassical economics. Stage # 1 Stage # 2 Stage # 3 Stage # 4 Conclusion From the above discussion, we can conclude that the evolutionary economies put a greater emphasis on the factors related to religion as opposed to the classical economic theories. In other words, it is recognized that religion is embedded in our society in general and it has a significant amount of influence on the economy of a given nation. In addition, the New Institutional Economics also places a greater influence on the weight of various "human" factors on the economy of a nation. As opposed to the classical approach, New Institutional Economics is of the view that the psychology of people should be understood, rather than simply using them as a function of "utility maximizers". (Brock, 2003) Therefore we can state that, "the literature in evolutionary economics is expanding rapidly and gaining increasing adherents and influence in economics, political science, law, strategy, sociology, growth and development, history and other disciplines. It is a highly diverse field and its many branches are rich in theoretical insight, relevant for policy and empirically useful." (Klein 1999, pp. 479) References Alchian, Armen A. and Demsetz, Harold (1972), 'Production, Information Costs, and Economic Organization', 62 American Economic Review, 777-795. Arrow, Kenneth J. (1963), 'Uncertainty and the Welfare Economics of Medical Care', 53 American Economic Review, 941-73. Brock, G.W. (2003) The Center For Public Justice, Public Justice Report, The New Institutional Economics, Third in a Series on Poverty, Wealth and Globalization, First Quarter, http://www.cpjustice.org/stories/storyReader$937 Retrieved November 05, 2006 Chandler, Alfred D., Jr (1962), Strategy and Structure: Chapters in the History of the American Industrial Enterprise, Cambridge, MA, MIT Press. Coase, Ronald H. (1937), 'The Nature of the Firm', in Coase, Ronald H. (ed.), The Firm, the Market, and the Law, Chicago, University of Chicago Press, 33-55. Davis, Lance E. and North, Douglass C. (1971), Institutional Change and American Economic Growth, Cambridge, Cambridge University Press. Duncan Williamson, Introduction to Management Accounting, Simple Definition of Management Accounting, 3rd March 2003, http://www.duncanwil.co.uk/manacc/trial/trial2.htm Retrieved November 05, 2006 Hayek, F.A (1937), 'Economics and Knowledge', in idem (1948), Individualism and Economic Order, London, Routledge and Kegan Paul, 33-56. Hayek, F.A. (1945), 'The Use of Knowledge in Society', in idem (1948), Individualism and Economic Order, London, Routledge and Kegan Paul, 77-91. Holmstrm, B. (1979), 'Moral Hazard and Observability', 10 Bell Journal of Economics, 74-91. Klein, P.G. (1999) "New Institutional Economics" Department of Economics, University of Georgia, http://encyclo.findlaw.com/0530book.pdf Retrieved November 05, 2006 Macneil, Ian R. (1978), 'Contracts: Adjustments of Long-Term Economic Relations under Classical, Neoclassical, and Relational Contract Law', 72 Northwestern University Law Review, 854-906. Management Accounting, Definition, Investor Dictionary.Com http://www.investordictionary.com/definition/management+accounting.aspx Retrieved November 05, 2006 Rosenberg A (1994) Does evolutionary theory give comfort or inspiration to economics In: Mirowski P (ed) Natural images in economic thought: markets read in tooth and claw, pp 384-407. Cambridge University Press, Cambridge New York Simon, Herbert A. (1961) [1947], Administrative Behavior, 2nd Ed, New York, Macmillan. Transaction cost economics as a predictor of management accounting practices at the Hudson's Bay Company, 1860 to 1914, Look Smart http://findarticles.com/p/articles/mi_qa3933/is_199811/ai_n8812605/print Retrieved November 05, 2006 Wikipedia, New Institutional Economics, http://en.wikipedia.org/wiki/New_institutional_economics Retrieved November 05, 2006 Williamson, Oliver E. (1975), Markets and Hierarchies: Analysis and Antitrust Implications, New York, NY, Free Press. Williamson, Oliver E. (1996), "Transaction Cost Economics and Organization Theory," Mechanisms of Governance. http://www.stanford.edu/jchong/articles/Yosem/Williamson%20--%20Mechanics%20of%20Governance.doc Retrieved November 05, 2006 Williamson, Oliver E. (2000), "Why Law, Economics & Organization" http://groups.haas.berkeley.edu/bpp/oew/wleaorg17b121800.pdf Retrieved November 05, 2006 Rudolf Richter. The New Institutional Economics - Its Start, Its Meaning, Its Prospects (2003) http://cniss.wustl.edu/workshoppapers/richterpaper.pdf Retrieved November 05, 2006 Read More