The Elgar Companion to Transaction Cost Economics
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The Elgar Companion to Transaction Cost Economics

Edited by Peter G. Klein and Michael E. Sykuta

Since its emergence in the 1970s, transaction cost economics (TCE) has become a leading approach in the research on contracts, firm organization and strategy, antitrust, marketing, inter-firm collaboration and entrepreneurship. With contributions by leading scholars in economics, law and business administration – including Oliver E. Williamson, recipient of the 2009 Nobel Prize in economics for his development of the transaction cost approach – this volume reviews the latest developments in TCE and applies them to contemporary theoretical and empirical problems.
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Chapter 14: Bounded Rationality and Organizational Economics

Nicolai J. Foss


Nicolai J. Foss In very overall terms the existing research efforts on bounded rationality may be understood as a very diverse set of attempts to elaborate and examine the insights that: (1) the human capacity to process information is limited (Simon, 1955); (2) humans try to economize on cognitive effort by relying on short-cuts (‘heuristics’; Simon and Newell, 1972); and (3) because of (1) and (2), as well as other factors, such as the influence of emotions on cognition, human cognition and judgment is subject to a wide range of biases and errors (Tversky and Kahneman, 1986; Rabin, 1998). Economists’ thinking about the role of rationality (bounded as well as full) has surprisingly often been done with reference to the business firm. Thus, the issue has been highlighted in debates ranging from the descriptive validity of profit maximization in the 1940s over Herbert Simon’s criticism of oligopoly theory (Simon, 1979) to modern debates on incomplete contracting and therefore issues that are central to new institutional economics, such as efficient firm boundaries (for example, Williamson, 1985; Hart, 1990; Tirole, 1999). The reason why economists have associated firm organization and bounded rationality (BR) arguably lies in the inherent complexity and uncertainty of decisions relating to competitive strategy, investment decisions, the design of human resource management systems, and so on. By comparison most consumption choices seem relatively simple and more given to a treatment in terms of the standard maximizing model. Recently, BR has, under the banner of behavioural economics, neuronomics, and so...

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