THEORIES OF CO-OPERATIVES

PRESENTED BY

SIMRAN KAUR

MBA2ND YEAR

IGICM

ECONOMIC THEORY OF COOPERATIVES• Important elements of economy and society• Theory given by Faulkner and DeRond• Represents conceptual foundation applied to address the

research question• Set of related statements about how members, directors,

and employees would behave and achieve given assumptions about their objectives and resources• Raise information, communication and learning issues• Describe impact of cost or other efficiency criteria to

coordinate economic agents

TYPES OF ECONOMIC THEORY OF CO-OPERATIVES1. Agency Theory

2. Theory of Contracts

3. Transaction Cost Economics Theory

4. Game Theory

AGENCY THEORY• Compare what happens when a business is owned and managed

by the same person and when the business is owned by one person and managed by another whom one can call the agent• Explains relationship between principals and agents in business• Resolving problems that can exist in agency relationships• Main focus is on incentive and measurement problems• Two problems that agency theory addresses are:

1. When desires or goals of the principal and agent are in conflict

2. When principal and agent have different attitudes towards risk

CONCEPTS OF AGENCY THEORY• Agent is employed by a principal to carry-out a task on

their behalf• Agency refers to the relationship between principal and

agent• Agency costs are incurred by principals in monitoring

agency behavior• An agent becomes accountable to the principal by

whom they are employed

CHARACTERISTICS OF AGENCY THEORY• Two acting parties, namely the agent and the principal• Delegation of property rights by the principal to the

agent• Conflicting interests between both parties arising due

to maximization of their individual utility• Choice of some action under uncertainty by the agent,

which influences utility of principal• Informational asymmetry

CRITICISMS OF AGENCY THEORY• Focus on individual• Individualistic behavior• Contracts have to be adaptable• Neglecting ethical aspects• Ignoring distrust development of agents• Disregarding of principal’s obligation towards agent

THEORY OF CONTRACTS• Study of how individuals and businesses construct and

develop legal agreements• Draws upon principles of financial and economic behaviour• Conflict of interest between the parties and asymmetric

information• Extension of price theory in the following sense• Subset of Game theory• Seeks to understand organizations, institutions and

relationships between productive individuals when there are differences in personal objectives

TYPES OF THEORY OF CONTRACTS• OBJECTIVE THEORY OF CONTRACTContract is not an agreement in the sense of a subjective

meeting of mindsExistence of contract determined by legal significance of

external acts of a party to a purported agreement• SUBJECTIVE THEORY OF CONTRACTAgreement in which the parties have a subjective meeting of

mindsRoundly rejected by courts and commentators, in favor of

the objective

FORMS OF CONTRACTS• HIDDEN ACTIONUncertainty is exogenous and affects the agent’s performances Agent’s action is costly to himself but benefits the principalPrincipal designs contract based on observable outcome• HIDDEN INFORMATION PARADIGMAgent’s actions are observableUncertainty may be exogenous as well as endogenousAgent obtains perfect information by which feasible sharing

rules are derived

FORMS OF CONTRACTS(CONTD.)• CONTRACTUAL INCOMPLETENESSIncomplete contract theory suggests main concern to

consider limitations of contracts that fail to specify investment levels

Reasons of incomplete contract

i. Unforeseen contingencies

ii. Cost of writing contracts

iii. Cost of enforcing contracts

TRANSACTION COST ECONOMICS THEORY(TCE)• Organization of transactions that occur whenever a

good or service is transferred from a provider to user across a technologically separable interface• Understands firm as a hierarchy which allocates

productive resources by command• Developed by Coase in seminal paper• Effort to identify, explicate and mitigate contractual

hazards

CHARACTERISTICS OF TCE• Bounded rationality• Opportunistic behavior• Asset specificity• Uncertainty• Frequency

TYPES OF TRANSACTION COSTS• Search and information costs• Bargaining costs• Policing and enforcement costs

APPLICATIONS OF TCE• Credible commitments• Governance trade-off• New theory of incomplete contracting

CRITICISMS OF TCE• Focuses on cost minimization• Understands cost of organizing• Neglects role of social relationship in economic

transactions

GAME THEORY• Study of strategic decision making• Study of mathematical models of conflict and cooperation between

intelligent rational decision makers• Mainly used in economics, political science, psychology, as well as

logic and biology• Applied during situations in which decision-makers must take into

account the reasoning of other decision makers• Cooperative game theory studies frictionless bargaining among

rational players who can make binding agreements about how to play a game• Cooperative game theory applies both to zero-sum and non-zero-sum

games

GAME• Contest involving two or more decision-makers, each of

whom wants to win• Represents conflicting situations• Predetermined rules• Some games have transferable utility• For other games, utility is non-transferrable

CHARACTERISTICS OF GAME• Finite• Series of plans• Conflict of interests• Well known• Choices• Outcome

COMPETITIVE SITUATIONS IN GAME• Situation where there are two or more opposite parties

with conflicting interests and action of one depends upon the action that opponent takes• Situation of decision making under uncertainty• 3 categories

1. Decision-making under certainty

2. Decision-making under risk

3. Decision-making under uncertainty

ELEMENTS OF GAME• Players• Actions• Information• Strategies• Outcomes• Pay-off• Equilibrium

TERMINOLOGY OF GAME• Sum of gains and losses• Number of players• Number of activities• Number of alternative available to each person• Payoff(quantitative measure of satisfaction a person

gets at the end of the play)• Fair game• Saddle point(smallest value in row and largest value in

its column)

STRATEGIES OF GAME• Strategy is list of all possible action that he will take for

every pay-off • Assumption of rules governing the choices are known in

advance to the players• Particular strategy by which player optimizes his gains or

losses without knowing the competitor’s strategies is called optimal strategy• Expected outcome per play when players follow their

optimal strategy is called value of game• Types of strategies: pure and mixed

PURE STRATEGY• Decision rule always used by the player to select

particular course of action• Pre-determined course of action to be employed by the

player• Opponent is sure of the course of action• Objective of the players is to maximize gains or

minimize losses

MIXED STRATEGY• Player is using more than one strategy• Player decide his course of action• Opponent can’t be sure of the course of action• Objective of players is to maximize expected gains or to

minimize expected costs or to minimize losses by making solution among pure strategies with fixed probability

ASSUMPTIONS OF GAME• Each player has finite set of possible courses of actions

or strategies• Number of participants is known• Players attempt to maximize gains and minimize losses• Players adopt individual decisions without any direct

communication• Player ‘A’ gains or Player ‘B’ loses and vice versa• Players are intelligent and rational

ASSUMPTIONS OF GAME(CONTD.)• Each player makes individual decision• Participants of game have a perfect knowledge of game• Decision of game can be positive, negative or zero or

either of these to each participant• Pay-offs are predetermined in reaction to different

courses of players• Set of rules according to which pay-off will be

determined• Gain or loss of each player is finite and is fixed before

the game

ADVANTAGES OF GAME THEORY• Gives insight into several less-known aspects• Develops a framework for analyzing decision making

where interdependence of firms is considered• At least in two-person zero-sum games, game theory

outlines a scientific quantitative technique to arrive at an optimal strategy

LIMITATIONS OF GAME THEORY• Assumes each firm has knowledge of strategies of the

other• Assumption of maximin and minimax• Various strategies lead to endless chain• Analysis becomes elaborated to three or four persons

game• Use of mixed strategies for making non-zero sum games

determinant is unlikely to be found

APPLICATION OF GAME THEORY• Political Science• Economics and business• Biology• Computer science and logic

WELFARE ECONOMICS• Branch which is primarily concern with promotion of

welfare of community as measured in satisfaction derived from consumption of goods and services at the disposal of community• Term welfare in economics is health, happiness and

fortune of person or group• According to Alfred Marshall,” The economist, like

everyone else, must concern himself with the ultimate aims of man.”• Think on the line of maximizing the human happiness

without making others to suffer

HISTORY OF WELFARE ECONOMICS1. Neoclassical welfare economics• First developed in late 19th and early 20th centuries• Leading figures were Edgeworth, Sidgwick, Marshall and Pigou

2. New welfare economics• Leading figures were Pareto, Hicks and Kaldor• Uses ordinal utility• In 1940s

3. Happiness economics• Welfare of overall wealth and GDP• Richard Easterlin is the modern forefather• In 1970s

SCOPE OF WELFARE ECONOMICS• Economic and non-economic welfare• Both positive as well as normative study• Individual welfare as well as social welfare

IMPORTANCE OF WELFARE ECONOMICS• Pricing• Trade policy on international trade• Policy regarding monopoly vs competition• Taxation policy• National income• Socialist ideology

PARETO’S ANALYSIS OF WELFARE ECONOMICS• Vilifredo Pareto, an Italian economist, founder of new welfare

economist• Pareto’s analysis is called paretein optimum• Pareto formula

1. If everyone in the society is indifferent between two alternative social situations X and Y, then society should be indifferent too

2. If atleast one individual strictly prefers X to Y, and every other individual regards X to be atleast as good as Y, then society should prefer X to Y

3. Pareto optimality is in a given choice situation, consider set of alternatives X from which choice should have to be made

PARETIAN OPTIMALITY CONDITIONS• Optimum allocation of products• Optimum degree of specialization• Optimum factor utilization• Optimum allocation of factors of product among various

uses• Optimum direction of production• Optimum allocation offactor

SOCIAL WELFARE FUNCTION• Mapping from allocations of goods or rights among

people to the real numbers• Describe preferences of an individual over social states• Complete and consistent ranking of social states• If the social welfare ordering is continuous, it can be

translated into a social welfare function• Function f(U1,U2) of utility levels of all (both)

households such that a higher value of function is preferred to a lower one. This function is called Bergsonian welfare function

PROPERTIES OF SOCIAL WELFARE FUNCTION• Assumed to satisfy welfarism which means social

welfare depends only on utility levels of the household• Assumed to be increasing in each household’s utility

level(ceteris paribus)• Intensity of trade-off is usually assumed to depend on

degree of inequality

SOCIAL WELFARE INDIFFERENCE CURVES

CO-OPERATIVES• Serving the society and members also• Model of enterprise relevant in difficult economic times

and instances of market failures• Promote and support entrepreneurial development• Create productivity employment, raising incomes and

help to reduce poverty

COOPERATIVES IN WELFARE ECONOMICS• Agricultural cooperatives• Child-care cooperatives• Credit unions• Worker co-operatives• Utility co-operatives• Insurance co-operatives

THANK YOU!!!