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This chapter models the optimal degree of delegation and centralization of government as the degree of availability of communication between periphery and centre in a hierarchy. Under bounded rationality, delegation is shown to be superior as it uses more information than centralization. Under delegation with risk‐averse agents, it is shown that new transaction costs are introduced since the risk‐averse agent will require a risk premium for incentive compatibility.
Keywords: bounded rationality; centralization; communication; delegation; government; hierarchy; incentive compatibility; risk premium; risk‐aversion; transaction costs
Chapter. 7105 words. Illustrated.
Subjects: Microeconomics
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