In law, agency is the relationship in which one party acting as an agent on behalf may undertake the control of the other individual in concern by the virtue of employing the principle governing the dealing with the third parties. Agency has its root in ancient servant master relations. The involvement of agency in dealing is considered a legal issue when the agent injures or does any wrongs with the third party. The principles employed in the dealing are bound by and liable for the acts of such agents as stock brokers, business agents, contractors, real estate agents, lawyer, union representatives, private detectives, and managing partners in Anglo-American law. At present scenario, the agencies have taken a significant role in the world of trade and commerce.
The above answer is very good. To simplify, though, an agency is formed by allowing someone to act on your behalf. You would be the principle. The person acting for you is the agent. As long as the agent is acting within the scope of his duty to you, the principle is generally liable for the actions of the agent. For example, you allow someone to sell your home on your behalf as is common in real estate. You are the principal, the person selling the home is your agent.