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|Managerial Economics |
|Course Assessment 1 |
|Jinglu Han 8996966 |
|Global MBA 2013 Shanghai |
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|2013-03-03 |

Transaction Cost Economics

Ronald Coase introduced in his article “the nature of the firm” (1937) transaction cost. Coase asserts that transaction costs are the costs of using the market and are the reason why production processes are organized within a firm, rather than purchased from the market, when the cost of using the market is higher than the cost of internal production. In his article, Coase concludes that transaction costs can be avoided by organizing activities within a firm in accordance with the nature of the firm within the context of the institutional production structure.

Coase’s theory was not developed any further into the 1980s and 1990s. Williamson and others greatly extended Coase’s theory and founded the theory of Transaction Cost Economics (TCE), which explores the dimensions explaining transaction costs and contractual forms (Williamson, 1981). TCE is useful in the determination of the most efficient organizational structure and what firms or markets are more efficient to coordinate exchange. According to Williamson (1981), the theory has shifted away from Coase’s initial intentions and more generally concerns issues of appropriation, ownership, alignment of incentives and self-interest.

Madhok, A. concludes in his article (2002) that—in spite of emphasizing difference issues—both Coase and Williamson regard firms and markets as alternate means of coordination: the firm being characterized by coordination through authority and the market being characterized by coordination through the price mechanism.

Key Characteristics of Transaction Cost Economics

A transaction occurs when a good or service is transferred across a technologically separable interface; one stage of activity terminates and another begins. Transaction cost economics focuses on transactions and the costs incurred over its implementation. As opposed to the costs of internal coordination, transaction costs include costs such as researching potential suppliers, collection of pricing information, negotiating contracts, monitoring supplier output, and the legal costs incurred should the supplier breach contractual negotiations.

TCE determines whether a firm should produce something internally or purchase it from the market. When technical efficiency is higher than transaction efficiency, market firms experience two benefits: taking advantage of economies of scale and the learning curve, and the elimination of bureaucracy.

TCE presumes that independent firms are bound by the limits of their own knowledge. Uncertainty and