Answer to Question #199399 in Economics for lee kuek

Question

Explain the concept of transaction cost and its significance to businesses.

Answer 1

Transaction costs are costs (monetary and non-monetary) that arise when making managerial decisions on the sale of goods (information costs about sales markets, buyers, suppliers, competitors, selling prices, advertising costs, contracts, etc.).

The concept of transaction costs was introduced by R. Coase in the 30s in his article "The Nature of the Firm". It has been used to explain the existence of hierarchical structures that are opposite to the market, such as the firm. R. Coase linked the formation of these “islands of consciousness” with their relative advantages in terms of saving on transaction costs. He saw the specifics of the functioning of the company in the suppression of the price mechanism and its replacement with a system of internal administrative control.

One of the most important features of transaction costs is that they allow for significant economies of scale. There are constant components in all types of transaction costs: when information is collected, it can be used by any number of potential buyers and sellers; contracts are being standardized; the cost of developing legislation or administrative procedures depends on little on how many persons are subject to.

The role of transaction costs in the economic world is often compared with the role of friction in the physical world: "Just as friction interferes with the movement of physical objects, dispersing energy in the form of heat, so transaction costs prevent the movement of resources to users for whom they are most valuable." spraying "the usefulness of these resources in the course of the economic process. Just as each known physical object is given such a form that either minimizes friction, or obtains from it some useful effect (a wheel, for example, serves both) so, in fact, any institution known to us arises as a reaction to the presence of transaction costs and in order, apparently, to minimize their impact, thereby increasing the benefits of exchange. Finally, it should be noted that an economist who ignores the existence of transaction costs will face the same difficulty in explaining the economic behavior that would be encountered by a physicist who ignores the fact of friction when describing the motion of physical objects. "