The transaction cost approach to the theory of the firm was created by Ronald Co
ID: 1112359 • Letter: T
Question
The transaction cost approach to the theory of the firm was created by Ronald Coase. Transaction cost refers to the cost of providing for some good or service through the market rather than having it provided from within the firm. Coase describes in his article "The Problem of Social Cost" the transaction costs he is concerned with:
In order to carry out a market transaction it is necessary to discover who it is that one wishes to deal with, to conduct negotiations leading up to a bargain, to draw up the contract, to undertake the inspection needed to make sure that the terms of the contract are being observed, and so on.
More succinctly transaction costs are:
search and information costs
bargaining and decision costs
policing and enforcement costs
Coase contends that without taking into account transaction costs it is impossible to understand properly the working of the economic system and have a sound basis for establishing economic policy.
What are the ways of reducing transaction costs? Do you think online shopping is good for reducing transaction cost? Are there any disadvantages? Briefly, discuss.
Explanation / Answer
Coase theorem offers a solution to the problem of externality. The transaction in the society is composed of search and information cost, bargaining cost and enforcement costs. See this in the market for lemons, insurance, banking or any other market. Society can achieve their optimal levels it through bargaining process if the following three conditions hold:
Thus, Coase theorem provides the essential circumstances under which private markets are most likely to come up with effective solutions to the problem of externalities. The outcome will be optimal and hence efficient but they will no more be equitable.
In the case with convenience stores, most of the time the store owners have more information about the products they are displaying than the consumers. For consumers, they are more concerned about making their purchases under one roof rather than searching for the stores selling the same products at a lower price.
In a way, this is a searching cost that affects buying decisions. Consumers may be willing to pay a higher price for a product they can buy in a nearby store instead of searching it in remotely located stores for a lower price.
Used cars market (used cars are termed as lemons) is a type of market in which sellers always have more information than the buyers as they know which of their cars is a lemon (poor quality car). This information asymmetry makes buying decision difficult and the supply and demand model is unable to capture this. Hence their willingness to pay is impeded by this asymmetry.
Internet is playing a pivotal important role in many markets. Reduced consumer search costs has led to a wave of creative destruction. The tools of Internet make it easier for consumers to find lower-price sellers, meaning lower-cost firms (an increased concentration of merged firms to reduce cost) have grabbed larger shares of business away from their higher-cost competitors.
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