One of the more reasonable settings to consider non-negligible transaction costs
ID: 1136060 • Letter: O
Question
One of the more reasonable settings to consider non-negligible transaction costs is in the labor market. To formalize this concept, consider potential workers who must spend costly effort to find prospective employers (a) Suppose the potential worker finds the prospective employer. Upon working 1. together, the employer and the worker would generate a joint surplus of v. Suppose the prospective employer makes an ultimatum to the potential employee regarding salary, i.e. the division of the joint surplus. What fraction of the surplus will the prospective employer offer? Is the prospective employer offering to pay the would-be worker any salary? (b) Suppose searching for the prospective employer costs the potential worker e >0 in search costs. Anticipating the negotiation in part (a), will the potential worker look for a job?Explanation / Answer
T HE new institutional economics is preoccupied with the origins, inci-
dence, and ramifications of transaction costs. Indeed, if transaction costs are
negligible, the organization of economic activity is irrelevant, since any
advantages one mode of organization appears to hold over another will
simply be eliminated by costless contracting. But despite the growing reali-
zation that transaction costs are central to the study of economics,1 skeptics
remain. Stanley Fischer's complaint is typical: "Transaction costs have a
well-deserved bad name as a theoretical device . . . [partly] because there is a
suspicion that almost anything can be rationalized by invoking suitably
specified transaction costs."2 Put differently, there are too many degrees of
freedom; the concept wants for definition.
* This paper has benefited from support from the Center for Advanced Study in the Behav-
ioral Sciences, the Guggenheim Foundation, and the National Science Foundation. Helpful
comments by Yoram Ben-Porath, Richard Nelson, Douglass North, Thomas Palay, Joseph
Sax, David Teece, and Peter Temin and from the participants at seminars at the Yale Law
School and the Institute for Advanced Study at Princeton are gratefully acknowledged. The
paper was rewritten to advantage after reading Ben-Porath's discussion paper, the
F-Connection: Family, Friends, and Firms and the Organization of Exchange, and Temin's
discussion paper, Modes of Economic Behavior: Variations on Themes of J. R. Hicks and
Herbert Simon.
1 Ronald Coase has forcefully argued the importance of transaction costs at twenty-year
intervals. See R. H. Coase, The Nature of the Firm, 4 Economica 386 (n.s. 1937), reprinted in
Readings in Price Theory 331 (George J. Stigler & Kenneth E. Boulding eds. 1952) and R. H.
Coase, The Problem of Social Cost, 3 J. Law & Econ. 1 (1960). Much of my own work has been
"preoccupied" with transaction costs during the past decade. See especially Oliver E. William-
son, Markets and Hierarchies: Analysis and Antitrust Implications (1975). Other works in
which transaction costs are featured include: Guido Calabresi, Transaction Costs, Resource
Allocation, and Liability Rules: A Comment, 11 J. Law & Econ. 67 (1968); Victor P. Goldberg,
Regulation and Administered Contracts, 7 Bell J. Econ. 426 (1976); Benjamin Klein, Robert G.
Crawford, and Armen A. Alchian, Vertical Integration, Appropriable Rents, and the Competi-
tive Contracting Process, 21 J. Law & Econ. 297 (1978); and Carl J. Dahlman, The Problem of
Externality, 22 J. Law & Econ. 141 (1979). For an examination of Pigou in which transaction
costs are featured, see Victor P. Goldberg, P
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.