6.1. Transactions and Transaction Costs

The representatives of Transaction Cost Economics believe that transactions are fundamental for the economic process. They are interested in the analysis of conditions under which welfare-enhancing transactions take place. As already spelt out in the chapter on predictability, the costs that have to be incurred to execute a transaction are a crucial factor for the number of transactions to be expected. Transaction costs are thus a basic concept used by representatives of the New Institutional Economics. Transaction costs are

– the costs of searching exchange partners with whom to transact and to get information on the qualities of the goods that they offer as well as information concerning their reliability;

– the costs of reaching agreement, i.e., bargaining and decision-making costs;

– the costs of monitoring whether the exchange partner has delivered as promised;

– the costs that have to be incurred to get the terms of the original contract implemented, e.g., fees for lawyers and court costs.

In economics, transaction costs have long been neglected. It was thus implicitly assumed that the costs of transacting were zero. This amounts to assuming that all actors were fully rational and had at their disposal complete knowledge concerning every conceivable state of the world. This is a highly unrealistic assumption and the representatives of transaction cost economics can claim credit for having outlined the consequences of assuming transaction costs to be positive.

Another traditional assumption in economics was to model the firm as a production function, i.e., as a technological relationship between inputs and outputs. In this approach, the firm really was a black box, because the process by which inputs were transformed into outputs was completely ignored. But different organisational structures have different consequences on the incentives of those working inside the firm and also on those transacting with the firm. It is, again, the merit of the representatives of transaction cost economics to have pointed to the crucial importance of organisational structures. Conceptualising organisation structures as devices to economise on transaction costs can lead to a fresh look at some business practices that had hitherto been judged as monopolising behaviour which can be interpreted differently now. This should, quite obviously, have far-reaching consequences for competition policy.