Transaction Costs

Transaction costs are the costs of using the market itself, the resources spent searching for a trading partner, negotiating and drafting an agreement, and monitoring and enforcing that the other party complies, distinct from the price of the good or service being exchanged. Ronald Coase introduced the concept in his 1937 essay The Nature of the Firm to explain why firms exist at all: a firm arises to internalize transactions whose transaction costs are cheaper to bear inside a managed hierarchy than to repeat, again and again, across the open market, and a firm expands until the cost of organizing one more transaction internally equals the cost of carrying it out on the market instead. Transaction costs became the organizing idea of New Institutional Economics, extended by Oliver Williamson into a general theory of which governance structure, market, firm or hybrid contract, best carries out a given transaction.