Transaction costs are the costs that have to be incurred in order to reach a transaction.
What are transaction costs?
This can relate to the economic market, but also in politics and within organizations this concept is used. Transaction cost theory is an important part of the new institutional economy as a supplement to the neoclassical economy.
In the economy, it concerns the costs over and above the price of the product. Within the neoclassical economy, only the price of the product itself is taken into account and it is assumed that it is completely rational, that everyone pursues profit maximization and that all parties have all relevant information.
Transaction costs were seen by Coase as costs for the use of the market. Precisely because not every party has complete information, these costs occur and a role arises for the company, a role that does not clearly follow from the neoclassical theory. The theory was extended by Williamson, according to which the costs result from uncertainty and opportunism in which limited rationality also plays a role. In many transactions, one of the parties therefore has an information advantage.
North expanded the concept further by not considering every individual transaction, but the framework of institutions that lower or even increase transaction costs. Within the development economics it becomes clear how it is possible that certain countries have greater economic growth than others.
Example of transaction costs
When purchasing a product, the costs consist not only of the price of the product itself, but also the energy and effort it takes to decide which one best meets the requirements, where it has to be purchased, at what price, transport costs, the time spent on the purchase. All these additional costs are transaction costs. When evaluating a transaction, one also has to take these costs into consideration because they can be significant in certain cases.
Some transaction costs are known under their own definition:
- Search and information costs are costs that have to be made in order to find out whether a product is available, where it is available, where it can be found at the lowest price, etc.;
- contract costs are the costs of reaching an agreement with another party in the transaction, drawing up a contract, etc. This is analyzed in game theory in game of chicken. In the securities markets, the difference between the bid and late prices is the transaction costs;
- Control and compliance costs are the costs that have to be incurred to ensure that all parties comply with the terms of the contract and the costs incurred to take action against a party that does not comply with the conditions, for example legal costs.
Over time, major innovations have led to a reduction in transaction costs. Important were innovations that contributed to:
- the mobility of capital;
- the reduction of information costs;
- risk-sharing and distribution.