Transaction costs Theory

R. Coase observes that market prices govern the relationships between firms but within a firm decisions are made on a basis different from maximizing profit subject market prices. Within the firm decisions are made on through entrepreneurial coordination. Coase quotes D.H. Robertson on there being,

"Islands of conscious power in this ocean of unconscious co-operation like lumps of butter coagulating in a pail of buttermilk."

There are a great variety of arrangements in producing goods. In agriculture often most of the labour force works on a day-to-day basis. In other industries the labour force may be permanent, tied to the firm with long-term contracts. Repair services in some firms may be supplied by an internal organisation; in others it is provided by specialized firms from outside. A firm is a system of long-term contracts that emerge when short-term contracts are unsatisfactory.

The unsuitability of short term contracts arise from the costs collecting information and the costs of negotiating contracts. This leads to long term contracts in which the remuneration is specified for the contractee in return for obeying, within limits, the direction of the entrepreneur.

R. Coase notes that the economic theory of the production level of a plant in the short run and long run are well worked out, but the theory of the size of the firm is not well developed. This is clear in the matter of acquisition of companies by other companies.

Ronald Coase gives the origin of “The Nature of the Firm” as a course in the organisation of the business unit which he taught in 1932. He noted that there are inconveniences of market transactions, but if transactions are not governed by the price system there has to be an organisation. The object of an business organisation is to reproduce the conditions of a competitive market for the factors of production within the firm at a lower cost than the actual market. But if an organisation exists to reduce costs then why is there any market transactions at all? Coase gave two reasons:

Þ the costs of organising additional transactions rise with scale and are equated with the costs of additional market transactions;

Þ the organisation of bigger firms may not reproduce the effects of market conditions.

In economics R. Coase single handedly pioneered a nonmathematical but deeply penetrating economic analysis. He examined questions that never occured to most economists. In the rare cases where others considered those questions they did not come to meaningful conclusions as did Coase. The uniqueness of his contribution was recognized with his being awarded the Nobel Prize in economics.

His contribution which is most widely known in economics is what George Stigler named the Coase Theorem. Coase never referred to this proposition as a theorem and its role is subsidiary to transaction cost approach.

In the absence of transaction costs many surprising results hold. The Coase Theorem says that even in the presence of externalities (although he doesn't use that term) if there are no transactions costs to creating private agreements the levels of productions of goods will be the same no matter which party to an externality has legal right to compensation. This means that the intervention of the government in the case of externality doesn't affect production if there are no transaction costs. Intervention of the government in such cases does affect the distribution of income. The economics profession has focused upon the content of the proposition rather than the fact that significance of the presence or absence of transaction costs.

Date: 2016-03-03; view: 703