Chapter 6
Chapter 6
The idea that “Perfect markets direct all production in the absence
of transaction costs (zero)” is a fiction, leading to the Coase
Theorem:
Cont’d….
Coase (1937)
o Market exchange is not costless
o Firms emerge to economize on transaction costs
o Boundary of the firm determined by nature and extent of
transaction costs
Therefore, TC are the costs that an actor bears in order to engage in
exchange (political, economic, social etc.).
TC exist because info is costly to obtain as well as due to “bound
rationality”, cognitive limits and the opportunism (self-interested
individuals will not readily disclose the information about their
preferences).
Cont’d….
Types of transaction costs
Cont’d….
Factors affecting effectiveness of contracts
o Asset specificity(የንብረት ልዩነት) A specialized investment that cannot
be redeployed to alternative uses or by alternative users except at a
loss of productive value.
Asset specificity can take several forms, of which human, physical,
site, and dedicated assets are the most common.
Specific assets give rise to bilateral dependency, which complicates
contractual relations.
o Safeguard The added security features, if any, that are introduced
into a contract in order to reduce hazards (due mainly to asset
specificity) and to create confidence.
Cont’d….
Safeguards can take the form of penalties, a reduction in incentive
intensity, and/ or more fully developed private-ordering apparatus to
deal with contingencies.