The concept of transaction costs are the centrepiece of New Institutional Economics
. They are the costs of engaging in the market, invented as a theoretical tool for explaining the existence of firms by Ronald H. Coase
in The Nature of the Firm
Transaction costs are divided into:
- Search costs – the cost of finding an exchange partner via obtaining information about the different prices available on the market.
- Negotiation costs – the cost of agreeing a contract, and
- Enforcement costs – the cost of making sure your exchange partner does not default on the contract.
According to New Institutional Economics, the purpose of a market is to lower these costs and so facilitate exchange. In a market place, be it an Arab bazaar or a Stock Exchange in London or New York, there are a variety of institutions to make it easier to trade. In a primitive market place you will still have a clustering of suppliers, so it is possible to compare all the products available, their quality and prices. By clustering together, the suppliers gain some security as they can cooperate in catching thieves. However, the practice of haggling makes it expensive to
In an advanced marketplace, such as a department store or a stock exchange, you have a massive variety of products available and specialised security staff and credit agencies to protect against theft and fraud. In most shops in today’s developed world, a policy of fixed prices reduces the cost of negotiating a contract. Stock exchanges minimise the costs of obtaining prices of the most complicated and abstract of products – ownership of corporations, and make visible the vast fluctuations in the value caused by speculation, as often only the highest levels of their management have full knowledge of their assets and profitability.
The New Institutional school of Economic thought holds that a decline in transaction costs, caused by the rise of institutions to minimise them, are the principle driving force behind economic growth since the beginning of the Middle Ages.
Some related concepts are transport costs (the costs of shiping your goods to market) and political costs (actions by the government that retard economic growth).