Explain The Distinction Between Transaction Costs And Other Costs That Occur In Economic Systems

2839 words - 12 pages

IntroductionThe economic importance of transaction costs in widely recognized. In modern economies, transaction costs have become equally (and perhaps more) important than production costs. Early economic theory focused entirely on production costs assuming that transaction costs did not exist. However, nowadays it has become relatively more sensible to do research in transaction cost rather than production cost.Naturally, there are four parts to the essay. The first part explains the definition of transaction cost. The following parts try to compare the difference with production costs and look at factors contribute to transaction costs. The last part is giving case on retail industry ...view middle of the document...

Transaction costs arise when it is in the interests of one party to act opportunistically at the expense of the other. The other party then spends time, money, time and effort writing and enforcing contracts to prevent this kind of behavior. We have to note that if a firm does not suffer as a consequence of opportunistic behavior, this does not mean it did not incur transaction costs. Costs of preventing the behavior are very much part of transaction costs. On the other hand possibility of an opportunistic behavior will raise the risk of a project, and hence the return required by investors. Therefore, contracts are at the very heart of transaction costs. Complete contracts would eliminate the costs of outsourcing, as they would clearly specify each party's rights and responsibilities for any type of situation that might possibly arise.2. Distinction between transaction costs and production costA company's costs can be classified in two categories: production costs and transaction costs. Production costs are those we are most familiar with. They are all the costs that are associated directly with productive activities (Masten, 1982) such as manufacturing, logistics and product development. Transaction costs, on the other hand, are those cost associated with organizing economic activity. They thus vary with organizational form (Mastern, 1982).2.1 Distinction in definitionØ Production cost is costs associated with transforming inputs into outputs or "direct" production expenses. Production cost refers to opportunity cost of using labor, capital, land, and entrepreneurship in the production of goods and services. Production cost is important to supply. The price received by a seller must be great enough to cover production cost. Note that production cost includes what you probably think of as the traditional "cost of doing business," e.g. cost of materials used in production, cost of people in production that does not do maintenance. But it includes other less obvious costs, as well. While labor, capital, and land typically involve an explicit cost--an actual money payment--the cost of entrepreneurship is often an implicit cost. In particular, the cost of entrepreneurship is termed normal profit.Ø Eirik Furubotn and Rudolf Richter examine transaction costs in the following terms:"Transaction costs include the costs of resources utilized for the creation, maintenance, use, change, and so on of institutions and organizations.... When considered in relation to existing property and contract rights, transaction costs consist of the costs of defining and measuring resources or claims, plus the costs of utilizing and enforcing the rights specified. Applied to the transfer of existing property rights and the establishment or transfer of contract rights between individuals (or legal entities), transaction costs include the costs of information, negotiation, and enforcement.Furubon, Eirik G and Rudolf Richer,1997Distinction compared...


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