Essential Coase: Transaction Costs & Institutions
Welcome to the essential ideas of Ronald Coase.
In a previous video, we explored the importance of the costs incurred when
goods and services are exchanged, such as the time it takes to find a person to exchange with,
the time and costs to negotiate a deal, and the costs of enforcing the sales agreement.
Coase called these “transaction costs.” But he not only identified the importance
of transaction costs, he also understood the way they shaped how the entire economy works.
As Coase explained, it's important to keep transaction costs low so that more economic
exchanges can occur, which makes people better off. But when transaction costs are too high,
they impede economic activity. For example, imagine if the legal and
regulatory steps required to buy a house—hiring a realtor and a lawyer and changing titles with the
land registry office, and so on—were also required when you bought a bike. No one would ever buy a
bike because the transaction costs are too high. However, for a major and costly purchase like a
house, the higher transaction costs don't impede exchange. Or imagine if bikes were only allowed to
be sold in separate parts. You have to buy the frame from one store, the tires from another,
the gears and brakes from another, and the accessories from yet another. The time,
energy and costs involved would likely prohibit almost everyone except the most ardent cyclists
from buying bikes. Simply put, the transaction costs involved in buying a bike would be too high.
Given that there are transaction costs for every exchange we make, and because it's so important
to keep them as low as possible, many of the institutions we see in the economy emerged to
do exactly that—minimize transaction costs. Take the banking industry, for example,
whose entire reason for being is to conveniently –and at a low cost—bring
together savers and borrowers. Without banks, the transaction costs for borrowing money would be
much higher because it would mean borrowers would have to spend a lot of time and money to find
other people interested in lending their savings. A more modern example is internet search engines,
which reduce transaction costs by making it easier to find shops and sellers who offer
what you're looking for. Online reviews, too, reduce transaction costs because they
help would-be buyers identify better, potentially more trustworthy sellers and service providers.
Coase not only identified the importance of transaction costs, but also how businesses
and institutions designed to lower the costs of exchange are all around us today.
For more information on Ronald Coase visit EssentialCoase.org,
and to learn about more essential scholars, visit EssentialScholars.org
