Essential Coase: What Are Transaction Costs?
Welcome to the essential ideas of Ronald Coase.
One of Coase's most significant contributions to our understanding of how the economy worksis
his explanation of the importance of transaction costs—the costs that people incur
when they exchange goods and services with others. For example, it costs time and money to find a
seller of the good or service a person wants to buy. There are also bargaining and decision costs,
like how the price of a good or service is determined and drawing up the contract associated
with a sale. And then there are enforcement costs, for example the courts, lawyer fees or
other legal institutions involved in resolving disputes after an exchange is completed.
Prior to Coase, economists greatly underestimated, and
even ignored the importance of transaction costs. Let's explore this important idea with an example.
Bob is a cyclist who wants to buy a new bike. And Jane's company builds and sells mountain bikes.
Traditionally, economists would assume that Bob and Jane find each other,exchange
money for the bike, and everyone is better off. But Coase's insight is that it's more complicated.
First, Bob has to decide what kind of bike he wants, and perhaps what brand. That takes time,
and so imposes a cost on Bob. Having decided what bike he wants to buy, he has to find a
store that sells it and this, too, imposes a cost. Having located and travelled to Jane's bike shop,
Bob and Jane have to agree on a price for the bike Bob wants to buy. This negotiation, too,
imposes a cost on both Bob and Jane. And Jane, the seller, faces other transaction costs.
First, Jane had to advertise that she carries this particular bike, and Jane needs to have a
lawyer review the contract she has with the bike manufacturer so that she understands
the obligations she has to Bob for the proper functioning of the bike. And, she
pays a fee so that she can accept credit cards, which Bob uses to buy the bike.
These transaction costs are present in every exchange that occurs every day,
and are sometimes so high, they impede or even prevent exchanges from taking place.
Coase's insight into the prevalence and importance of transaction costs in the economy
transformed the way economists viewed how markets work.
For more information on Ronald Coase visit EssentialCoase.org,
and to learn about more essential scholars, visit EssentialScholars.org
