Explain the distinction between transaction costs and other costs that occur in economic systems.

Essay by shirleyexUniversity, Master's May 2004

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The 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 to analysis changes in transaction cost cause restructure such as vertical integration, multi-channel and so on. I would like to point out to possible problems with finding support for the conclusions reached in this paper.

Main body

1 Definition of transaction cost

Transaction cost has been described by Arrow as the costs of running the economic system but besides that no clear definition has been provided.

Broadly speaking, Transaction Costs are all costs of organizing and facilitating exchanges. They are not incurred by firms only. We as individuals incur transaction costs, when we buy a packet of cigarettes from newsagent or purchase cinema tickets. They account for over one third of US economy and are even higher for less efficient economies.

A number of kinds of transaction cost have come to be known by particular names. Search and information costs are costs such as those incurred in determining that the required good is available on the market, who has the lowest price, etc.. Bargaining costs are the costs required to come to an acceptable agreement with the other party to the transaction, drawing up an appropriate contract, etc.. Policing and enforcement costs are the costs of making...