Transaction costs refer to the costs incurred in order to carry out a market transaction.
The concept of transaction costs was first developed by Nobel Prize Ronald Coase who wondered why companies exist. According to Coase, transaction costs are the costs associated with using the market price mechanism and companies are created in order to reduce those costs.
Types of transaction costs
- Searchcosts: costs associated with finding the suppliers of the good or service we need. Investigate its suitability, reliability, availability and prices.
- Contract costs: are the costs of negotiating and drafting contracts. To which are included the costs of verifying compliance with the agreement.
- Coordination costs: it is the cost of organizing and coordinating the different inputs or processes that are required to obtain the desired good or service. Among these costs are the costs of communication, transportation, etc.
The relationship between transaction costs and company size
According to Coase, the company and the market are alternative means of economic organization. In the market, goods and services are traded in a decentralized manner. In the case of the company instead, it is determined internally which transactions are carried out and a hierarchical organization system is established.
For example, a designer can sell his services independently in the market or he can be part of a company’s workforce, dedicating himself exclusively to it.
Companies exist because using the market mechanism implies costs, so companies are a more efficient way to organize resources and reduce the costs of carrying out each transaction.
How long will a company grow? The company will grow until the costs of organizing an additional transaction internally match the costs of acquiring it in the open market.
Companies do not grow unlimitedly since organizational costs grow with size. In this way, there will come a point where it is more efficient to use the market mechanism.