Microeconomics

CIA-3
Analysis of Transaction Cost
 

 Srestha Das 
2237058

2MAECO

Manjari Agrawal 
2237044
2MAECO

Submitted to

Professor Deepa V K

MA APPLIED ECONOMICS

DEPARTMENT OF ECONOMICS

CHRIST (DEEMED TO BE UNIVERSITY)

21st April,2023
Transaction cost is a concept in economics that refers to the costs associated with carrying
out an economic transaction. These costs can include search costs, negotiation costs,
monitoring costs, and enforcement costs. Transaction costs are an important consideration in
economic theory because they can have a significant impact on the efficiency and structure of
economic organizations and markets.

There are two main approaches to analyzing transaction costs: “The property rights
approach” and “The neoclassical approach”. While both approaches acknowledge the
existence of transaction costs, they differ in their explanation of the sources and solutions to
transaction costs.

The Property Right approach to Transaction cost theory has its roots in the work of
economists such as Ronald Coase, who argued that transaction costs depend on the allocation
and definition of property rights. Coase's work emphasized the importance of property rights
in shaping transaction costs, and he argued that the assignment of property rights could help
reduce these costs and improve economic performance.
The Property Rights approach, also known as the New Institutional Economics, argues that
well-defined and secure property rights are essential for efficient economic transactions, as
they provide incentives for individuals to invest, innovate, and engage in economic activities.
According to this approach, clear and enforceable property rights reduce transaction costs by
providing a framework for agreements and contracts, facilitating trade, and protecting against
expropriation or opportunistic behavior.
When property rights are well defined and enforceable, transaction costs are low, and
economic transactions can be carried out efficiently. When they are ill-defined or
unenforceable, transaction costs are high, and economic transactions may not take place at
all. For example, in the case of intellectual property rights, the government can create laws
and institutions that protect these rights, which would reduce transaction costs for those
seeking to transact in intellectual property.

The Neo-Classical approach to Transaction cost theory emerged in the 1970s and 1980s
as economists sought to build on Coase's work and develop a more comprehensive
understanding of the nature and causes of transaction costs. Neo-Classical approach is also
known as the mainstream economic approach, and tends to downplay the significance of
property rights and focuses more on market forces and price signals in shaping economic
outcomes. It assumes that transaction costs are low and that markets are efficient in allocating
resources without much emphasis on property rights as an explicit factor.
This approach emphasized the importance of market structures and information asymmetries
in shaping transaction costs.

The neoclassical approach to transaction costs is based on the idea that transaction costs arise
from market imperfections. According to the neoclassical approach, transaction costs are the
costs of gathering information, searching for a suitable transaction partner, negotiating the
terms of the transaction, and enforcing the agreement. This approach assumes that market
participants are rational and self-interested, and that they will always try to minimize
transaction costs in order to maximize their own benefits.
For example, in the case of a market with high transaction costs due to limited information, a
company could invest in research and development to generate more information, which
would reduce transaction costs for all market participants.

While the two approaches differ in their explanation of the sources and solutions to
transaction costs, there are similarities between the two approaches. Both approaches
acknowledge the existence of transaction costs and suggest that they can have a significant
impact on economic efficiency. Both approaches also suggest that transaction costs can be
reduced through institutional and market-based solutions.
However, there are also important differences between the two approaches. The property
rights approach emphasizes the importance of legal and institutional arrangements for
reducing transaction costs, while the neoclassical approach emphasizes market structures and
the behavior of market participants. The property rights approach suggests that well-defined
and enforceable property rights are necessary for efficient economic transactions, while the
neoclassical approach suggests that competition and market efficiency are the key drivers of
economic efficiency.

In practice, the most effective approach for reducing transaction costs may depend on the
specific transaction or economic organization being considered. For example, in cases where
property rights are well-defined and enforceable, the property rights approach may provide
the most effective solution for reducing transaction costs. On the other hand, in cases where
market imperfections are the main source of transaction costs, the neoclassical approach may
provide the most effective solution.

The superiority of the Property Rights approach or the Neo-Classical approach based on
transaction costs depends on the context and factors being considered. Both approaches have
their strengths and weaknesses, and the most appropriate approach may vary depending on
the specific economic, institutional, and policy context being analyzed. It is essential to
carefully consider the nuances and complexities of each approach and apply them
appropriately to the specific circumstances at hand.

REFERENCES
1. Journal of Institutional and Theoretical Economics (JITE) / Zeitschrift für die gesamte
Staatswissenschaft , March 1987, Vol. 143, No. 1, 4th Symposium on The New
Institutional Economics: Some Perspectives on the Modern Theory of the Firm (March
1987), pp. 7-22.

2. Williamson, Óliver. (1995). Transaction Cost Economics: How It Works; Where It is

Headed. Berkeley Olin Program in Law & Economics, Berkeley Olin Program in Law &
Economics, Working Paper Series. 146. 10.1023/A:1003263908567. 
3. Transactions Cost Theory influence in strategy research: A review through a bibliometric
study in leading journals Rodrigo Martins