Transaction costs
Topic: Market Structures, Market Failure and Competition · NCERT: Beyond NCERT
Meaning
Transaction costs are the costs of making an exchange, beyond the price itself. They include:
- finding a partner (search);
- negotiating terms;
- drawing up contracts;
- enforcing the deal.
They are central to the Coase theorem (Ronald Coase, "The Problem of Social Cost", 1960; Nobel 1991). The theorem says that if property rights are clear and transaction costs are low, private bargaining will solve an externality efficiently. When transaction costs are high, bargaining breaks down and the state often has to step in.
Example
Delhi's winter smog comes from millions of polluters and harms millions of residents. Bringing all of them together, agreeing on who pays whom and enforcing the deal would be impossibly costly. Victims also free ride on one another. So private bargaining cannot fix the problem, and government rules or created markets are needed.
Don't confuse with
- Price: the amount paid for the good itself. Transaction costs are the extra effort and expense needed to make the deal happen.