ABSTRACT

This chapter discusses the concept of transaction costs and provides the theoretical link to institutions. Economic theory is centered on the concept of efficiency. Students in introductory microeconomic courses are taught that the efficient outcome is a world of perfect competition in which all firms earn the normal rate of return on their operations. Transaction costs are the costs of negotiating, measuring, and enforcing exchanges. Transaction costs include the costs of enforcing exchanges. In 1960 Ronald Coase published an article that clarified the role of transaction costs in neoclassical economic theory. His finding has come to be called the Coase theorem. The theorem states that in a world of zero transaction costs, the efficient outcome always prevails. The Coase theorem can be related directly to the role of institutions in an economy, as illustrated in the example of transaction costs. A monopoly exists when there is a single seller of a good or service.