8/3/2019 Transaction Costs Economics

1/1

TRANSACTION COSTS ECONOMICS

Why do firms exist? Why is it sometimes beneficial to, say, produce a part needed in the

production process yourself, and why is it better to contract with an outside firm at other

times? Where are the boundaries between what will be performed internally, and what will be

performed externally? How should firms be organized? Robert Salomon explains thecontributions of Oliver Williamson to the field of Transaction Cost Economics, and he reacts

to some of the reactions to the announcement of the award:

Oliver Williamson, Nobel Honoree, by Robert Salomon: I was delighted to hear that Oliver

Williamson was awarded the Nobel Prize in Economics (shared with Elinor Ostrom). Oliver

Williamson is recognized for his contribution to the field ofTransaction Cost Economics,

building on the path-breaking work of scholars likeRonald Coase.

Transaction Cost Economics is a central theory in the field of Strategy. It addresses questions

about why firms exist in the first place (i.e., to minimize transaction costs), how firms define

their boundaries, and how they ought to govern operations.In Transaction Cost Economics, the starting point is the individual transaction (the synapse

between the buyer and the seller). The question then becomes: Why are some transactions

performed within firms rather than in the market, as the neoclassical view prescribes.

The answer, not surprisingly, is because markets break down.

As a consequence of human cognitive limitations, coupled with the costs associated with

transacting, the basic assumptions associated with efficient markets (e.g., anonymous actors,

atomistic actors, rational actors, perfect information, homogeneous goods, the absence of

liquidity constraints) fail to hold. For these reasons it is often more advantageous to structure

transactions within firms. And this is why firms are not just ubiquitous in our society, but also

worthy of study in their own right. This contrasts with the typical view of firms inneoclassical economic theory as, at worst, a market aberration that ought not exist, and at

best, a black box production function.

Williamsons contributions to the field of Transaction Cost Economics complement, and

extend, those of Coase. First, Williamson started with an explicitly behavioral assumption of

human behavior (bounded rationality). Second, he recognized that transacting parties

sometimes behave opportunistically and take advantage of their counterparties. Finally, he

identified features of transactions (e.g., specificity, uncertainty, frequency) that cause markets

to fail; and hence, are likely to lead certain transactions to be organized within firms

(hierarchies) rather than markets.

http://blog.robertsalomon.com/2009/10/13/oliver-williamson-nobel-honoree/http://blog.robertsalomon.com/2009/10/13/oliver-williamson-nobel-honoree/http://en.wikipedia.org/wiki/Theory_of_the_firmhttp://en.wikipedia.org/wiki/Theory_of_the_firmhttp://en.wikipedia.org/wiki/Theory_of_the_firmhttp://en.wikipedia.org/wiki/Ronald_Coasehttp://en.wikipedia.org/wiki/Ronald_Coasehttp://en.wikipedia.org/wiki/Ronald_Coasehttp://en.wikipedia.org/wiki/Ronald_Coasehttp://en.wikipedia.org/wiki/Theory_of_the_firmhttp://blog.robertsalomon.com/2009/10/13/oliver-williamson-nobel-honoree/