Umair Javed

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Theory of Transaction cost in historical

context
Introduction
From beginning of humankind, societies were simpler. One can easily produce the goods for personal
consumption. There was no need to contact with other humans. They were used to produce growth
plants just for sake of personal consumption . Humans were living a lives of isolation. They would
animals whenever they like. However, society has changed its contours throughout the history. Societies
were getting complex. Humans created complex but possible standard of lives. Throughout changes in
humans behaviour, requirement for transactions were not abrupt. It was rather slow process. But
industrial revolution in Europe drastically altered need for transaction. With massive consumption and
consumerism, transactions were needed to perform. Ronald Corase in this regard presented his theory
in 1937 in “Nature of Firm” whereby he discussed the fundamental nature of transactions costs and
need of institutions.

How transaction cost were carried out?

Biggest conundrum for social scientists for intellectual paragons were to look why transaction costs are
costly. Due to phenomenal increase of transactions costs, society needed to have policing and
enforcement structure for property right and security. Goods and services have carry extra values
attached producer and consumer. Sometimes consumers are more willing to pay more if certain more
features to product and services are attached. However, producer may have attached lower values to
their product. Because both producer and buyers are consumers are wiling to not to tell their respective
preferences. Reason for this tendency to tell false value to counterpart in economic activity is wealth
maximization behavior of individuals. Attributes to certain goods are attached. For example, if someone
has to buy mobile phone, they are told some abstract values that this mobile will be come with cutting-
edge technology that other companies might not offer. Such information create the situation of
asymmetric information created by economic agent. Similarly, in purchase of service, one can be fooled
by asymmetric information if seller or buyers are conveying different values than their expected values.

Ubiquitous nature of transactions

Transitions costs are inextricably linked modern lifestyle emerged with evolution of economic activity.
We have to pay for extra attributes and features we buy a good. This attributes could be tangible
features like when we buy premium versions of products like television we could experience more
advanced features in television. These attributes could be intangible in form of doctor services.

Types of Exchange
There are two types basic nature of exchange.
Umair Javed
Becon01173005

Personal Exchange
We can also call it clientize exchange. This type of exchange occurs within close circles of family
members, relative and friends. Usually, there are less element of fraud and chances of cheating.
Consequently, transaction costs will be minimum under this system.

Impersonal Exchange
When there is need of greater number of exchanges, then one has to perform the impersonal exchange.
So, it is inevitable to interact with unknown people. There would be more chances of cheating and
fraud. There would be could chances of asymmetric information. As a result, when we enter in this
system of exchange, the volume of transaction costs would be increased.

Impersonal exchange with Third Party Enforcement

In this system of exchange, impersonal exchange is possible through help of third party enforcement.
Third party enforcement could be comprised of judiciary, law enforcement authorities, and policing. If
the there is strong presence of enforcement by third party, then there would be less volume of
transactional costs. If enforcement is not effective, so transaction costs could pile up. Thus situation
happens in third world countries where institutional structure are not strong.