Transaction Cost Economics and Organized Labor Essay

1030 Words 5 Pages
Cooperation and exchange among individuals often organize in firms rather than adhering to market institutions. This anomaly of market systems can be explained through what Oliver Williamson calls “Transaction Cost Economics.” Transaction costs are defined as the “costs of running the economic system” (Williamson 18). Similar to friction in a physical system, transaction costs may be small compared to other costs such encountered by market players, but basing entire models on a ‘frictionless’ system is unrealistic. It is these transaction costs explain the development of firms and hierarchies rather than contracting by market forces.

There are three limitations to a market system: bounded rationality, opportunism and asset
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Staying with the original accounting firm insures that many of these transaction costs will be kept to a minimum and in some cases eliminated all together.

The three market limitations produce four concepts of contract: planning, promise, competition, and governance. Planning assumes high opportunism, asset specificity but no bounded rationality. Promise assumes bounded rationality, asset specificity but not opportunism. Competition assumes both bounded rationality and opportunism, but not asset specificity. Finally, governance assumes all three. The contract concepts of planning and promise can be ruled out of most market systems and are rarely observed in the real world. Their assumptions of no bounded rationality and no opportunism respectively are unrealistic assumptions about basic human nature. A basic assumption of a market system is that players will act rationally and work to improve their present position. In the absence of asset specificity, competition arises which accounts for the majority of the situations in a market setting. Since asset specificity is often absent or negligible, the market model is widely accepted and firms are regarded as outliers of the model. However, when asset specificity is a factor, governance is the presiding form of contracting which is often the case in firms. Coase offers a similar argument that the main reason to move to a firm instead of using market mechanisms is the cost associated with

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