Identify the Key Characteristics of Tce. Analse the Vertical Boundaries of a Firm by Describing the Critical Role Played by Coordination in a Vertical Chain.

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  • Topic: Transaction cost, Contract, Cost
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  • Published : November 5, 2010
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EVOLUTION OF THE FIRM
In the 1840’s the firm was characterised by being family owned. Therefore businesses were small and widely dispersed. Businesses were limited by the infrastructure at the time – transportation was done mainly by sea; hence it was very slow, communication was also done by the same medium, financing was basically none existent because the banks did not want to take on what seemed at the time a risky venture. If loans were given it was based on personal relationships. There was nothing to prevent price fluctuations in the market. Product technology was not developed. Government was not actively involved in the business environment. In the 1910’s, as a result of the introduction of railways businesses began to expand and looked to vertically integrate. Mass production led to less companies being around but the ones left were much larger and were able to collude in the market; therefore government had to intervene in the market. The infrastructure now facilitated agency-principal relationship in business. The telephone drastically reduced the time spent in communicating and suppliers and distributers could keep abreast of what was happening in the market place so that they would know how to plan production so to minimise oversupply. In the world today globalisation plays a major role. Specialists are emerging as firms no longer see the need to vertically integrate. New modes of transportation: - air travel, interstate trucking were introduced. The computer has made communication almost instant. Banks have large sums available for investment based of the firm’s ability to pay back. Changes in production technology create better quality of goods at lower costs. Government regulation increased and this changed how firms compete in the marketplace. TRANSACTION COST DEFINITION

‘Transaction costs consist of costs incurred in the searching for the best supplier/partner/customer, the costs of establishing a supposedly ‘tamperproof’ contract, and the costs of monitoring and enforcing the implementation of the contract.’1 Transaction costs is also known as coordination costs. The total cost incurred by a firm consists of two components – transaction costs and production costs. Transaction costs include all information needed to coordinate the work of people and equipment that perform the primary processes. Production costs include costs incurred from the physical or other primary processes necessary to create and distribute the goods or services being produced. Firms are faced with difficulties with the market which leads them to transact in house production of the goods. When the market is favourable it is used. CHARACTERISTICS OF TRANSACTION COST

Transaction cost economics (TCE) is similar to game theory where all the parties to the contract is assumed to understand the strategic situation and will position themselves accordingly; but TCE differs from game theory because contractual incompleteness sets in as the limits on rationality becomes binding in relation to transactional complexity. TCE uses authority as a way to deter ‘bad games’. The key characteristics of transaction cost economics are:

1.Bounded rationality: concept that decision makers have to work under three unavoidable constraints oOnly limited, often unreliable information is available regarding possible alternatives and their consequences. oHuman mind has only limited capacity to evaluate and process the information that is available. oOnly a limited amount of time is available to make a decision. These limits (bounds) on rationality also make it nearly impossible to draw up contracts that cover every contingency, necessitating reliance on rules of thumb. – Definition from BusinessDictionary.com 2.Opportunism: practice of exploiting circumstances in self-interest, especially without regard to moral principles or others’ interests. - Definition from BusinessDictionary.com 3.Uncertainty: decision making – situation where the current...
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