This assignment deals with the role of transaction cost in reaching to the efficient outcome. The analysis has been conducted from the perspective of a firm. Different approaches followed by the firms to negotiate the transaction cost has been discussed in the paper.
Role of Transaction Cost
The production of any particular good consists of a number of stages (Skousen, 2007). The beginning is when a company acquires raw materials and ending with the distribution of its manufactured goods and services to the end customers. The entire system can be collectively called a vertical chain (Besanko, et al., 2009). The main challenge to any entrepreneur is to organise various components of the vertical chain of a company.
In order to understand the concept of vertical boundaries of a firm, the role of transaction cost has gain enough support from eminent economists like Oliver Williamson, in 2009 explained the role of transaction cost economics while defining the boundary of a firm (Martins, et al., 2010). Transaction cost is the cost that a company has to incur in order to participate in market activities (Schneider, 2014). This paper illustrates how a company can come to a negotiation so that they can eliminate transaction cost in order to achieve efficient outcome.
According to Coase theorem, in an economy with no transaction cost, trade will provide efficient outcome but the only requirement would be well defined property rights (The Economists, 2010). In absence of transaction cost, if an individual wish to sell his car which has value attached to it, the first requirement is to own a car in the beginning. In the later stage, the car will be sold to the highest bidder so that the owner can reap the entire surplus (Todorova, 2007).
Effect of the Presence of Transaction cost: In the modern economy, individuals and companies have to incur transaction cost so that they can own resources which can be utilised by the concerned owner to earn profit. Considering the same example, in a modern economy, if an individual has to sell a car then the seller has to find potential buyer who will negotiate over the price and there will be the intervention of a governing body that will enforce the transfer of property rights (Martins, et al., 2010). In simple words, legal cost of the transaction has to be incurred by both the parties.
A Firm’s Perspective
A firm in order to reach an efficient outcome with increasing positive returns on the invested capital would require that it has to incur minimum transaction cost. The accomplishment of this objective requires firms to negotiate it with its suppliers (Federal Trade Commission, 2005). If a firm can obtain input at the lowest price, then it will have the opportunity to raise its profit. A firm need to find suppliers who will provide the raw materials at the lowest cost and this search involves cost. Again, the firm will have to engage in bargaining so that it can lower the cost incurred for production. After obtaining the raw materials in order to produce the output, the firms need labour who will put the required effort to transform input into output.