1. 1

2. When market, when firm Transaction basic unit of Analysis
Dimensions of a transaction are price and quality 2

3. An organization is a response to issues but has its own issues3

4. Organization
Both uncertainty and bounded rationality are necessary to require an organization. Why is one not sufficient? 4

5. Organization
Both uncertainty and bounded rationality are necessary to require an organization. Why is one not sufficient?
If there is no uncertainty everything is known and bounded rationality is most likely sufficient to process the information. 5

6. Organization
Both uncertainty and bounded rationality are necessary to require an organization. Why is one not sufficient?
If there is no uncertainty everything is known and bounded rationality is most likely sufficient to process the information.
With uncertainty there are many possible events. With unbounded rationality all possible events are known, and a contract can be designed that will dictate particular action in each case. 6

7. Organization
Both uncertainty and bounded rationality are necessary to require an organization. Why is one not sufficient?
If there is no uncertainty everything is known and bounded rationality is most likely sufficient to process the information.
With uncertainty there are many possible events. With unbounded rationality all possible events are known, and a contract can be designed that will dictate particular action in each case.
Because rationality is bounded not all possible events are known. This is why it is impossible to write a complete contract. 7

8. Organization
Both uncertainty and bounded rationality are necessary to require an organization. Why is one not sufficient?
If there is no uncertainty everything is known and bounded rationality is most likely sufficient to process the information.
With uncertainty there are many possible events. With unbounded rationality all possible events are known, and a contract can be designed that will dictate particular action in each case.
Because rationality is bounded not all possible events are known. This is why it is impossible to write a complete contract.
Solution: Organization 8

9. Risk vs. Uncertainty
 It will appear that a measurable uncertainty, or "risk" proper, as we shall use the term, is so far different from an unmeasurable one that it is not in effect an uncertainty at all. We ... accordingly restrict the term "uncertainty" to cases of the non-quantitative type. (Frank Knight, Risk, Uncertainty and Profit)

10. Uncertainty
Even unbounded rationality cannot cope with Uncertainty

11. Contracts
A contract cannot be “sharp in” because buyer does not know what exactly she wants from seller (e.g., car door). Knowing what you want requires in-house production (e.g., contracting out of fire protection in Rye Brook, Sclar ch.4). 11

12. Why bargaining and not “take it or leave it?”
Because price is not the only variable. Optimal work rules are particular to each firm. Observing other firms would not give management sufficient information about what's either efficient or acceptable (Hayek). Transaction costs are minimized in collective bargaining.
Leave it may lead to a disruption of employment and/or work because alternative jobs and/or alternative workers are not immediately available.
Pareto efficiency: Collective bargaining gives the sides an opportunity to reveal the intensity of their preferences and reveal potential Pareto Improvements. 12

13. Why arbitration and not courts?13

14. Why arbitration and not courts?
Transaction Costs. When the “in” is not “sharp,” disputes require negotiations refereed by the arbitrator. 14

15. The task of theory 15

16. Why firms and not incomplete contracts
The organizational response to uncertainty and bounded rationality would have been incomplete contracts except for opportunism. 16

17. Opportunism 17

18. Opportunism
Definition 1 (Williamson): When an unanticipated zero- sum game situation arises, the party that at that moment has greater bargaining power exploits it. 18

19. Opportunism
Definition 1 (Williamson): When an unanticipated zero- sum game situation arises, the party that at that moment has greater bargaining power exploits it.
Definition 2 (Klein, Alchian and Crawford): Opportunism is a violation of a contract that occurs because enforcement is costly.
The violating party can impose a cost (e.g., delay delivery) on the other side even if that behavior is a violation.
The violating party can increase the cost of enforcement by claiming hardship. 19

20. Why are opportunists not afraid of the loss of future business?
If opportunists were afraid of the loss of future business, there would have been no need for the firm.
Why are opportunists not afraid of the loss of future business? 20

21. Why are opportunists not afraid of the loss of future business?
If opportunists were afraid of the loss of future business, there would have been no need for the firm.
Why are opportunists not afraid of the loss of future business?
Klein and Leffler: Short term gains may exceed long term losses. 21

22. Why are opportunists not afraid of the loss of future business?
Klein and Leffler: Short term gains may exceed long term losses.
Adler: Opportunists need not worry about long term losses
The threat of terminating a cheating provider is not credible
Buyers will not verify that the quantity of non- salvageable capital is sufficient given the size of the market
Market-anonymity (re-entry under a different identity) is possible 22

23. Why are opportunists not afraid of the loss of future business?
Klein Crawford and Alchian: Capital Specificity: Physical and Human means that replacing the opportunist is difficult.
Capital specificity leads to a firm:
Site specific stations: Steps in the production process that produce intermediary goods that are of no use to anybody else (Unlike tires or plane engines). 23

24. Asset Specificity produces a trade-off
Markets (competition between potential suppliers for the contract) minimize production costs
Organizations minimize transaction costs
The production of a unique product requires asset specificity. But this gives rise to opportunism unless done within a firm. 24

25. ΔC=production cost in firm-production cost in market ΔG=transaction costs in firm-transaction costs in market A= Degree of asset specificity 25

26. Examples Backward Integration: GM and Fisher Body
Forward Integration: Manufacturing and retailing where there is human asset specificity, to make sure that sales force is well trained and has no incentive to take advantage of uninformed buyers (a-la Akerlof or Klein and Leffler) (farm equipment and sewing machines)
Manufacturing and wholesaling for perishables (perished goods should be discarded rather than sold) [retailing should be integrated also]
No Integration: Manufacturing stand alone when product is ready to use non-perishables 26

27. The Employment Relationship27

28. Employment Relationship
H1M1: Employment at will (farm, custodial)
H1M2: Pay the team, let members divide it (piano movers)
H2M1: Employer must guarantee long term job security (tenure for teachers), employee is tied to the job because some payments (pensions) are deferred
H2M2: Employee must be given reasons to believe in the mission, since effort cannot be metered 28

29. Why Unions 29

30. Conclusion
Transactions Costs analysis did to the diversity of organizational forms what evolution did to the diversity of species. Rather than taking the diversity as inexplicable, it asked why and gave a similar answer: efficiency
The definition of efficiency remains to be discussed. But regardless of the definition, it is clear that for a gov't, cost minimizing is not the only goal. In evaluating governmental organization forms, citizens' well being is a legitimate concern also. 30