Q. Explain about Transaction Cost Theory?

The below model reveals market and institutions as a possible form of organisation to coordinate economic transactions. When external transaction costs are higher than internal transaction costs, company will grow. If external transaction costs are lower than internal transaction costs the company would be downsized by outsourcing. For illustration, Ronald Coase set out his transaction cost theory of the firm in 1937, making it one of the first (neo-classical) efforts to define the firm theoretically in relation to market. Coase sets out to define a firm in a manner that is both compatible and realistic with the idea of substitution at margin, so instruments of conventional economic analysis apply.

He notes that a firm's interactions with the market mayn't be under its control (for example due to sales taxes), though its internal allocation of resources is: 'Within a firm, market transactions are eliminated and in place of complicated market structure with exchange transactions is substituted the entrepreneur who directs production'. He asks why alternative methods of production (like the economic planning andprice mechanism), couldn't either achieve all production, so that either firms use internal prices for all their production or one big firm runs the whole economy.