The Effects of Transaction Costs, Power and Risk on Contractual Arrangements: A Conceptual Framework for Quantitative Analysis

Increased reliance on commercial traders in liberalised agricultural markets poses questions about the nature of contractual relations between traders and farmers; about welfare, efficiency and equity characteristics of these relations; and about conditions necessary for traders to engage in these markets. A new institutional economics analysis seeks to understand the institutions that affect transaction costs and risks for each party, and power relations between them. Transaction cost analysis has not, however, developed a unifying conceptual or quantitative framework to integrate these issues. This paper develops a methodology for modelling negotiated choice of contractual arrangements in buyer/seller relationships, taking account of the socioeconomic characteristics of each party, economic and technical characteristics of the commodity, and the institutional environment. The model is set up as a non-linear programming problem. The approach provides a framework for the application of transaction cost economics to quantitative empirical study of markets, to individual firms’ supply chain decisions, and to the analysis of policy interventions in markets.