Question

Since specialized investments are often sunk, relationship-specific exchanges create which of the following?

A. variable costs
B. explicit costs
C. transaction costs
D. implied costs
E. both answers A & B are correct

Answer 1

Relationship-specific exchanges create transaction costs, which are costs associated with the inefficiencies in market exchanges. These costs differ from explicit costs, which are direct payments, and implicit costs, which represent opportunity costs of owned resources.

Step-by-step explanation:

Relationship-specific investments often lead to sunk costs, which are expenditures that cannot be recovered. In the context of relationship-specific exchanges, these sunk costs create transaction costs. Transaction costs are the expenses incurred when buying or selling goods or services, which include searching for information, negotiating contracts, and enforcing agreements. Unlike variable or explicit costs that are directly related to the production, transaction costs are related to the inefficiencies or complexities within market exchanges.

Explicit costs are out-of-pocket, real payments such as wages and rent, while implicit costs represent the opportunity cost of using resources the firm already owns. When businesses enter into specific exchanges that result in sunk costs, they should focus on minimizing future transaction costs to maintain cost-effectiveness.