The costs other than the money price that are incurred in trading goods or services. Before a particular mutually beneficial trade can take place, at least one party must figure out that there may be someone with which such a trade is potentially possible, search out one or more such possible trade partners, inform him/them of the opportunity, and negotiate the terms of the exchange. All of these activities involve opportunity costs in terms of time, energy and money. If the terms of the trade are to be more complicated than simple "cash on the barrelhead" (for example, if the agreement involves such complications as payment in installments, prepayment for future delivery, warranties or guarantees for quality, provision for future maintenance and service, options for additional future purchases at a guaranteed price, etc.), negotiations for such a detailed contract may itself be prolonged and very costly in terms of time, travel expenses, lawyers' fees, and so on. After a trade has been agreed upon, there may also be significant costs involved in monitoring or policing the other party to make sure he is honoring the terms of the agreement (and, if he is not, to take appropriate legal or other actions to make him do so). These are the main sorts of transaction costs, then: search and information costs, bargaining and decision costs, policing and enforcement costs.

Elementary versions of economic theorizing often make the simplifying assumption that information and other transaction costs are zero (and, indeed, in a generally law-abiding society with a stable money system, cheap transportation and cheap communications, they are often pretty negligible). But realism nevertheless demands that we keep in mind the fact that the benefits to the participants in an exchange have to be high enough to cover their transaction costs if the trade is to take place at all. Indeed, many otherwise mutually advantageous trades do not take place because of the very high transaction costs that would be involved. High transaction costs are very often at the root of the problems discussed under the heading of externalities, especially in those situations where the external costs or benefits accrue to very large numbers of third parties and therefore a contractual agreement to internalize the externality is extremely costly to negotiate.

[See also: externalities, cost, barter, money]