In general terms, transactions costs are the costs that arise when individuals exchange ownership rights to economic assets and enforce their exclusi… - Þráinn Eggertsson

Demsetz (1980) refers to the hypothetical economic system of neoclassical economics as the decentralized model. According to the usual implicit and explicit assumptions of the decentralized model, the cost of information is zero; private property rights are fully defined and enforced at zero cost; and the state stays in the background, upholding the institutions of market exchange. Economic outcomes derived from this model are found in the standard textbook: For any underlying distribution of resources, wealth is maximized; output is valued by consumers who take indirectly into account the value of leisure and other extra-market activities; income distribution depends on wages and the prices of nonhuman inputs which equal the value of marginal products; and economic resources always find their highest-valued uses.

Adam Smith began his Wealth of Nations with an examination of the internal works of a pin factory, but he soon turned his attention to other things: the coordination of a market system and the economics of growth and development. For more than a century and a half following the publication of Smith's masterpiece, the nature and internal organization of the firm received little attention in mainstream economic theory.

When analyzing the nature of the firm, the new literature tends to emphasize two aspects: A firm involves a set of long-term contracts between input owners, and a firm replaces the product market with a factor market where price signals play a relatively small role (as output is not measured continuously and sold for a price) and, typically, hierarchical relationships are substituted for market exchange.