Briefly explain the connection between transaction costs and internalization theory

What will be an ideal response?

Transaction costs are the costs of entering into a transaction- the costs connected to negotiating, monitoring, and enforcing a contract. A firm must decide whether it is better to own and operate its own factory overseas or to contract with a foreign firm to do this through a franchise, licensing, or supply agreement. Internalization theory suggests that FDI is more likely to occur - that is, international production will be internalized within the firm - when the costs of negotiating, monitoring, and enforcing a contract with a second firm are high.