Wallis and North’s unprecedented endeavor in 1986 to measure transaction costs in the American economy has caused a contradiction between their empirical result and North’s theory of transaction costs. It is argued in this Master’s thesis that what they estimate is actually the value contributed by the transaction sector to the economy. The transaction sector therefore is a potential source of revenue for the ruler and thus becomes a variable in the ruler’s objective function. The ruler, individuals and voluntary organizations interact in accordance with their self-interest, and the resultant institutional environment will dictate the development of the transaction sector and affects the performance of an economy.