The term “transaction cost” is usually use to denote the fee charged by the party doing an exchange or providing other services. The definition of transaction costs can be found in any textbook on microeconomics, yet it has never been clearly stating why should transaction costs affect the total number of transactions conducted. All textbooks tend towards explaining this fact without bringing up the reason why it should be so says Brian Colombana.
Some theory textbooks claim that transaction costs are include in a total number of transactions because, when transaction costs are taken into account, the total value of non-purchases (i.e. barter) can become negative if sellers start charging for their services too much. For example, consider a farmer who trades part of his crop with the baker for bread and then sells this bread to other people or to other farmers at zero price – not taking into account any possible intermediary fees. The same farmer might stop selling bread to people if he has to pay more than $1 per loaf due to high commissions charged by bakers for each sale – which would make his business unprofitable! This example shows that if transaction costs rise, the total number of transactions can fall and vice versa.
It is also claimed in some textbooks that every aggregate measure of macroeconomic activity (such as GDP) has to include transaction costs because otherwise, we shall not be able to compare different economies which might have very different levels of such costs explains Brian Colombana. This explanation sounds plausible but it does not hold water. There is no need for GDP to include everything that affects our well-being; this figure should only reflect the things we buy on markets (and possibly some other externalities).
The key problem with all these claims is that they rely on circular reasoning: according to these explanations. Transaction costs affect the total number of transactions because transaction costs influence. Economic decisions and thus affect the volume of transactions. In other words, transaction costs affect the number of transactions both directly and indirectly! The crucial point is that transaction cost affects. Not only the actual dollar value we get for selling an item (or what we pay to buy it). But also our willingness to sell or buy items in the first place – and this effect is ultimately responsible for affecting total numbers of transactions. Even if there were no extra fees charge by sellers and buyers for their services.
If you are surprise by such a counterintuitive fact about human behavior then consider yourself lucky. Many people tend to take into account only direct effects when making economic decisions like buying bread rather than taking into account the indirect effect which comes from changing prices of goods (because they expected higher inflation).
The basic idea behind transaction costs is that any exchange involves several decisions. To be made by both parties, all of which take time and cost money says Brian Colombana. The more transactions are taking place, the higher are transaction costs. There are two main types of transaction costs: explicit costs (commissions) and implicit ones (e.g. loss of time or frustration). Transaction costs rise along with exchange but they do not affect all exchanges equally. Because some exchanges are simpler than others. For example, buying bread from a bakery is much easier than catching fish in the middle of a lake.
Transaction costs might appear at different stages of an exchange process: before the sale occurs (when searching for information on prices), during actual (negotiations between buyers and sellers), and after the exchange (when buyers and sellers have to settle accounts). Simply put, transaction costs are any costs related to economic transactions. The process by which we perform exchanges with other people.
Our economic decisions can divide into two main groups: expenditure decisions and income-earning decisions. Expenditure decisions are all those decisions that affect our spending patterns on various goods and services. Buying some things, not buying others, selling some assets, or running a business instead of retiring. Income earning decisions are all those different ways in which an individual can make money from his or her assets. Working at a job, owning a business, being an employee at home by another family member, etc.
The first thing one has to realize about transaction costs is that they do not exist for their own benefit. Any costs involved in carrying out self-interest economic transactions will tend to avoid by both parties through appropriate bargaining. However, transaction costs cannot be simply classified as either bearing or non-bearing because there are different types of expenses. For example, fees paid to a real estate agent should count as explicit transaction costs. Whereas time spent on conducting repeated searches for information. About house prices and other people’s intentions would constitute implicit transaction costs.
Transaction costs are simply all those expenses related to conducting self-interested economic transactions says Brian Colombana. Transaction costs don’t have a limit to any specific time period. They include both the explicit and implicit expenses incurred during all stages of an exchange process. And also affect our decisions about whether to buy or sell in the first place.