Are transaction costs good for consumers?

25 February 2017
25 Feb 2017
4 min read

An aspect of economics that I think doesn’t get enough attention is the idea of transaction costs. Like the name suggests, a transaction cost is a cost that is incurred during the transaction. This could be any middlemen in a transaction.

As an example, take buying a car. Before the internet, you didn’t know what the true price of a car was, which makes negotiation more difficult. In addition, there were only a few local car stores nearby, so the supply of the cars was limited as well. But once the internet came along, services grew up to take advantage of these costs present, such as Kelly Blue Book and Carmax. Both services reduce the friction present in buying a car and transfer some of what used to be transaction costs to themselves.1 If the profits are going to these newly created companies, this means that these profits are not going to the car dealership.

One driver of transaction costs is often asymmetrical information. If I’m a car salesman, I (should) know more about the car than you do. I’m then able to take advantage of this knowledge in order to squeeze out a slightly higher price.

The benefits of the internet

The internet leveled this information advantage. With the iPhone, I now had accessible internet wherever I went. Not sure what the actual cost of a car is? Look it up on Kelly Blue Books. Think the car salesman is being shifty? See how many reviews they have on help. Being able to access information reduced transaction costs and thus increase consumer surplus.

This lowering of transaction costs can come with unexpected side effects. Take the case of ebooks. When Amazon invented the Kindle and the online bookstore, it was revolutionary because these two interlocking parts removed many of the transaction costs present in publishing a novel. 2 If I had written a novel in the pre-Internet era, I would have to acquire an agent, send my manuscript in to the main publishers and hope it gets picked. In short, the gatekeepers 3 were removed from the situation. Since those costs disappeared, it became (and now is) cheaper to publish a book. All I had to do was push upload! This increased the the supply for books.

Who replaces the Gatekeepers?

Although their role has diminished, these gatekeepers provided a valuable service in making sure these books had a uniform quality. If I was buying a book from Barnes and Noble, I could be pretty sure that there wouldn’t be any misspellings or incorrect grammar. These publishing houses were taking a risk with each book; by paying an advance they had incentives to make sure I was reading a “good” book. Once these gatekeepers disappeared, the quality of each ebook started to vary wildly. This puts more emphasis on finding an author who consistently puts out good work, but that often doesn’t last. Browsing the Kindle online store, I now face a higher chance of reading a lower quality book. Ratings help somewhat, but the problem still persists. 4

Consumers are still better off

I perhaps over exaggerate the dangers involved in finding a poor quality book. 5 This reduction in transaction costs has lead to a dramatic boom in consumer surplus, making everyone better off. Countless individuals have earned a living off of the Kindle store, creating music in the digital age or building iPhone apps. I always want to be aware of the trade offs present; economics is nothing else.

  1. These companies were able to undercut the dealerships, taking some of the profits and giving the rest to consumers. Because the consumers end up with more then they had previously, it makes sense for them to use these new services.
  2. And later Apple’s iBooks store and publishing platform. [return]
  3. read: the friction [return]
  4. You can find the same problem in music. Anybody with a mac can now throw something on SoundCloud, but does that mean any of it is good? [return]
  5. Although I am reminded of a joke regarding Medium, a web publishing service that has done something similar. It’s called medium because it’s neither rare nor well done. [return]

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