TRANSACTION COSTS

In a widely used but limited sense, transaction costs refer to the cost of transferring ownership or property rights. Transaction costs are associated with buying and selling different kinds of property, including real estate, stocks and bonds, and currencies. Examples of such transaction costs include brokers' fees and salespeople's commissions, among others. In calculating the transaction costs of buying and selling any kind of property, both the costs to the seller and those of the buyer are considered.

In another sense, transaction costs as discussed in economic theory refer to the cost of anything that might be defined as a transaction. Whenever goods exchange hands, there are transaction costs. Broadly defined, transaction costs include that which would have been saved had the goods not exchanged hands. Many transaction cost studies have been conducted to determine their effect on different aspects of economic behavior and performance.

In a simple bilateral exchange, it is generally easy to quantify transaction costs. When there are complex contracts calling for exchanges among many different parties, however, transaction costs become so complex that it may be impossible to quantify them. Studies of such complex transactions often rely on a qualitative discussion of transaction costs.

Depending on the situation, transaction costs may be independent of the quantity or value of goods transferred. In other cases there may be pronounced economies of scale, where larger transactions incur relatively smaller transaction costs on a cost per unit basis. It is clear, however, that the existence of transaction costs serves to reduce the overall volume of transactions in an economy. As the cost of transferring of goods increases, traders have a stronger incentive to minimize the number of their transactions.

Transaction costs have an interesting effect on currency trading. If there were no transaction costs in the foreign currency market, then each currency could be traded against any other currency using consistent rates. That is, the value of the dollar against the yen would equal the value of the yen against the British pound multiplied by the value of the British pound against the dollar. Since there are transaction costs involved, however, it is not possible to calculate consistent rates among the many different currencies. That is, one cannot in practice calculate the value of the dollar against the yen by measuring the values of the dollar and the yen against a third currency.

Transaction costs also influence the structure of markets and the nature of intermediary networks. When transaction costs are low, a more complex intermediary network tends to arise. This is the case for financial assets such as securities, foreign exchange, commodity contracts, and gold, among others. The markets for these assets tend to move to where the transaction costs are lowest. As technological advances affect financial transactions and lower the transaction costs involved, it is anticipated that the financial system will become more elaborate, with greater specialization or division of labor and an increase in the number of transactions relative to the volume of traded assets.

It is also theorized that transaction costs determine what will be used as money, or a medium of exchange, in a particular economy. If one imagines that there are several commodities that could serve as a medium of exchange, the ones that will be chosen are those that involve the lowest transaction costs. The one that is selected as money, then, is the one with the lowest transaction cost (and holding cost). Thus, it can be seen that money serves to conserve resources that would otherwise disappear as transaction costs.