Transaction Costs (Part 1)

First up, here’s a definition from Investopedia on what Transaction costs are, “Transaction costs are expenses incurred when buying or selling a good or service. Transaction costs represent the labor required to bring a good or service to market, giving rise to entire industries dedicated to facilitating exchanges. In a financial sense, transaction costs include brokers’ commissions and spreads, which are the differences between the price the dealer paid for a security and the price the buyer pays.”

So, if after reading the definition you’re wondering why eliminating transaction costs might be good, (even if you weren’t wondering why so? -Too bad. We in the economics field like making assumptions), here’s a snippet from Investopedia again -“When transaction costs diminish, an economy becomes more efficient, and more capital and labor are freed to produce wealth. A shift of this nature does not come without growing pains, as the labor market must adjust to its new environment.”

So, the reason why transaction costs is today’s topic today is because of a paper written by everyone’s favorite economist, Michael Munger, on what the future looks like. Specifically, how reduction in transaction costs is going to expand the sharing economy and possibly exacerbate the current labor market trends. I haven’t had the chance to read his book, but hopefully I’ll update this post when I do. In the meantime, I’ve had the chance to go through his paper here and listen to Cato’s podcast with him here.

I highly recommend buying the book, and reading the paper in the meantime.

The basic gist of the paper is this- most people don’t prefer owning stuff, but gain more value from the constant stream of services that stuff provides overtime. The paper hence makes the assumption that as transaction costs go on decreasing, the sharing economy will expand and constitute a larger and larger part of the economy. Keep in mind, hardly any services exchanged in the sharing economy do make into current economic calculations. While all of this makes perfect conceptual and as we’ve seen with the ride sharing boom lately, practical sense. I have trouble seeing it being fully realized the same way Munger is. Maybe I’m wrong, and I most likely am. But I do feel, his projection that the renting culture is going to outpace the ownership culture is highly optimistic. While it might be true that the renting culture could outpace the ownership culture it’ll most likely be narrowed to a specific basket of goods.

When it comes to the major things we consume, we’d rather own them than rent them. For example, very few things beat the sense of accomplishment one feels after owning a home. There’s certain things that simply don’t provide the same utility/satisfaction if you rent them. In most instances owning something, a piece of land, defines who you are. In some instances it defines who your family is for generations (farmers). On a personal note, I would much rather own a book than rent one. The same goes for most things that individuals consume daily. Munger does take this into consideration and hence the distinction he makes between paying average fixed costs and marginal costs. So then, if we as a society do prefer owning things, which tend to be more capital/labor intensive, then does renting, for example, a power drill make that much of a difference in economic output?

The other concern might be how profitable could these middlemen that sell reductions in transaction costs be?

-Uber currently operates such a business model, and has tremendous profitability concerns. It might just be that it’s extremely hard to achieve profitability with such a business model.

Overall, even if the renting culture is going to be as pronounced as Munger makes it out to be, the interesting thing to watch out for what would be its effects on the labor market. Hence a part 2 on the greater labor market trends of the sharing economy will be out as soon as I’m done reading the book.

See ya then!

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