Comments on: What Does “Zero Transaction Costs” Mean, Epistemically?

By: Paolo Mariti

Paolo Mariti — Wed, 30 May 2007 10:57:22 +0000

spostrel’s comment above is well taken indeed. From much of literature one all too often gets the feeling that transaction costs are transportation costs from ignorance to omniscience.
The very few things - but of great relevance - we can say ( and formally prove ) are that TC reduce gains from trade:redistribution of commodities in accordance with people’s preferecnes is hindered and specialization in production is decreased.
As to building transaction cost functions one could start from the idea that they depend on a) the number of parties involved in a transaction, b) the number of distinct commodities per transaction ,c) the nature (or characteristics) of commodities, d) the frequency of echange (consumers and firms do not trade continuously) ,e) the volume of commodities traded.
To write down a testable cost function along all this is obviuosly difficult but not impossible.

By: ~Tim Miano Seeks Job

~Tim Miano Seeks Job — Tue, 29 May 2007 22:04:01 +0000

The Relationship Between Price & Utility

It will always maximize utility to satisfy the higher ranked preference of both A and B for any pair of disparately ranked preferences (presuming no transaction costs).

By: spostrel

spostrel — Tue, 29 May 2007 19:50:02 +0000

The zero-transaction-cost benchmark is an interesting one. You can’t understand the role of transactions costs without thinking about the world without them. Looking at problems without transactions costs is no silier than looking at the kinematics of falling bodies while ignoring friction. Sometimes abstraction is the best way to see what’s going on.

Positive transactions costs, on the other hand, are a bit like bounded rationality–no one knows exactly what they entail, what they look like, etc., and there are lots of theoretical choices. So they can become an all-purpose ex post rationalization for any observed outcome. If someone would write down a transactions cost function and empirically show under what circumstances it fit, we would be far ahead of the game. Right now, however, discussions of transaction costs are often far more pie-in-the-sky than analyses that abstract away from them.

By: Joe Mahoney

Joe Mahoney — Tue, 29 May 2007 15:27:24 +0000

The Coase “Theorem” is typically expressed as: In the absence of transaction costs, the initial setting of liability rules does not matter for economic efficiency.

That said, when I teach “The Problem of Social Cost” I emphasize that in the world we live in, of positive transaction costs, the initial setting of liablity rules DOES matter for economic efficiency . Focusing on the world of positive transaction costs was the agenda of Coase (1960). Coase over the years has expressed his frustrations that the profession has focused on the (ideal) case, in which he was trying to move economists to think beyond.

As a footnote, the Modigliani-Miller (1958) Theorem states that in the absence of transaction costs (no taxes, no bankruptcy costs) the Debt-Equity ratio does not matter, and the financial economists tend to focus on expressing the result this way.

Once again, when I teach this material, I emphasize that in a world of positive transactions costs, the debt-equity ration DOES MATTER for economic efficiency.

It is curious that in both cases in the choice of focusing on intellectual nourishment here and now or intellectual pie in the sky that economists choose to focus on latter — that is, on the world of zero transaction costs. Coase, I am certain, does not approve.

By: Mark

Mark — Tue, 29 May 2007 12:50:55 +0000

It all depends on how you define transaction costs. If information problems are deemed a transaction cost, then by assumption Coase would argue that without such problems there is no need for markets.

The fact that we have ANY frictions whatsoever - much less to the extent we actually have - requires market institutions to try to overcome. And as Coase also (rightfully in my opinion) argued, the fact that we have some frictions that are not overcome via markets does not mean that government has any better chance of rectifying via force.

By: spostrel

spostrel — Tue, 29 May 2007 07:46:16 +0000

Avinash Dixit and the late Mancur Olson had a paper where they argued that with large N, even with zero transactions costs there would still be a collective action problem. The nub of their argument was that “zero transactions costs” should be modeled as common knowledge of the payoffs and strategy sets along with frictionless ability to make (and receive) offers. Anything more than that, they claimed, expanded the meaning of “transactions costs” so far that it would be meaningless. Then they showed how you could still have free-rider problems with large N under their definition of zero transactons costs.

I think they were basically correct. But that position gets you in hot water with all the folks who want to use “zero transaction costs” to mean “all externalities extingushed by bargaining.” The former sounds more scientific than the latter, but I think that’s more of an appearance than a reality. I would prefer a definition of TC that is less tied to the results and more tied to the inital conditions of the problem.