Transaction Costs: Are They Just Costs?*

Abstract

What are the main effects of the cost of transacting, and what distinguishes them from other costs? In this paper it is argued that when transaction costs are positive, people are able to gain at each other's expense. In order to minimize the associated loss, people will agree to restrain themselves in various ways, and will erect social institutions to impose and enforce the restraints. Such institutions have no significant function when transacting is costless. The model presented here is compared with a stylized, costless transaction, Walrasian model to bring out some of the unique features of positive costs of transacting. Even though the Walrasian model asssumes that the cost of transacting is zero, some practitioners use it to analyze transaction cost problems. For instance, the Pareto conditions as obtained from a zero transaction cost model are routinely used for the assessment of advertising. It is sufficient to observe that ignorance is a precondition for advertising, whereas the Walrasian model assumes full knowledge of exchanged products1. The division of labor is a major contributor to the maximization of the total value of the resources used. A result of specializing is that the producers of a good are distinct from its consumers. Resources are required then not only for producing goods (and for shipping them to consumers), but also for effecting exchange - identifying potential buyers, describing the good to them, setting the terms of trade, and transfering rights. In much of the theory of perfect competition, particularly as developed by Walras and his followers, it is assumed that homogeneous commodities are traded at a point in space. Moreover, buyers are assumed to be fully informed regarding the attributes of every unit of every good, and know the market clearing prices of various sellers2. All units of the same commodity must, then, be traded at a uniform price. As the costs of effecting exchange in this model are assumed to be zero, resources are needed for 'production'