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💸principles of economics review

key term - Transaction Costs

Citation:

Definition

Transaction costs refer to the expenses incurred when participating in an economic exchange or market transaction. These costs go beyond the direct price of the good or service and include additional expenses such as search, negotiation, and enforcement costs associated with the transaction.

5 Must Know Facts For Your Next Test

  1. Transaction costs can create barriers to market entry and limit the number of participants in a transaction, potentially leading to less efficient outcomes.
  2. Reducing transaction costs is a key driver for the development of institutions, organizations, and technologies that facilitate economic exchanges.
  3. Information asymmetry, where one party has more or better information than the other, is a major source of transaction costs.
  4. Moral hazard and adverse selection are two specific problems that can arise from information asymmetry and increase transaction costs.
  5. The existence of transaction costs is a key justification for the role of government in regulating markets and providing public goods to reduce the overall burden of these costs.

Review Questions

  • Explain how transaction costs can create barriers to market entry and limit the number of participants in a transaction.
    • Transaction costs, such as the expenses associated with searching for information, negotiating terms, and enforcing agreements, can create significant barriers to entry for new market participants. These additional costs can make it difficult for smaller or less-established firms to compete effectively, as they may not have the resources to overcome the hurdles posed by transaction costs. This can lead to a concentration of market power among a smaller number of larger, more established players, potentially reducing the overall efficiency and competitiveness of the market.
  • Describe how information asymmetry can contribute to higher transaction costs and less efficient economic exchanges.
    • Information asymmetry, where one party in a transaction has more or better information than the other, can lead to higher transaction costs in several ways. First, the uninformed party may have to spend more resources searching for and verifying relevant information, increasing their overall costs. Second, information asymmetry can create opportunities for moral hazard or adverse selection, where the informed party may take advantage of the uninformed party, leading to less efficient or even failed transactions. This can result in a breakdown of trust between market participants, further increasing the costs associated with negotiating and enforcing agreements.
  • Evaluate the role of government in regulating markets and providing public goods to reduce the burden of transaction costs.
    • The existence of significant transaction costs in economic exchanges is a key justification for government intervention in markets. By regulating markets and providing public goods, the government can help reduce the overall burden of transaction costs on market participants. For example, the government can establish clear and enforceable rules and regulations, reducing the costs associated with negotiating and enforcing agreements. Additionally, the government can provide public infrastructure, such as transportation networks and communication systems, which can lower the costs of searching for and accessing relevant information. In this way, government intervention can help improve the efficiency and competitiveness of markets by addressing the challenges posed by transaction costs.
Transaction Costs - (Principles of Economics) - Vocab, Definition, Explanations | Fiveable | Fiveable