Transaction costs

The previous section analysed a setting with frictionless markets. But there are many situations in which there may be costs of arranging exchanges (including transport costs, search costs or production inspection costs) or other non-monetary costs that buyers and sellers may face. As Coase (1991) states: 'There are negotiations to be undertaken, contracts have to be drawn up, inspections have to be made, arrangements have to be made to settle disputes, and so on. These costs have come to be known as transaction costs.'

As Chapter 3 will illustrate, transaction costs are of vital importance in law and economics. For consumers, the full price that is paid to consume a good includes money prices and the non-money costs that are incurred. Similarly, for producers, the monetary price that is received from the sale of a good is reduced by the costs that are incurred in obtaining that money price. When there are no transaction costs in a market, then the market-clearing price is that which is exchanged in money terms between buyers and sellers. Buyers or demanders pay a money price of PD and this money price is also received by sellers, so PD = PS. However, when there are transaction costs, this equality of full prices paid breaks down.

 
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