Transaction cost

Definition

In economics and related disciplines, a transaction cost is a cost incurred in making an economic exchange.

Overview

For example, most people, when buying or selling a stock, must pay a commission to their broker; that commission is a transaction cost of doing the stock deal. Or consider buying a banana from a store; to purchase the banana, your costs will be not only the price of the banana itself, but also the energy and effort it requires to find out which of the various banana products you prefer, where to get them and at what price, the cost of traveling from your house to the store and back, the time waiting in line, and the effort of the paying itself; the costs above and beyond the cost of the banana are the transaction costs. When rationally evaluating a potential transaction, it is important to consider transaction costs that might prove significant.

A number of kinds of transaction cost have come to be known by particular names:

• Search and information costs are costs such as those incurred in determining that the required good is available on the market, who has the lowest price, etc.
• Bargaining costs are the costs required to come to an acceptable agreement with the other party to the transaction, drafting an appropriate contract and so on.
• Policing and enforcement costs are the costs of making sure the other party performs its obligations under the contract, and taking appropriate action (often through the legal system) if this turns out not to be the case.