What is transaction cost?

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Costs incurred in connection with purchasing or selling goods or services are transaction costs. The work required to deliver a service or product to market is characterized by transaction costs, which have given rise to entire sectors specialized in facilitating exchanges. 

Broker commissions & spreads, which have been the gaps between the amount the dealer paid for security and the amount the buyer pays, are examples of transaction costs in the economic context. The payments brokers and banks get for their services are known as transaction costs to sellers and buyers.

When acquiring or selling real estate, there will also be transaction costs, including the agent’s commission plus closing costs, such as appraisal fees, title search fees, and government fees. The time and work associated with shipping products or services over long distances is another transaction cost.

In economies, transaction costs are being used to illustrate why specific markets can accommodate lots of companies while others, known as hierarchies, are dominated by only a tiny fraction. Rankings rule organizational development in the current economy since it is a highly effective approach to forming relationships. 

There are four components to transaction cost economies:

  1. The world is full of uncertainty & unpredictability.

2. Organizations that participate in transactions find it costly to exit them due to bargaining & asset specificity.

3. People with limited reasoning get and understand restricted information, which means they have limited options to choose from.

4. Humans’ innate opportunistic attitude in an economy makes it more challenging to enforce contractual agreements after a long period.

About the author

Pieter Borremans
By Pieter Borremans

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