Transaction Cost: Unaccounted and Underestimated Expenses Often Overlooked

The resolution of unfair distribution of wealth entail cost. This is referred to as transaction cost. This article clarifies this concept in view of understanding how one’s actions can affect a great number of people.

In times when controversy arises due to faulty transactions or market failures, the cost associated with it is usually unaccounted for or underestimated. People tend to overlook the significance of transaction cost hence incur expenses which should have been better avoided.

But what is a transaction cost? If you search the internet for a definition of this concept, you will notice that there is no consensus on what it really means. In fact, Korolyova devoted a paper in an attempt to explain it.

Transaction Cost Defined

According to the Business Dictionary, transaction cost is the cost associated with exchange of goods or services and incurred in overcoming market imperfections. Examples include communication charges, legal feeds, informational cost of finding the price, quality, and durability, transport cost, among others.

On the other hand, based on textbook definition, About.com lists the components of transaction cost into 1) search costs, 2) negotiation costs, and 3) enforcement cost. Search cost is the cost incurred in locating information for a potential exchange, negotiation cost is the cost associated to forge an agreement on the terms of exchange, and enforcement cost is the cost of enforcing the agreement.

These definitions are a bit complex especially to an economics neophyte. To simplify matters, Turkcebilgi.com’s examples offer a better perspective of what transaction cost really means.

Transaction cost is:

  • the commission paid to brokers by a stock buyer or seller of stock.
  • the cost of buying a banana, excluding the price of the banana itself, such as the time, energy and effort you exerted to find the kind or price of banana you prefer, cost of transportation from your house to the store, the time you spend in the queue, the effort you made in paying, etc.

Budget conscious mothers tend to overlook this cost. Typically, they tend to spend a lot of time haggling the prices of goods with the vendor whenever possible, walk around in circles trying to find the cheapest price of a pair of shoes, dress, jewelry, among others. They forget the cost in time (opportunity cost), effort (all those energies equate to calories of energy from food to power the walk), and transportation cost to the male with the cheapest goods in town.

Hidden Transaction Cost in Controversial Transactions

Based on the definitions provided above, transaction cost may be defined as the costs incurred in the instance of doing business. Let me expand discussion on this subject further to cover a recent controversial issue: the politics of the resource allocation  I recently wrote about. The original transaction involves misuse of public funds, which in business, can be equated to failed market transaction.negotiation

As the controversy rages on, lots of energies are expended to pursue the case. I felt I need to write about the high cost involved in this issue and identified these costs as transaction costs that for me unnecessarily becomes a burden to taxpayers.

As the investigations are going on, while concerned government agencies are hot on heels on the alleged perpetrators of misused government funds, costs are incurred. Specifically, the transaction costs associated with the pursuance of this case include the following:

  1. Provision of security, escorts, housing, medical treatment, etc. to the whistleblowers,
  2. Going after the principal suspect and accessories to the crime,
  3. Hearings plus more security costs to keep the suspects unharmed,
  4. Attorney’s fees for both the defendant and the plaintiff,
  5. Privileged speeches and investigations to clarify issues or shed light on some lawmakers’ involvement,
  6. Time, money and effort of people who go to the streets to protest the misuse of pork barrel funds, among others.

These are the transaction costs but these costs can also be treated as externalities of the misallocation of government funds, particularly royalties from sale of natural gas. Unless the issue is resolved soonest, transaction costs will incrementally go up. Had not the major issue arose, no cost would have been incurred for its resolution. Had there been fair distribution of wealth a big portion of which come from natural gas, there would not have been no transaction costs to correct the unfair distribution of proceeds.

How to Minimize or Get Rid of Transaction Costs

How should those involved in transactions reduce or eliminate the associated costs? Firstly, they should be made fully aware that there are costs involved in facilitating transactions. As cases like the misuse of funds can drag for years, a speedy resolution must be made to avoid incurring more expenses. It is obvious, and there are many evidences available to pursue the merits of the case. The problem appears to be that creative dodges made by defendants (as they have enough money to spend) can keep the wheel of justice from moving swiftly. This will entail more cost at the expense of the public.

If it is just a simple transaction of buying, say, a banana, buy that heck of a banana the first time you see it. If there will ever be a difference between the one you bought and the cheapest one available, you have saved time anyway. Time is more important than that negligible savings on price. Five minutes of valuable time spent with your children or loved one is way too important to miss.

© 2013 October 9 P. A. Regoniel

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